Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 61974-62277 [2019-22695]
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Federal Register / Vol. 84, No. 220 / Thursday, November 14, 2019 / Rules and Regulations
DATES:
DEPARTMENT OF TREASURY
Effective date: The effective date for
amendatory instructions 1 through 14
(OCC), 16 through 29 (Board), 31
through 44 (FDIC), and 46 through 58
(CFTC) is January 1, 2020; the effective
date for amendatory instructions 60
through 73 (SEC) is January 13, 2020;
and the effective date for the addition of
appendices Z at amendatory
instructions 15 (OCC), 30 (Board), and
45 (FDIC) is January 1, 2020, through
December 31, 2020, except for
amendatory instruction 74 (SEC), which
is effective January 13, 2020, through
December 31, 2020.
Compliance date: Banking entities
must comply with the final amendments
by January 1, 2021. Until the
compliance date, banking entities must
continue to comply with the 2013 rule
(as set forth in appendices Z to 12 CFR
parts 44, 248, and 351 and 17 CFR parts
75 and 255). Alternatively, a banking
entity may voluntarily comply, in whole
or in part, with the amendments
adopted in this release prior to the
compliance date, subject to the agencies’
completion of necessary technological
changes.
Office of the Comptroller of the
Currency
12 CFR Part 44
[Docket No. OCC–2018–0010]
RIN 1557–AE27
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12 CFR Part 248
[Docket No. R–1608]
RIN 7100–AF 06
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 351
RIN 3064–AE67
COMMODITY FUTURES TRADING
COMMISSION
17 CFR Part 75
RIN 3038–AE72
SECURITIES AND EXCHANGE
COMMISSION
FOR FURTHER INFORMATION CONTACT:
17 CFR Part 255
[Release no. BHCA–7; File no. S7–14–18]
RIN 3235–AM10
Prohibitions and Restrictions on
Proprietary Trading and Certain
Interests in, and Relationships With,
Hedge Funds and Private Equity Funds
Office of the Comptroller of the
Currency, Treasury (OCC); Board of
Governors of the Federal Reserve
System (Board); Federal Deposit
Insurance Corporation (FDIC); Securities
and Exchange Commission (SEC); and
Commodity Futures Trading
Commission (CFTC).
ACTION: Final rule.
AGENCY:
The OCC, Board, FDIC, SEC,
and CFTC are adopting amendments to
the regulations implementing section 13
of the Bank Holding Company Act.
Section 13 contains certain restrictions
on the ability of a banking entity and
nonbank financial company supervised
by the Board to engage in proprietary
trading and have certain interests in, or
relationships with, a hedge fund or
private equity fund. These final
amendments are intended to provide
banking entities with clarity about what
activities are prohibited and to improve
supervision and implementation of
section 13.
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SUMMARY:
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OCC: Roman Goldstein, Risk
Specialist, Treasury and Market Risk
Policy, (202) 649–6360; Tabitha Edgens,
Counsel; Mark O’Horo, Senior Attorney,
Chief Counsel’s Office, (202) 649–5490;
for persons who are deaf or hearing
impaired, TTY, (202) 649–5597, Office
of the Comptroller of the Currency, 400
7th Street SW, Washington, DC 20219.
Board: Flora Ahn, Special Counsel,
(202) 452–2317, Gregory Frischmann,
Senior Counsel, (202) 452–2803, Kirin
Walsh, Attorney, (202) 452–3058, or
Sarah Podrygula, Attorney, (202) 912–
4658, Legal Division, Cecily Boggs,
Senior Financial Institution Policy
Analyst, (202) 530–6209, David Lynch,
Deputy Associate Director, (202) 452–
2081, David McArthur, Senior
Economist, (202) 452–2985, Division of
Supervision and Regulation; Board of
Governors of the Federal Reserve
System, 20th and C Streets NW,
Washington, DC 20551.
FDIC: Bobby R. Bean, Associate
Director, bbean@fdic.gov, Michael E.
Spencer, Chief, Capital Markets
Strategies, michspencer@fdic.gov,
Andrew D. Carayiannis, Senior Policy
Analyst, acarayiannis@fdic.gov, or Brian
Cox, Senior Policy Analyst, brcox@
fdic.gov, Capital Markets Branch, (202)
898–6888; Michael B. Phillips, Counsel,
mphillips@fdic.gov, Benjamin J. Klein,
Counsel, bklein@fdic.gov, or Annmarie
H. Boyd, Counsel, aboyd@fdic.gov,
Legal Division, Federal Deposit
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Insurance Corporation, 550 17th Street
NW, Washington, DC 20429.
SEC: Andrew R. Bernstein, Senior
Special Counsel, Sam Litz, AttorneyAdviser, Aaron Washington, Special
Counsel, or Carol McGee, Assistant
Director, at (202) 551–5870, Office of
Derivatives Policy and Trading
Practices, Division of Trading and
Markets, and Matthew Cook, Senior
Counsel, Benjamin Tecmire, Senior
Counsel, and Jennifer Songer, Branch
Chief at (202) 551–6787 or IArules@
sec.gov, Division of Investment
Management, U.S. Securities and
Exchange Commission, 100 F Street NE,
Washington, DC 20549.
CFTC: Cantrell Dumas, Special
Counsel, (202) 418–5043, cdumas@
cftc.gov; Jeffrey Hasterok, Data and Risk
Analyst, (646) 746–9736, jhasterok@
cftc.gov, Division of Swap Dealer and
Intermediary Oversight; Mark Fajfar,
Assistant General Counsel, (202) 418–
6636, mfajfar@cftc.gov, Office of the
General Counsel; Stephen Kane,
Research Economist, (202) 418–5911,
skane@cftc.gov, Office of the Chief
Economist; Commodity Futures Trading
Commission, Three Lafayette Centre,
1155 21st Street NW, Washington, DC
20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
II. Notice of Proposed Rulemaking
III. Overview of the Final Rule and
Modifications From the Proposal
A. The Final Rule
B. Agency Coordination and Other
Comments
IV. Section by Section Summary of the Final
Rule
A. Subpart A—Authority and Definitions
B. Subpart B—Proprietary Trading
Restrictions
C. Subpart C—Covered Fund Activities and
Investments
D. Subpart D—Compliance Program
Requirement; Violations
E. Subpart E—Metrics
V. Administrative Law Matters
A. Use of Plain Language
B. Paperwork Reduction Act
C. Regulatory Flexibility Act Analysis
D. Riegle Community Development and
Regulatory Improvement Act
E. OCC Unfunded Mandates Reform Act
Determination
F. SEC Economic Analysis
G. Congressional Review Act
I. Background
Section 13 of the Bank Holding
Company Act of 1956 (BHC Act),1 also
known as the Volcker Rule, generally
prohibits any banking entity from
engaging in proprietary trading or from
1 12
U.S.C. 1851.
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acquiring or retaining an ownership
interest in, sponsoring, or having certain
relationships with a hedge fund or
private equity fund (covered fund).2 The
statute expressly exempts from these
prohibitions various activities,
including among other things:
• Trading in U.S. government,
agency, and municipal obligations;
• Underwriting and market makingrelated activities;
• Risk-mitigating hedging activities;
• Trading on behalf of customers;
• Trading for the general account of
insurance companies; and
• Foreign trading by non-U.S.
banking entities.3
In addition, section 13 of the BHC Act
contains several exemptions that permit
banking entities to engage in certain
activities with respect to covered funds,
subject to certain restrictions designed
to ensure that banking entities do not
rescue investors in those funds from
loss, and do not guarantee nor expose
themselves to significant losses due to
investments in or other relationships
with these funds.4
Authority under section 13 for
developing and adopting regulations to
implement the prohibitions and
restrictions of section 13 of the BHC Act
is shared among the Board, the FDIC,
the OCC, the SEC, and the CFTC
(individually, an agency, and
collectively, the agencies).5 The
agencies issued a final rule
implementing section 13 of the BHC Act
in December 2013 (the 2013 rule), and
those provisions became effective on
April 1, 2014.6
Since the adoption of the 2013 rule,
the agencies have gained several years
of experience implementing the 2013
rule, and banking entities have had
more than five years of becoming
familiar and complying with the 2013
rule. The agencies have received various
communications from the public and
other sources since adoption of the 2013
rule and over the course of the 2013
rule’s implementation. Staffs of the
agencies also have held numerous
meetings with banking entities and
other market participants to discuss the
2013 rule and its implementation. In
addition, the data collected in
connection with the 2013 rule,
compliance efforts by banking entities,
and the agencies’ experiences in
reviewing trading, investment, and
2 Id.
3 12
U.S.C. 1851(d)(1).
12 U.S.C. 1851(d)(1)(G).
5 12 U.S.C. 1851(b)(2).
6 Prohibitions and Restrictions on Proprietary
Trading and Certain Interests in, and Relationships
with, Hedge Funds and Private Equity Funds; Final
Rule, 79 FR 5535 (Jan. 31, 2014).
4 E.g.,
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other activity under the 2013 rule have
provided valuable insights into the
effectiveness of the 2013 rule. Together,
these experiences have highlighted
areas in which the 2013 rule may have
resulted in ambiguity, overbroad
application, or unduly complex
compliance routines or may otherwise
not have been as effective or efficient in
achieving its purpose as intended or
expected.
II. Notice of Proposed Rulemaking
Based on their experience
implementing the 2013 rule, the
agencies published a notice of proposed
rulemaking (the proposed rule or
proposal) on July 17, 2018, that
proposed amendments to the 2013 rule.
These amendments sought to provide
greater clarity and certainty about what
activities are prohibited under the 2013
rule and to improve the effective
allocation of compliance resources
where possible.7
The agencies sought to address a
number of targeted areas for revision in
the proposal. First, the agencies
proposed further tailoring to make the
scale of compliance activity required by
the 2013 rule commensurate with a
banking entity’s size and level of trading
activity. In particular, the agencies
proposed to establish three categories of
banking entities based on the firms’
level of trading activity—those with
significant trading assets and liabilities,
those with moderate trading assets and
liabilities, and those with limited
trading assets and liabilities.8 The
agencies also invited comments on
whether certain definitions, including
‘‘banking entity’’ 9 and ‘‘trading desk,’’ 10
and ‘‘covered fund’’ 11 should be
modified.
The agencies also proposed making
several changes to subpart B of the 2013
rule, which implements the statutory
prohibition on proprietary trading and
the various statutory exemptions to this
prohibition. The agencies proposed
revisions to the trading account
definition,12 including replacing the
short-term intent prong of the trading
account definition in the 2013 rule with
7 Proposed Revisions to Prohibitions and
Restrictions on Proprietary Trading and Certain
Interests in, and Relationships With, Hedge Funds
and Private Equity Funds, 83 FR 33432 (July 17,
2018).
8 See 83 FR 33437, 40–42.
9 See 83 FR 33442–46.
10 See 83 FR 33453–54.
11 See 83 FR 33471–82.
12 The definition of ‘‘trading account’’ is a
threshold definition that determines whether the
purchase or sale of a financial instrument by a
banking entity is subject to the restrictions and
requirements of section 13 of the BHC Act and the
2013 rule.
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a new prong based on the accounting
treatment of a position (the accounting
prong) and, with respect to trading
activity subject only to the accounting
prong, establishing a presumption of
compliance with the prohibition on
proprietary trading, based on the
absolute value of a trading desk’s profit
and loss.13 Under the proposed
accounting prong, the trading account
would have encompassed financial
instruments recorded at fair value on a
recurring basis under applicable
accounting standards.
In addition, the proposal would have
modified several of the exemptions and
exclusions from the prohibition on
proprietary trading in subpart B to
clarify how banking entities may qualify
for those exemptions and exclusions, as
well as to reduce associated compliance
burdens. For example, the agencies
proposed revising the 2013 rule’s
exemptions for underwriting and market
making-related activities,14 the
exemption for risk-mitigating hedging
activities,15 the exemption for trading
by a foreign banking entity that occurs
solely outside of the United States,16
and the liquidity management
exclusion.17 In addition, the agencies
proposed establishing an exclusion for
transactions to correct trading errors.18
The agencies also proposed certain
modifications to the prohibitions in
subpart C on banking entities directly or
indirectly acquiring or retaining an
ownership interest in, or having certain
relationships with, a covered fund. For
example, the proposed rule would have
modified provisions related to the
underwriting or market making of
ownership interests in covered funds 19
and the exemption for certain permitted
covered fund activities and investments
outside of the United States. The
proposal also would have expanded a
banking entity’s ability to engage in
hedging activities involving an
ownership interest in a covered fund.20
In addition, the agencies requested
comment regarding tailoring the
definition of ‘‘covered fund,’’ including
potential additional exclusions,21 and
revising the provisions limiting banking
entities’ relationships with covered
funds.22
To enhance compliance efficiencies,
the agencies proposed tailoring the
13 See
83 FR 33446–51.
83 FR 33454–62.
15 See 83 FR 33464–67.
16 See 83 FR 33467–70.
17 See 83 FR 33451–52.
18 See 83 FR 33452–53.
19 See 83 FR 33482–83
20 See 83 FR 33483–86.
21 See 83 FR 33471–82.
22 See 83 FR 33486–87.
14 See
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compliance requirements based on new
compliance tiers. The proposed rule
would have applied the six-pillar
compliance program, and a CEO
attestation requirement largely
consistent with the 2013 rule, to firms
with significant trading assets and
liabilities and eliminated the enhanced
minimum standards for compliance
programs in Appendix B of the 2013
rule.23 Firms with moderate trading
assets and liabilities would have been
required to adhere to a simplified
compliance program, with a CEO
attestation requirement,24 and firms
with limited trading assets and
liabilities would have had a
presumption of compliance with the
rule.25 The proposal also included a
reservation of authority specifying that
the agencies could impose additional
requirements on banking entities with
limited or moderate trading assets and
liabilities if warranted.26 The proposal
would have revised the metrics
reporting and recordkeeping
requirements by, for example, applying
those requirements based on a banking
entity’s size and level of trading activity,
eliminating some metrics, and adding a
limited set of new metrics to enhance
compliance efficiencies.27 In addition,
the agencies requested comment on
whether some or all of the reported
quantitative measurements should be
made publically available.
The agencies invited comment on all
aspects of the proposal, including
specific proposed revisions and
questions posed by the agencies. The
agencies received over 75 unique
comments from banking entities and
industry groups, public interest groups,
and other organizations and individuals.
In addition, the agencies received
approximately 3,700 comments from
individuals using a version of a short
form letter to express opposition to the
proposed rule. For the reasons
discussed below, the agencies are now
adopting a final rule that incorporates a
number of modifications.
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III. Overview of the Final Rule and
Modifications From the Proposal
A. The Final Rule
Similar to the proposal, the final rule
includes a risk-based approach to
revising the 2013 rule that relies on a set
of clearly articulated standards for both
prohibited and permitted activities and
investments. The final rule is intended
to further tailor and simplify the rule to
23 See
83 FR 33487–89; 33490–94.
83 FR 33489.
25 See 83 FR 33490.
26 See 83 FR 33454.
27 See 83 FR 33494–514.
24 See
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allow banking entities to more
efficiently provide financial services in
a manner that is consistent with the
requirements of section 13 of the BHC
Act.
The comments the agencies received
from banking entities and financial
services industry trade groups were
generally supportive of the proposal,
with the exception of the proposed
accounting prong, and provided
recommendations for further targeted
changes. The agencies also received a
few comments in opposition to the
proposal from various organizations and
individuals.28 As described further
below, the agencies have adopted many
of the proposed changes to the 2013
rule, with certain targeted adjustments
based on comments received.
Furthermore, the agencies intend to
issue an additional notice of proposed
rulemaking that would propose
additional, specific changes to the
restrictions on covered fund
investments and activities and other
issues related to the treatment of
investment funds under the regulations
implementing section 13 of the BHC
Act.
The final rule includes the same
general three-tiered approach to
tailoring the compliance program
requirements as the proposal. However,
based on comments received, the
agencies have modified the threshold
for banking entities in the ‘‘significant’’
compliance category from $10 billion in
gross trading assets and liabilities to $20
billion in gross trading assets and
liabilities. The final rule also includes
modifications to the calculation of
trading assets and liabilities for
purposes of determining which
compliance tier a banking entity falls
into by excluding certain financial
instruments that banking entities are
permitted to trade without limit under
section 13. Additionally, the final rule
aligns the methodologies for calculating
the ‘‘limited’’ and ‘‘significant’’
compliance thresholds for foreign
banking organizations by basing both
thresholds on the trading assets and
liabilities of the firm’s U.S. operations.29
The final rule also includes many of
the proposed changes to the proprietary
28 See, e.g., Senators Merkley et al.; Elise J. Bean
(Bean); National Association of Federally-Insured
Credit Unions (NAFCU); Better Markets, Inc. (Better
Markets); Americans for Financial Reform (AFR);
Volcker Alliance; Occupy the SEC; and Volcker 2.0
Form Letter.
29 Under the proposal, the ‘‘limited’’ compliance
threshold would have been based on the trading
assets and liabilities of a foreign banking
organization’s worldwide operations whereas the
‘‘significant’’ compliance threshold would have
been based on the trading assets and liabilities of
a foreign banking organization’s U.S. operations.
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trading restrictions, with certain
changes based on comments received.
One such change is that the final rule
does not include the proposed
accounting prong in the trading account
definition. Instead, the final rule retains
a modified version of the short-term
intent prong and replaces the 2013
rule’s rebuttable presumption that
financial instruments held for fewer
than 60 days are within the short-term
intent prong of the trading account with
a rebuttable presumption that financial
instruments held for 60 days or longer
are not within the short-term intent
prong of the trading account. The final
rule also provides that a banking entity
that is subject to the market risk capital
rule prong of the trading account
definition is not also subject to the
short-term intent prong, and a banking
entity that is not subject to the market
risk capital rule prong may elect to
apply the market risk capital rule prong
(as an alternative to the short-term
intent prong). Additionally, the final
rule modifies the liquidity management
exclusion from the proprietary trading
restrictions to permit banking entities to
use a broader range of financial
instruments to manage liquidity, and it
adds new exclusions for error trades,
certain customer-driven swaps, hedges
of mortgage servicing rights, and
purchases or sales of instruments that
do not meet the definition of trading
assets or liabilities. Furthermore, the
final rule revises the trading desk
definition to provide more flexibility to
banking entities to align the definition
with other trading desk definitions in
existing or planned compliance
programs. This modified definition also
will provide for consistent treatment
across different regulatory regimes.
The final rule also includes the
proposed changes to the exemptions
from the prohibitions in section 13 of
the BHC Act for underwriting and
market making-related activities, riskmitigating hedging, and trading by
foreign banking entities solely outside
the United States. The final rule also
includes the proposed changes to the
covered funds provisions for which
specific rule text was proposed,
including with respect to permitted
underwriting and market making and
risk-mitigating hedging with respect to a
covered fund, as well as investment in
or sponsorship of covered funds by
foreign banking entities solely outside
the United States and the exemption for
prime brokerage transactions. With
respect to the exemptions for
underwriting and market making-related
activities, the final rule adopts the
presumption of compliance with the
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reasonably expected near-term demand
requirement for trading within certain
internal limits, but instead of requiring
banking entities to promptly report limit
breaches or increases to the agencies,
banking entities are required to
maintain and make available upon
request records of any such breaches or
increases and follow certain internal
escalation and approval procedures in
order to remain qualified for the
presumption of compliance.
With respect to the compliance
program requirements, the final rule
includes the changes from the proposal
to eliminate the enhanced compliance
requirements in Appendix B of the 2013
rule and to tailor the compliance
program requirements based on the size
of the banking entity’s trading activity.
However, different from the proposal,
the final rule only applies the CEO
attestation requirement to firms with
significant trading assets and liabilities.
Also, in response to comments, the final
rule includes modifications to the
metrics collection requirements to,
among other things, eliminate certain
metrics and reduce the compliance
burden associated with the requirement.
For the OCC, Board, FDIC, and CFTC,
the final amendments will be effective
on January 1, 2020. For the SEC, the
final amendments will be effective on
January 13, 2020. In order to give
banking entities a sufficient amount of
time to comply with the changes
adopted, banking entities will not be
required to comply with the final
amendments until January 1, 2021.
During that time, the 2013 rule will
remain in effect as codified in appendix
Z, which is a temporary appendix that
will expire on the compliance date.
However, banking entities may
voluntarily comply, in whole or in part,
with the amendments adopted in this
release prior to the compliance date,
subject to the agencies’ completion of
necessary technical changes. In
particular, the agencies need to
complete certain technological
programming in order to accept metrics
compliant with the final amendments.
The agencies will conduct a test run
with banking entities of the revised
metrics submission format. A banking
entity seeking to switch to the revised
metrics prior to January 1, 2021, must
first successfully test submission of the
revised metrics in the new XML format.
Accordingly, banking entities should
work with each appropriate agency to
determine how and when to voluntarily
comply with the metrics requirements
under the final rules and to notify such
agencies of their intent to comply, prior
to the January 1, 2021, compliance date.
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B. Interagency Coordination and Other
Comments
Section 13(b)(2)(B)(ii) of the BHC Act
directs the agencies to ‘‘consult and
coordinate’’ in developing and issuing
the implementing regulations ‘‘for the
purpose of assuring, to the extent
possible, that such regulations are
comparable and provide for consistent
application and implementation of the
applicable provisions of [section 13 of
the BHC Act] to avoid providing
advantages or imposing disadvantages
to the companies affected . . . .’’ 30 The
agencies recognize that coordinating
with each other to the greatest extent
practicable with respect to regulatory
interpretations, examinations,
supervision, and sharing of information
is important to maintaining consistent
oversight, promoting compliance with
section 13 of the BHC Act and
implementing regulations, and to
fostering a level playing field for
affected market participants. The
agencies further recognize that
coordinating these activities helps to
avoid unnecessary duplication of
oversight, reduces costs for banking
entities, and provides for more efficient
regulation.
In the proposal, the agencies
requested comment on interagency
coordination regarding the Volcker Rule
in general and asked several specific
questions relating to transparency,
efficiency, and safety and soundness.31
Numerous commenters, including
banking entities and industry groups,
suggested that the agencies more
effectively coordinate Volcker Rule
related supervision, examinations, and
enforcement, in order to improve
efficiency and predictability in
supervision and oversight.32 For
example, several commenters suggested
that Volcker Rule related supervision
should be conducted solely by a bank’s
prudential onsite examiner,33 and that
the two market regulators be required to
consult and coordinate with the
prudential onsite examiner.34 Several
commenters encouraged the agencies to
memorialize coordination and
information sharing between the
agencies by entering into a formal
30 12
U.S.C. 1851(b)(2)(B)(ii).
FR 33436.
32 See, e.g., American Bankers Association (ABA);
Institute of International Bankers (IIB); BB&T;
Committee on Capital Markets Regulation (CCMR);
Japanese Bankers Association (JBA); and the CFA
Institute (CFA). Commenters also recommended
designating to one agency the task of interpreting
the implementing regulations and issuing guidance
to smaller banking entities. See, e.g., Credit Suisse
and Lori Nuckolls.
33 See, e.g., ABA; Arvest Bank (Arvest); Credit
Suisse; and Financial Services Forum (FSF).
34 See ABA.
31 83
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61977
written agreement, such as an
interagency Memorandum of
Understanding.35
Several comment letters from public
interest organizations suggested that the
agencies have not provided sufficient
transparency when implementing and
enforcing the Volcker Rule, and urged
the agencies to make public certain
information related to enforcement
actions, metrics, and covered funds
activities.36 In addition, several
commenters, including a member of
Congress, argued that the agencies have
not adequately explained or provided
evidence to support the current
rulemaking.37
The agencies agree with commenters
that interagency coordination plays an
important role in the effective
implementation and enforcement of the
Volcker Rule, and acknowledge the
benefits of providing transparency in
proposing and adopting rules to
implement section 13 of the BHC Act.
Accordingly, the agencies have
endeavored to provide specificity and
clarity in the final rule to avoid
conflicting interpretations or
uncertainty. The final rule also includes
notice and response procedures that
provide a greater degree of certainty
about the process by which the agencies
will make certain determinations under
the final rule. The agencies continue to
recognize the benefits of consistent
application of the rules implementing
section 13 of the BHC Act and intend to
continue to consult with each other
when formulating guidance on the final
rule that would be shared with the
public generally. That said, the agencies
also are mindful of the need to strike an
appropriate balance between public
disclosure and the protection of
sensitive, confidential information, and
the agencies are generally restricted
from disclosing sensitive, confidential
business and supervisory information
on a firm-specific basis.
Several commenters provided general
comments regarding the proposal and
the current rulemaking. For example,
several public interest commenters
suggested that the proposed rule did not
provide a sufficient financial
disincentive against proprietary trading
and encouraged the agencies to adopt
certain limitations on compensation
arrangements.38 A commenter also
suggested possible penalties for rule
violations and encouraged the agencies
to elaborate on the consequences of
35 See,
e.g., ABA; BB&T; CCMR; and FSF.
e.g., AFR; Public Citizen; Volcker Alliance;
and CFA.
37 See, e.g., CAP; Merkley; and Public Citizen.
38 See, e.g., Public Citizen and CAP.
36 See,
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significant violations of the rule.39 Other
commenters recommended that the
agencies impose strong penalties on
banking entities that break the law.40
The agencies believe that the
appropriate consequences for a violation
of the rule will likely depend on the
specific facts and circumstances in
individual cases, as well as each
agency’s statutory authority under
section 13, and therefore are not
amending the rule to provide for
specific penalties or financial
disincentives for violations. Finally,
several commenters suggested that the
proposed rule is too complex and may
provide too much deference to a
banking entity’s internal procedures and
models (for example, in provisions
related to underwriting, market making,
and hedging), and that the proposed
revisions would make the rule less
effective.41 As discussed further below,
the agencies believe that the particular
changes adopted in the final rule are
meaningfully simpler and streamlined
compared to the 2013 rule, and are
appropriate for the reasons described in
greater detail below.
IV. Section by Section Summary of the
Final Rule
A. Subpart A—Authority and
Definitions
1. Section ll.2: Definitions
a. Banking Entity
Section 13(a)(1)(A) of the BHC Act
prohibits a banking entity from engaging
in proprietary trading or acquiring or
retaining an ownership interest, or
sponsoring, a covered fund, unless the
activity is otherwise permissible under
section 13.42 Therefore, the definition of
the term ‘‘banking entity’’ defines the
scope of entities subject to restrictions
under the rule. Section 13(h)(1) of the
BHC Act defines the term ‘‘banking
entity’’ to include (i) any insured
depository institution (as defined by
statute); (ii) any company that controls
an insured depository institution; (iii)
any company that is treated as a bank
holding company for purposes of
section 8 of the International Banking
Act of 1978; and (iv) any affiliate or
subsidiary of any such entity.43 The
regulations implementing this provision
are consistent with the statute and also
exclude covered funds that are not
themselves banking entities, certain
portfolio companies, and the FDIC
acting in its corporate capacity as
conservator or receiver.44
In addition, the agencies note that,
consistent with the statute, for purposes
of this definition, the term ‘‘insured
depository institution’’ does not include
certain institutions that function solely
in a trust or fiduciary capacity, and
certain community banks and their
affiliates.45 Section 203 of the Economic
Growth, Regulatory Relief, and
Consumer Protection Act (EGRRCPA)
amended the definition of ‘‘banking
entity’’ in the Volcker Rule to exclude
certain community banks from the
definition of insured depository
institution, the general result of which
was to exclude community banks and
their affiliates and subsidiaries from the
scope of the Volcker Rule.46 On July 22,
2019, the agencies adopted a final rule
amending the definition of ‘‘insured
depository institution,’’ in a manner
consistent with EGRRCPA.47
The proposed rule did not propose
specific rule text to amend the
definition of ‘‘banking entity,’’ but
invited comment on a number of
specific issues.48 The agencies received
several comments about the ‘‘banking
entity’’ definition, many of which asked
that the agencies revise this definition to
exclude specific types of entities.
Several commenters expressed
concern about the treatment of certain
funds that are excluded from the
definition of ‘‘covered fund’’ in the 2013
rule, including registered investment
companies (RICs), foreign public funds
(FPFs), and, with respect to a foreign
banking entity, certain foreign funds
offered and sold outside of the United
States (foreign excluded funds).49 In
particular, these commenters noted that
when a banking entity invests in such
funds, or has certain corporate
governance rights or other control rights
with respect to such funds, the funds
could meet the definition of ‘‘banking
entity’’ for purposes of the Volcker
Rule.50 Concerns about certain funds’
potential status as banking entities arise,
in part, because of the interaction
2013 rule § ll.2(c).
final rule § ll.2(r).
46 Public Law 115–174 (May 24, 2018).
47 See 84 FR 35008.
48 See 83 FR 33442–446.
49 See, e.g., ABA; American Investment Council
(AIC); Bundesverband Investment (BVI); Canadian
Bankers Association (CBA); European Banking
Federation (EBF); Federated Investors II; Financial
Services Agency and Bank of Japan (FSA/Bank of
Japan); European Fund and Asset Management
Association (EFAMA); and IIB.
50 Id.
44 See
45 See
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39 See
Public Citizen.
Volcker 2.0 Form Letter.
41 See, e.g., Systemic Risk Council and Oonagh
McDonald.
42 12 U.S.C. 1851(a)(1)(A). A banking entity may
engage in an activity that is permissible under
section 13 of the BHC Act only to the extent
permitted by any other provision of Federal and
State law, and subject to other applicable
restrictions. See 12 U.S.C. 1851(d)(1).
43 12 U.S.C. 1851(h)(1).
40 See
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between the statute’s and the 2013 rule’s
definitions of the terms ‘‘banking
entity’’ and ‘‘covered fund.’’ Sponsors of
RICs, FPFs, and foreign excluded funds
have noted that the treatment of such
funds as ‘‘banking entities’’ would
disrupt bona fide asset management
activities (including fund investment
strategies that may include proprietary
trading or investing in covered funds),
which these sponsors argued would be
inconsistent with section 13 of the BHC
Act.51 Commenters also noted that
treatment of RICs, FPFs, and foreign
excluded funds as ‘‘banking entities’’
would put such banking entity-affiliated
funds at a competitive disadvantage
compared to funds not affiliated with a
banking entity, and therefore not subject
to restrictions under section 13 of the
BHC Act.52 In general, commenters also
asserted that the treatment of RICs,
FPFs, and foreign excluded funds as
banking entities would not further the
policy objectives of section 13 of the
BHC Act.53
Several commenters suggested that
the agencies exclude from the definition
of ‘‘banking entity’’ foreign excluded
funds.54 These commenters generally
noted that failing to exclude such funds
from the definition of ‘‘banking entity’’
in the 2013 rule has the unintended
consequence of imposing proprietary
trading restrictions and compliance
obligations on foreign excluded funds
that are in some ways more burdensome
than the requirements that would apply
under the 2013 rule to covered funds.
Another commenter expressed
opposition to carving out foreign
excluded funds from the definition of
banking entity.55 The staffs of the
agencies continue to consider ways in
which the regulations may be amended
in a manner consistent with the
statutory definition of ‘‘banking entity,’’
or other appropriate actions that may be
taken, to address any unintended
consequences of section 13 of the BHC
Act and the 2013 rule. The agencies
intend to issue a separate proposed
51 See, e.g., IIB and Securities Industry and
Financial Markets Association (SIFMA).
52 See, e.g., Capital One et al.; Credit Suisse; EBF;
and Investment Adviser Association (IAA).
53 See, e.g., ABA; EBF; and Investment Company
Institute (ICI).
54 Id. In addition to the requests from commenters
for the agencies to exclude foreign excluded funds
from the ‘‘banking entity’’ definition, commenters
also asked the agencies to adopt other amendments
to address the treatment of such funds, including
by providing a presumption of compliance for such
funds (CBA; EBF; and IIB), to permit a banking
entity to elect to treat a foreign excluded fund as
a covered fund (CBA; EBF; and IIB), and to
permanently extend the temporary relief currently
provided to foreign excluded funds (IIB).
55 See Data Boiler Technologies, LLC (Data
Boiler).
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rulemaking that specifically addresses
the fund structures under the rule,
including the treatment of foreign
excluded funds.
To provide additional time to
complete this rulemaking, the Federal
banking agencies released a policy
statement on July 17, 2019, in response
to concerns about the treatment of
foreign excluded funds. This policy
statement provides that the Federal
banking agencies would not propose to
take action during the two-year period
ending on July 21, 2021, against a
foreign banking entity based on
attribution of the activities and
investments of a qualifying foreign
excluded fund to the foreign banking
entity,56 or against a qualifying foreign
excluded fund as a banking entity, in
each case where the foreign banking
entity’s acquisition or retention of any
ownership interest in, or sponsorship of,
the qualifying foreign excluded fund
would meet the requirements for
permitted covered fund activities and
investments solely outside the United
States, as provided in section 13(d)(1)(I)
of the BHC Act and § ll.13(b) of the
2013 rule, as if the qualifying foreign
excluded fund were a covered fund.57
Several commenters expressed
concern with the treatment of RICs and
FPFs, which are subject to significant
regulatory requirements in the United
States and foreign jurisdictions,
respectively. These commenters
encouraged the agencies to consider
excluding such entities from the
definition of ‘‘banking entity.’’ 58 In the
past, the staffs of the agencies issued
several FAQs to address the treatment of
RICs and FPFs.59 One of these staff
56 Foreign banking entity was defined for
purposes of the policy statement to mean a banking
entity that is not, and is not controlled directly or
indirectly by, a banking entity that is located in or
organized under the laws of the United States or
any State.
57 See Board of Governors of the Federal Reserve
System, Federal Deposit Insurance Corporation, and
Office of the Comptroller of the Currency,
‘‘Statement regarding Treatment of Certain Foreign
Funds under the Rules Implementing Section 13 of
the Bank Holding Company Act’’ (July 17, 2019).
This policy statement continued the position of the
Federal banking agencies that was released on July
21, 2017, and the position that the agencies
expressed in the proposal. See 83 FR 33444.
58 See, e.g., CCMR; IAA; ICI; and Capital One et
al. One commenter also expressed support for a
narrower exclusion for RICs and FPFs that would
apply only during a non-time-limited seeding
period. JP Morgan Asset Management.
59 See https://www.occ.treas.gov/topics/
capitalmarkets/financial-markets/trading-volckerrule/volcker-rule-implementation-faqs.html (OCC);
https://www.federalreserve.gov/bankinforeg/
volcker-rule/faq.htm (Board); https://www.fdic.gov/
regulations/reform/volcker/faq.html (FDIC); https://
www.sec.gov/divisions/marketreg/faq-volckerrulesection13.htm (SEC); https://www.cftc.gov/
LawRegulation/DoddFrankAct/Rulemakings/DF_
28_VolckerRule/index.htm (CFTC).
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FAQs provides guidance about the
treatment of RICs and FPFs during the
period in which the banking entity is
testing the fund’s investment strategy,
establishing a track record of the fund’s
performance for marketing purposes,
and attempting to distribute the fund’s
shares (the so-called seeding period).60
Another FAQ stated that staffs of the
agencies would not view the activities
and investments of an FPF that meets
certain eligibility requirements in the
2013 rule as being attributed to the
banking entity for purposes of section
13 of the BHC Act or the 2013 rule,
where the banking entity (i) does not
own, control, or hold with the power to
vote 25 percent or more of any class of
voting shares of the FPF (after the
seeding period), and (ii) provides
investment advisory, commodity trading
advisory, administrative, and other
services to the fund in compliance with
applicable limitations in the relevant
foreign jurisdiction. Similarly, this FAQ
stated that the staffs of the agencies
would not view the FPF to be a banking
entity for purposes of section 13 of the
BHC Act and the 2013 rule solely by
virtue of its relationship with the
sponsoring banking entity, where these
same conditions are met.61
As noted above, the agencies intend to
issue a separate proposal addressing and
requesting comment on the covered
fund provisions and other fund-related
issues. The final rule does not modify or
revoke any previously issued staff FAQs
or guidance related to RICs, FPFs, and
foreign excluded funds.62
Apart from these topics, the agencies
received numerous other comments
about the treatment of entities as
‘‘banking entities’’ under section 13 of
the BHC Act. In general, these
commenters requested that the agencies
provide additional exclusions from the
definition of ‘‘banking entity’’ for
various types of entities. One
commenter suggested that, as an
alternative to excluding certain entities
from the banking entity definition, the
agencies could exempt the activities of
these entities from the proprietary
trading and covered fund
prohibitions.63
One commenter recommended that
the agencies provide a general
60 Id.,
FAQ 16.
FAQ 14.
62 The FAQs represent the views of staff of the
agencies. They are not rules, regulations, or
statements of the agencies. Furthermore, the
agencies have neither approved nor disapproved
their content. The FAQs, like all staff guidance,
have no legal force or effect: They do not alter or
amend applicable law, and they create no new or
additional obligations for any person.
63 See Bank Policy Institute (BPI).
61 Id.,
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61979
exemption from the banking entity
definition for investment funds, except
in circumstances where the investment
fund is determined to have been
organized to permit the banking entity
sponsor to engage in impermissible
proprietary trading.64 Some commenters
encouraged the agencies to exclude
employee securities companies from the
definition of ‘‘banking entity.’’ 65 One
commenter argued that despite a
banking entity’s role as a general partner
in employee securities companies,
treating such entities as ‘‘banking
entities’’ does not further the policy
goals of section 13 of the BHC Act.66
Several commenters encouraged the
agencies to exclude from the definition
of ‘‘banking entity’’ any nonconsolidated subsidiaries not operated
or managed by a banking entity, on the
basis that such entities were never
intended to be subject to section 13 of
the BHC Act.67 Another commenter said
the agencies should exclude from the
definition of ‘‘banking entity’’ all
employee compensation plans,
regardless of whether such plans are
qualified or non-qualified.68 Other
commenters suggested that the agencies
should exclude subsidiaries of foreign
banking entities that do not engage in
trading activities in the United States, or
otherwise limit application to foreign
subsidiaries of foreign banking groups.69
Other commenters requested
modification of the definition of
‘‘banking entity’’ to exclude parent
companies and affiliates of industrial
loan companies, noting that such
companies are generally not subject to
other restrictions on their activities
under the BHC Act.70
One commenter encouraged the
agencies to exclude international banks
from the definition of ‘‘banking entity’’
if they have limited U.S. trading assets
and liabilities.71 This commenter also
64 See
EFAMA.
e.g., ABA and FSF.
66 See ABA.
67 See, e.g., ABA; BPI; SIFMA; JBA.
68 See BB&T.
69 See JBA. This commenter suggested that in the
absence of an exclusion for such entities, simplified
compliance program requirements should apply to
foreign subsidiaries of foreign banking entities that
do not engage in trading activities in the United
States. The agencies believe that several of the other
changes in this final rule will provide relief to
foreign banking entities that engage in no trading
activities in the United States, including
simplifications to the exemption for foreign banking
entities engaged in trading outside of the United
States, and more tailored compliance program
requirements. See also FSA/Bank of Japan; IIB.
70 See, e.g., EnerBank USA (EnerBank);
Marketplace Lending Association; National
Association of Industrial Bankers.
71 See IIB. This commenter also proposed
modifying the manner in which ‘‘banking entity’’
65 See,
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encouraged the agencies to exclude
certain non-U.S. commercial companies
that are comparable to U.S. merchant
banking portfolio companies.72 This
commenter argued that excluding these
entities would not pose material risks to
the financial stability of the United
States.
Some commenters suggested that the
agencies should clarify the standards for
what constitutes ‘‘control’’ in the
context of determining whether an
entity is an ‘‘affiliate’’ or ‘‘subsidiary’’
for purposes of the definition of
‘‘banking entity’’ in the Volcker Rule.73
One commenter suggested that the
definition of ‘‘banking entity’’ should
include only a company in which a
banking entity owns, controls, or has the
power to vote 25 percent or more of a
class of voting securities of the
company.74
The definition of ‘‘banking entity’’ in
section 13 of the BHC Act uses the
definition of control in section 2 of the
BHC Act.75 Under the BHC Act,
‘‘control’’ is defined by a three-pronged
test. A company has control over
another company if the first company (i)
directly or indirectly or acting through
one or more other persons owns,
controls, or has power to vote 25
percent or more of any class of voting
securities of the other company; (ii)
controls in any manner the election of
a majority of the directors of the other
company; or (iii) directly or indirectly
exercises a controlling influence over
the management or policies of the other
company.76 The Board recently issued a
proposed rulemaking that would clarify
the standards for evaluating whether
one company exercises a controlling
influence over another company for
purposes of the BHC Act.77
The final rule does not amend the
definition of banking entity.
Commenters raised important
considerations with respect to the
consequences of the current ‘‘banking
entity’’ definition under section 13 of
the BHC Act and the 2013 rule. The
agencies believe that other amendments
to the requirements of the regulations
implementing the Volcker Rule may
address some of the issues raised by
commenters. Certain concerns raised by
commenters may need to be addressed
through amendments to section 13 of
status is determined by disaggregating separate,
independent corporate groups.
72 Id.
73 See, e.g., EnerBank and Capital One et al. See
12 U.S.C. 1841(a)(2)(C).
74 See Capital One et al.
75 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e).
76 Id.
77 See ‘‘Control and Divestiture Proceedings,’’ 84
FR 21634–666 (May 14, 2019).
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the BHC Act.78 In addition, as noted
above, the agencies intend to revisit the
fund-related provisions of the Volcker
Rule in a separate rulemaking.
b. Limited, Moderate, and Significant
Trading Assets and Liabilities
The proposal would have established
three categories of banking entities
based on their level of trading activity,
as measured by the average gross trading
assets and liabilities of the banking
entity and its subsidiaries and affiliates
(excluding obligations of or guaranteed
by the United States or any agency of
the United States) over the previous four
consecutive quarters.79 These categories
would have been used to calibrate
compliance requirements for banking
entities, with the most stringent
compliance requirements applicable to
those with the greatest level of trading
activities.
The first category would have
included firms with ‘‘significant’’
trading assets and liabilities, defined as
those banking entities that have
consolidated trading assets and
liabilities equal to or exceeding $10
billion.80 The second category would
have included firms with ‘‘moderate’’
trading assets and liabilities, which
would have included those banking
entities that have consolidated trading
assets and liabilities of $1 billion or
more, but with less than $10 billion in
consolidated trading assets and
liabilities.81 The final category would
have included firms with ‘‘limited’’
trading assets and liabilities, defined as
those banking entities that have less
than $1 billion in consolidated trading
assets and liabilities.82 The proposal
would have also provided the agencies
with a reservation of authority to require
a banking entity with limited or
moderate trading assets and liabilities to
apply the compliance program
requirements of a higher compliance tier
if an agency determined that the size or
complexity of the banking entity’s
trading or investment activities, or the
risk of evasion of the requirements of
78 See, e.g., Economic Growth, Regulatory Relief,
and Consumer Protection Act § 203 (excluding
community banks from the definition of ‘‘banking
entity’’).
79 See proposed rule § ll.2(t), (v), (ff). Under the
proposal, a foreign banking entity’s trading assets
and liabilities would have been calculated based on
worldwide trading assets and liabilities with
respect to the $1 billion threshold between limited
and moderate trading assets and liabilities, but
based on the trading assets and liabilities only of
its combined U.S. operations with respect to the
$10 billion threshold between moderate and
significant trading assets and liabilities. See
proposed rule § ll.2(t)(1), (ff)(2)–(3).
80 Proposed rule § ll.2(ff).
81 Proposed rule § ll.2(v).
82 Proposed rule § ll.2(t).
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the rule, warranted such treatment.83
The proposal also solicited comment as
to whether there should be further
tailoring of the thresholds for a banking
entity that is an affiliate of another
banking entity with significant trading
assets and liabilities, if that entity
generally operates on a basis that is
separate and independent from its
affiliates and parent companies.84
Commenters provided feedback on
multiple aspects of the tiered
compliance framework, including the
level of the proposed thresholds
between the categories ($1 billion and
$10 billion in trading assets and
liabilities), the manner in which
‘‘trading assets and liabilities’’ should
be measured, and alternative
approaches that commenters believed
would be preferable to the proposed
three-tiered compliance framework. As
described further below, after
consideration of the comments received,
the agencies are adopting a three-tiered
compliance framework that is consistent
with the proposal, with targeted
adjustments to further tailor compliance
program requirements based on the
level of a firm’s trading activities, and
in light of concerns raised by
commenters.85 The agencies believe that
this approach will increase compliance
efficiencies for all banking entities
relative to the 2013 rule and the
proposal, and will further reduce
compliance costs for firms that have
little or no activity subject to the
prohibitions and restrictions of section
13 of the BHC Act.
Several commenters expressed
support for the proposed three-tiered
compliance framework in the
proposal.86 One commenter noted that
the 2013 rule’s compliance regime,
which imposes significant compliance
obligations on all banking entities with
$50 billion or more in total consolidated
assets, does not appropriately tailor
compliance obligations to the scope of
activities covered under the regulation,
particularly for firms engaged in limited
trading activities.87 Other commenters
expressed general opposition to the
proposed three-tiered compliance
program.88 Another commenter
expressed concern in particular that
banking entities with ‘‘limited’’ trading
assets and liabilities would have been
presumed compliant with the
requirements of section 13 of the BHC
rule § ll.20(h).
83 FR at 33442 (question 7).
85 See final rule § ll.2(s), (u), (ee).
86 See, e.g., BB&T Corporation; CFA; CCMR; and
State Street Corporation (State Street).
87 See State Street.
88 See, e.g., Bean; Data Boiler Technologies; and
Occupy the SEC.
83 Proposed
84 See
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Act under the proposed rule.89 Some
commenters also suggested that the
agencies adopt a two-tiered compliance
program, bifurcating banking entities
into those with and without significant
trading assets and liabilities.90 One
commenter expressed opposition to
tailoring compliance requirements for
banking entities that operate separately
and independently from their affiliates,
by calculating trading assets and
liabilities for such entities independent
of the activities of affiliates.91 The
agencies believe that the three-tiered
framework set forth in the proposal,
subject to the additional amendments
described below, appropriately
differentiates among banking entities for
the purposes of tailoring compliance
requirements. Specifically, the agencies
believe that the significant differences
in business models and activities among
banking entities that would have
significant trading assets and liabilities,
moderate trading assets and liabilities,
and limited trading assets and
liabilities, as described below, support
having a three-tiered compliance
framework.
A few commenters recommended that
the agencies raise the proposed $1
billion threshold between banking
entities with limited and moderate
trading assets and liabilities.92 These
commenters suggested that raising this
threshold to $5 billion in trading assets
and liabilities would be consistent with
the objective of the proposal to have the
most streamlined requirements imposed
on banking entities with a relatively
small amount of trading activities. Other
commenters recommended that the
threshold between banking entities with
limited and moderate trading activities
was appropriate or should be set at a
lower level.93 The agencies believe that
the compliance obligations applicable to
banking entities with limited trading
assets and liabilities are most
appropriately reserved for banking
entities below the $1 billion threshold
set forth in the proposal. Such banking
entities tend to have simpler business
models and do not have large trading
operations that would warrant the
expanded compliance obligations
applicable to banking entities with
moderate and significant trading assets
and liabilities. As discussed further
89 See
Occupy the SEC.
e.g., ABA; Capital One et al.; and KeyCorp
and KeyBank (KeyCorp).
91 See Data Boiler Technologies.
92 See, e.g., ABA; Capital One et al.; and BPI.
93 See, e.g., Data Boiler (encouraging the agencies
to lower the threshold to $500 million in trading
assets and liabilities) and B&F Capital Markets
(B&F) (expressing support for the proposed $1
billion threshold).
90 See,
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below, these banking entities also hold
a relatively small amount of the trading
assets and liabilities in the U.S. banking
system. Therefore, the final rule adopts
the threshold from the proposed rule for
determining whether a banking entity
has limited trading assets and
liabilities.94
Several commenters recommended
that the agencies modify the threshold
for ‘‘significant’’ trading assets and
liabilities.95 Generally, these
commenters expressed support for
raising the threshold from $10 billion in
trading assets and liabilities to $20
billion in trading assets and liabilities.96
These commenters noted that this
change would have minimal impact on
the number of banking entities that
would remain categorized as having
significant trading assets and
liabilities.97 Several commenters also
noted that increasing the threshold from
$10 billion to $20 billion would provide
additional certainty to banking entities
that are near or approaching the $10
billion threshold, because market events
or unusual customer demands could
cause such banking entities to exceed
(permanently or on a short-term basis)
the $10 billion trading assets and
liabilities threshold.98 The final rule
adopts the change recommended by
several commenters to raise the
threshold from $10 billion to $20 billion
for calculating whether a banking entity
has significant trading assets and
liabilities.99
The agencies estimate that, under the
final rule with the increased threshold
from $10 billion to $20 billion described
above, banking entities classified as
having significant trading assets and
liabilities would hold approximately 93
percent of the trading assets and
liabilities in the U.S. banking system.
The agencies also estimate that banking
entities with significant trading assets
and liabilities and those with moderate
trading assets and liabilities in
combination would hold approximately
99 percent of the trading assets and
liabilities in the U.S. banking system.
Therefore, both of these thresholds will
tailor the compliance obligations under
the final rule for all firms by virtue of
imposing greater compliance obligations
on those banking entities with the most
substantial levels of trading activities.
final rule § ll.2(s)(2)–(3).
e.g., ABA; Bank of New York Mellon
Corporation, Northern Trust Corporation, and State
Street Corporation (Custody Banks); New England
Council; Capital One et al.; SIFMA; State Street; and
BPI.
96 Id.
97 Id.
98 See, e.g., ABA; Capital One et al.; and SIFMA.
99 See final rule § ll.2(ee)(1)(i).
94 See
95 See,
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One commenter suggested that the
agencies index the compliance tier
thresholds to inflation.100 At present,
the agencies do not believe that the
additional complexity associated with
inflation-indexing the thresholds in the
final rule is necessary in light of the
other changes to the thresholds and
calculation methodologies described
below, including the increase in the
threshold for firms with significant
trading assets and liabilities from $10
billion to $20 billion, and the
modifications to the calculation of
trading assets and liabilities adopted in
the final rule.101
Commenters recommended that the
regulations incorporate a number of
changes to the methodology used in the
proposed rule to classify firms into
different compliance tiers. Some
commenters recommended that the
agencies apply a consistent
methodology to foreign banking entities
to classify such firms as having
significant trading assets and liabilities,
moderate trading assets and liabilities,
or limited trading assets and
liabilities.102 For purposes of classifying
the banking entity as having significant
trading assets and liabilities, the
proposal would have included only the
trading assets and liabilities of the
combined U.S. operations of a foreign
banking entity, but used the banking
entity’s worldwide trading assets and
liabilities for purposes of classifying the
firm as having either limited trading
assets and liabilities or moderate trading
assets and liabilities.103 Commenters
recommended that the agencies apply a
consistent standard for classifying a
foreign banking entity as having
significant trading assets and liabilities,
moderate trading assets and liabilities,
or limited trading assets and liabilities,
and that the most appropriate measure
would look only at the combined U.S.
operations of such a banking entity.104
These commenters noted that
classifying foreign banking entities
based on their global trading activities
could have the result of imposing
extensive compliance obligations on the
non-U.S. trading activities of a banking
entity with minimal U.S. trading
activities.105
The final rule adopts a consistent
methodology for calculating the trading
assets and liabilities of foreign banking
entities across all categories, taking into
account only the trading assets and
100 See
Capital One et al.
e.g., final rule § ll.2(ee)(1)(i).
102 See, e.g., IIB and JBA.
103 See proposed rule § ll.2(t)(1), (ff)(2)–(3).
104 See, e.g., IIB and JBA.
105 Id.
101 See,
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liabilities of such banking entities’
combined U.S. operations.106 The
agencies believe this approach is
appropriate, particularly for foreign
firms with little or no U.S. trading
activity but substantial worldwide
trading operations. The agencies further
believe that the trading activities of
foreign banking entities that occur
outside of the United States and are
booked into such foreign banking
entities (or into their foreign affiliates),
pose substantially less risk to the U.S.
financial system than trading activities
booked into a U.S. banking entity,
including a U.S. banking entity that is
an affiliate of a foreign banking entity.
This approach is also appropriate in
light of provisions in section 13 of the
BHC Act that provide foreign banking
entities with significant flexibility to
conduct trading and covered fund
activities outside of the United
States.107
One commenter expressed concern
that the regulations did not give banking
entities sufficient guidance as to how to
calculate their trading assets and
liabilities, and asked that the regulations
expressly permit a banking entity to rely
on home jurisdiction accounting
standards when calculating trading
assets and liabilities.108 In light of the
changes to the methodology for
calculating trading assets and liabilities
noted above, in particular using
combined U.S. trading assets and
liabilities for establishing the
appropriate compliance tier for foreign
banking entities, the agencies believe
that further clarifications to the
standards for calculating ‘‘trading assets
and liabilities’’ are not necessary for
banking entities to have sufficient
information available as to the manner
in which to calculate trading assets and
liabilities.
A few commenters suggested that the
threshold for ‘‘significant trading assets
and liabilities’’ should be determined
based on the relative size of the banking
entity’s total trading assets and
liabilities as compared to other metrics,
such as total consolidated assets or
capital, thereby establishing a banking
entity’s compliance requirements based
on the significance of trading activities
to the banking entity.109 Some
commenters suggested that the use of
trading assets and liabilities alone as a
metric to classify banking entities for
determining compliance obligations was
final rule § ll.2(s)(3), (ee)(3).
107 See Section 13(d)(1)(H), (I) (12 U.S.C.
1851(d)(1)(H), (I)).
108 See JBA.
109 See, e.g., ABA; Capital One et al.
106 See
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inappropriate.110 The agencies believe
that a banking entity’s trading assets and
liabilities, as calculated under the
methodology described in the final rule,
is an appropriate metric to use in
establishing compliance requirements
for banking entities. Imposing
compliance obligations on a banking
entity based on the relative significance
of trading activities to the firm could
have the result of imposing fewer
compliance obligations on a larger
banking entity with identical trading
activities to a smaller counterpart,
simply because of that entity’s larger
size.
Several commenters recommended
that the regulations exclude particular
types of trading assets and liabilities for
purposes of determining whether a
banking entity has significant trading
assets and liabilities, moderate trading
assets and liabilities, or limited trading
assets and liabilities. In particular, some
commenters encouraged the agencies to
exclude all government obligations and
other assets and liabilities that are not
subject to the prohibition on proprietary
trading under section 13 of the BHC Act
and the regulations.111 The final rule
modifies the methodology for
calculating a firm’s trading assets and
liabilities to exclude all financial
instruments that are obligations of, or
guaranteed by, the United States, or that
are obligations, participations, or other
instruments of or guaranteed by an
agency of the United States or a
government-sponsored enterprise as
described in the regulations.112 As
commenters noted, banking entities are
permitted to engage in trading activities
in these products under section 13 of
the BHC Act and the implementing
regulations, and therefore the exclusion
of such instruments for the final rule
will result in a more appropriately
tailored standard than under the
proposal. The agencies also believe that
the calculation of trading assets and
liabilities, subject to these
modifications, should continue to be
relatively simple for banking entities
and the agencies, without requiring the
imposition of additional reporting
requirements.
A few commenters recommended that
certain de minimis risk portfolios, such
as matched derivatives holdings and
loan-related swaps, be excluded from
the calculation of trading assets and
liabilities.113 Another commenter
110 See,
e.g., Data Boiler and John Hoffman.
e.g., BMO Financial Group (BMO);
Capital One et al.; and KeyCorp.
112 See final rule § ll.2(s)(2), (3); see also final
rule § ll.6(a)(1), (2).
113 See, e.g., ABA; Arvest; and BOK Financial
(BOK).
111 See,
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recommended the calculation of trading
assets and liabilities should exclude
insurance assets.114 Another commenter
proposed that the trading assets and
liabilities of non-consolidated affiliates
be excluded, because tracking the
trading assets and liabilities of such
subsidiaries on an ongoing basis may
present significant practical burdens.115
As discussed herein, the final rule
makes several amendments to the
methodology for calculating trading
assets and liabilities, for example by
excluding securities issued or
guaranteed by certain governmentsponsored enterprises, and by
calculating trading assets and liabilities
for foreign banking entities based only
on the combined U.S. operations of such
banking entities.116 The agencies believe
that the revisions in the final rule
should simplify the manner in which a
banking entity calculates its trading
assets and liabilities. However, the final
rule does not adopt the changes
recommended by a few commenters to
exclude trading assets and liabilities
associated with particular business
activities or business lines, other than
the express modifications noted above,
or to exclude the trading assets and
liabilities of certain types of
subsidiaries. Rather, the final rule
adopts an approach that is intended to
be straightforward and consistent and
allow banking entities greater ability to
leverage regulatory reports that banking
entities are already required to prepare
under existing law, such as the Form
Y9–C and the Call Report.117
Some commenters noted that the
regulations should clarify the manner in
which a banking entity should calculate
trading assets and liabilities, and make
clear whether it would be appropriate to
rely on regulatory reporting forms such
as the Board’s Consolidated Financial
Statements for Holding Companies,
Form FR Y–9C or call report
information, or other regulatory
reporting forms.118 Other commenters
recommended that the agencies clarify
whether the calculation of ‘‘trading
assets and liabilities’’ should include
only positions that would be within the
scope of the ‘‘trading account’’
definition, or should otherwise exclude
114 See
Insurance Coalition.
JBA.
116 See final rule § ll.2(s)(2)–(3), (ee)(2)–(3).
117 Compliance obligations are determined on a
consolidated basis under the final rule. For that
reason, where a banking entity has an
unconsolidated subsidiary, the banking entity
would not need to examine additional financial
reports to determine its compliance obligations.
118 See, e.g., Bank of Oklahoma; KeyCorp; BPI;
and Capital One et al Banks.
115 See
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certain types of instruments.119 The
agencies support banking entities
relying on current regulatory reporting
forms to the extent possible to
determine their compliance obligations
under the final rule. As discussed
above, the calculation of significant
trading assets and liabilities, moderate
trading assets and liabilities, and
limited trading assets and liabilities is
based on a four-quarter average, and
therefore would not require daily or
more frequent monitoring of trading
assets and liabilities.120
A few commenters encouraged the
agencies to include transition periods
for a banking entity that moves to a
higher compliance tier, to allow the
banking entity time to comply with the
different expectations under the
compliance tier.121 Some commenters
said that the regulations should permit
a banking entity to breach a threshold
for a higher compliance category
without needing to comply with the
heightened compliance requirements
applicable to banking entities with that
level of trading assets and liabilities,
provided the banking entity’s trading
assets and liabilities drop below the
relevant threshold within a limited
period of time.122 The final rule does
not adopt transition periods or cure
periods as recommended by
commenters. The calculation of a
banking entity’s trading assets and
liabilities is calculated based on a 4quarter average, which should provide
banking entities with ample notice to
come into compliance with the
requirements of the final rule when
crossing from having limited to
moderate trading assets and liabilities,
or from moderate to significant trading
assets and liabilities.123
One commenter recommended that
the agencies provide for notice and
response procedures prior to exercising
the reservation of authority to require a
banking entity to apply the
requirements of a higher compliance
program tier, and, if a banking entity is
determined to be required to apply
increased compliance program
requirements, it should be given a twoyear conformance period to come into
compliance with such requirements.124
After considering this comment, the
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119 See,
e.g., BMO and Capital One et al.
final rule § ll.2(s)(1)(i), (ee)(1)(i).
121 See, e.g., ABA; BPI; Custody Banks; Capital
One et al.; and State Street.
122 See State Street.
123 A banking entity approaching a compliance
threshold is encouraged to contact its primary
financial regulatory agency to discuss the steps the
banking entity should take to satisfy its compliance
obligations under the new threshold.
124 See BPI.
120 See
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agencies believe that the notice and
response procedures provided in the
proposal for rebutting the presumption
of compliance for banking entities with
limited trading assets and liabilities
would also be appropriate with respect
to an agency exercising this reservation
of authority. However, the agencies
believe that providing an automatic twoyear conformance period would be
inappropriate, especially in instances
where the agency has concerns
regarding evasion of the requirements of
the final rule. Therefore, the agencies
are adopting the reservation of authority
with a modification to require that the
agencies exercise such authority in
accordance with the notice and
response procedures in section
ll.20(i) of the final rule.125 To the
extent that an agency exercises this
authority to require a banking entity to
apply increased compliance program
requirements, an appropriate
conformance period shall be determined
through the notice and response
procedures.
B. Subpart B—Proprietary Trading
Restrictions
Section 13(a)(1)(A) of the BHC Act
prohibits a banking entity from engaging
in proprietary trading unless otherwise
permitted in section 13. Section 13(h)(4)
of the BHC Act defines proprietary
trading, in relevant part, as engaging as
principal for the trading account of the
banking entity in any transaction to
purchase or sell, or otherwise acquire or
dispose of, a security, derivative,
contract of sale of a commodity for
future delivery, or other financial
instrument that the agencies include by
rule. Section 13(h)(6) of the BHC Act
defines ‘‘trading account’’ to mean any
account used for acquiring or taking
positions in the securities and
instruments described in section
13(h)(4) principally for the purpose of
selling in the near term (or otherwise
with the intent to resell in order to
profit from short-term price
movements), and any such other
accounts as the agencies, by rule
determine.126 Section 3 of the
implementing regulations defines
‘‘proprietary trading,’’ ‘‘trading
account,’’ and several related
definitions.
1. Section ll.3: Prohibition on
Proprietary Trading and Related
Definitions
a. Trading Account
The 2013 rule’s definition of trading
account includes three prongs and a
rebuttable presumption. The short-term
intent prong includes within the
definition of trading account the
purchase or sale of one or more
financial instruments principally for the
purpose of (A) short-term resale, (B)
benefitting from actual or expected
short-term price movements, (C)
realizing short-term arbitrage profits, or
(D) hedging one or more positions
resulting from the purchases or sales of
financial instruments for the foregoing
purposes.127 Under the 2013 rule’s
rebuttable presumption, the purchase
(or sale) of a financial instrument by a
banking entity is presumed to be for the
trading account under the short-term
intent prong if the banking entity holds
the financial instrument for fewer than
sixty days or substantially transfers the
risk of the financial instrument within
sixty days of the purchase (or sale). A
banking entity could rebut the
presumption by demonstrating, based
on all relevant facts and circumstances,
that the banking entity did not purchase
(or sell) the financial instrument
principally for any of the purposes
described in the short-term intent
prong.128
The market risk capital rule prong
(market risk capital prong) includes
within the definition of trading account
the purchase or sale of one or more
financial instruments that are both
covered positions and trading positions
under the market risk capital rule (or
hedges of other covered positions under
the market risk capital rule), if the
banking entity, or any affiliate of the
banking entity, is an insured depository
institution, bank holding company, or
savings and loan holding company, and
calculates risk-based capital ratios
under the market risk capital rule.129
Finally, the dealer prong includes
within the definition of trading account
any purchase or sale of one or more
financial instruments for any purpose if
the banking entity (A) is licensed or
registered, or is required to be licensed
or registered, to engage in the business
of a dealer, swap dealer, or securitybased swap dealer, to the extent the
instrument is purchased or sold in
connection with the activities that
require the banking entity to be licensed
or registered as such; or (B) is engaged
in the business of a dealer, swap dealer,
or security-based swap dealer outside of
the United States, to the extent the
instrument is purchased or sold in
2013 rule § ll.3(b)(1)(i).
2013 rule § ll.3(b)(2).
129 See 2013 rule § ll.3(b)(1)(ii).
127 See
final rule § ll.20(i).
126 12 U.S.C. 1851(h)(6).
125 See
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128 See
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connection with the activities of such
business.130
The proposal would have replaced the
2013 rule’s short-term intent prong with
a new third prong based on the
accounting treatment of a position (the
accounting prong). The proposal also
would have added a presumption of
compliance with the proposed rule’s
prohibition on proprietary trading for
trading desks whose activities are not
covered by the market risk capital prong
or the dealer prong if the activities did
not exceed a specified quantitative
threshold. The proposal would have
retained a modified version of the
market risk capital prong and would
have retained the dealer prong
unchanged from the 2013 rule. As
described in detail below, the final rule
retains the three-pronged definition of
trading account from the 2013 rule and
does not adopt the proposed accounting
prong or presumption of compliance
with the proprietary trading prohibition.
Rather, the final rule makes targeted
changes to the definition of trading
account.
Among other changes, the final rule
eliminates the 2013 rule’s rebuttable
presumption and replaces it with a
rebuttable presumption that financial
instruments held for sixty days or more
are not included in the trading account
under the short-term intent prong.131
The agencies believe that the market
risk capital prong, which expressly
includes certain short-term trading
activities, is an appropriate
interpretation of the statutory definition
of trading account for all firms subject
to the market risk capital rule.132
Therefore, the final rule provides that
banking entities that are subject to the
market risk capital prong are not subject
to the short-term intent prong.133
However, the final rule provides that
130 See 2013 rule § ll.3(b)(1)(iii). An insured
depository institution may be registered as a swap
dealer, but only the swap dealing activities that
require it to be so registered are covered by the
dealer trading account. If an insured depository
institution purchases or sells a financial instrument
in connection with activities of the insured
depository institution that do not trigger registration
as a swap dealer, such as lending, deposit-taking,
the hedging of business risks, or other end-user
activity, the financial instrument is included in the
trading account only if the instrument falls within
the definition of trading account under at least one
of the other prongs. See 79 FR at 5549.
131 See final rule § ll.3(b)(4).
132 See 12 U.S.C. 1851(h)(6); see also Instructions
for Preparation of Consolidated Financial
Statements for Holding Companies, Trading Assets
and Liabilities, Schedule HC–D, available at https://
www.federalreserve.gov/reportforms/forms/FR_Y9C20190731_i.pdf, and Instructions for Preparation
of Consolidated Reports of Condition and Income,
Schedule RC–D, available at https://www.ffiec.gov/
pdf/FFIEC_forms/FFIEC031_FFIEC041_201803_
i.pdf.
133 See final rule § ll.3(b)(2)(i).
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banking entities that are subject to the
short-term intent prong may elect to
apply the market risk capital prong
instead of the short-term intent
prong.134 These changes are designed to
simplify and tailor the trading account
definition in a manner that is consistent
with section 13 of the BHC Act and
applicable safety and soundness
standards.
i. Accounting Prong
The proposed accounting prong
would have provided that ‘‘trading
account’’ meant any account used by a
banking entity to purchase or sell one or
more financial instruments that is
recorded at fair value on a recurring
basis under applicable accounting
standards.135 Such instruments
generally include, but are not limited to,
derivatives, trading securities, and
available-for-sale securities. The
proposed inclusion of this prong in the
definition of ‘‘trading account’’ was
intended to provide greater certainty
and clarity to banking entities than the
short-term intent prong in the 2013 rule
about which transactions would be
included in the trading account, because
banking entities could more readily
determine which positions are recorded
at fair value on their balance sheets.136
Many commenters strongly opposed
replacing the short-term intent prong
with the accounting prong.137 These
commenters asserted that the
accounting prong could inappropriately
scope in, among other things: Over $400
billion in available-for-sale debt
securities; 138 certain long term
investments; 139 static hedging of long
term investments; 140 traditional assetliability management activities; 141
derivative transactions entered into for
any purpose and duration; 142 long-term
holdings of commercial mortgagebacked securities; 143 seed capital
final rule § ll.3(b)(2)(ii).
proposed rule § ll.3(b)(3); 83 FR at
33447–48.
136 See 83 FR at 33447–48.
137 See, e.g., BOK; New York Community Bank
(NYCB); IAA; ABA; KeyCorp; International Swaps
and Derivatives Association (ISDA); Mortgage
Bankers Association (MBA); Commercial Real
Estate Finance Council (CREFC), Mortgage Bankers
Association, and the Real Estate Roundtable (Real
Estate Associations); State Street; Chatham
Financial et al. (Chatham); Capital One et al.; BPI;
FSF; Goldman Sachs; SIFMA; Center for Capital
Markets Competitiveness (CCMC); IIB; Credit
Suisse; EBF; and Arvest.
138 See, e.g., BPI and SIFMA.
139 See, e.g., Capital One et al.; BPI; SIFMA; and
CCMR.
140 See, e.g., BPI and ISDA.
141 See, e.g., KeyCorp; BPI; Capital One et al.;
FSF; and Goldman Sachs.
142 See e.g., ISDA and BPI.
143 See MBA.
134 See
135 See
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investments; 144 investments that are
expressly permitted under the covered
fund provisions; 145 investments in
connection with employee
compensation; 146 bank holding
company-permissible investments in
enterprises engaging in activities that
are part of the business of banking or
incidental thereto, as well as other
investments made pursuant to the BHC
Act; 147 and financial holding company
merchant banking investments.148 Some
commenters argued that the accounting
prong was inconsistent with the
statute; 149 would lead to increased
regulatory burden and uncertainty; 150
could encourage banking entities not to
elect to account for financial
instruments at fair value, thereby
reducing transparency into banking
entities’ financial reporting and
frustrating risk management practices
that are based on the fair value
option; 151 could result in disparate
treatment of the same activity between
two banking entities where one banking
entity elects the fair value option and
the other does not; 152 would have a
disproportionately negative impact on
midsize and regional banks; 153 could
negatively impact the securitization
industry if liquidity for asset-backed
securities is impeded; 154 could
inappropriately scope in investment
advisers’ use of seed capital to develop
products, services, or strategies for asset
management clients; 155 could lead to
increased burden for international banks
by requiring them to apply both local
accounting standards and U.S. generally
accepted accounting principles (GAAP)
to non-U.S. positions, one for regular
accounting purposes and one
specifically for assessing compliance
with the regulations implementing
section 13 of the BHC Act; 156 that the
exclusions and exemptions from the
prohibition on proprietary trading in the
2013 rule are ill-suited with respect to
positions captured by the accounting
prong; 157 and that fair valuation of
144 See, e.g., ICI; Capital One et al.; Credit Suisse;
FSF; and SIFMA.
145 See, e.g., Capital One et al. and BPI.
146 See, e.g., Capital One et al. and BPI.
147 See Capital One et al.
148 See Capital One et al.
149 See, e.g., Capital One et al.; CCMC; IAA; ABA;
ISDA; Credit Suisse; CREFC; BPI; FSF; Goldman
Sachs; and SIFMA.
150 See, e.g., CCMC; JBA; Structured Finance
Industry Group (SFIG); IIB; American Action
Forum; ABA; BPI; ISDA; and SIFMA.
151 See, e.g., BPI and IIB.
152 See BPI.
153 See, e.g., BOK; ABA; and NYCB.
154 See SFIG.
155 See IAA.
156 See IIB.
157 See, e.g., SIFMA; BPI; CCMR; FSF; and BB&T.
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assets and liabilities under applicable
accounting standards is not indicative of
short-term trading intent.158
Some commenters expressed a
preference for the 2013 rule’s short-term
intent prong over the accounting
prong.159 Other commenters suggested
revisions to the accounting prong if
adopted, such as excluding from the
definition of trading account any
financial instrument for which financial
institutions record the change in value
in other comprehensive income; 160
expressly excluding available-for-sale
portfolios from the accounting prong; 161
and clarifying that non-U.S. banking
entities are permitted to use accounting
standards adopted by individual
banking entities other than International
Financial Reporting Standards and
GAAP.162 One commenter expressed
concern that a banking entity could
circumvent the prohibition on
proprietary trading by recording
financial instruments at amortized cost
instead of fair value.163
Some commenters supported
adopting the accounting prong.164 One
commenter urged the agencies to retain
the short-term intent prong and to adopt
the accounting prong as an additional
test without any presumption of
compliance.165 Another commenter
argued that the accounting prong should
be implemented as a new presumption
within the short-term trading prong.166
This commenter urged the agencies to
revise the accounting prong by
codifying language from the applicable
accounting standards and coupling this
with preamble language indicating that
the agencies intend to interpret the
accounting prong in a manner that is
consistent with GAAP and international
accounting codifications and guidance,
thereby allowing the agencies to
definitively interpret the text rather than
accounting authorities, who might not
consider the regulations implementing
section 13 of the BHC Act when making
further changes to accounting
standards.167
After considering all comments
received,168 the agencies are not
158 See, e.g., Capital One et al.; ABA; BPI; FSF;
SIFMA; and Credit Suisse.
159 See, e.g., Chatham; BPI; SIFMA; IIB; Credit
Suisse; and Arvest.
160 See BOK.
161 See BOK.
162 See JBA.
163 See Volcker Alliance.
164 See, e.g., Public Citizen; CAP; Better Markets;
and AFR.
165 See CAP.
166 See Better Markets.
167 See Better Markets.
168 See, e.g., BOK; NYCB; IAA; ABA; KeyCorp;
ISDA; MBA; Real Estate Associations; State Street;
Chatham; Capital One et al.; BPI; FSF; Goldman
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adopting the accounting prong in the
final rule. The agencies agree with
commenters’ concerns that the
accounting prong would have
inappropriately scoped in many
financial instruments and activities that
section 13 of the BHC Act was not
intended to capture, including some
long-term investments. In addition, the
accounting prong would have
inappropriately scoped in entire
categories of financial instruments,
regardless of the banking entity’s
purpose for buying or selling the
instrument, such as all derivatives and
equity securities with a readily
determinable fair value. Furthermore,
the accounting prong would have
captured certain seeding activity that
would otherwise be permitted under
subpart C of the regulations
implementing section 13 of the BHC
Act. As noted in the preamble to the
proposed rule, the impetus behind
replacing the short-term intent prong
with the accounting prong was to
address the uncertain application of the
short-term intent prong to certain
trades.169 As discussed in detail below,
the agencies have modified the shortterm intent prong to provide more
clarity. The agencies have also provided
further clarity to the trading account
definition in the final rule by adding
additional exclusions from the
‘‘proprietary trading’’ definition. The
agencies are adopting these clarifying
measures as a more tailored approach to
address the difficulties that have arisen
under the existing short-term intent
prong.
ii. Presumption of Compliance With the
Prohibition on Proprietary Trading
Under the accounting prong, the
proposal would have added a
presumption of compliance with the
proprietary trading prohibition based on
an objective, quantitative measure of a
trading desk’s activities.170 Under this
proposed presumption of compliance,
the activities of a trading desk of a
banking entity that are not covered by
the market risk capital prong or the
dealer prong— i.e., the activities that
would be within the trading account
under the proposed accounting prong—
would have been presumed to comply
with the proposed rule’s prohibition on
proprietary trading if the activities did
not exceed a specified quantitative
threshold. The trading desk would have
remained subject to the prohibition on
Sachs; SIFMA; CCMC; IIB; Credit Suisse; EBF;
CREFC; and Arvest.
169 See 83 FR at 33448.
170 See proposed rule § ll.3(c); 83 FR at 33449–
51.
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61985
proprietary trading and, unless the desk
engaged in a material level of trading
activity (or the presumption of
compliance was rebutted), the desk
would not have been required to comply
with the more extensive requirements
that would otherwise apply under the
proposal to demonstrate compliance.
The agencies proposed to use the
absolute value of the trading desk’s
profit and loss on a 90-calendar-day
rolling basis as the relevant quantitative
measure for this threshold.
Two commenters supported adopting
the presumption of compliance with the
prohibition on proprietary trading.171
Several commenters opposed adopting
this presumption of compliance.172
Some of these commenters argued that
the presumption of compliance could
allow banks to evade the restrictions on
proprietary trading by splitting trades
over multiple trading desks.173 One of
these commenters suggested that the
presumption of compliance for trading
desk activities that would have been
within the trading account under the
accounting prong in the proposed rule
could invite proprietary trading within
the $25 million threshold.174 Another
commenter had several concerns with
this proposal, including that not all
businesses calculate daily profits and
losses, and that even businesses that do
not sell a single position within a 90day period might exceed $25 million in
unrealized gains and losses.175 Two
commenters asserted there is no
statutory basis to permit a de minimis
amount of proprietary trading.176 Other
commenters asserted that the
presumption could increase regulatory
burden.177 Several commenters argued
that, if the presumption is adopted, the
threshold should be increased,178 or the
method of calculating profit and loss
should be modified.179 Many
commenters stated that the proposed
trading desk-level presumption of
compliance did not adequately address
the overbreadth of the accounting
prong.180
After considering the comments, the
agencies have decided not to adopt a
trading desk-level presumption of
compliance with the prohibition on
171 See,
e.g., New England Council and CFA.
e.g., Volcker Alliance; Public Citizen;
CAP; Bean; Feng; AFR; and Better Markets.
173 See, e.g., Volcker Alliance; Public Citizen;
CAP; and Bean.
174 See Public Citizen.
175 See IIB.
176 See, e.g., Bean and CAP.
177 See, e.g., BOK; BPI; IIB; and JBA.
178 See, e.g., BOK; BPI; IIB; and Capital One et al.
179 See, e.g., CFA.
180 See, e.g., Capital One et al.; BPI; FSF; and
SIFMA.
172 See,
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proprietary trading. As discussed in the
preamble to the proposal, this
presumption of compliance would have
been available only for a trading desk’s
activities that would have been within
the trading account under the proposed
accounting prong, and not for a trading
desk that is subject to the market risk
capital prong or the dealer prong of the
trading account definition. This
presumption of compliance was
intended to address the potential impact
of the accounting prong, which the
proposal recognized would have been a
significant change from the 2013 rule. In
particular, the proposal noted that the
proposed trading desk-level
presumption of compliance with the
prohibition on proprietary trading was
intended to allow banking entities to
conduct ordinary banking activities
without having to assess every
individual trade for compliance with
subpart B of the implementing
regulations and the proposed
accounting prong.181 Since the agencies
are not adopting the accounting prong
and are adopting additional clarifying
revisions to the short-term intent prong,
the agencies have determined it is not
necessary to adopt the presumption of
compliance.
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iii. Short-Term Intent Prong
The 2013 rule’s short-term intent
prong included within the definition of
trading account the purchase or sale of
one or more financial instruments
principally for the purpose of (A) shortterm resale, (B) benefitting from actual
or expected short-term price
movements, (C) realizing short-term
arbitrage profits, or (D) hedging one or
more positions resulting from the
purchases or sales of financial
instruments for the foregoing
purposes.182 Under the 2013 rule’s
rebuttable presumption, the purchase
(or sale) of a financial instrument by a
banking entity was presumed to be for
the trading account under the short-term
intent prong if the banking entity held
the financial instrument for fewer than
sixty days or substantially transferred
the risk of the financial instrument
within sixty days of the purchase (or
sale). A banking entity could rebut the
presumption by demonstrating, based
on all relevant facts and circumstances,
that the banking entity did not purchase
(or sell) the financial instrument
principally for any of the purposes
described in the short-term intent
prong.183
181 See
83 FR at 33449.
2013 rule § ll.3(b)(1)(i).
183 See 2013 rule § ll.3(b(2).
182 See
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Several commenters stated that, for
banking entities that are subject to the
market risk capital prong, the short-term
intent prong is redundant.184 In
addition, several commenters stated that
the final rule should eliminate the shortterm intent prong altogether, as
proposed.185 Other commenters stated
that, consistent with the statutory
definition of trading account, the
agencies should not eliminate the shortterm intent prong.186 One commenter
suggested re-adopting the short-term
intent prong but defining the term
‘‘short-term’’ differently based on asset
class.187 Several commenters supported
retaining the short-term intent prong
with modifications, such as eliminating
or reversing the rebuttable presumption
or aligning the short-term intent prong
more closely with the market risk
capital prong.188 The agencies agree that
there is substantial overlap between the
short-term intent prong and the market
risk capital prong and have revised the
definition of trading account
accordingly.
Under the final rule, the definition of
trading account includes any account
that is used by a banking entity to
purchase or sell one or more financial
instruments principally for the purpose
of short-term resale, benefitting from
actual or expected short-term price
movements, realizing short-term
arbitrage profits, or hedging one or more
of the positions resulting from the
purchases or sales of financial
instruments for the foregoing
purposes.189 The agencies believe that it
is necessary to include a prong other
than the market risk capital prong or the
dealer prong to define ‘‘trading account’’
for banking entities that are subject to
the final rule but are not subject to the
market risk capital prong. The agencies
believe that requiring banking entities
that are not subject to the market risk
capital rule to apply the market risk
capital prong in order to identify the
scope of positions subject to the Volcker
Rule’s proprietary trading provisions
could be unduly complex and
burdensome for banking entities with
smaller and less active trading activities.
The final rule allows a banking entity
not subject to the market risk capital
prong to define its trading account by
reference to either the short-term intent
184 See, e.g., Capital One et al.; BPI; FSF;
KeyCorp; and SIFMA.
185 See, e.g., JBA; Credit Suisse; CREFC; and
SIFMA.
186 See AFR and Bean.
187 See Occupy the SEC.
188 See, e.g., SIFMA; BPI; State Street; Chatham;
FSF; CCMR; ABA; KeyCorp; Capital One et al.;
Arvest; and IIB.
189 See final rule § ll.3(b)(1)(i).
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prong or the market risk capital prong
because both tests are consistent with
the statutory definition of trading
account; this flexible approach for
banking entities with less trading
activities is appropriate for various
reasons, including because these
banking entities are already familiar
with the short-term intent prong.190
Under the final rule, the regulatory
short-term intent prong applies only to
a banking entity that is not subject to the
market risk capital prong and that has
not elected to apply the market risk
capital prong to determine the scope of
the banking entity’s trading account.191
For purposes of the final rule, a banking
entity is subject to the market risk
capital prong if it, or any affiliate with
which the banking entity is
consolidated for regulatory reporting
purposes, calculates risk-based capital
ratios under the market risk capital
rule.192 Applying the short-term intent
prong only to banking entities whose
trading account is not covered by the
market risk capital prong will simplify
application of the rule. No longer
applying the short-term intent prong to
banking entities that are subject to the
market risk capital prong is appropriate
because the scope of activities captured
by the short-term intent prong is
substantially similar to the scope of
activities captured by the market risk
capital prong. Indeed, the preamble to
the 2013 rule noted that the definition
of trading position in the market risk
capital rule largely parallels the
statutory definition of trading
account,193 which in turn mirrors the
language in the short-term intent prong.
Accordingly, the agencies believe that a
banking entity should be subject either
to the short-term intent prong or to the
market risk capital prong, but not
both.194
The final rule allows a banking entity
that is not subject to the market risk
capital prong to elect to apply the
market risk capital prong in place of the
short-term intent prong.195 The final
rule includes this option to provide
parity between smaller banking entities
that are not subject to the market risk
capital rule and larger banking entities
with active trading businesses that are
190 See
12 U.S.C. 1851(h)(6).
final rule § ll.3(b)(2)(i), (ii).
192 See 12 CFR part 3, subpart F; part 217, subpart
F; part 324, subpart F.
193 See 79 FR at 5548.
194 A number of commenters suggested that, due
to the overlap between the market risk capital prong
and the short-term intent prong, banking entities
that are subject to the market risk capital prong
should not also be subject to the short-term intent
prong. See, e.g., Capital One et al.; BPI; FSF;
Goldman Sachs; CREFC; and SIFMA.
195 See final rule § ll.3(b)(2)(ii).
191 See
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subject to the market risk capital
prong.196 Under the final rule, a banking
entity that is not subject to the market
risk capital rule may choose to define its
trading account as if the banking entity
were subject to the market risk capital
prong. If a banking entity opts into the
market risk capital prong, the banking
entity’s trading account would include
all accounts used by the banking entity
to purchase or sell one or more financial
instruments that would be covered
positions and trading positions under
the market risk capital rule if the
banking entity were subject to the
market risk capital rule. Banking entities
that do not make this election will
continue to apply the short-term intent
prong.
Under the final rule, an election to
apply the market risk capital prong must
be consistent among a banking entity
and all of its wholly owned
subsidiaries.197 This consistency
requirement is intended to facilitate
banking entities’ compliance with the
proprietary trading prohibition by
subjecting wholly owned legal entities
within a firm to the same definition.
Requiring a consistent definition of
‘‘trading account’’ is particularly
important to simplify compliance
because a trading desk may book trades
into different legal entities within an
organization, and having a consistent
definition of ‘‘trading account’’ among
these entities should help ensure that
each banking entity can identify
relevant trading activity and meet its
compliance obligations under the final
rule. This requirement is also expected
to facilitate the agencies’ supervision of
compliance with the final rule. This
consistency requirement would apply
only to a banking entity and its wholly
owned subsidiaries. In the case of
minority-owned subsidiaries or other
subsidiaries that the banking entity does
not functionally control, it may be
impractical for one banking entity
within the organization to ensure that
all affiliates will make a consistent
election. However, the relevant primary
financial regulatory agency may subject
a banking entity that is not a wholly
196 Several commenters recommended defining
the trading account solely by reference to the dealer
prong and market risk capital prong for banking
entities subject to the market risk capital rule. See,
e.g., Capital One et al.; BPI; FSF; Goldman Sachs;
CREFC; and SIFMA. One commenter suggested that
banking entities that are not subject to the market
risk capital rule and subject to a third prong should
be allowed to elect to be treated as a banking entity
subject to the market risk capital rule for purposes
of the regulations implementing section 13 of the
BHC Act. This approach would maintain parity
between banking entities that are subject to the
market risk capital rule and those that are not. See
SIFMA.
197 See final rule § ll.3(b)(3).
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owned subsidiary to the consistency
requirement if the agency determines it
is necessary to prevent evasion of the
rule’s requirements. When exercising
this authority, the relevant primary
financial regulatory agency will follow
the same notice and response
procedures used elsewhere in the final
rule.
iv. 60-Day Rebuttable Presumption
The proposal would have eliminated
the 2013 rule’s 60-day rebuttable
presumption. Many commenters
supported the proposed rule’s
elimination of this rebuttable
presumption.198 Some commenters
urged the agencies to establish a
presumption that positions held for
more than 60 days are not proprietary
trading.199 Some commenters suggested
that the agencies should presume, for
banking entities not subject to the
market risk capital rule, that financial
instruments held for longer than 60
days, or that have an original maturity
or remaining maturity upon acquisition
of fewer than 60 days to their stated
maturities, are not for the banking
entity’s trading account.200 One
commenter suggested that any third
prong to the definition of trading
account that applies to banking entities
that are not subject to the market risk
capital rule should have a rebuttable
presumption that any position held by
the banking entity as principal for 60
days or more is not for the trading
account, as well as a reasonable
challenge procedure through which a
banking entity would be provided an
opportunity to demonstrate to its
primary financial regulatory agency that
positions held for fewer than 60 days do
not constitute proprietary trading.201
Several commenters asked that the
agencies—if they do not eliminate the
presumption—provide guidance on the
rebuttal process,202 or make certain
revisions to the presumption, such as
revising the ‘‘substantial transfer of
risk’’ language; 203 exempting financial
instruments close to maturity; 204 and
excluding hedging activity.205 Some
commenters argued, in contrast, that the
60-day rebuttable period was underinclusive.206 One commenter argued
198 See, e.g., State Street; Chatham; BPI; FSF;
CCMR; and CFA.
199 See, e.g., ABA; KeyCorp; Capital One et al.;
State Street; and Arvest.
200 See, e.g., ABA; Arvest; BPI; SIFMA; and IIB.
201 See SIFMA.
202 See, e.g., ABA; Arvest; BPI; SIFMA; State
Street; and FSF.
203 See, e.g., ABA and Arvest.
204 Id.
205 See Capital One et al.
206 See AFR and Occupy the SEC.
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61987
that any position purchased or sold
within 180 days should be
automatically included within the
definition of trading account, or, in the
alternative, that the presumption should
be extended from 60 to 180 days, and
the agencies should mandate ongoing
monitoring and disclosure of all
components, excluded or not, of the
banking entities’ reported trading
account assets.207 This commenter also
argued that there should not be a
presumption that certain positions are
not within the trading account; that
documentation requirements for
rebutting the presumption should be
clearly specified and the criteria more
restrictive; that all arbitrage positions
should be presumed to be trading
positions; and that the definition of
‘‘short-term’’ should vary by asset class.
Another commenter generally opposed
eliminating the 60-day rebuttable
presumption.208
After considering all comments
received, the agencies are eliminating
the 60-day rebuttable presumption from
the 2013 rule and establishing a new
rebuttable presumption that financial
instruments held for sixty days or more
are not within the short-term intent
prong. Since the 2013 rule came into
effect, the agencies have found that the
rebuttable presumption has captured
many activities that should not be
included in the definition of proprietary
trading,209 which, under the statute,
only covers buying and selling financial
instruments principally for the purpose
of selling in the near term (or otherwise
with the intent to resell in order to
profit from short-term price
movements).210 Several commenters
supported eliminating the 2013 rule’s
rebuttable presumption for this reason
or due to difficulties in rebutting the
presumption.211 Given the type of
activities that have triggered the 2013
rule’s rebuttable presumption but that
are not undertaken principally for the
purpose of selling in the near-term,212
207 See
Occupy the SEC.
Bean.
209 For example, asset-liability, liquidity
management activities, transactions to correct error
trades and loan-related swaps. See Part IV.B.2.b.i–
iii.
210 12 U.S.C. 1851(h)(4) and (6).
211 See, e.g., State Street; Chatham; BPI; FSF;
CCMR; and CFA.
212 Such activities include a foreign branch of a
U.S. banking entity purchasing a foreign sovereign
debt obligation with remaining maturity of fewer
than 60 days in order to meet foreign regulatory
requirements. Similarly, error correcting trades and
matched derivative transactions, discussed infra
may have triggered the 2013 rule’s rebuttable
presumption but are not undertaken principally for
the purpose of selling in the near term (or otherwise
208 See
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the agencies have concluded that it is
not appropriate to continue to presume
short-term trading intent from holding a
financial instrument for fewer than 60
days.
However, the agencies recognize the
utility for both the agencies and the
subject banking entities of an objective
time-based standard.213 The final rule
contains a new rebuttable presumption:
The purchase or sale of a financial
instrument presumptively lacks shortterm trading intent if the banking entity
holds the financial instrument for 60
days or longer and does not transfer
substantially all of the risk of the
financial instrument within 60 days of
the purchase (or sale).214 The agencies
agree with commenters that a banking
entity subject to the short-term intent
prong that holds an instrument for at
least 60 days should receive the benefit
of a presumption that the trade was not
entered into for the purpose of selling in
the near term or otherwise with the
intent to resell in order to profit from
short-term price movements. Replacing
the 2013 rule’s rebuttable presumption
with a rebuttable presumption that
financial instruments held for sixty days
or longer are not within the short-term
intent prong will provide clarity for
banking entities with respect to such
positions, without imposing the burden
associated with the 2013 rule’s
rebuttable presumption.
In light of the revision to the 60-day
rebuttable presumption, the agencies do
not believe it is necessary to provide a
formal challenge procedure with respect
to financial instruments that are
purchased or sold within 60 days.
Under the final rule, such activity is no
longer presumptively within a banking
entity’s trading account.
As in the 2013 rule, the final rule’s
presumption only applies to the shortterm intent prong and does not apply to
the market risk capital or dealer prongs
v. Market Risk Capital Prong
Modification
The proposal would have revised the
market risk capital prong to apply to the
activities of foreign banking
organizations (FBOs) to take into
account the different market risk
frameworks FBOs may have in their
home countries.215 Specifically, the
proposal included within the market
risk capital prong an alternative
definition that permitted a banking
with the intent to resell in order to profit from
short-term price movements).
213 See 79 FR at 5550; see also ABA; KeyCorp;
Capital One et al.; State Street; Arvest; and SIFMA.
214 See final rule § ll.3(b)(4).
215 See proposed rule § ll. 3(b)(1)(ii); 83 FR at
33447.
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entity that is not, and is not controlled
directly or indirectly by a banking entity
that is, located in or organized under the
laws of the United States or any State,
to include any account used by the
banking entity to purchase or sell one or
more financial instruments that are
subject to risk-based capital
requirements under a market risk
framework established by the homecountry supervisor that is consistent
with the market risk framework
published by the Basel Committee on
Banking Supervision (Basel Committee),
as amended from time to time.
One commenter asserted that, under
some foreign regulatory market risk
capital frameworks, this expansion
would capture positions that are not
held for short-term trading.216 This
commenter advocated adopting a
flexible approach where foreign banking
entities could exclude a position subject
to a foreign jurisdiction’s market risk
capital framework from the trading
account by demonstrating that the
position was not acquired for short-term
purposes or otherwise should not be
treated as a trading account position.217
After considering the comments on
this issue,218 the agencies have decided
not to modify the market risk capital
prong to incorporate foreign market risk
capital frameworks. The agencies
believe that relying on the short-term
intent prong, market risk capital prong,
and dealer prong will ensure consistent
treatment of U.S. and foreign banking
entities. Foreign banking entities that
are not subject to the market risk capital
rule may continue to use the short-term
intent prong to define their trading
accounts. However, a banking entity,
including a foreign banking entity, may
elect to apply the market risk capital
prong in determining the scope of its
trading account. As discussed above, a
banking entity that uses the market risk
capital prong to determine the scope of
its trading account is not also subject to
the short-term intent prong. This
approach will provide appropriate
parity between U.S. and foreign banking
entities and will also maintain
consistency with the statutory trading
account definition.219
Accordingly, the final rule retains a
market risk capital prong that is
216 See
IIB.
id.
218 See IIB (noting that the scope of some foreign
supervisory market risk capital frameworks may
capture positions that are not held solely for shortterm purposes and thus should be out of scope for
purposes of the final rule).
219 In the course of developing the final rule, the
agencies have considered the prudential actions of
foreign regulators in this area and the resulting
effects on U.S. and non-U.S. financial institutions
and the relevant markets in which they participate.
217 See
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substantially similar to that in the 2013
rule. The final rule’s market risk capital
prong includes within the definition of
trading account any account that is used
by a banking entity to purchase or sell
one or more financial instruments that
are both covered positions and trading
positions under the market risk capital
rule (or hedges of other covered
positions under the market risk capital
rule), if the banking entity, or any
affiliate that is consolidated with the
banking entity for regulatory reporting
purposes, calculates risk-based capital
ratios under the market risk capital
rule.220
In addition, the final rule includes a
transition period for banking entities as
they become subject to the market risk
capital prong.221 Under the final rule, if
a banking entity is subject to the shortterm intent prong and then becomes
subject to the market risk capital prong,
the banking entity may continue to
apply the short-term intent prong
instead of the market risk capital prong
for one year from the date on which it
becomes, or becomes consolidated for
regulatory reporting purposes with, a
banking entity that calculates risk-based
capital ratios under the market risk
capital rule. The agencies are adopting
this transition period to provide banking
entities a reasonable period to update
compliance programs.
The market risk capital rule includes
a position that is reported as a covered
position for regulatory reporting
purposes on applicable reporting
forms.222 Certain banking entities that
may be subject to, or elect to apply, the
220 See final rule § ll.3(b)(1)(ii). The final rule’s
market risk capital prong has, however, been
modified as compared to the 2013 rule to account
for a banking entity that is not consolidated with
an affiliate (for regulatory reporting purposes) that
calculates risk-based capital ratios under the market
risk capital rule. For example, the trading positions
of a broker-dealer that is not consolidated with its
parent bank holding company will not be included
in the holding company’s trading positions in the
holding company’s Form FR Y–9C. In such an
instance, even though the broker-dealer is affiliated
with an entity that calculates risk-based capital
ratios under the market risk capital rule, it would
not be subject to the market capital risk prong due
to the fact that the broker-dealer is not consolidated
with the affiliate for regulatory reporting purposes.
As a result, the broker-dealer would be subject to
the amended short-term intent prong and the dealer
prong (with respect to instruments purchased or
sold in connection with the activities that require
the broker-dealer to be licensed or registered as
such). It may, however, be able to elect to use the
market risk capital prong (as an alternative to the
short-term intent prong) by following the
procedures described above.
221 Unlike the Volcker Rule compliance program
requirements, which are based on average gross
trading assets and liabilities over the prior four
quarters, the thresholds in the market risk capital
rule are based on the most recent quarter.
222 See 12 CFR 3.202; 12 CFR 217.202; 12 CFR
324.202 (defining ‘‘covered position’’).
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market risk capital prong may not report
positions on applicable regulatory
reporting forms as trading assets or
trading liabilities. Therefore, the final
rule amends the definition of ‘‘market
risk capital rule covered position and
trading position’’ to clarify that this
definition includes any position that
meets the criteria to be a covered
position and a trading position, without
regard to whether the financial
instrument is reported as a covered
position or trading position on any
applicable regulatory reporting forms.
The final rule also modifies the
definition of ‘‘market risk capital rule’’
to update a cross-reference to the
Board’s capital rules and to clarify what
the applicable market risk capital rule
would be for a firm electing to apply the
market risk capital prong.223
vi. Dealer Prong
The proposal did not propose
revisions to the dealer prong. However,
several commenters requested that the
agencies clarify that not all purchases
and sales of financial instruments by a
dealer are captured by the dealer
prong.224 Specifically, these
commenters requested that the agencies
clarify that the dealer prong does not
capture purchases or sales made by a
dealer in a non-dealing capacity,
including financial instruments
purchased for long-term investment
purposes.225 Among other things, those
commenters noted that without such
modifications, the dealer prong may
require a position-by-position analysis
to confirm whether a long-term
investment is part of the trading
account. Another commenter requested
that the agencies revise the dealer prong
to ensure that derivatives activities
remain in the trading account without
regard to potential SEC and CFTC
actions on the de minimis thresholds or
other registration requirements, and that
such derivatives activities do not benefit
from any presumption of compliance.226
The final rule retains the 2013 rule’s
dealer prong without any substantive
change.227
223 See
12 CFR part 217.
e.g., BPI; FSF; and SIFMA.
225 See e.g., BPI; FSF; and SIFMA.
226 See Better Markets.
227 In response to the commenter, the agencies
clarify that banking entities that are licensed or
registered (or required to be licensed or registered)
as dealers, swap dealers, or security-based swap
dealers analyze the types of activities that would be
captured by the dealer prong without regard to the
de minimis thresholds for swap dealer or securitybased swap dealer registration. However, regardless
of whether a banking entity is so licensed or
registered, the banking entity is also required to
determine whether a purchase or sale of a financial
instrument would be captured by either the short-
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The final rule’s dealer prong includes
within the definition of trading account
any account that the banking entity uses
to purchase or sell one or more financial
instruments for any purpose if the
banking entity (A) is licensed or
registered, or is required to be licensed
or registered, to engage in the business
of a dealer, swap dealer, or securitybased swap dealer, to the extent the
instrument is purchased or sold in
connection with the activities that
require the banking entity to be licensed
or registered as such; or (B) is engaged
in the business of a dealer, swap dealer,
or security-based swap dealer outside of
the United States, to the extent the
instrument is purchased or sold in
connection with the activities of such
business.228 In response to commenters
and consistent with the 2013 rule, the
agencies reaffirm that a banking entity
may be licensed or registered as a
dealer, but only the types of activities
that require it to be so licensed or
registered are covered by the dealer
prong. Thus, if a banking entity
purchases or sells a financial instrument
in connection with activities that are not
the types of activities that would trigger
registration as a dealer, the purchase or
sale of the financial instrument is not
covered by the dealer prong. However,
it may be included in the trading
account under the short-term intent
prong or the market risk capital prong,
as applicable.229 Moreover, in response
to commenters’ concerns that the
existing rule may require dealers to
conduct a position-by-position analysis
of their trading activities to determine
whether a position is captured by the
dealer prong, the agencies believe that
the changes being adopted today,
particularly the exclusions for financial
instruments that are not trading assets
or liabilities,230 should help alleviate
those concerns by narrowing the range
of transactions covered by the rule.
b. Proprietary Trading Exclusions
Section ll.3 of the 2013 rule
generally prohibits a banking entity
from engaging in proprietary trading. In
addition to defining the scope of trading
activity subject to the prohibition on
proprietary trading, the 2013 rule also
provides several exclusions from the
definition of proprietary trading. Based
on experience implementing the 2013
rule, the agencies proposed modifying
the exclusion for liquidity management
and adopting new exclusions for
term intent prong or the market risk capital prong,
as applicable.
228 See final rule § ll.3(b)(1)(iii).
229 See final rule § ll.3(b)(1)(i), (ii).
230 See infra section IV.B.1.b.v.
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61989
transactions made to correct errors and
for certain offsetting swap transactions.
In addition, the agencies requested
comment regarding whether any
additional exclusions should be added,
for example, to address certain
derivatives entered into in connection
with a customer lending transaction.
The agencies are adopting the liquidity
management exclusion as proposed,
with a modification to encompass nondeliverable cross-currency swaps, and
additional exclusions for the following
activities: (i) Trading activity to correct
trades made in error, (ii) loan-related
and other customer accommodation
swaps, (iii) matched derivative
transactions, (iv) hedges of mortgage
servicing rights where trading in the
underlying mortgage servicing rights is
not prohibited by the rule; and (v)
financial instruments that do not meet
the definition of trading assets or
trading liabilities under applicable
reporting forms.
i. Liquidity Management Exclusion
Amendments
The 2013 rule excludes from the
definition of proprietary trading the
purchase or sale of securities for the
purpose of liquidity management in
accordance with a documented liquidity
management plan.231 This exclusion
contains several requirements. First, the
liquidity management exclusion is
limited by its terms to securities and
requires that transactions be conducted
pursuant to a liquidity management
plan that specifically contemplates and
authorizes the particular securities to be
used for liquidity management
purposes; describes the amounts, types,
and risks of securities that are consistent
with the banking entity’s liquidity
management plan; and the liquidity
circumstances in which the particular
securities may or must be used. Second,
any purchase or sale of securities
contemplated and authorized by the
plan must be principally for the purpose
of managing the liquidity of the banking
entity, and not for the purpose of shortterm resale, benefitting from actual or
expected short-term price movements,
realizing short-term arbitrage profits, or
hedging a position taken for such shortterm purposes. Third, the plan must
require that any securities purchased or
sold for liquidity management purposes
be highly liquid and limited to
instruments the market, credit, and
other risks of which the banking entity
does not reasonably expect to give rise
to appreciable profits or losses as a
result of short-term price movements.
Fourth, the plan must limit any
231 See
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securities purchased or sold for
liquidity management purposes to an
amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan. Fifth, the banking
entity must incorporate into its
compliance program internal controls,
analysis, and independent testing
designed to ensure that activities
undertaken for liquidity management
purposes are conducted in accordance
with the requirements of the 2013 rule
and the banking entity’s liquidity
management plan. Finally, the plan
must be consistent with the supervisory
requirements, guidance, and
expectations regarding liquidity
management of the agency responsible
for regulating the banking entity. The
2013 rule established these
requirements to provide some
safeguards to ensure that the liquidity
management exclusion is not misused
for the purpose of impermissible
proprietary trading.232 While some
safeguards around a banking entity’s
liquidity management are appropriate,
the restrictions under the 2013 rule have
limited the ability of banking entities to
engage in certain types of bona fide
liquidity management activities.
The proposal would have amended
the exclusion for liquidity management
activities to allow banking entities to
use foreign exchange forwards and
foreign exchange swaps, each as defined
in the Commodity Exchange Act,233 and
physically settled cross-currency swaps
(i.e., cross-currency swaps that involve
an actual exchange of the underlying
currencies) as part of their liquidity
management activities.234 Foreign
exchange forwards, foreign exchange
swaps, and physically settled crosscurrency swaps are often used by
trading desks of foreign branches and
subsidiaries of a U.S. banking entity to
manage liquidity in foreign
jurisdictions.235 The proposal would
have provided that a banking entity
could use foreign exchange forwards,
foreign exchange swaps, and physically
settled cross-currency swaps for
liquidity management purposes
provided that the use of such financial
instruments was in accordance with a
documented liquidity management
plan.236
232 See
79 FR at 5555.
7 U.S.C. 1a(24) and 1a(25).
234 See proposed rule § ll.3(e)(3).
235 See 83 FR at 33451–52
236 See id.
233 See
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Many commenters supported the
proposed expansion of activities
covered by the liquidity management
exclusion.237 However, some
commenters expressed the view that the
expansion did not go far enough and
should be expanded to include other
types of financial instruments.238 One
commenter asserted that expanding the
scope of the liquidity management
exclusion would streamline compliance
for banking entities without introducing
additional safety and soundness
concerns or the risk of impermissible
proprietary trading.239 Some
commenters said that non-deliverable
currency derivatives should also qualify
for the exclusion, because there are
some currencies for which physically
settled cross-currency swaps are not
available.240 Additionally, other
commenters argued that given the role
of derivatives in liquidity risk
management, the agencies should
expand the exclusion further to cover all
derivatives, including interest rate
swaps.241 Certain commenters suggested
that the agencies should further expand
the liquidity management exclusion to
include all financial instruments that
would be convenient and useful for
managing liquidity and asset-liability
mismatch risks of the organization.242
Several commenters claimed that the
eligibility criteria of the liquidity
management exclusion are opaque and
confusing, and suggested modifying,
clarifying, or eliminating some or all of
the requirements.243 For example,
several commenters argued that the
requirement to maintain a documented
liquidity management plan with certain
enumerated elements is unnecessarily
prescriptive.244 Some commenters
stated that banking entities do not rely
on the exclusion due to the number and
limiting nature of the requirements.245
Some commenters argued that the
agencies should be promoting, rather
than restricting, appropriate liquidity
management and structural interest rate
risk management activities, and that the
237 See, e.g., ISDA; Goldman Sachs; ABA; SIFMA;
IIB; BPI; GFMCA; CFA; New England Council,
CCMC; Capital One et al., FSF; and State Street.
238 See, e.g., ISDA; ABA; FSF; New England
Council; CCMC; Capital One et al.; Goldman Sachs;
SIFMA; IIB; Credit Suisse; and State Street.
239 See ISDA.
240 See, e.g., Global Financial Markets Association
(GFMA) (noting that certain non-deliverable
financial instruments are also used for liquidity
management purposes); SIFMA; State Street; JBA;
ABA; BPI; IIB; and Credit Suisse.
241 See, e.g., FSF; Capital One et al.; IIB; and JBA.
242 See, e.g., IIB and State Street.
243 See, e.g., Capital One et al.; BPI; JBA; SIFMA;
CCMC; and FSF.
244 See, e.g., ISDA; KeyCorp; IIB; CCMC; SIFMA;
and Goldman Sachs.
245 See, e.g., FSF and Credit Suisse.
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retention of these requirements is not
consistent with the removal of the
prescriptive requirements of Appendix
B in the 2013 rule.246 Other commenters
argued that the agencies should
eliminate the compliance-related
requirements and permit banking
entities to design and manage their
liquidity management function
according to their existing internal
compliance frameworks.247 In addition,
a commenter recommended clarifying
whether treasury functions within
banking entities may manage global
liquidity through the newly added
financial instruments.248
In contrast, other commenters did not
support the proposed expansion of the
liquidity management exclusion.249 One
commenter asserted that the proposed
rule fails to demonstrate the need for
providing banks greater opportunity to
use foreign currency transactions to
manage their liquidity needs when
those needs are already being met via
the securities markets.250 Another
commenter argued that the proposed
change would create concern for the
currency markets by making it easier for
trading desks to trade these instruments
for speculative purposes under the guise
of legitimate liquidity management.251
One commenter argued that the
proposal would encourage banking
entities to exclude impermissible trades
as liquidity management and engage in
speculative currency trading. As a
result, it would increase banks’ risktaking and moral hazard, reducing the
effectiveness of regulatory oversight.252
In addition, some commenters suggested
that the agencies did not provide
sufficient justification to support the
proposed changes to the exclusion.253
After reviewing the comments
received, the agencies are adopting the
liquidity management exclusion
substantially as proposed, but with a
modification to permit the use of nondeliverable cross-currency swaps. The
agencies recognize the various types of
financial instruments that can be used
by a banking entity for liquidity
management as noted by commenters.
However, the agencies continue to
believe, as stated in the proposal, that
the purpose of the expansion is to
streamline compliance for banking
entities operating in foreign
246 See,
e.g., SIFMA and Goldman Sachs.
e.g., BPI; IIB; and FSF.
248 See ABA.
249 See, e.g., Volcker Alliance; Data Boiler;
NAFCU; Public Citizen; CAP; Occupy the SEC; and
Merkley.
250 See Bean.
251 See Volcker Alliance.
252 See Data Boiler.
253 See, e.g., Public Citizen and Bean.
247 See,
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jurisdictions.254 Thus, the final rule
expands the liquidity management
exclusion to permit the purchase or sale
of foreign exchange forwards (as that
term is defined in section 1a(24) of the
Commodity Exchange Act (7 U.S.C.
1a(24)), foreign exchange swaps (as that
term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C.
1a(25)), and cross-currency swaps 255
entered into by a banking entity for the
purpose of liquidity management in
accordance with a documented liquidity
management plan.256
In response to commenters’ concerns
that physically settled cross-currency
swaps are not available for some
currencies (e.g., due to currency
controls), the exclusion also
encompasses non-deliverable crosscurrency swaps. For currencies where
physically settled cross-currency swaps
are not available, a banking entity may
have had to engage in procedures such
as using spot transactions or holding
currency at foreign custodians, which
could be inefficient. Allowing banking
entities to use non-deliverable crosscurrency swaps can provide greater
flexibility in conducting liquidity
management in these situations. Even
though physically settled cross-currency
swaps are available in many currencies,
the agencies believe it is appropriate to
allow non-deliverable cross-currency
swaps to be used for liquidity
management in all currencies. Requiring
physical settlement for some crosscurrency swaps but not others would
make the exclusion more difficult for
banking entities to use and for the
agencies to monitor, particularly if
currency controls change, causing the
list of currencies for which physical
settlement is permitted to change. These
administrative hurdles would negate
many of the benefits of allowing the use
of non-deliverable cross-currency
swaps.
Regarding the assertion that banking
entities could meet their liquidity needs
in the securities markets, the agencies
have found that, to the contrary, foreign
exchange forwards, foreign exchange
swaps, and cross-currency swaps are
254 See
83 FR at 33451–52.
proposed, the final rule defines a crosscurrency swap as a swap in which one party
exchanges with another party principal and interest
rate payments in one currency for principal and
interest rate payments in another currency, and the
exchange of principal occurs on the date the swap
is entered into, with a reversal of the exchange of
principal at a later date that is agreed upon for
when the swap is entered. This definition is
consistent with regulations pertaining to margin
and capital requirements for covered swap entities,
swap dealers, and major swap participants. See 12
CFR 45ll.2; 12 CFR 237.2; 12 CFR 349.2; 17 CFR
23.151.
256 See final rule § ll.3(d)(3).
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often used by trading desks to manage
liquidity both in the United States and
in foreign jurisdictions. As foreign
branches and subsidiaries of U.S.
banking entities often have liquidity
requirements mandated by foreign
jurisdictions, U.S. banking entities often
use foreign exchange products to
address currency risk arising from
holding this liquidity in foreign
currencies. Thus, these foreign exchange
products are important for liquidity
management and should be included in
the expansion of the liquidity
management exclusion.
The agencies believe that adding
foreign exchange forwards, foreign
exchange swaps, and cross-currency
swaps to the exclusion addresses the
primary liquidity management needs for
foreign entities, and therefore are
declining to expand the exclusion to
other products as suggested by some
commenters. While some commenters
asserted that further expanding the
liquidity management exclusion would
streamline compliance without
introducing additional safety and
soundness or proprietary trading
concerns, the agencies believe that the
range of financial instruments that will
qualify for the exclusion under the final
rule will be sufficient for managing
banking entities’ liquidity risks.
The final rule permits a banking
entity to purchase or sell foreign
exchange forwards, foreign exchange
swaps, and cross-currency swaps to the
same extent that a banking entity may
purchase or sell securities under the
liquidity management exclusion in the
2013 rule, and the conditions that apply
for securities transactions also apply to
transactions in foreign exchange
forwards, foreign exchange swaps, and
cross-currency swaps.257
The agencies acknowledge that, as
stated in the proposal, cross-currency
swaps generally are more flexible in
their terms, may have longer durations,
and may be used to achieve a greater
variety of potential outcomes, as
compared to foreign exchange forwards
and foreign exchange swaps.258
However, the agencies believe that the
requirement to conduct liquidity
management in accordance with a
documented liquidity management plan
appropriately limits the use of crosscurrency swaps to activities conducted
for liquidity management purposes, and
therefore banking entities’ use of these
swaps should not adversely affect
currency markets, as one commenter
warned. Under the plan, the purpose of
the transactions must be liquidity
257 See
258 See
PO 00000
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83 FR at 33452.
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61991
management. The timing of purchases
and sales, the types and duration of
positions taken and the incentives
provided to managers of these purchases
and sales must all indicate that
managing liquidity, and not taking
short-term profits (or limiting short-term
losses), is the purpose of these activities.
Thus, to be in compliance with the plan,
cross-currency swaps must be used
principally for the purpose of managing
the liquidity of the banking entity, and
not for the purpose of short-term resale,
benefitting from actual or expected
short-term price movements, realizing
short-term arbitrage profits, or hedging a
position taken for such short-term
purposes.259
Regarding the assertion from some
commenters that the compliance-related
requirements for the liquidity
management exclusion are opaque or
unnecessarily prescriptive, the agencies
believe it is important to retain these
requirements in order to provide clarity
in administration of the rule and to
protect against potential misuse of the
liquidity management exclusion for
proprietary trading. As noted above, the
documented liquidity management
plan, required under the 2013 rule and
retained in the final rule,260 is a key
element in assuring that liquidity
management is the purpose of the
relevant transactions. The agencies do
not believe that the final rule will stand
as an obstacle to or otherwise impair the
ability of banking entities to manage
their liquidity risks. Although other
changes to the 2013 rule in the final
rule, such as the elimination of
Appendix B, reflect efforts to tailor
compliance obligations, the agencies
believe it is important to be explicit in
maintaining targeted compliance
requirements for specific provisions of
the final rule, such as the liquidity
management exclusion.
The agencies believe that the six
required elements of the liquidity
management plan help to mitigate
commenters’ concerns that the proposal
would have encouraged banking entities
to exclude impermissible trades as
liquidity management or increase risktaking. Under the liquidity management
plan required by the final rule, the
exclusion does not apply to activities
undertaken with the stated purpose or
effect of hedging aggregate risks
incurred by the banking entity or its
affiliates related to asset-liability
mismatches or other general market
risks to which the entity or affiliates
may be exposed. Further, the exclusion
does not apply to any trading activities
259 See
260 See
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that expose banking entities to
substantial risk from fluctuations in
market values, unrelated to the
management of near-term funding
needs, regardless of the stated purpose
of the activities.261
This final rule also includes a change
to one of the liquidity management
exclusion’s requirements. The 2013 rule
requires that activity conducted under
the liquidity management exclusion be
consistent with applicable ‘‘supervisory
requirements, guidance, and
expectations.’’ 262 Consistent with
changes elsewhere in the final rule and
with the Federal banking agencies’
Interagency Statement Clarifying the
Role of Supervisory Guidance,263 the
agencies are removing references to
guidance and expectations from the
regulatory text of the liquidity
management exclusion. In addition, the
final rule includes conforming changes
that reflect the addition of foreign
exchange forwards, foreign exchange
swaps, and cross-currency swaps as
permissible contracts in conjunction
with the other criteria under the
exclusion.264
ii. Transactions To Correct Bona Fide
Trade Errors
The proposal included an exclusion
from the definition of proprietary
trading for trading errors and
subsequent correcting transactions.265
As discussed in the proposal, the
exclusion was intended to address
situations in which a banking entity
erroneously executes a purchase or sale
of a financial instrument in the course
of conducting a permitted or excluded
activity. For example, a trading error
may occur when a banking entity is
acting solely in its capacity as an agent,
broker, or custodian pursuant to
§ ll.3(d)(7) of the 2013 rule, such as
by trading the wrong financial
instrument, buying or selling an
incorrect amount of a financial
instrument, or purchasing rather than
selling a financial instrument (or vice
versa). To correct such errors, a banking
entity may need to engage in a
subsequent transaction as principal to
261 See
79 FR at 5555.
2013 rule § ll.3(d)(3)(vi).
263 Interagency Statement Clarifying the Role of
Supervisory Guidance (Sept. 11, 2018; https://
www.occ.gov/news-issuances/news-releases/2018/
nr-ia-2018-97a.pdf, https://www.fdic.gov/news/
news/financial/2018/fil18049.html, https://
www.federalreserve.gov/supervisionreg/srletters/
sr1805.htm). The final rule similarly removes
references to ‘‘guidance’’ from subparts A and C.
264 The term ‘‘financial instruments’’ is
substituted for the term ‘‘securities’’ when referring
to what contracts are permitted under the
exclusion.
265 See 83 FR at 33452–53.
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fulfill its obligation to deliver the
customer’s desired financial instrument
position and to eliminate any principal
exposure that the banking entity
acquired in the course of its effort to
deliver on the customer’s original
request. As the proposal noted, banking
entities have expressed concern that,
however, under the 2013 rule, the initial
trading error and any corrective
transactions could, depending on the
facts and circumstances involved, fall
within the proprietary trading definition
if the transaction is covered by any of
the prongs of the trading account
definition and is not otherwise excluded
pursuant to a different provision of the
rule.
To address this concern, the agencies
proposed a new exclusion from the
definition of proprietary trading for
trading errors and subsequent correcting
transactions. The proposal noted that
the availability of this exclusion would
depend on the facts and circumstances
of the transactions, such as whether the
banking entity made reasonable efforts
to prevent errors from occurring, or
identified and corrected trading errors
in a timely and appropriate manner. The
proposed exclusion required that
banking entities, once they identified
purchases or sales made in error,
transfer the financial instrument to a
separately managed trade error account
for disposition. The proposal would
have required that this separately
managed trade error account be
monitored and managed by personnel
independent from the traders
responsible for the error, and that
banking entities monitor and manage
trade error corrections and trade error
accounts.
The majority of commenters generally
supported the proposed exclusion for
trade errors.266 Some commenters noted
that, consistent with operational risk
management practices, bona fide trade
error activity is separately managed and
classified as an operational loss when
there is a loss event or a ‘‘near miss’’
when error activity results in a gain.267
Many commenters urged the agencies
not to mandate a separately managed
trade error account, but to permit
banking entities to resolve trading errors
in accordance with internal policies and
procedures to avoid duplicative
resolution systems and unnecessary
regulatory costs.268 One commenter
argued that error trades are clearly
outside the scope of activities meant to
266 See, e.g., ABA; BB&T; Capital One et al.; BPI;
FSF; CFA; and JBA.
267 See, e.g., ABA; BB&T; BPI; Capital One et al.;
and FSF.
268 See, e.g., ABA; Credit Suisse; FSF; JBA; and
SIFMA.
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Sfmt 4700
be prohibited by the statute, so it should
not be necessary to include any
additional documentation or
administrative requirements related to
them.269 One comment letter requested
that the agencies clarify that the
exclusion covers both pre-settlement
trade errors (where the error is
identified and corrected prior to being
settled in the client’s account and is
settled in a separately managed trade
error account) and post-settlement trade
errors (where the trade error is settled in
and posted directly to the client’s
account).270
One commenter supported providing
an exclusion for bona fide error trades,
but suggested certain changes to the
proposed exclusion.271 This commenter
expressed concern that the proposed
exclusion did not provide sufficient
protections to ensure that banking
entities correct errors in a timely and
comprehensive manner and do not use
the exclusion to facilitate directional
exposures. To this end, the commenter
recommended requiring banking entities
to establish reasonably designed
controls, including periodic exception
reports containing certain specified
fields. These reports, the commenter
argued, should be provided to
independent personnel in the second
line-of-defense, including compliance
and risk personnel, and escalated
internally in accordance with the
banking entity’s internal policies and
procedures. The commenter also
recommended requiring periodic error
trade testing and audits conducted by
the second line-of-defense.
One commenter argued against a
blanket exclusion for error trades, and
urged the agencies to require any profit
from error trades be forfeited to the U.S.
Treasury, thereby removing any
incentive for a banking entity to
erroneously classify intentional
financial positions as error trades.272
Another commenter argued that the
proposal did not adequately explain or
provide sufficient data to justify the
necessity of providing an exclusion for
error trades, and that the exclusion
could be used to evade the prohibition
on proprietary trading.273
After weighing the comments
received, the agencies are excluding
from the definition of ‘‘proprietary
trading’’ any purchase or sale of one or
more financial instruments that was
made in error by a banking entity in the
course of conducting a permitted or
269 See
SIFMA.
Capital One et al.
271 See Better Markets.
272 See Public Citizen.
273 See CAP.
270 See
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excluded activity or is a subsequent
transaction to correct such an error.274
The agencies do not believe bona fide
trading errors and correcting
transactions are proprietary trading.
Under the 2013 rule, trading errors and
subsequent transactions to correct such
errors could trigger the short-term intent
prong’s 60-day rebuttable presumption
and thus could be considered to be
presumptively within the trading
account. In addition, trading errors and
correcting transactions could be within
the definition of proprietary trading
under the market risk prong or dealer
prong. While the final rule eliminates
the 2013 rule’s 60-day rebuttable
presumption,275 the agencies believe it
is useful and appropriate to clarify in
the final rule that trading errors and
subsequent correcting transactions are
not proprietary trading because banking
entities do not enter into these
transactions principally for the purpose
of selling in the near-term (or otherwise
with the intent to resell in order to
profit from short-term price
movements).276 Rather, the principal
purpose of a trading error correction is
to remedy a mistake made in the
ordinary course of the banking entity’s
permissible activities.277 Accordingly,
the agencies are adopting this exclusion
to provide clarity regarding bona fide
trading errors and subsequent correcting
transactions.
Consistent with feedback from several
commenters,278 the exclusion in the
final rule does not require banking
entities to transfer erroneously
purchased (or sold) financial
instruments to a separately managed
trade error account for disposition. The
agencies agree that this requirement
could have resulted in duplicative
resolution systems and imposed undue
regulatory costs, which are not
appropriate in light of the narrow class
of bona fide trading errors that fall
within the exclusion. As with all
exclusions and permitted trading
activities, the agencies intend to
monitor use of this exclusion for
evasion. For example, the magnitude or
frequency of errors could indicate that
the trading activity is inconsistent with
this exclusion.
The agencies have considered
comments suggesting that the agencies
should impose on banking entities
certain reporting, auditing, and testing
requirements specifically related to
rule § ll.3(d)(10).
final rule § ll.3(b)(4).
276 See 12 U.S.C. 1851(h)(6).
277 See, e.g., BPI and FSF.
278 See, e.g., ABA; Credit Suisse; FSF; JBA; and
SIFMA.
274 Final
275 See
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trade error transactions.279 As noted
above, the agencies believe mandating
requirements such as these could lead to
undue costs for banking entities, which
are not appropriate in light of the
narrow class of bona fide trading errors
that fall within the exclusion. Such
bona fide trade errors and subsequent
correcting transactions do not fall
within the statutory definition of
‘‘proprietary trading’’ because they lack
the requisite short-term intent.
Accordingly, the agencies do not find it
necessary to impose additional
requirements with respect to such
activities. Further, the agencies do not
agree that any profits resulting from
trade error transactions should be
remitted to the U.S. Treasury.
iii. Matched Derivative Transactions
The proposal requested comment on
the treatment of loan-related swaps
between a banking entity and customers
that have received loans from the
banking entity.280 The proposal
explained that, in a loan-related swap
transaction, a banking entity enters into
a swap with a customer in connection
with the customer’s loan and
contemporaneously offsets the swap
with a third party. The swap with the
customer is directly related to the terms
of the customer’s loan.281 In one typical
type of loan-related swap, a banking
entity seeks to make a floating-rate loan
to a customer that could have the
benefit to the banking entity of reducing
the banking entity’s interest rate risk,
but the customer would prefer to have
the economics of a fixed-rate loan.282 To
achieve a result that addresses these
divergent preferences, the banking
entity makes a floating-rate loan to the
customer and contemporaneously or
nearly contemporaneously enters into a
floating rate to fixed rate interest rate
swap with the same customer and an
offsetting swap with another
counterparty.283 As a result, the
customer receives economic treatment
similar to a fixed-rate loan.284 The
banking entity has entered into the
preferred floating rate loan, provided
the customer with the customer’s
preferred fixed rate economics though
the interest rate swap with the customer
and offset its market risk exposure from
the customer-facing interest rate swap
through a swap with another
counterparty.285
279 See
Better Markets.
83 FR at 33462–64.
281 See id. at 33462.
282 Id.
283 Id.
284 Id.
285 Id. In this example, the banking entity retains
the counterparty risk from both swaps. However,
280 See
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61993
Loan-related swaps have presented a
compliance challenge particularly for
smaller non-dealer banking entities.286
These banking entities may enter into
loan-related swaps infrequently, and the
decision to do so tends to be situational
and dependent on changes in market
conditions as well as on the interaction
of a number of factors specific to the
banking entity, such as the nature of the
customer relationship.287
The proposal sought comment on
whether loan-related swaps should be
excluded from the definition of
proprietary trading, exempted from the
prohibition on proprietary trading, or
permitted under the exemption for
market making-related activities.288 The
proposal also asked whether other types
of swaps, such as end-user customerdriven swaps that are used by a
customer to hedge commercial risk
should be treated the same way as loanrelated swaps.289 The proposal also
requested comment as to whether it is
appropriate to permit loan-related
swaps to be conducted pursuant to the
exemption for market making-related
activities where the frequency with
which a banking entity executes such
swaps is minimal but the banking entity
remains prepared to execute such swaps
when a customer makes an appropriate
request.290
Most commenters supported allowing
loan-related swaps, either by adopting
an exclusion from the definition of
proprietary trading,291 creating a new
exemption for loan-related swaps,292 or
clarifying that banking entities could
enter into loan-related swaps under
existing exemptions.293 The majority of
these commenters supported explicitly
excluding loan-related swaps from the
definition of proprietary trading.294
These commenters noted that loanrelated swap transactions generally do
not fall within the statutory definition of
trading account and that these
depending on the type of swap and the particular
transaction, the banking entity may be able to
manage the counterparty risk, for example, by
clearing the transaction at a clearing agency or
derivatives clearing organization acting as a central
counterparty, as applicable.
286 Id.
287 Id. at 33463.
288 Id.
289 Id. at 33464.
290 Id. at 33463.
291 See, e.g., BOK; ABA; Covington & Burling LLP
(Covington); JBA; Chatham; Credit Suisse; BPI;
SIFMA; IIB, Covington; Arvest; IIB; KeyCorp; and
Capital One et al.
292 See, e.g., Covington and BPI.
293 See, e.g., Covington; BPI; SIFMA; Credit
Suisse; and BB&T.
294 See, e.g., BOK; ABA; Covington; JBA;
Chatham; Credit Suisse; BPI; SIFMA; IIB,
Covington; Arvest; IIB; KeyCorp; and Capital One
et al.
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transactions are important riskmitigating activities.295 Commenters
stated that providing an exclusion or
permitted activity exemption for loanrelated swaps would prevent section 13
of the BHC Act from having an
unintended chilling effect on an
important and prudent lending-related
activity.296 Commenters also stated that
these types of swap transactions are
important tools that facilitate bank
customers’ ability to manage their
risks.297 One commenter opposed
providing an exclusion for loan-related
swaps, arguing that these activities
instead should be conducted under the
risk-mitigating hedging exemption.298
Two commenters requested that the
agencies adopt a permitted activity
exemption for loan-related swaps or
revise the existing exemption for market
making-related activities if the agencies
do not explicitly exclude loan-related
swaps from the definition of proprietary
trading.299 In addition, two commenters
suggested that the exemption for riskless
principal transactions in § ll.6(c)(2) of
the 2013 rule could cover loan-related
swaps.300 These commenters and two
others suggested that excluding loanrelated swaps from the definition of
proprietary trading would be more
effective than adopting a new permitted
activity exemption or relying on an
existing permitted activity
exemption.301
Two commenters argued that banking
entities should be allowed to engage in
loan-related swaps using the exemption
for market making-related activities.302
Several other commenters asserted that
the market-making exemption is a poor
fit for loan-related swaps and that the
market-making exemption’s
requirements were unduly burdensome
with respect to this activity, particularly
for smaller banking entities.303
Several commenters supported
excluding additional derivatives
activities from the definition of
proprietary trading, such as customerdriven matched-book trades that enable
customers to hedge commercial risk
regardless of whether the swaps are
295 See, e.g., BOK; ABA; Covington; JBA;
Chatham; Arvest; and IIB.
296 See, e.g., Covington and Credit Suisse.
297 See, e.g., Arvest and BOK.
298 See Data Boiler.
299 See, e.g., Covington and BPI.
300 See, e.g., SIFMA and Credit Suisse.
301 See, e.g., Covington; BPI; SIFMA; and Credit
Suisse.
302 See, e.g., BB&T and Credit Suisse (Credit
Suisse noted, however, that an exclusion would be
preferable to using the market-making exemption).
303 See, e.g., IIB; Covington; SIFMA; Capital One
et al.; BPI; and B&F.
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related to a loan.304 Commenters noted
that such customer-driven matchedbook trades do not expose banking
entities to risk other than counterparty
credit risk.305 Moreover, these trades
reduce risks to the bank’s customer and
thus also reduce the risk of the banking
entity’s loans to that customer.306
Three commenters requested that the
exclusion be expanded to cover
instances where a banking entity enters
into a loan-related swap with a
customer but does not offset that swap
with a third party.307
One commenter urged the agencies to
adopt a definition of loan-related swaps
that is substantially similar to the
definition adopted by the CFTC for
swaps executed in connection with
originating loans to customers, and to
include in the definition, the derivatives
transaction entered into with a dealer to
offset the risk of the customer-facing
swap.308 Another commenter opposed
using the CFTC’s definition, noting that
the CFTC’s definition would not address
commodity-based matched-book
derivative transactions.309 One
commenter recommended defining
‘‘customer-facing loan-related swap’’ to
mean any swap with a customer or
affiliate thereof in which the rate, asset,
liability, or other notional item
underlying the swap with the customer
or affiliate thereof is, or is directly
related to, a financial term of a loan or
other credit facility with the customer or
affiliate thereof (including, without
limitation, the loan or other credit
facility’s duration, rate of interest,
currency or currencies, or principal
amount).310 The same commenter stated
that the exclusion should not include a
timing requirement with respect to the
offsetting swap or, if a timing condition
is included, the banking entity should
be required to enter into the offsetting
swap ‘‘contemporaneously or
substantially contemporaneously’’ with
the customer-facing loan-related
swap.311
After considering the comments
received, the agencies are excluding
from the definition of ‘‘proprietary
trading’’ entering into a customer-driven
swap or a customer-driven securitybased swap and a matched swap or
security-based swap if: (i) The
transactions are entered into
contemporaneously; (ii) the banking
304 See, e.g., BOK; JBA; ABA; Capital One et al.;
and KeyCorp.
305 See, e.g., BOK and ABA.
306 See, e.g., BOK.
307 See, e.g., ABA; Arvest; and IIB.
308 See Chatham.
309 See BOK.
310 See Covington.
311 See id.
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entity retains no more than minimal
price risk; 312 and (iii) the banking entity
is not a registered dealer, swap dealer,
or security-based swap dealer.313 The
agencies are adopting this exclusion to
provide greater certainty for non-dealer
banking entities that engage in these
customer-driven matched-book swap
transactions.
Under the 2013 rule, these customerdriven matched swap transactions could
trigger the short-term intent prong’s
rebuttable presumption and thus would
be presumptively within the trading
account. Although the agencies are
eliminating the 2013 rule’s rebuttable
presumption,314 the agencies believe
that it is nevertheless useful and
appropriate to clarify in the final rule
that these customer-driven matched
swap transactions are not proprietary
trading because banking entities do not
enter into these transactions principally
for the purpose of selling in the nearterm (or otherwise with the intent to
resell in order to profit from short-term
price movements).315 For this reason,
the agencies are providing an exclusion
for these activities from the proprietary
trading definition rather than requiring
them to be conducted pursuant to the
risk-mitigating hedging exemption, as
one commenter suggested.
The agencies believe that adopting
this exclusion will reduce costs for nondealer banking entities and avoid
disrupting a common and traditional
banking service provided to small and
medium-sized businesses. This
exclusion will provide a greater degree
of certainty that these customer-driven
matched swap transactions are outside
the scope of the final rule.
Consistent with feedback received
from commenters,316 the exclusion in
the final rule is not limited to loanrelated swaps.317 Thus, the exclusion in
the final rule could apply to a swap
with a customer in connection with the
312 Price risk is the risk of loss on a fair-value
position that could result from movements in
market prices.
313 Final rule § ll.3(d)(11).
314 See final rule § ll.3(b)(4).
315 See 12 U.S.C. 1851(h)(6).
316 See, e.g., BOK; JBA; ABA; Capital One et al.;
and KeyCorp.
317 As a result, the agencies are not adopting a
definition of ‘‘loan-related swap’’ substantially
similar to the definition adopted by the CFTC for
swaps executed in connection with originating
loans to customers, as requested by one customer.
See Chatham. The agencies also note that this
exclusion does not impact the ‘‘insured depository
institution swaps in connection with originating
loans to customers’’ provisions in the CFTC’s
definition of ‘‘swap dealer.’’ See 17 CFR 1.3, Swap
dealer, paragraphs (4)(i)(C) and (5). Additionally,
this exclusion does not affect any other aspects of
the ‘‘swap dealer’’ definition in CFTC regulations,
or how that term is interpreted by the CFTC.
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customer’s end-user activity (provided
that all the terms of the exclusion are
met). For example, a corn farmer is a
customer of a non-dealer banking entity.
To manage its risk with respect to the
price of corn, the corn farmer enters into
a swap on corn prices with the banking
entity. The banking entity
contemporaneously enters into a cornprice swap with another counterparty to
offset the price risk of the swap with the
corn farmer. The swap with the corn
farmer and the offsetting swap with the
counterparty have matching terms such
that the banking entity retains no more
than minimal price risk. The agencies
have determined that it is appropriate to
exclude these types of transactions from
the definition of proprietary trading
because, like matched loan-related
swaps discussed above, banking entities
do not enter into these customer-driven
transactions principally for the purpose
of selling in the near-term (or otherwise
with the intent to resell in order to
profit from short-term price
movements).318
Several conditions must be met for
the exclusion to apply.319 The exclusion
applies only to banking entities that are
not registered dealers, swap dealers, or
security-based swap dealers. This
approach is consistent with feedback
from commenters noting that primarily
smaller banking entities have faced
compliance challenges with respect to
customer-driven swaps activities.320
Banking entities that are registered
dealers, swap dealers, or security-based
swap dealers generally engage in these
activities on a more regular basis and
therefore have been able to conduct
their derivatives activities pursuant to
the exemption for market makingrelated activities. Although some
commenters argued that the exemption
for market making-related activities is
too burdensome to apply to this type of
activity,321 the agencies note that the
final rule streamlines certain
requirements of that exemption.322
The exclusion only applies to
transactions where one of the two
matched swaps or security-based swaps
is customer-driven, in that the
transaction is entered into for a
customer’s valid and independent
business purposes. In addition, the
hedging swap or hedging security-based
swap must match the customer-driven
318 See
12 U.S.C. 1851(h)(6).
a transaction does not satisfy all of the
conditions of the exclusion but is not within the
definition of trading account, the transaction would
not constitute proprietary trading.
320 See, e.g., Chatham; ABA; and Covington.
321 See, e.g., IIB; Covington; SIFMA; Capital One
et al.; BPI; and B&F.
322 See final rule § ll.4(b).
319 If
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swap or customer-driven security-based
swap. The banking entity may retain no
more than minimal price risk between
the two swaps or security-based
swaps.323 Finally, the banking entity
must enter into the customer-driven
swap or customer driven security-based
swap contemporaneously with the
matching swap or matching securitybased swap.324 These conditions carve
out from the exclusion activities whose
principal purpose is resale in the near
term.325 For example, if a banking entity
entered into a hedging swap whose
economic terms did not match the terms
of the customer-driven swap, the
banking entity would be exposed to
price risk and could be speculating on
short-term price movements. Similarly,
if a banking entity waited multiple days
between entering into a customer-driven
swap and entering into the offsetting
swap, the banking entity could be
speculating on short-term price
movements during the unhedged period
of the swap transaction. In either case,
the banking entity could be engaged in
proprietary trading.326 The requirements
in the final rule’s exclusion are intended
to limit the exclusion to activities that
the agencies have determined lack the
requisite short-term trading intent.
The agencies have considered the
comments requesting an exclusion for
unmatched loan-related swaps and
determined that such an exclusion is
not necessary in the final rule.327 For
example, if a bank provides a loan to a
customer and enters into a swap with
the customer related directly to the
terms of that loan but does not offset
that customer-driven swap with a thirdparty, the exclusion does not apply.
Although the exclusion may not apply,
the agencies believe that this type of
activity is unlikely to be within the
trading account under the final rule,
particularly because the agencies are not
adopting the proposed accounting
prong. Entering into such a loan-related
swap would be proprietary trading only
if the purchase or sale of the swap is
principally for short term trading
323 The banking entity would retain minimal
price risk if the economic terms of the two swaps
(e.g., index, amount, maturity, and underlying
reference asset or index) match.
324 The exclusion only applies to transactions
where the customer-driven swap or customerdriven security-based swap is offset by a matching
swap or security-based swap on a one-for-one basis.
The exclusion does not apply to portfolio-hedged
derivatives transactions.
325 See 12 U.S.C. 1851(h)(6).
326 Whether the banking entity is actually engaged
in impermissible proprietary trading would depend
on the facts and circumstances of the particular
transaction.
327 See ABA and Arvest.
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61995
purposes or is otherwise within the
definition of trading account.328
iv. Hedges of Mortgage Servicing Rights
or Assets
The final rule excludes from the
definition of proprietary trading any
purchase or sale of one or more
financial instruments that the banking
entity uses to hedge mortgage servicing
rights or mortgage servicing assets in
accordance with a documented hedging
strategy. The agencies are adopting this
exclusion to clarify the scope of the
prohibition on proprietary trading and
to provide parity between banking
entities that are subject to the market
risk capital prong and banking entities
that are subject to the short-term intent
prong.
Section 13 of the BHC Act defines
‘‘trading account’’ to mean ‘‘any account
used for acquiring or taking positions in
. . . securities and instruments . . .
principally for the purpose of selling in
the near term (or otherwise with the
intent to resell in order to profit from
short-term price movements),’’ and any
such other accounts that the agencies
determine by rule. The purchase or sale
of a financial instrument as part of a
bona fide mortgage servicing rights or
mortgage servicing asset hedging
program is not within the statutory
definition of ‘‘trading account’’ under
the short-term intent prong because the
principal purpose of such a purchase or
sale is hedging rather than short-term
resale for profit.
The agencies have determined to
explicitly exclude this type of hedging
activity from the definition of
‘‘proprietary trading’’ to provide greater
clarity to banking entities that are
subject to the short-term intent prong in
light of changes made elsewhere in the
final rule. Under the final rule, banking
entities that are subject to the market
risk capital prong (or that elect to apply
the market risk capital prong) are not
subject to the short-term intent prong.
The market risk capital rule explicitly
excludes intangibles, including
servicing assets, from the definition of
‘‘covered position.’’ Financial
instruments used to hedge mortgage
servicing rights or assets generally
would not be captured under the market
risk capital prong. Therefore, absent an
explicit exclusion, banking entities that
are subject to the market risk capital
prong have more certainty than banking
entities that are subject to the short-term
intent prong that the purchase or sale of
a financial instrument to hedge
mortgage servicing rights or mortgage
servicing assets is not proprietary
328 See
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trading. The agencies are explicitly
excluding mortgage servicing rights and
mortgage servicing asset hedging
activity to provide banking entities that
are not subject to the market risk capital
prong (or that elect to apply the market
risk capital prong) the same degree of
certainty. As described in part
IV.B.1.a.iii of this SUPPLEMENTARY
INFORMATION, the final rule seeks to
provide parity between smaller banking
entities that are not subject to the
market risk capital rule and larger
banking entities with active trading
businesses that are subject to the market
risk capital prong. The agencies believe
an express exclusion for mortgage
servicing rights and mortgage servicing
hedging activity is useful in light of the
revision to the trading account
definition that applies the short-term
intent prong only to banking entities
that are not subject to the market risk
capital prong.
This exclusion applies only to bona
fide hedging activities, conducted in
accordance with a documented hedging
strategy. This requirement will assist the
agencies in monitoring for evasion or
abuse. In addition, the agencies note
that banking entities’ mortgage servicing
activities and related hedging activities
remain subject to applicable law and
regulation, including the Federal
banking agencies’ safety and soundness
standards.
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v. Financial Instruments That Are Not
Trading Assets or Trading Liabilities
The final rule excludes from the
trading account any purchase or sale of
a financial instrument that does not
meet the definition of ‘‘trading asset’’ or
‘‘trading liability’’ under the banking
entity’s applicable reporting form. As
with the exclusion for hedges of
mortgage servicing rights or assets, the
agencies are adopting this exclusion to
clarify the scope of the prohibition on
proprietary trading and to provide
parity between banking entities that are
subject to the market risk capital prong
(or that elect to apply the market risk
capital prong) and banking entities that
are subject to the short-term intent
prong.
The agencies have determined to
exclude the purchase or sale of assets
that would not meet the definition of
trading asset or trading liability from the
definition of ‘‘proprietary trading’’ to
provide greater clarity to banking
entities that are subject to the short-term
intent prong. As described above, under
the final rule, banking entities that are
subject to the market risk capital prong
(or that elect to apply the market risk
capital prong) are not subject to the
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short-term intent prong.329 Under the
market risk capital prong, a purchase or
sale of a financial instrument is within
the trading account if it would be both
a covered position and trading position
under the market risk capital rule. In
general, a position is a covered position
under the market risk capital prong if it
is a trading asset or trading liability
(whether on- or off-balance sheet).330
Thus, the exclusion for financial
instruments that are not ‘‘trading assets
and liabilities’’ extends the same
certainty to banking entities subject to
the short-term intent prong as is
provided by operation of the market risk
capital prong.
One commenter recommended that
the agencies modify the short-term
intent prong to include only financial
instruments that meet the definition of
trading assets and liabilities and that are
held for the purpose of short-term
trading.331 The agencies have
determined that including only
financial instruments that meet the
definition of trading assets and
liabilities (by excluding instruments
that do not meet this definition) is
appropriate because the trading asset
and liability definitions used for
regulatory reporting purposes
incorporate substantially the same
short-term trading standard as the shortterm intent prong and section 13 of the
BHC Act. The Call Report and FR Y–9C
provide that trading activities typically
include, among other activities,
acquiring or taking positions in
financial instruments ‘‘principally for
the purpose of selling in the near term
or otherwise with the intent to resell in
order to profit from short-term price
movements.’’ 332 This language is
substantially identical to the statutory
definition of trading account, which
applies to any account used for
acquiring or taking positions in
financial instruments ‘‘principally for
the purpose of selling in the near term
(or otherwise with the intent to resell in
order to profit from short-term price
movements) . . . .’’ 333 Therefore,
excluding any purchase or sale of a
financial instrument that would not be
classified as a trading asset or trading
final rule § ll.3(b).
12 CFR 3.202(b); 12 CFR 217.202(b); 12
CFR 324.202(b). In addition, the market risk capital
rule’s ‘‘covered position’’ definition expressly
includes and excludes additional classes of
instruments.
331 See SIFMA.
332 See, e.g., Instructions for Preparation of
Consolidated Reports of Condition and Income,
FFIEC 031 and FFIEC 041, Schedule RC–D;
Instructions for Preparation of Consolidated
Financial Statements for Holding Companies,
Reporting Form FR Y–9C, Schedule HC–D.
333 12 U.S.C. 1851(h)(6).
329 See
330 See
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liability on these applicable reporting
forms is consistent with the statutory
definition of trading account in section
13 of the BHC Act. This exclusion is
expected to provide additional clarity to
banking entities subject to the shortterm intent prong, while also better
aligning the compliance program
requirements with the scope of activities
subject to section 13 of the BHC Act.
This exclusion applies to any
purchase or sale of a financial
instrument that does not meet the
definition of ‘‘trading asset’’ or ‘‘trading
liability’’ under the applicable reporting
form as of the effective date of this final
rule. The final rule references the
reporting forms in effect as of the final
rule’s effective date to ensure the scope
of the exclusion remains consistent with
the statutory trading account definition.
Because the reporting forms are used for
many purposes and are generally based
on generally accepted accounting
principles, future revisions to the
reporting forms could define ‘‘trading
asset’’ and ‘‘trading liability’’
inconsistently with the ‘‘trading
account’’ definition in section 13 of the
BHC Act. Further, tying the exclusion to
the reporting forms currently in effect
will provide greater certainty to banking
entities. If the scope of the exclusion
were subject to change based on
revisions to the applicable reporting
forms, it could require banking entities
to make corresponding changes to
compliance systems to remain in
compliance with the rule, which could
result in disruption both for banking
entities and the agencies. Accordingly,
the final rule excludes any purchase or
sale of a financial instrument that does
not meet the definition of trading asset
or trading liability under the applicable
reporting form as of the effective date of
the final rule.
c. Trading Desk
The 2013 rule applies certain
requirements at the ‘‘trading desk’’-level
of organization.334 The 2013 rule
defined ‘‘trading desk’’ to mean the
smallest discrete unit of organization of
a banking entity that purchases or sells
financial instruments for the trading
account of the banking entity or an
affiliate thereof.335
As noted in the proposal, some
banking entities had indicated that, in
practice, the 2013 rule’s definition of
trading account had led to uncertainty
regarding the meaning of ‘‘smallest
discrete unit.’’ 336 In addition, banking
334 See 2013 rule §§ ll.4, ll.5, App. A., App.
B; final rule §§ ll.4, ll.5, App. A.
335 2013 rule § ll.3(e)(13).
336 See 83 FR at 33453.
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entities had communicated that this
definition has caused confusion and
duplicative compliance and reporting
efforts for banking entities that also
define trading desks for purposes
unrelated to the 2013 rule, including for
internal risk management and reporting
and calculating regulatory capital
requirements.337 In response to these
concerns, the proposal included a
detailed request for comment on
whether to revise the trading desk
definition to align with the trading desk
concept used for other purposes.338
Specifically, the proposal requested
comment on using a multi-factor trading
desk definition based on the same
criteria typically used to establish
trading desks for other operational,
management, and compliance
purposes.339
Commenters that addressed the
definition of ‘‘trading desk’’ generally
supported revising the definition along
the lines contemplated in the
proposal.340 Commenters asserted that
the 2013 rule’s ‘‘smallest discrete unit
language’’ was subjective, ambiguous,
and had been interpreted in different
ways.341 Commenters said that adopting
a multi-factor definition would be
preferable to the 2013 rule’s definition
because a multi-factor definition would
align the definition of trading desk with
other operational and managerial
structures, whereas the 2013 rule’s
definition could be interpreted to
require banking entities to designate
certain units of organization as trading
desks purely for purposes of the
regulations implementing section 13 of
the BHC Act.342 One commenter
supported the multi-factor definition in
the proposal but recommended that the
agencies should be required to approve
the initial trading desk designations and
any changes in trading desk
designations.343 One commenter said
the agencies should allow the unit of the
trading desk to be determined at the
discretion of each financial
institution 344 and another said it is not
necessary to introduce complexity into
how banking entities organize their
internal operations.345
The final rule adopts a multi-factor
definition that is substantially similar to
the definition included in the request
337 See
id.
id.
339 See id.
340 See, e.g., ABA; ISDA 1; CCMC; SIFMA 2;
Goldman Sachs; FSF; JBA; and AFR.
341 See, e.g., ABA and CCMC.
342 See, e.g., ABA; ISDA 1; CCMC; SIFMA 2;
Goldman Sachs; FSF; and JBA.
343 See AFR.
344 See JBA.
345 See CCMC.
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338 See
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for comment in the proposal, except that
the first prong has been revised and the
reference to incentive compensation has
been removed. This multi-factor
definition will align the criteria used to
define trading desk for purposes of the
regulations implementing section 13 of
the BHC Act with the criteria used to
establish trading desks for other
operational, management, and
compliance purposes.
The definition of trading desk
includes a new second prong that
explicitly aligns the definition with the
market risk capital rule.346 The final
rule provides that, for a banking entity
that calculates risk-based capital ratios
under the market risk capital rule, or a
consolidated affiliate of a banking entity
that calculates risk-based ratios under
market risk capital rule, ‘‘trading desk’’
means a unit of organization that
purchases or sells financial instruments
for the trading account of the banking
entity or an affiliate thereof that is
established by the banking entity or its
affiliate for purposes of capital
requirements under the market risk
capital rule.347 This change specifies
that, for a banking entity that is subject
to the market risk capital prong, the
trading desk established for purposes of
the market risk capital rule must be the
same unit of organization that is
established as a trading desk under the
regulations implementing section 13 of
the BHC Act. This prong of the trading
desk definition is expected to simplify
the supervisory activities of the Federal
banking agencies that also oversee
compliance with the market risk capital
rule because the same unit of
organization can be assessed for
purposes of both the market risk capital
rule and section 13 of the BHC Act,
which will reduce complexity and cost
for banking entities, and improve the
effectiveness of the final rule. Together
with providing firms with the flexibility
to leverage existing or planned
compliance programs in order to satisfy
the elements of § ll.20 as appropriate,
the agencies expect aligning the
definition of trading desk will minimize
346 Currently, the market risk capital rule does not
include a definition of ‘‘trading desk.’’ However, the
federal banking agencies expect to implement the
Basel Committee’s revised market risk capital
standards, which do. See Basel Committee on
Banking Supervision, ‘‘Minimum Capital
Requirements for Market Risk,’’ MAR12 (Feb. 2019).
The federal banking agencies expect their revised
market risk capital rule will include a definition of
‘‘trading desk’’ that is consistent with the trading
desk concept described in the ‘‘Minimum Capital
Requirements for Market Risk,’’ and the multifactor
approach in this final rule.
347 See final rule § ll.3(e)(13)(ii).
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compliance burden on banking entities
subject to both rules.
To further align the final rule’s
trading desk concept with the market
risk capital rule, the final rule provides
that a trading desk must be ‘‘structured
by the banking entity to implement a
well-defined business strategy.’’ 348 This
further aligns the trading desk definition
with the definition of ‘‘trading desk’’ in
the Basel Committee’s minimum capital
requirements for market risk.349 This
change will ensure that banking entities
that are subject to the market risk capital
prong and banking entities that are not
subject to the market risk capital prong
have comparable trading desk
definitions. In general, a well-defined
business strategy typically includes a
written description of a desk’s
objectives, including the economics
behind its trading and hedging
strategies, as well as the instruments
and activities the desk will use to
accomplish its objectives. A desk’s welldefined business strategy may also
include an annual budget and staffing
plan and management reports.
Like the proposal, the final rule states
that a trading desk is organized to
ensure appropriate setting, monitoring,
and management review of the desk’s
trading and hedging limits, current and
potential future loss exposures, and
strategies. The final rule also states that
a trading desk is characterized by a
clearly-defined unit that: (i) Engages in
coordinated trading activity with a
unified approach to its key elements; (ii)
operates subject to a common and
calibrated set of risk metrics, risk levels,
and joint trading limits; (iii) submits
compliance reports and other
information as a unit for monitoring by
management; and (iv) books its trades
together. The agencies consider a unit to
be ‘‘clearly-defined’’ if it meets these
four factors.
The proposal included a multi-factor
definition of trading desk that
referenced incentive compensation as
one defining factor. However, the
banking agencies do not incorporate
incentive compensation in regulatory
capital rules generally, and therefore
omitting this criterion would better
align the trading desk definition
between the market risk capital rule and
the Volcker Rule. Thus, the final rule
does not incorporate any reference to
incentive compensation.350
The final rule does not require the
agencies to approve banking entities’
rule § ll.3(e)(13)(i)(A).
Basel Committee on Banking Supervision,
Minimum Capital Requirements for Market Risk
(Feb. 2019).
350 Compare 83 FR at 33453 with final rule
§ ll.3(e)(13)(i)(B).
348 Final
349 See
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initial trading desk designations and
any changes in trading desk
designations, as one commenter had
recommended.351 The agencies believe
such an approval process is unnecessary
for purposes of the final rule because
the agencies intend to continue
assessing banking entities’ trading desk
designations as part of the agencies’
ongoing supervision of banking entities’
compliance with the final rule as well
as other safety and soundness
regulations, as applicable. At the same
time, the final rule does not allow the
trading desk to be set completely at the
discretion of the banking entity, as one
commenter suggested.352 The adopted
definition will provide flexibility to
allow banking entities to define their
trading desks based on the same criteria
typically used for other operational,
management, and compliance purposes
but would not be so broad as to hinder
the agencies’ or banking entities’ ability
to detect prohibited proprietary trading.
d. Reservation of Authority
The proposal included a reservation
of authority that would have permitted
an agency to determine, on a case-bycase basis, that any purchase or sale of
one or more financial instruments by a
banking entity for which it is the
primary financial regulatory agency
either is or is not for the trading account
as defined in section 13(h)(6) of the BHC
Act.353 The preamble requested
comment on whether such a reservation
of authority would be necessary in
connection with the proposed trading
account definition, which would have
focused on objective factors to define
proprietary trading. The agencies
explained that this approach may have
produced results that were over- or
under-inclusive with respect to the
statutory trading account definition. The
agencies further explained that the
reservation of authority could provide
appropriate balance by recognizing the
subjective elements of the statute in
light of the bright-line approach of the
proposed accounting prong.
Two commenters supported adopting
the reservation of authority.354 Both of
these commenters noted the importance
of coordination and consistent
application of the reservation of
authority, particularly in instances
where the primary financial regulatory
agency may vary by legal entity within
a firm.355 One of these commenters
suggested that the agencies keep such
351 See
AFR.
JBA.
353 See 83 FR at 33454.
354 See, e.g., BB&T and CFA.
355 Id.
352 See
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authority in reserve for use solely in
those circumstances wherein poor
management is putting an institution at
risk of failure.356
The final rule does not include the
proposed reservation of authority.357
The revised trading account definition
in the final rule retains a short-term
intent standard that largely tracks the
statutory standard.358 Because the final
trading account definition does not
include the proposed accounting prong
and is aligned with the statutory
standard, the agencies do not find it
necessary to retain a reservation of
authority.
2. Section ll.4: Permitted
Underwriting and Market Making
Related Activities
a. Current Exemptions for Underwriting
and Market Making—Related
Activities 359
Section 13(d)(1)(B) of the BHC Act
contains an exemption from the
prohibition on proprietary trading for
the purchase, sale, acquisition, or
disposition of securities, derivatives,
contracts of sale of a commodity for
future delivery, and options on any of
the foregoing in connection with
underwriting or market making-related
activities, to the extent that such
activities are designed not to exceed the
reasonably expected near term demands
of clients, customers, or counterparties
(RENTD).360 As the agencies noted
when they adopted the 2013 rule, clientoriented financial services, which
include underwriting, market making,
and asset management services, are
important to the U.S. financial markets
and the participants in those markets.361
In particular, underwriters play a key
role in facilitating issuers’ access to
356 See
CFA.
proposed rule § ll.3(g).
358 Although banking entities that are subject to
the market risk capital prong are not subject to the
short-term intent prong, the market risk capital
prong incorporates a substantially similar shortterm intent standard. As described above, the
market risk capital rule’s definition of trading
position largely parallels the statutory definition of
trading account, which in turn mirrors the language
in the short-term intent prong.
359 In contrast to the proposal, the discussions of
the exemptions for underwriting and market
making-related activity have been combined in
order to avoid any unnecessary redundancy as well
as any confusion that could arise to the extent there
are differences in the way that otherwise identical
provisions of those exemptions operate. However,
the two exemptions remain separate and distinct.
Banking entities seeking to rely on one or both
exemptions are required to comply with the
requirements and legal standards contained in each
applicable exemption, and will continue to be
required to do so following adoption of the final
rule.
360 12 U.S.C. 1851(d)(1)(B).
361 See 79 FR at 5615.
357 See
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funding, and are accordingly important
to the capital formation process and to
economic growth.362 For example,
underwriters can help reduce issuers’
costs of capital by mitigating potential
information asymmetries between
issuers and their potential investors.363
Similarly, market makers operate to
help ensure that securities,
commodities, and derivatives markets in
the United States remain wellfunctioning by, among other things,
providing important intermediation and
liquidity.364 At the same time, however,
the agencies also recognized that
providing appropriate latitude to
banking entities to provide such clientoriented services need not and should
not conflict with clear, robust, and
effective implementation of the statute’s
prohibitions and restrictions.365
Accordingly, the 2013 rule follows a
comprehensive, multi-faceted approach
to implementing the statutory
exemptions for underwriting and market
making-related activities. Specifically,
section ll.4(a) of the 2013 rule
implements the statutory exemption for
underwriting and sets forth the
requirements that banking entities must
meet in order to rely on the exemption.
Among other things, the 2013 rule
requires that:
• The banking entity act as an
‘‘underwriter’’ for a ‘‘distribution’’ of
securities and the trading desk’s
underwriting position be related to such
distribution;
• The amount and types of securities
in the trading desk’s underwriting
position be designed not to exceed
RENTD, and reasonable efforts be made
to sell or otherwise reduce the
underwriting position within a
reasonable period, taking into account
the liquidity, maturity, and depth of the
market for the relevant type of security;
• The banking entity has established
and implements, maintains, and
enforces an internal compliance
program that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of the
underwriting exemption, including
reasonably designed written policies
and procedures, internal controls,
analysis, and independent testing
identifying and addressing:
Æ The products, instruments, or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
Æ Limits for each trading desk, based
on the nature and amount of the trading
362 See
79 FR at 5561 (internal footnotes omitted).
363 Id.
364 See
365 See
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79 FR at 5541.
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desk’s underwriting activities, including
RENTD, on the (1) amount, types, and
risk of the trading desk’s underwriting
position, (2) level of exposures to
relevant risk factors arising from the
trading desk’s underwriting position,
and (3) period of time a security may be
held;
Æ Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
Æ Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
• The compensation arrangements of
persons performing the banking entity’s
underwriting activities are designed not
to reward or incentivize prohibited
proprietary trading; and
• The banking entity is licensed or
registered to engage in the activity
described in the underwriting
exemption in accordance with
applicable law.
Similarly, section ll.4(b) of the
2013 rule implements the statutory
exemption for market making-related
activities and sets forth the
requirements that all banking entities
must meet in order to rely on the
exemption. Among other things, the
2013 rule requires that:
• The trading desk that establishes
and manages the financial exposure
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure and is willing and available to
quote, purchase and sell, or otherwise
enter into long and short positions in
those types of financial instruments for
its own account, in commercially
reasonable amounts and throughout
market cycles on a basis appropriate for
the liquidity, maturity, and depth of the
market for the relevant types of financial
instruments;
• The amount, types, and risks of the
financial instruments in the trading
desk’s market-maker inventory are
designed not to exceed, on an ongoing
basis, RENTD, as required by the statute
and based on certain factors and
analysis specified in the rule;
• The banking entity has established
and implements, maintains, and
enforces an internal compliance
program that is reasonably designed to
ensure its compliance with the
exemption for market making-related
activities, including reasonably
designed written policies and
procedures, internal controls, analysis,
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and independent testing identifying and
assessing certain specified factors; 366
• To the extent that any required
limit 367 established by the trading desk
is exceeded, the trading desk takes
action to bring the trading desk into
compliance with the limits as promptly
as possible after the limit is exceeded;
• The compensation arrangements of
persons performing market makingrelated activities are designed not to
reward or incentivize prohibited
proprietary trading; and
• The banking entity is licensed or
registered to engage in market makingrelated activities in accordance with
applicable law.368
In the several years since the adoption
of the 2013 rule, public commenters
have observed that the significant and
costly compliance requirements in the
existing exemptions may unnecessarily
constrain underwriting and market
making without a corresponding
reduction in the type of trading
activities that the rule was designed to
prohibit.369 As the agencies noted in the
proposal, implementation of the 2013
rule has indicated that the existing
approach to give effect to the statutory
standard of RENTD may be overly broad
and complex, and also may inhibit
otherwise permissible activity.370
Accordingly, the proposal was
intended to tailor, streamline, and
clarify the requirements that a banking
entity must satisfy to avail itself of
either exemption for underwriting or
market making-related activities. In
particular, the proposal intended to
provide a clearer way to determine if a
trading desk’s activities satisfy the
statutory requirement that underwriting
or market making-related activity, as
applicable, be designed not to exceed
RENTD. Specifically, the proposal
would have established a presumption,
available to banking entities both with
and without significant trading assets
and liabilities, that trading within
internally set limits satisfies the
requirement that permitted activities
must be designed not to exceed
RENTD.371 In addition, the agencies also
proposed to tailor the exemption for
underwriting and market making-related
2013 rule § ll.4(b)(2)(iii).
79 FR at 5615.
368 2013 rule § ll.4(b)(2). This provision was
not intended to expand the scope of licensing or
registration requirements under relevant U.S. or
foreign law that are applicable to a banking entity
engaged in market-making activities, but rather to
recognize that compliance with applicable law is an
essential indicator that a banking entity is engaged
in market-making activities. See 79 FR at 5620.
369 83 FR at 33435, 33459.
370 83 FR at 33445–46.
371 Proposed rules § ll.4(a)(8) and
§ ll.4(b)(6).
366 See
367 See
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activities’ compliance program
requirements to the size, complexity,
and type of activity conducted by the
banking entity by making those
requirements applicable only to banking
entities with significant trading assets
and liabilities.372
b. Proposed Presumption of Compliance
With the Statutory RENTD Requirement
As described above, the statutory
exemptions for underwriting and market
making-related activities in section
13(d)(1)(B) of the BHC Act requires that
such activities be designed not to
exceed RENTD.373 Consistent with the
statute, for the purposes of the
exemption for underwriting activities,
section ll.4(a)(2)(ii) of the 2013 rule
requires that the amount and type of the
securities in the trading desk’s
underwriting position be designed not
to exceed RENTD, and reasonable efforts
are made to sell or otherwise reduce the
underwriting position within a
reasonable period, taking into account
the liquidity, maturity, and depth of the
market for the relevant type of
security.374
Similarly, for the purposes of the
exemption for market making-related
activities, section ll.4(b)(2)(ii) of the
2013 rule requires that the amount,
types, and risks of the financial
instruments in the trading desk’s
market-maker inventory are designed
not to exceed, on an ongoing basis,
RENTD, based on certain factors and
analysis.375 Specifically, these factors
are: (i) The liquidity, maturity, and
depth of the market for the relevant type
of financial instrument(s), and (ii)
demonstrable analysis of historical
customer demand, current inventory of
financial instruments, and market and
other factors regarding the amount,
types, and risks of or associated with
positions in financial instruments in
which the trading desk makes a market,
including through block trades.376
Under § ll.4(b)(2)(iii)(C) of the 2013
rule, a banking entity must account for
these considerations when establishing
limits for each trading desk.377
In the proposal, the agencies
recognized that the prescriptive
standards for meeting the statutory
RENTD requirements in the exemptions
for underwriting and market makingrelated activities were complex, costly,
and did not provide bright line
conditions under which trading activity
372 83
FR at 33438 and 33459.
U.S.C. 1851(d)(1)(B).
374 2013 rule § ll.4(a)(2)(ii).
375 2013 rule § ll.4(b)(2)(ii).
376 Id.
377 2013 rule § ll.4(b)(2)(iii)(C).
373 12
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could be classified as permissible
underwriting or market making-related
activity.378 Accordingly, the agencies
sought comment on a proposal to
implement this key statutory factor—in
connection with both relevant
exemptions—in a manner designed to
provide banking entities and the
agencies with greater certainty and
clarity about what activity constitutes
permissible underwriting or market
making-related activity pursuant to the
applicable exemption.379
Instead of the approach taken in the
2013 rule, the agencies proposed to
establish the articulation and use of
internal limits as a key mechanism for
conducting trading activity in
accordance with the rule’s exemptions
for underwriting and market makingrelated activities.380 Specifically, the
proposal would have provided that the
purchase or sale of a financial
instrument by a banking entity would be
presumed to be designed not to exceed
RENTD if the banking entity establishes
internal limits for each trading desk,
subject to certain conditions, and
implements, maintains, and enforces
those limits, such that the risk of the
financial instruments held by the
trading desk does not exceed such
limits.381 As stated in the proposal, the
agencies believe that this approach
would provide banking entities with
more flexibility and certainty in
conducting permissible underwriting
and market making-related activities.382
Under the proposal, all banking
entities, regardless of their volume of
trading assets and liabilities, would
have been able to voluntarily avail
themselves of the presumption of
compliance with the RENTD
requirement by establishing and
complying with these internal limits.
With respect to the underwriting
exemption, the proposal would have
provided that a banking entity would
establish internal limits for each trading
desk that are designed not to exceed
RENTD, based on the nature and
amount of the trading desk’s
underwriting activities, on the:
(1) Amount, types, and risk of its
underwriting position;
378 See
83 FR at 33455, 33459.
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379 Id.
380 As stated in the proposal, as a consequence of
the changes to focus on limits, many of the
requirements of the 2013 rule relating to limits
associated with the exemptions for underwriting
and market making-related activities would be
incorporated into this requirement and modified or
removed as appropriate in the proposal.
381 See proposed rule § ll.4(a)(8); proposed rule
§ ll.4(b)(6).
382 83 FR at 33438.
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(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held.383
With respect to the exemption for
market making-related activities, the
proposal would have provided that all
banking entities, regardless of their
volume of trading assets and liabilities,
would be able to voluntarily avail
themselves of the presumption of
compliance with the RENTD
requirement by establishing and
complying with internal limits.
Specifically, the proposal would have
provided that a banking entity would
establish internal limits for each trading
desk that are designed not to exceed
RENTD, based on the nature and
amount of the trading desk’s market
making-related activities, on the:
(1) Amount, types, and risks of its
market-maker positions;
(2) Amount, types, and risks of the
products, instruments, and exposures
the trading desk may use for risk
management purposes;
(3) Level of exposures to relevant risk
factors arising from its financial
exposure; and
(4) Period of time a financial
instrument may be held.384
In the case of both exemptions, the
proposal provided that banking entities
utilizing the applicable presumption of
compliance with the RENTD
requirement would have been required
to maintain internal policies and
procedures for setting and reviewing
desk-level risk limits.385 The proposed
approach would not have required that
a banking entity’s limits be based on any
specific or mandated analysis, as
required with respect to RENTD
analysis under the 2013 rule. Rather, a
rule § ll.4(a)(8)(i).
rule § ll.4(6)(i)(B).
385 See 83 FR at 33456, 33460. Under the
proposal, banking entities with significant trading
assets and liabilities would have continued to be
required to establish internal limits for each trading
desk as part of the underwriting compliance
program requirement in § ll.4(a)(2)(iii)(B), the
elements of which would cross-reference directly to
the requirement in proposed § ll.4(a)(8)(i).
Similarly, banking entities with significant trading
assets and liabilities would have continued to be
required to establish internal limits for each trading
desk as part of the compliance program requirement
for market making-related activity in
§ ll.4(b)(2)(iii)(C), the elements of which would
cross-reference directly to the requirement in
proposed § ll.4(b)(6)(i). Banking entities without
significant trading assets and liabilities would have
no longer been required to establish a compliance
program that is specific for the purposes of
complying with the either exemption, but would
need to establish, implement, maintain and enforce
internal limits if they chose to utilize the proposed
presumption of compliance with respect to the
statutory RENTD requirement in section 13(d)(1)(B)
of the BHC Act.
383 Proposed
384 Proposed
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banking entity would have established
the limits according to its own internal
analyses and processes around
conducting its underwriting activities
and market making-related activities in
accordance with section 13(d)(1)(B).386
In addition, the proposal would have
required, for both the exemption for
underwriting and market making-related
activities, a banking entity to promptly
report to the appropriate agency when a
trading desk exceeds or increases its
internal limits.387
The proposal also provided that
internal limits established by a banking
entity for the presumption of
compliance with the statutory RENTD
requirement under both the exemption
for underwriting and market makingrelated activities would have been
subject to review and oversight by the
appropriate agency on an ongoing basis.
Any review of such limits would have
assessed whether or not those limits are
established based on the statutory
standard—i.e., the trading desk’s
RENTD, based on the nature and
amount of the trading desk’s
underwriting or market making-related
activities.388
Finally, under the proposal, the
presumption of compliance with the
statutory RENTD requirement for
permissible underwriting and market
making-related activities could have
been rebutted by the appropriate agency
if the agency determines, based on all
relevant facts and circumstances, that a
trading desk is engaging in activity that
is not based on the trading desk’s
RENTD on an ongoing basis. The agency
would have provided notice of any such
determination to the banking entity in
writing.389
The agencies requested comment on
the proposed addition of a presumption
that conducting underwriting or market
making-related activities within
internally set limits satisfies the
requirement that permitted such
activities be designed not to exceed
RENTD.
386 See 83 FR at 33456, 34460. In the proposal,
the agencies indicated that they expected that the
risk and position limits metric that is required for
certain banking entities under the 2013 rule (and
would continue to be required under the Appendix
to the proposal) would help banking entities and
the agencies to manage and monitor the
underwriting and market making-related activities
of banking entities subject to the metrics reporting
and recordkeeping requirements of the Appendix.
387 Proposed rule § ll.4(a)(8)(iii); proposed rule
§ ll.4(b)(6)(iii).
388 See 83 FR at 33456.
389 See proposed rule § ll.4(a)(8)(iv); proposed
rule § ll.4(b)(6)(iv).
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c. Commenters’ Views
General Approach of a Presumption of
Compliance With the Statutory RENTD
Requirement
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As discussed above, the agencies
proposed to establish the articulation
and use of internal limits as a key
mechanism for conducting trading
activity in accordance with the rule’s
exemptions for underwriting and market
making-related activities.390 A number
of commenters expressed support for
the general approach of a presumption
of compliance to satisfy the RENTD
standard.391 Claiming that the 2013 rule
has chilled market making-related
activities and is complex and costly and
does not provide bright line conditions
under which trading can clearly be
classified as permissible market makingrelated activities, one commenter
asserted that the general approach
would significantly improve upon the
approach of the 2013 rule.392
One commenter supported the
proposed approach on the basis that the
presumption would allow banking
entities to estimate and manage
inventory limits in a more holistic
manner to allow for greater and more
efficient liquidity and pricing for its
clients.393 That commenter argued that,
in comparison to the 2013 rule, a
presumption will more effectively
leverage existing industry practices and
reporting requirements related to
managing market-making inventory,
such as maintaining daily VaR metrics
by product and position limits
compared to relative levels of client
activity.394 Another suggested that
because internally set limits are
developed and applied by each banking
entity in light of capital requirements
and risk management it would be
reasonable to provide a presumption of
compliance tied to internally set
limits.395 Finally, one commenter said
that the approach would provide a more
efficient use of compliance resources
and allow banking entities to tailor
compliance requirements to its specific
underwriting and market making-related
activities.396
Several commenters, however,
expressed concerns about the creation of
a presumption of compliance to satisfy
proposed rule § ll.4(a)(8); proposed rule
§ ll.4(b)(6).
391 See, e.g., Credit Suisse; SIFMA; State Street;
Real Estate Associations; and BOK.
392 See SIFMA.
393 See State Street.
394 Id.
395 See JBA.
396 See ABA.
390 See
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the statutory RENTD standard.397 For
example, commenters argued that the
proposed presumption is not consistent
with the statute,398 with one commenter
claiming that the statutory requirement
was intended to constrain bank
activities, not bank risks.399
Commenters expressed concerns that
the proposed presumption of
compliance is too deferential to banking
entities 400 and would reward aggressive
banking entities that set their risk limits
too high.401 One commenter argued that
the limits would not constrain
proprietary trading because the
proposed presumption of compliance
with RENTD allows banking entities to
raise their limits and does not
distinguish between permissible and
impermissible proprietary trades within
risk limits.402 Another commenter
disagreed with a presumption of
compliance for underwriting activity,
asserting that this approach would
undermine well-established principles
of safety and soundness, particularly
given what the commenter referred to as
a general lack of scrutiny over bankdeveloped risk limits.403
Required Analysis for Establishing Risk
Limits
As discussed above, the agencies
recognized in the proposal that the
prescriptive standards in the 2013 rule
for meeting the RENTD requirements
were complex, costly, and did not
provide bright line conditions under
which trading can clearly be classified
as permissible proprietary trading.404 As
a result, the proposal would not have
required that a banking entity’s limits be
based on any specific or mandated
analysis, as was required under the 2013
rule. Rather, under the presumption of
compliance with the RENTD
requirement in the proposal, a banking
entity would have established limits
according to its own internal analyses
and processes around conducting its
underwriting and market making-related
activities in accordance with section
13(d)(1)(B) of the BHC Act.405 Several
397 See, e.g., Merkley; AFR; Bean; Better Markets;
Center for American Progress (CAP); Public Citizen;
Volcker Alliance; and Data Boiler.
398 See, e.g., Bean; Better Markets; CAP; and
Public Citizen.
399 See AFR.
400 See, e.g., AFR; Bean; CAP; Public Citizen;
Volcker Alliance; and Data Boiler.
401 See, e.g., Bean and Volcker Alliance.
402 See Better Markets.
403 See NAFCU.
404 See 83 FR 33459.
405 See 83 FR at 33460. In the proposal, the
agencies noted that they expect that the risk and
position limits metric that is already required for
certain banking entities under the 2013 rule (and
would continue to be required under the Appendix
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commenters provided their views on
this element of the proposal.
Two commenters supported the
agencies’ contention in the proposal that
the prescriptive standards in the 2013
rule were complex, costly, and did not
provide bright line conditions under
which trading can clearly be classified
as permissible proprietary trading.406
Some commenters said that removing
certain conditions, such as the
demonstrable analysis of historical
customer demand in § ll.4(b)(2)(ii)(B)
of the 2013 rule, would increase
flexibility and provide certainty for
banking entities to engage in market
making-related activities since current
or reasonably forecasted market demand
may be different than historical data
may suggest.407
Several commenters, however,
expressed concerns about the proposed
removal of the demonstrable analysis
requirement. Some commenters argued
that the removal of this requirement will
make it harder to for the agencies to
rebut the presumption or determine
when banking entities have not properly
set their RENTD limits.408 One
commenter argued that by not requiring
a demonstrable analysis, the proposed
rule will allow banking entities to
engage in trading activities only
superficially tied to customer
demand.409 One commenter expressed a
belief that the demonstrable analysis
cannot be effectively replaced by other
metrics in the proposal, such as the risk
and position limits and usage metric in
the Appendix because this metric does
not provide information on customer
demand relative to trading
inventories.410
To increase flexibility and certainty
for banking entities engaged in
permitted activities, several of the
commenters that supported the general
approach of the presumption of
compliance with the RENTD
requirement requested that this
proposed requirement be modified in
certain ways. One commenter suggested
that the presumption should be
available to trading desks that establish
internal limits appropriate for their risk
appetite, risk capacity, and business
strategy and hold themselves out as a
to the proposal) would help banking entities and
the agencies to manage and monitor the market
making-related activities of banking entities subject
to the metrics reporting and recordkeeping
requirements of the Appendix.
406 See, e.g., Capital One et al. and SIFMA.
407 See FSF; State Street and SIFMA.
408 See Merkley; Volcker Alliance; and Data
Boiler.
409 See Better Markets.
410 See AFR.
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market maker.411 A commenter
requested that the agencies revise the
presumption to make it available to a
banking entity that sets, in a manner
agreed to with its onsite prudential
examiner and consistent with the intent
and purposes of section 13 of the BHC,
internal RENTD limits based on factors
relevant to the reasonable near-term
demand of clients, customers and
counterparties, which are calibrated
with the intention of not exceeding
RENTD.412 One commenter suggested
that, instead of adhering to the more
prescriptive aspects of the proposed
RENTD presumption, the trading desks
of moderate and limited trading assets
and liabilities banking entities should
be given discretion to adopt internal risk
limits appropriate to the activities of the
desk subject to other existing bank
regulations, supervisory review, and
oversight by the appropriate agency and
still be able to utilize the presumption
of compliance.413
Some commenters requested that the
agencies clarify aspects of the proposal’s
RENTD presumption. Commenters
asked the agencies to clarify that
supervisors and examiners will not
impose a one-size fits all approach given
the differences in business models
among banking entities.414 While
opposed to the general approach of a
presumption of compliance with the
statutory RENTD requirement, one
commenter suggested that, if the
agencies adopt the presumption of
compliance, additional guidance should
be given to banking entities regarding
the factors to consider when setting the
limits required to establish the
presumption of compliance, as the
factors in the proposal were too broad
and malleable.415 Another commenter
suggested that the agencies clarify that
the presumption of compliance should
include activity-based limits as a part of
its risk-limit structure, such as financial
instrument holding periods, notional
size and inventory turnover, because
activity-based limits are reflective of
client demand and an appropriate
statutory substitute compared to riskbased limits, which can be hedged.416
411 See
JBA.
SIFMA (recommended that such factors
might include, for example, anticipated market
volatility and current client inquiries and other
indications of client interest, among many others);
FSF.
413 See Capital One et al.
414 See CCMR and JBA (In particular, this
commenter argued that the agencies should not
compare banking entities as it would be an
impediment to banking entities that are not the
most conservative in its internal risk controls).
415 See Better Markets.
416 See BB&T.
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412 See
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Specific to the underwriting
exemption, one commenter asserted that
underwriting activity can be sporadic
due to client demand or market factors,
which may result in low limit
utilization and a rebuttal of the
presumption of compliance even when
the underwriting position itself is
identifiable as part of a primary or
follow-on offering of securities.417 The
commenter suggested that the agencies
consider corporate actions, such as a
debt offering, as an appropriate
identifier of permissible
underwriting.418 Another commenter
suggested that the agencies permit
banking entities to set limits based on
the absolute value of profits and losses
in the case of an underwriting desk.419
Prompt Notifications
As discussed above, the proposal
would have required a banking entity to
promptly report to the appropriate
agency when a trading desk exceeds or
increases the internal limits it sets to
avail itself of the RENTD presumption
with respect to the exemptions for
underwriting and market making-related
activities.420 With two exceptions,421
commenters strongly opposed the
proposal’s requirement that banking
entities promptly report limit
breaches.422 For example, many of these
commenters stated that the notifications
would be impractical and burdensome
to banking entities 423 and would not
enhance the oversight capabilities of the
agencies because the information is
already otherwise available through
ordinary supervisory processes,424
including the internal limits and usage
metric.425 Two commenters asserted
that the notices would provide little
insight into how risk is managed.426
417 Id.
418 Id.
419 See
JBA.
proposed rule § ll.4(a)(8)(iii); proposed
rule § ll.4(b)(6)(iii).
421 See, e.g., CFA at 7 (stating that, some small
and mid-sized institutions may not have strong
internal controls and may be susceptible to the
activities of a rogue trader, so the prompt notice
requirements allow regulators to impose stricter
controls if necessary); Data Boiler at 36
(representing that the prompt reporting requirement
would decrease opportunities for evasion of the
rule’s requirements).
422 See, e.g., CCMC; BOK; ISDA; Real Estate
Associations; Goldman Sachs; GFMA; CREFC; ABA;
SIFMA; IIB; BB&T; JBA; FSF; Credit Suisse; and
Capital One et al.
423 See, e.g., CCMR; Credit Suisse; GFMA; FSF;
and JBA.
424 See, e.g., Credit Suisse; ABA; GFMA; IIB;
BOK; and SIFMA.
425 See, e.g., FSF; JBA; ABA; Goldman Sachs;
CREFC; and CCMC.
426 See, e.g., BOK (stating that limit excesses do
not, of themselves, show that an institution has
changed it strategy or risk tolerance and that
420 See
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Some commenters expressed concern
that complying with the requirement
would be particularly challenging for
banking entities with parents that are
FBOs because these banking entities
lack on-site examiners to receive
notifications.427 A few commenters
claimed that the prompt notification
requirement provides incentives for
banking entities to set their limits so
high that they have fewer breaches and
changes to limits.428 Commenters also
noted that, when risk limits are
appropriately calibrated, breaches are
not uncommon, and notifying the
agencies of each breach could
overwhelm the agencies.429 Another
commenter argued that the prompt
notification may chill traders’
willingness to request changes to limits
where it would otherwise be
appropriate to accommodate legitimate
customer demand.430
As an alternative to the prompt
notification requirement, many
commenters suggested that the agencies
require banking entities to make
detailed records of limit changes and
breaches.431 Other commenters
suggested that the agencies rely on
existing supervisory processes to
monitor limit breaches and increases,432
including the internal limits and usage
metric.433
Rebutting the Presumption
As discussed above, under the
proposal, the RENTD presumption
could have been rebutted by the
appropriate agency if the agency
determined, based on all relevant facts
and circumstances, that a trading desk
is engaging in activity that is not based
reporting by financial institutions might detract
from a focus on risk management and shift to a
‘‘number of times exceeded’’ view which provides
very little insight into how risk is managed); MBA
(stating that prompt reporting would encourage the
agencies to view events in isolation without
consideration to facts and circumstances and that
it would be more appropriate to review limit-events
in the ordinary course of established supervisory
process).
427 See, e.g., JBA (stating that it would be
operationally difficult and costly for foreign
headquarters to collect and report data to US
regulators); IIB (stating that foreign trading desks
would not have on-site examiners to receive reports
and that the requirement could intrude into local
supervisory matters).
428 See, e.g., Better Markets; Capital One et al.;
and State Street.
429 See, e.g., GFMA and BOK (stating that limits
that are never exceeded ‘‘may not be very useful
limits.’’).
430 See CCMC.
431 See, e.g., CCMR and BB&T.
432 See, e.g., FSF; GFMA; and Real Estate
Associations.
433 See, e.g., FSF; JBA; and ABA.
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on the trading desk’s RENTD on an
ongoing basis.434
A few commenters discussed the
rebuttal process. For example, one
commenter requested that the agencies
specify the procedures for an agency to
rebut the presumption of compliance.435
Another commenter recommended that
the agencies adopt a consistent
procedure for challenging the
presumptions in the rule.436 Another
commenter stated that the proposal
would only allow the agencies to
challenge the risk limit approval and
exception process, not the nexus
between RENTD and the limits
themselves.437
d. Final Presumption of Compliance
With the Statutory RENTD Requirement
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The agencies are adopting the
presumption of compliance with the
RENTD requirement for both the
exemptions for underwriting and market
making-related activities largely as
proposed, but with modifications
intended to be responsive to
commenters’ concerns.438
The agencies are mindful of the
concerns raised by commenters
regarding the general approach of
relying on a banking entity’s internal
limits to satisfy the statutory RENTD
requirement.439 With respect to the
comments described above that the
presumption would not be consistent
with the statute, the agencies note that
the statute permits underwriting and
market making-related activities to the
extent that such activities are designed
not to exceed RENTD. Accordingly,
under the final rule the presumption
will be available to each trading desk
that establishes, implements, maintains,
and enforces internal limits that are
434 See proposed rule § ll.4(a)(8)(iv); proposed
rule § ll.4(b)(6)(iv).
435 See MBA.
436 See IIB.
437 See Better Markets.
438 In addition to the changes described in this
section, the presumption of compliance has been
moved into a new paragraph (c) in § ll.4, as
opposed to including separate provisions under
each of the two relevant exemptions. That change
was intended solely for clarity and to avoid any
unnecessary duplication in light of the fact that the
process for complying with the presumption of
compliance is identical for both exemptions. New
paragraph (c) does, however, recognize that the
limits banking entities will be required to
implement, maintain, and enforce will differ as
between the exemptions for underwriting and
market making-related activities. See final rule
§§ ll.4(c)(2)(A) and ll.4(c)(2)(B).
439 As noted above, this includes commenters
who argue that such amendments will undermine
the operation of the 2013 rule, lead to increased risk
taking among banking entities, and conflict with the
statutory requirements in section 13(d)(1)(B) of the
BHC Act. See supra notes 28, 36–41 and
accompanying text.
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designed not to exceed RENTD.440 In
addition, with respect to the commenter
who expressed concern that the
presumption would undermine safety
and soundness due to a perceived lack
of general scrutiny over banking entitydeveloped limits, the agencies note that
these internal limits will be subject to
supervisory review and oversight,
which constrains banking entities’
ability to set their limits too high.
Further, the agencies may review such
limits to assess whether or not those
limits are consistent with the statutory
RENTD standard. This allows the
supervisors and examiners to look to the
articulation and use of limits to
distinguish between permissible and
impermissible proprietary trading. The
agencies believe that the presumption of
compliance, along with the other
requirements of the final rule’s
exemptions for underwriting and market
making-related activities, create a
framework that will allow banking
entities and the agencies to determine
whether a trading activity has been
designed not to exceed RENTD.
Further, the agencies are concerned
that compliance with the 2013 rule’s
exemptions for underwriting and market
making-related activities may be
unnecessarily complex and costly to
achieve the intended goal of compliance
with these exemptions. For example, as
noted in the proposal, a number of
banking entities have indicated that
even after conducting a number of
complex and intensive analyses to meet
the ‘‘demonstrable analysis’’
requirements for the exemption for
market making-related activities, they
still may be unable to gain comfort that
their bona fide market making-related
activity meets the factors.441 Further,
the absence of clear, bright-line
standards for assessing compliance with
the statutory RENTD standard may be
unnecessarily constraining underwriting
and market making, two critical
functions to the health and well-being of
financial markets in the United States.
The agencies note commenters’
concerns regarding the removal of
‘‘demonstrable analysis’’ requirement
will make it harder for agencies to rebut
the presumption of compliance with the
RENTD requirement or determine when
banking entities have not properly set
their RENTD limits. The agencies
believe, however, that requiring a
banking entity’s internal limits to be
based on RENTD as a requirement for
utilizing the presumption of compliance
440 For consistency with the final rule’s RENTD
requirement, the sub-heading for § ll.4(c)(1) has
been changed from ‘‘risk limits’’ to ‘‘limits.’’
441 83 FR at 33459.
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62003
should help to simplify compliance
with, and oversight of, that statutory
standard by placing the focus on how
those limits are established, maintained,
implemented, and enforced.
Accordingly, under the rule, a
banking entity will be presumed to meet
the RENTD requirements in § ll.4
(a)(2)(ii)(A) or § ll.4(b)(2)(ii) with
respect to the purchase or sale of a
financial instrument if the banking
entity has established and implements,
maintains, and enforces the limits for
the relevant trading desk as described in
the final rule.442 With respect to
underwriting activities, the presumption
will be available to each trading desk
that establishes, implements, maintains,
and enforces internal limits that are
designed not to exceed RENTD, based
on the nature and amount of the trading
desk’s underwriting activities, on the:
(1) Amount, types, and risk of its
underwriting position;
(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held.443
With respect to market making-related
activities, the presumption will be
available to each trading desk that
establishes, implements, maintains, and
enforces risk and position limits that are
designed not to exceed RENTD, based
on the nature and amount of the trading
desk’s market making-related activities,
that address the:
(1) Amount, types, and risks of its
market-maker positions;
(2) Amount, types, and risks of the
products, instruments, and exposures
the trading desk may use for risk
management purposes;
(3) Level of exposures to relevant risk
factors arising from its financial
exposure; and
(4) Period of time a financial
instrument may be held.444
final rule, § ll.4(c)(1)(i).
final rule § ll.4(c)(1)(ii)(A). The
language in this paragraph of the rule has been
modified slightly from the proposal to clarify that
such limits should take into account the liquidity,
maturity, and depth of the market for the relevant
types of financial instruments. As this language
comes directly from the RENTD requirement in
§ ll.4 (a)(2)(ii)(A), the agencies do not view this
as a substantive change. Rather, the agencies believe
that it is important to emphasize in the rule text that
the limit used to satisfy the presumption of
compliance for one type of financial instrument
will not necessarily be the same for other types of
financial instruments and that the particular
characteristics of the relevant market should be
taken into account throughout the process of setting
these limits.
444 See final rule § ll.4(c)(1)(ii)(B). For the
reasons described in connection with the limits
required as satisfy the presumption of compliance
in connection with the underwriting exemption, the
442 See
443 See
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Some commenters also noted that the
agencies should not take a ‘‘one-sizefits-all’’ approach to the limits that must
be established to satisfy the
presumption of compliance with
RENTD on the basis that not all of the
proposed limits may be applicable to
every type of financial instrument,
particularly derivatives.445 In response
to these commenters, the agencies have
modified the rule text to clarify that the
limits required to be established by a
banking entity in order to satisfy the
presumption of compliance must
address certain items. The agencies
recognize that certain of the enumerated
items, which are unchanged from the
proposal, may be more easily applied
for desks that engage in market-making
in securities rather than derivatives, and
emphasize that section ll.4(b), both as
currently in effect and as amended, is
intended to provide banking entities
with the flexibility to determine
appropriate limits for market makingrelated activities that are designed not to
exceed RENTD, taking into account the
liquidity, maturity, and depth of the
market for the relevant types of financial
instruments.
With respect to derivatives, certain of
the enumerated items may not be
effective for designing market makingrelated activities not to exceed RENTD,
which is ultimately the primary purpose
of adopting a presumption of
compliance based on the establishment
and use of internal limits.446 Under
those circumstances, the agencies
acknowledge that it may be appropriate
for banking entities to establish limits
based on specific conditions that would
need to be satisfied in order to utilize
the presumption of compliance, rather
than a fixed number of market-maker
positions.447
For example, for a desk that engages
in market making-related activities only
with respect to derivatives (or
derivatives and non-financial
language in this paragraph has been modified
slightly from the proposal to clarify that such limits
must take into account the liquidity, maturity, and
depth of the market for the relevant types of
financial instruments. See id.
445 See e.g., FSF, SIFMA.
446 As previously noted, the final rule also
replaces the existing definition of ‘‘market makerinventory’’ with a definition of ‘‘market-maker
positions.’’ This change was intended to reflect the
fact that requiring banking entities seeking to rely
on the presumption of compliance with the RENTD
requirement to have limits on market makerinventory is generally unworkable in the context of
derivatives. See infra note 458 and accompanying
text.
447 The agencies note that this discussion does
not encompass or impact the CFTC’s or SEC’s
treatment of market-making in derivatives for
purposes other than section 13 of the BHC Act and
the rule.
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instruments), the requirement to
establish, implement, maintain, and
enforce limits designed not to exceed
RENTD could be satisfied to the extent
the banking entity establishes limits on
the market making desk’s level of
exposures to relevant risk factors arising
from its financial exposure and such
limits are designed not to exceed
RENTD (including derivatives positions
related to a request from a client,
customer, or counterparty), based on the
nature and amount of the trading desk’s
market making-related activities. Such
limits would be consistent with the
underlying purpose of the exemption for
market making-related activities, which
is to implement the restriction on a
banking entity’s proprietary trading
activities while still allowing market
makers to provide intermediation and
liquidity services necessary to the
functioning of our financial markets.
Consistent with the proposal, the
limits used to satisfy the presumption of
compliance under the final rule will be
subject to supervisory review and
oversight by the applicable agency on an
ongoing basis.448 Moreover, the final
rule provides that the presumption of
compliance may be rebutted by the
applicable agency if such agency
determines, taking into account the
liquidity, maturity, and depth of the
market for the relevant types of financial
instruments and based on all relevant
facts and circumstances, that a trading
desk is engaging in activity that is not
designed not to exceed RENTD.449 In a
modification from the proposed rule,
the final rule contains additional
language that specifies that the agencies
will take into account the liquidity,
maturity, and depth of the market for
the relevant types of financial
instruments when determining whether
to rebut the presumption of compliance.
This change is intended to provide
additional clarity regarding the factors
the agencies will consider when making
this determination. In response to
commenters’ concerns about the rebuttal
process, the final rule specifies that any
such rebuttal of the presumption must
be made in accordance with the notice
448 See final rule § ll.4(c)(2). The supervisory
review provision in the proposed rule stated that
‘‘any review of such limits will include assessment
of whether the limits are designed not to exceed the
reasonably expected near term demands of clients,
customers, or counterparties.’’ Sectionslll
.4(c)(1)(i)–(ii) of the final rule clearly stipulate that
such limits must be designed not to exceed the
reasonably expected near term demand of clients,
customers, or counterparties. To avoid redundancy,
this language has been omitted from § ll.4(c)(2)
in the final rule.
449 See final rule § ll.4(c)(4).
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and response procedures in subpart D of
the rule.450
The agencies are, however, persuaded
by the arguments raised by some
commenters with respect to the
proposed requirement that a banking
entity promptly report to the
appropriate agency when a trading desk
exceeds or increases its internal limits
to avail itself of the RENTD
presumption with respect to the
exemptions for underwriting and market
making-related activity.451 The agencies
recognize that limits that are set so high
as to never be breached are not
necessarily meaningful limits. Thus,
breaches of appropriately set limits may
occur with a frequency that does not
justify notifying the agencies for every
single breach. The agencies recognize
that the burdens associated with
preparing and reporting such
information may not be justified in light
of the potential benefits of such
requirement.
Accordingly, the final rule instead
requires banking entities to maintain
and make available to the applicable
agency, upon request, records regarding
(1) any limit that is exceeded and (2)
any temporary or permanent increase to
any limit(s), in each case in the form
and manner as directed by the
agency.452 Moreover, when a limit is
breached or increased, the presumption
of compliance with RENTD will
continue to be available so long as the
banking entity: (1) Takes action as
promptly as possible after a breach to
bring the trading desk into compliance;
and
(2) follows established written
authorization procedures, including
escalation procedures that require
review and approval of any trade that
exceeds a trading desk’s limit(s),
demonstrable analysis of the basis for
any temporary or permanent increase to
a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval.453
The agencies believe that this
requirement will provide the agencies
with sufficient information to determine
whether a banking entity’s existing
limits are appropriately calibrated to
comply with the RENTD requirement
for that particular financial
instrument.454
450 See infra notes 655–58 and accompanying text
(discussion of the notice and response procedures
in § ll.20(i)).
451 See proposed rule §§ ll.4(a)(8)(iii) and
ll.4(b)(6)(iii). See also supra note 387 and
accompanying text.
452 See final rule §ll.4(c)(3)(i).
453 See final rule § ll.4(c)(3)(i).
454 The agencies note that the final rule requires
that banking entities with significant trading assets
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e. Additional Changes to the Final
Rule’s Underwriting and Market
Making-Related Activities Exemptions
In addition to the changes described
above, the final rule’s exemptions for
underwriting and market making-related
activities contain several other
conforming and clarifying changes.
Consistent with the proposed rule, the
structure of § ll.4(a)(ii) in the final
rule has been modified to clarify that
the applicable paragraph contains two
separate and distinct requirements.455 In
addition, several definitions used in the
final rule’s exemptions for underwriting
and market making-related activities
have also been modified. Specifically,
the phrase ‘‘paragraph (b)’’ has been
replaced with ‘‘this section’’ in the
definition of ‘‘underwriting position’’
because the defined term is used in
several places.456 The definition of
‘‘financial exposure’’ has been similarly
modified.457 Finally, the final rule,
however, replaces the existing
definition of ‘‘market maker-inventory’’
with a definition for ‘‘market-maker
positions’’ to correspond with the
language in § ll.4(c)(ii)(B)(1), which is
the only place such definition is
used.458
f. Compliance Program and Other
Requirements for Underwriting and
Market Making-Related Activities
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2013 Rule Compliance Program
Requirements
The underwriting exemption in
§ ll.4(a) of the 2013 rule requires a
banking entity to establish, implement,
maintain, and enforce an internal
compliance program, as required by
subpart D, that is reasonably designed to
ensure compliance with the
requirements of the exemption. Such
compliance program is required to
include reasonably designed written
policies and procedures, internal
controls, analysis and independent
testing identifying and addressing: (i)
and liabilities must record and report the
quantitative measurements contained in the
Appendix to the final rule. See infra Subpart E—
Metrics: Appendix to Part [•]—Reporting and
Recordkeeping Requirements. The agencies believe
that the risk and position limits metric will also
help banking entities and the agencies monitor the
underwriting and market making-related activities
of banking entities with significant trading assets
and liabilities.
455 Unlike the 2013 rule, § ll.4(a)(ii) in the final
rule contains subparagraphs (A) and (B).
456 See § ll.4(a)(6).
457 See § ll.4(b)(4).
458 See § ll.4(c)(ii)(B)(1). With respect to the
exemption for market making-related activities, the
rebuttable presumption of compliance for the
RENTD requirement in the final rule requires,
among other things, that a trading desk establish,
implement, and enforce limits on the amounts,
types, and risks of its market-maker positions.
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The products, instruments, or exposures
each trading desk may purchase, sell, or
manage as part of its underwriting
activities; (ii) certain limits for each
trading desk, based on the nature and
amount of the trading desk’s
underwriting activities, including the
reasonably expected near term demands
of clients, customers, or
counterparties; 459 (iii) internal controls
and ongoing monitoring and analysis of
each trading desk’s compliance with its
limits; and (iv) authorization
procedures, including escalation
procedures that require review and
approval of any trade that would exceed
one or more of a trading desk’s limits,
demonstrable analysis of the basis for
any temporary or permanent increase to
one or more of a trading desk’s limits,
and independent review (i.e., by risk
managers and compliance officers at the
appropriate level independent of the
trading desk) of such demonstrable
analysis and approval.
The exemption for market makingrelated activities in the 2013 rule
contains similar requirements.
Specifically, § ll.4(b) of the 2013 rule
requires that a banking entity establish,
implement, maintain, and enforce an
internal compliance program, as
required by subpart D, that is reasonably
designed to ensure compliance with the
requirements of the exemption. Such a
compliance program is required to
include reasonably designed written
policies and procedures, internal
controls, analysis, and independent
testing identifying and addressing: (i)
The financial instruments each trading
desk stands ready to purchase and sell
in accordance with the exemption for
market making-related activities; (ii) the
actions the trading desk will take to
demonstrably reduce or otherwise
significantly mitigate the risks of its
financial exposure consistent with the
limits required under paragraph
(b)(2)(iii)(C), and the products,
instruments, and exposures each trading
desk may use for risk management
purposes; the techniques and strategies
each trading desk may use to manage
the risks of its market making-related
activities and inventory; and the
process, strategies, and personnel
responsible for ensuring that the actions
taken by the trading desk to mitigate
these risks are and continue to be
effective; (iii) the limits for each trading
desk, based on the nature and amount
of the trading desk’s market making459 These factors include the: (1) Amount, types,
and risk of its underwriting position; (2) level of
exposures to relevant risk factors arising from its
underwriting position; and (3) period of time a
security may be held.
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62005
related activities, including the
reasonably expected near term demands
of clients, customers, or
counterparties; 460 (iv) internal controls
and ongoing monitoring and analysis of
each trading desk’s compliance with its
limits; and (v) authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed one or more of
a trading desk’s limits, demonstrable
analysis of the basis for any temporary
or permanent increase to one or more of
a trading desk’s limits, and independent
review (i.e., by risk managers and
compliance officers at the appropriate
level independent of the trading desk) of
such demonstrable analysis and
approval.
Proposed Compliance Program
Requirement
Feedback from market participants
and agency oversight have indicated
that the compliance program
requirements of the existing exemptions
for underwriting and market makingrelated activities may be unduly
complex and burdensome for banking
entities with smaller and less active
trading activities. In the proposed rule,
the agencies proposed a tiered approach
to such compliance program
requirements, to make these
requirements commensurate with the
size, scope, and complexity of the
relevant banking entity’s trading
activities and business structure. Under
the proposed rule, a banking entity with
significant trading assets and liabilities
would continue to be required to
establish, implement, maintain, and
enforce a comprehensive internal
compliance program as a condition for
relying on the exemptions for
underwriting and market making-related
activities. However, the agencies
proposed to eliminate such compliance
program requirements for banking
entities that have moderate or limited
trading assets and liabilities.461
Comments on the Proposed Compliance
Program Requirement
Some commenters did not support the
removal of the underwriting or market
making-specific compliance program
460 Specifically, such limits include the: (1)
Amount, types, and risks of its market-maker
inventory; (2) amount, types, and risks of the
products, instruments, and exposures the trading
desk may use for risk management purposes; (3) the
level of exposures to relevant risk factors arising
from its financial exposure; and (4) period of time
a financial instrument may be held.
461 Under the 2013 rule, the compliance program
requirement in § ll.4(a)(2)(iii) is part of the
compliance program required by subpart D but is
specifically used for purposes of complying with
the exemption for underwriting activity.
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requirements for banking entities with
limited and moderate trading assets and
liabilities under the proposal. For
example, one commenter urged the
agencies to require all banking entities
to establish, implement, maintain, and
enforce such compliance program,
independent of any presumption of
compliance.462 This commenter
indicated that there are ‘‘exceedingly
low incremental costs’’ associated with
most elements of the RENTD
compliance and controls framework for
the exemptions for underwriting and
market making-related activities, even
for those banking entities with limited
or moderate trading assets and
liabilities.463 In the commenter’s view,
minimal incremental costs support the
retention of such requirements, which
are further justified by the increased
stability of financial institutions and
financial markets as a result of the 2013
rule.464
Further, that same commenter
asserted that the compliance
requirements under the 2013 rule
permit too much discretion for banking
entities to implement policies,
procedures, and controls, noting that
judgments on the effectiveness of
implemented controls depend on the
methodologies used by banking entities’
testing functions, and argued that the
agencies should consider additional
capital and activities-based
requirements specifically tied to the
reported inventory of trading assets,
taking into account the total size of
those trading assets, the overall capital
position of the financial institution, and
the average holding period or aging of
trading assets, which may indicate that
inventories are unrelated to
underwriting and market making
activities.465 Similarly, another
commenter indicated that a tiered
compliance approach would not be
appropriate because it considered the
proposed categorization of entities in
terms of trading assets and liabilities to
be flawed.466
Other commenters supported the
revisions under the proposed rule to
apply the market making-related
activities’ compliance program
requirements only to those banking
entities with significant trading assets
and liabilities. For example, one
commenter expressed concern that the
market making-related activities’
compliance program requirements
under the 2013 rule have contributed to
462 See
decreased market making activities
with, and increased costs for, banking
entities’ commercial end-user
counterparties.467 This commenter
indicated that applying the market
making-related activities’ compliance
program requirements only to banking
entities with significant trading assets
and liabilities would allow banking
entities to develop more efficient
compliance and liquidity risk
management programs, which would
ultimately reduce transaction costs for
commercial end users.468
Another commenter expressed the
view that the proposed approach of
applying the compliance program
requirements under the exemptions for
underwriting and market making-related
activities only to those banking entities
with significant trading assets and
liabilities was an appropriate means of
reducing the regulatory burdens on
banks with limited or moderate trading
and underwriting exposures.469 That
commenter noted that such approach
would continue to allow for the
appropriate monitoring of these
activities to ensure compliance with the
provisions of the 2013 rule.470
Final Compliance Program Requirement
The agencies believe that the
compliance program requirements that
apply specifically to the exemptions for
underwriting and market making-related
activities play an important role in
facilitating and monitoring a banking
entity’s compliance with the
requirements of those exemptions.
However, the agencies also believe that
those requirements can be appropriately
tailored to the nature of the
underwriting and market making
activities conducted by each banking
entity. It also is important to recognize
that the removal of such compliance
program requirements for banking
entities that do not have significant
trading assets and liabilities would not
relieve those banking entities of the
obligation to comply with the other
requirements of the exemptions for
underwriting and market making-related
activities, including RENTD
requirements, under the final rule.
Accordingly, and after consideration
of the comments, the agencies continue
to believe that removing the § ll.4
compliance program requirements for
banking entities that do not have
significant trading assets and liabilities
as a condition to engaging in permitted
underwriting and market making-related
Better Markets.
463 Id.
467 See
464 Id.
468 Id.
465 Id.
466 See
469 See
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Coalition of Derivatives End Users.
CFA.
470 Id.
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activities should provide these banking
entities with additional flexibility to
tailor their compliance programs in a
way that takes into account the risk
profile and relevant trading activities of
each particular trading desk.
The agencies recognize that banking
entities that do not have significant
trading assets and liabilities may incur
costs to establish, implement, maintain,
and enforce the compliance program
requirements applicable to permitted
underwriting activities under the 2013
rule. As the trading activities of banking
entities that do not have significant
trading activities comprise
approximately seven percent of the total
U.S. trading activity subject to the
Volcker Rule, the agencies believe the
costs of the compliance program
requirement would be disproportionate
to the banking entity’s trading activity
and the risk posed to U.S. financial
stability. Accordingly, eliminating the
§ ll.4 compliance program
requirements for permitted
underwriting and market making-related
activities conducted by banking entities
that do not have significant trading
assets and liabilities may reduce
compliance costs without materially
impacting conformance with the
objectives set forth in section 13 of the
BHC Act. Applying these specific
compliance requirements only to
banking entities with significant trading
assets and liabilities also is consistent
with the modifications to the general
compliance program requirements for
these banking entities under § ll.20 of
the final rule, as discussed below.
Accordingly, § ll.4(a)(2)(iii) of the
final rule will require banking entities
with significant trading assets and
liabilities, as a condition to complying
with the underwriting exemption, to
establish and implement, maintain, and
enforce an internal compliance program
required by subpart D that is reasonably
designed to ensure the banking entity’s
compliance with the requirements of the
exemption, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The products, instruments or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
(B) Limits for each trading desk, in
accordance with § ll.4(a)(2)(ii)(A); 471
471 Final rule § ll.4(a)(2)(ii)(A) requires that the
amount and type of the securities in the trading
desk’s underwriting position are designed not to
exceed RENTD, taking into account the liquidity,
maturity, and depth of the market for the relevant
type of security; and (B) that reasonable efforts are
made to sell or otherwise reduce the underwriting
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(C) Written authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
and
(D) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits.
With respect to the exemption for
market making-related activities,
§ ll.4(a)(b)(iii) of the final rule will
require banking entities with significant
trading assets and liabilities to establish
and implement, maintain, and enforce
an internal compliance program
required by subpart D that is reasonably
designed to ensure the banking entity’s
compliance with the requirements of the
exemption, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The financial instruments each
trading desk stands ready to purchase
and sell in accordance with
§ ll.4(b)(2)(i); 472
(B) The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the limits
required under § ll.4 (b)(2)(iii)(C); the
products, instruments, and exposures
each trading desk may use for risk
management purposes; the techniques
and strategies each trading desk may use
to manage the risks of its market
making-related activities and positions;
and the process, strategies, and
personnel responsible for ensuring that
the actions taken by the trading desk to
mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, in
accordance with § ll.4(b)(2)(ii); 473
position within a reasonable period, taking into
account the liquidity, maturity, and depth of the
market for the relevant type of security.
472 Final rule § ll.4(b)(2)(i) requires that the
trading desk that establishes and manages the
financial exposure routinely stands ready to
purchase and sell one or more types of financial
instruments related to its financial exposure and is
willing and available to quote, purchase and sell,
or otherwise enter into long and short positions in
those types of financial instruments for its own
account, in commercially reasonable amounts and
throughout market cycles on a basis appropriate for
the liquidity, maturity, and depth of the market for
the relevant types of financial instruments.
473 Final rule § ll.4(b)(2)(ii) requires that the
trading desk’s market making-related activities are
designed not to exceed, on an ongoing basis,
RENTD, taking into account the liquidity, maturity,
and depth of the market for the relevant type of
security.
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(D) Written authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
and
(E) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits.
The agencies are clarifying in the final
rule that the authorization procedures
for banking entities with significant
trading assets and liabilities of proposed
§ ll.4(a)(2)(iii)(D) and
§ ll.4(b)(2)(iii)(E) are to be in writing
pursuant to § ll.4(a)(2)(iii)(C) and
§ ll.4(b)(2)(iii)(D). Requiring that
these authorization procedures are
written provides a basis for which
banking entities and supervisors can
review for compliance with the
underwriting and market making
exemption compliance requirements.
Sections ll.4(a)(2)(iii) (which sets
forth the compliance program
requirements for the underwriting
exemption) and § ll.4(b)(2)(iii) (which
sets forth the compliance program
requirements for the exemptions for
market making-related activities) further
provide that a banking entity with
significant trading assets and liabilities
may satisfy the requirements pertaining
to limits and written authorization
procedures by complying with the
requirements pursuant to the
presumption of compliance with the
statutory RENTD requirement in
§ ll.4(c).474 As such, § ll.4(c)(1)
provides for a rebuttable presumption
that a banking entity’s purchase or sale
of a financial instrument complies with
the RENTD requirements in
§ ll.4(a)(2)(ii)(A) and § ll.4(b)(2)(ii)
if the relevant trading desk establishes,
implements, maintains, and enforces
internal limits that are designed not to
exceed the reasonably expected near
term demands of clients, customers, or
counterparties, taking into account the
liquidity, maturity, and depth of the
market for the relevant type of security.
In taking this approach, the agencies
recognize that requiring a banking entity
to establish separate limits in
accordance with the statutory RENTD
requirement would be unnecessary and
may reduce the benefit of relying on
474 See supra section IV.B.2.d (discussing the
requirements in the final rule associated with the
presumption of compliance with the statutory
RENTD requirement).
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62007
internal limits set pursuant to
§ ll.4(c)(1).
Additionally, in the case of a banking
entity with significant trading assets and
liabilities, the relevant exemption
compliance requirements pertaining to
written authorization procedures in
§ ll.4(a)(2)(iii)(C) are not required if
the criteria in § ll.4(c) are satisfied.
Without the requirement to establish
limits pursuant to § ll.4(a)(iii)(B),
such a requirement for written
authorization procedures would be
unnecessary. Further, because
§ ll.4(c)(3)(ii)(2) contains written
authorization procedures, also requiring
written authorization procedures in
§ ll.4(a)(2)(iii)(C) would be
duplicative.
These revisions clarify that banking
entities with significant trading assets
and liabilities that establish limits and
written authorization procedures
pursuant to the rebuttable presumption
of compliance do not have to establish
a second set of limits and written
authorization procedures pursuant to
the compliance program requirements of
the underwriting or market making
exemptions. Regardless of whether a
banking entity with significant trading
assets and liabilities relies on the
presumption of compliance in
§ ll.4(c), every banking entity with
significant trading assets and liabilities
is required to maintain limits and
written authorization procedures for
purposes of complying with the
exemption for permitted underwriting
or market making-related activities
under § ll.4.
The agencies are removing the
proposed rule’s requirement for a
banking entity with significant trading
assets and liabilities that, to the extent
that any limit identified pursuant to
§ ll.4(b)(2)(iii)(C) of the proposed rule
is exceeded, the trading desk takes
action to bring the trading desk into
compliance with the limits as promptly
as possible after the limit is exceeded.
Instead, this requirement is being
moved to § ll.4(c), the rebuttable
presumption of compliance for banking
entities that establish internal limits
pursuant to § ll.4(c)(1). Such
requirements would be redundant for a
banking entity with significant trading
assets and liabilities that is required, on
an ongoing basis, to ensure that its
trading desk’s market making activities
are designed not to exceed RENTD
while also establishing limits designed
not to exceed RENTD.475 In addition,
the written authorization procedures 476
475 See
476 See
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require internal compliance processes to
handle such limit breaches.
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g. Other Comments
Finally, some commenters
recommended changes to certain
aspects of the existing exemptions for
underwriting and market making-related
activities in the 2013 rule that were not
specifically proposed. For example, one
commenter suggested that the agencies
eliminate the limitations on treating
banking entities with greater than $50
billion in trading assets and liabilities as
clients, customers, or counterparties.477
As stated in the 2013 rule, the agencies
believe that removing this limitation
could make it difficult to meaningfully
distinguish between permitted market
making-related activity and
impermissible proprietary trading, and
allow a trading desk to maintain an
outsized inventory and to justify such
inventory levels as being tangentially
related to expected market-wide
demand.478 The agencies also believe
that banking entities engaged in
substantial trading activity do not
typically act as customers to other
market makers.479 As a result, the
agencies have retained the 2013 rule’s
definition of client, customer, or
counterparty. Another commenter
suggested broadening the scope of the
exemption for underwriting activities to
encompass any activity that assists
persons or entities in accessing the
capital markets or raising capital.480 The
agencies believe the final rule’s changes
provide additional clarity while
maintaining consistency with statutory
objectives. Accordingly, after
consideration of these comments, the
agencies have decided not to make any
changes to the exemptions for
underwriting or market making-related
activities other than those discussed
above.
h. Market Making Hedging
As noted in the proposal, during
implementation of the 2013 rule, the
agencies received a number of inquiries
regarding the circumstances under
which banking entities could elect to
comply with the market making risk
management provisions permitted in
§ ll.4(b) or alternatively the riskmitigating hedging requirements under
§ ll.5. These inquiries generally
related to whether a trading desk could
treat an affiliated trading desk as a
client, customer, or counterparty for
purposes of the exemption market
CCMC.
79 FR 5607.
479 See 79 FR 5606–5607.
480 See ISDA.
making-related activities’ RENTD
requirement; and whether, and under
what circumstances, one trading desk
could undertake market making risk
management activities for one or more
other trading desks.481
Each trading desk engaging in a
transaction with an affiliated trading
desk that meets the definition of
proprietary trading must rely on an
exemption or exclusion in order for the
transaction to be permissible. As noted
in the proposal, in one example
presented to the agencies, one trading
desk of a banking entity may make a
market in a certain financial instrument
(e.g., interest rate swaps), and then
transfer some of the risk of that
instrument (e.g., foreign exchange (FX)
risk) to a second trading desk (e.g., an
FX swaps desk) that may or may not
separately engage in market makingrelated activity. In the proposal, the
agencies requested comment as to
whether, in such a scenario, the desk
taking the risk (in the preceding
example, the FX swaps desk) and the
market making desk (in the preceding
example, the interest rate desk) should
be permitted to treat each other as a
client, customer, or counterparty for
purposes of establishing internal limits
or RENTD levels under the exemption
for market making-related activities.482
The agencies also requested comment
as to whether each desk should be
permitted to treat swaps executed
between the desks as permitted market
making-related activities of one or both
desks if the swap does not cause the
relevant desk to exceed its applicable
limits and if the swap is entered into
and maintained in accordance with the
compliance requirements applicable to
the desk, without treating the affiliated
desk as a client, customer, or
counterparty for purposes of
establishing or increasing its limits. This
approach was intended to maintain
appropriate limits on proprietary
trading by not permitting an expansion
of a trading desk’s market making limits
based on internal transactions. At the
same time, this approach was intended
to permit efficient internal risk
management strategies within the limits
established for each desk.483
The agencies also requested comment
on the circumstances in which an
organizational unit of an affiliate
(affiliated unit) of a trading desk
engaged in market making-related
activities in compliance with § ll.4(b)
(market making desk) would be
permitted to enter into a transaction
477 See
484 Id.
478 See
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with the market making desk in reliance
on the market making desk’s risk
management policies and procedures. In
this scenario, to effect such reliance the
market making desk would direct the
affiliated unit to execute a riskmitigating transaction on the market
making desk’s behalf. If the affiliated
unit did not independently satisfy the
requirements of the exemption for
market making-related activities with
respect to the transaction, it would be
permitted to rely on the exemption for
market making-related activities
available to the market making desk for
the transaction if: (i) The affiliated unit
acts in accordance with the market
making desk’s risk management policies
and procedures; and (ii) the resulting
risk-mitigating position is attributed to
the market making desk’s financial
exposure (and not the affiliated unit’s
financial exposure) and is included in
the market making desk’s daily profit
and loss calculation. If the affiliated unit
establishes a risk-mitigating position for
the market making desk on its own
accord (i.e., not at the direction of the
market making desk) or if the riskmitigating position is included in the
affiliated unit’s financial exposure or
daily profit and loss calculation, then
the affiliated unit may still be able to
comply with the requirements of the
risk-mitigating hedging exemption
pursuant to § ll.5 for such activity.484
The commenters were generally in
favor of permitting affiliated trading
desks to treat each other as a client,
customer, or counterparty for the
purposes of establishing risk limits or
RENTD levels under the exemption for
market making-related activities,485
particularly for banking entities that
service customers in different
jurisdictions. One commenter, however,
did not support this approach, and
expressed that it would be difficult to
validate banking entities’ RENTD limits
if affiliates could be considered as a
client, customer, or counterparty.486
One commenter argued that affiliated
trading desks with different mandates
should be able to treat each other as a
client, customer, or counterparty as long
as each desk stays within its limits,
because such an approach would allow
banking entities to take an enterprisewide view of risk management.487
Two commenters explained that, to
increase efficiencies, certain
internationally active banking entities
employ a ‘‘hub-and-spoke’’ model,
where trading desks at local entities
481 83
FR at 33464.
485 See,
e.g., HSBC; JBA; and IIB.
Data Boiler.
487 See IIB.
482 Id.
486 See
483 Id.
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(spoke) enter into transactions with
major affiliates (hub) that manage the
risks of, and source trading positions
for, the local entities.488 One of these
commenters expressed that these
trading desks have trouble
demonstrating they are indeed market
making desks without intra-entity and
inter-affiliate transactions being treated
as transactions with a client, customer,
or counterparty.489 The other
commenter expressed that, under the
hub-and-spoke model, treating the
‘‘spoke’’ trading desk as a client,
customer, or counterparty, would allow
the hub desk to look through to the
customer of the local entity since the
hub is acting as the ultimate market
maker.490
After consideration of comments, the
agencies continue to recognize that,
under certain circumstances, a trading
desk may undertake market making risk
management activities for one or more
affiliated trading desks 491 and trading
desks may rely on the exemption for
market making-related activities for its
transactions with affiliated trading
desks. The agencies, however, are
declining to permit banking entities to
treat affiliated trading desks as ‘‘clients,
customers, or counterparties’’ 492 for the
purposes of determining a trading desk’s
RENTD pursuant to § ll.4(b)(2)(ii) of
the exemption for market makingrelated activities.
The agencies believe that, under the
exemption for market making-related
activities, each trading desk must be
able to independently tie its activities to
the RENTD of external customers that
the trading desk services. Allowing a
desk to treat affiliated trading desks as
customers for purposes of RENTD
would allow the desk to accumulate
financial instruments if it has a reason
to believe that other internal desks will
be interested in acquiring the positions
in the near term. Those other desks
could then acquire the positions from
the first desk at a later time when they
have a reasonable expectation of near
term demand from external customers.
The agencies also believe that generally
allowing a desk to treat other internal
desks as customers for purposes of
RENTD could impede monitoring of
market making-related activity and
detection of impermissible proprietary
trading since a banking entity could
aggregate in a single trading desk the
RENTD of trading desks that engage in
multiple different trading strategies and
488 See
HSBC and JBA.
JBA.
490 See HSBC.
491 See 79 FR at 5594.
492 § ll.4(b)(3).
489 See
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aggregate a larger volume of trading
activities.493
With respect to the arguments raised
by these commenters that permitting
this treatment would facilitate efficient
risk management,494 the agencies
believe that the amendments to the riskmitigating hedging exemption in the
final rule 495 and the amendments to the
liquidity management exemption in the
final rule 496 will provide banking
entities with additional flexibility to
manage risks more efficiently than the
2013 rule.
Further, the agencies note that while
affiliated trading desks may not
consider each other clients, customers,
or counterparties, transactions between
affiliated trading desks may be
permitted under the exemption for
market making-related activities in
certain circumstances that do not
require the expansion of a trading desk’s
market making limits based on internal
transactions. Returning to the example
from the proposal and described
above 497 concerning an interest rate
swaps desk transferring some of the risk
of a financial instrument to an affiliated
FX swaps desk, if the FX swaps desk
acts as a market maker in FX swaps, the
FX swaps desk may be able to rely on
the exemption for market makingrelated activities for its transactions
with the interest rate swaps desk if
those transactions are consistent with
the requirements of the exemption for
market making-related activities,
including the FX swaps desk’s
RENTD.498 Further, if the FX swaps
desk does not independently satisfy the
requirements of the exemption for
market making-related activities with
respect to the transaction, it would be
permitted to rely on the exemption for
market making-related activities
available to the market making desk for
the transaction under certain
conditions. If the banking entity has
significant trading assets and liabilities,
493 See
79 FR at 5590.
HSBC; JBA; and IIB.
495 The agencies are streamlining several aspects
of the risk-mitigating hedging exemption for
banking entities with and without significant
trading assets and liabilities. See final rule § ll.5;
See also section IV.B.3, infra.
496 The agencies have expanded the types of
financial instruments eligible for the exclusion to
include for exchange forwards and foreign exchange
swaps. See final rule § ll.3(e); See also section
IV.B.1.b.i, supra.
497 See Part IV.B.2.h, supra; see also 83 FR 33463.
498 The interest rate market making desk can rely
on the exemption for market making-related
activities for the FX swap it enters into with the FX
swaps desk provided the interest rate market
making desk enters into the FX swap to hedge its
market making-related position and otherwise
complies with the requirements of the exemption
for market making-related activities.
494 See
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62009
the FX swaps desk would be permitted
to rely on the exemption for market
making-related activities if: (i) The FX
swaps desk acts in accordance with the
interest rate swaps desk’s risk
management policies and procedures
established in accordance with
§ ll.4(b)(2)(iii) and (ii) the resulting
risk-mitigating position is attributed to
the interest rate swaps desk’s financial
exposure (and not the FX swaps desk’s
financial exposure) and is included in
the interest rate swaps desk’s daily
profit and loss calculation. If the
banking entity does not have significant
trading assets and liabilities, the FX
swaps desk would be permitted to rely
on the exemption for market makingrelated activities if the resulting riskmitigating position is attributed to the
interest rate swaps desk’s financial
exposure (and not the FX swaps desk’s
financial exposure) and is included in
the interest rate swaps desk’s daily
profit and loss calculation. If the FX
swaps desk cannot independently
satisfy the requirements of the
exemption for market making-related
activities with respect to its transactions
with the interest rate swaps desk, the
risk-mitigating hedging exemption
would be available, provided the
conditions of that exemption are met.
3. Section ll.5: Permitted RiskMitigating Hedging Activities
a. Section ll.5 of the 2013 Rule
Section 13(d)(1)(C) of the BHC Act
provides an exemption from the
prohibition on proprietary trading for
risk-mitigating hedging activities that
are designed to reduce the specific risks
to a banking entity in connection with
and related to individual or aggregated
positions, contracts, or other holdings.
Section ll.5 of the 2013 rule
implements section 13(d)(1)(C).
Section ll.5 of the 2013 rule
provides a multi-faceted approach to
implementing the hedging exemption to
ensure that hedging activity is designed
to be risk-reducing and does not mask
prohibited proprietary trading. Under
the 2013 rule, risk-mitigating hedging
activities must comply with certain
conditions for those activities to qualify
for the exemption. Generally, a banking
entity relying on the hedging exemption
must have in place an appropriate
internal compliance program that meets
specific requirements, including the
requirement to conduct certain
correlation analysis, to support its
compliance with the terms of the
exemption, and the compensation
arrangements of persons performing
risk-mitigating hedging activities must
be designed not to reward or incentivize
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prohibited proprietary trading.499 In
addition, the hedging activity itself must
meet specified conditions. For example,
at inception, the hedge must be
designed to reduce or otherwise
significantly mitigate, and must
demonstrably reduce or otherwise
significantly mitigate, one or more
specific, identifiable risks arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, and the
activity must not give rise to any
significant new or additional risk that is
not itself contemporaneously hedged.500
Finally, § ll.5 establishes certain
documentation requirements with
respect to the purchase or sale of
financial instruments made in reliance
of the risk-mitigating exemption under
certain circumstances.501
b. Proposed Amendments to Section
ll.5
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i. Correlation Analysis for Section
ll.5(b)(1)(iii)
The agencies proposed to remove the
specific requirement to conduct a
correlation analysis for risk-mitigating
hedging activities.502 In particular, the
agencies proposed to remove the words
‘‘including correlation analysis’’ from
the requirement that the banking entity
seeking to engage in risk-mitigating
hedging activities conduct ‘‘analysis,
including correlation analysis, and
independent testing’’ designed to ensure
that hedging activities may reasonably
be expected to reduce or mitigate the
risks being hedged. Thus, the
requirement to conduct an analysis
would have remained, but the banking
entity would have had flexibility to
apply a type of analysis that was
appropriate to the facts and
circumstances of the hedge and the
underlying risks targeted.503
The agencies noted that they have
become aware of practical difficulties
with the correlation analysis
requirement, which according to
banking entities can add delays, costs,
and uncertainty to permitted riskmitigating hedging.504 The agencies
anticipated that removing the
correlation analysis requirement would
reduce uncertainties in meeting the
analysis requirement without
significantly impacting the conditions
that risk-mitigating hedging activities
2013 rule § ll.5(b)(1) and (3).
2013 rule § ll.5(b)(2).
501 See 2013 rule § ll.5(c).
502 See 83 FR at 33465.
503 See 83 FR at 33465.
504 See id.
must meet in order to qualify for the
exemption.505
The agencies also noted that section
13 of the BHC Act does not specifically
require this correlation analysis.506
Instead, the statute only provides that a
hedging position, technique, or strategy
is permitted so long as it is ‘‘. . .
designed to reduce the specific risks to
the banking entity . . . .’’ 507 The 2013
rule added the correlation analysis
requirement as a measure intended to
ensure compliance with this exemption.
ii. Hedge Demonstrably Reduces or
Otherwise Significantly Mitigates
Specific Risks for Sections
ll.5(b)(1)(iii), ll.5(b)(2)(ii), and
ll.5(b)(2)(iv)(B)
The agencies stated in the proposal
that the requirements in
§ ll.5(b)(1)(iii), § ll.5(b)(2)(ii), and
§ ll.5(b)(2)(iv)(B), that a riskmitigating hedging activity
demonstrably reduces or otherwise
significantly mitigates specific risks, is
not directly required by section
13(d)(1)(C) of the BHC Act.508 The
statute instead requires that the hedge
be designed to reduce or otherwise
significantly mitigate specific risks.509
Thus, the agencies proposed to remove
the ‘‘demonstrably reduces or otherwise
significantly mitigates’’ specific risk
requirement from § ll.5(b)(2)(ii) and
§ ll.5(b)(2)(iv)(B). This change would
retain the requirement that the hedging
activity be designed to reduce or
otherwise significantly mitigate one or
more specific, identifiable risks, while
providing banking entities with the
flexibility to apply a type of analysis
that was appropriate to the facts and
circumstances of the hedge and the
underlying risks targeted.
The agencies also proposed to remove
parallel provisions in § ll.5(b)(1)(iii).
In particular, the agencies proposed to
delete the word ‘‘demonstrably’’ from
the requirement that ‘‘the positions,
techniques and strategies that may be
used for hedging may reasonably be
expected to demonstrably reduce or
otherwise significantly mitigate the
specific, identifiable risk(s) being
hedged’’ in § ll.5(b)(1)(iii). This
change would have meant that the
banking entity’s analysis and testing
would have had to show that the
hedging may be expected to reduce or
mitigate the risks being hedged, but
without the specific requirement that
such reduction or mitigation be
499 See
500 See
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505 See
id.
83 FR at 33465.
507 12 U.S.C. 1851(d)(1)(C).
508 See 83 FR at 33465.
509 See id.
demonstrable. The agencies also
proposed to delete the requirement in
§ ll.5(b)(1)(iii) that ‘‘such correlation
analysis demonstrates that the hedging
activity demonstrably reduces or
otherwise significantly mitigates the
specific, identifiable risk(s) being
hedged’’ because this requirement was
not necessary if the ‘‘correlation
analysis’’ and ‘‘demonstrable’’
requirements were deleted.
The agencies noted that, in practice,
it appears that the requirement to show
that hedging activity demonstrably
reduces or otherwise significantly
mitigates a specific, identifiable risk that
develops over time can be complex and
could potentially reduce bona fide riskmitigating hedging activity. For
example, in some circumstances it
would be very difficult, if not
impossible, for a banking entity to
comply with the continuous
requirement to demonstrably reduce or
significantly mitigate the identifiable
risks, and therefore the firm would not
enter into what would otherwise be
effective hedges of foreseeable risks.510
iii. Reduced Compliance Requirements
for Banking Entities That Do Not Have
Significant Trading Assets and
Liabilities for Section ll.5(b) and (c)
For banking entities that do not have
significant trading assets and liabilities,
the agencies proposed to eliminate the
requirements for a separate internal
compliance program for risk-mitigating
hedging under § ll.5(b)(1); certain of
the specific requirements of
§ ll.5(b)(2); the limits on
compensation arrangements for persons
performing risk-mitigating activities in
§ ll.5(b)(3); and the documentation
requirements for certain hedging
activities in § ll.5(c).511 In place of
those requirements, the agencies
proposed a new § ll.5(b)(2) that
would require that the risk-mitigating
hedging activities be: (i) At the
inception of the hedging activity
(including any adjustments), designed
to reduce or otherwise significantly
mitigate one or more specific,
identifiable risks, including the risks
specifically enumerated in the proposal;
and (ii) subject to ongoing recalibration,
as appropriate, to ensure that the hedge
remains designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks.512 The
proposal also included conforming
changes to § ll.5(b)(1) and § ll.5(c)
of the 2013 rule to make the
requirements of those sections
506 See
PO 00000
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Fmt 4701
Sfmt 4700
510 See
511 See
id.
83 FR at 33466.
512 Id.
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applicable only to banking entities that
have significant trading assets and
liabilities.513
The agencies explained that these
requirements are overly burdensome
and complex for banking entities that do
not have significant trading assets and
liabilities, which are generally less
likely to engage in the types of trading
activities and hedging strategies that
would necessitate these additional
compliance requirements. Given these
considerations, the agencies believed
that removing the requirements for
banking entities that do not have
significant trading assets and liabilities
would be unlikely to materially increase
risks to the safety and soundness of the
banking entity or U.S. financial stability.
The agencies also believed that the
proposed requirements for banking
entities without significant trading
assets and liabilities would effectively
implement the statutory requirement
that the hedging transactions be
designed to reduce specific risks the
banking entity incurs.514
iv. Reduced Documentation
Requirements for Banking Entities That
Have Significant Trading Assets and
Liabilities for Section ll.5(c)
For banking entities that have
significant trading assets and liabilities,
the agencies proposed to retain the
enhanced documentation requirements
for the hedging transactions identified
in § ll.5(c)(1) to permit evaluation of
the activity.515 However, the agencies
proposed a new paragraph (c)(4) in
§ ll.5 that would eliminate the
enhanced documentation requirement
for hedging activities that meets certain
conditions.516 Under new paragraph
(c)(4) in § ll.5, compliance with the
enhanced documentation requirement
would not apply to purchases and sales
of financial instruments for hedging
activities that are identified on a written
list of financial instruments preapproved by the banking entity that are
commonly used by the trading desk for
the specific types of hedging activity for
which the financial instrument is being
purchased or sold.517 In addition, at the
time of the purchase or sale of the
financial instruments, the related
hedging activity would need to comply
with written, pre-approved hedging
limits for the trading desk purchasing or
selling the financial instrument, which
would be required to be appropriate for
the size, types, and risks of the hedging
513 Id.
514 Id.
515 Id.
516 Id.
517 Id.
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activities commonly undertaken by the
trading desk; the financial instruments
purchased and sold by the trading desk
for hedging activities; and the levels and
duration of the risk exposures being
hedged.518
The agencies explained that certain of
the regulatory purposes of these
documentation requirements, such as
facilitating subsequent evaluation of the
hedging activity and prevention of
evasion, are less relevant in
circumstances where common hedging
strategies are used repetitively.
Therefore the agencies believed that the
enhanced documentation requirements
were not necessary in such instances
and that reducing them would make
beneficial risk-mitigating activity more
efficient and effective. The agencies
intended that the conditions on the preapproved limits would provide clarity
regarding the limits needed to comply
with requirements.519
c. Commenters’ Views
One commenter argued that the
requirements associated with the 2013
rule’s risk-mitigating hedging exemption
have been overly prescriptive,
cumbersome, and unnecessary for
sound and efficient risk management.520
Many commenters supported the
agencies’ efforts to reduce costs and
uncertainty and improve the utility of
the risk-mitigating hedging
exemption.521 More specifically,
commenters agreed with the
recommendations to remove the
correlation analysis requirement,
remove the requirement that a hedge
demonstrably reduce or otherwise
significantly mitigate one or more
specific risks, and reduce the enhanced
documentation requirements.522
Although some commenters
supported the agencies’ effort to reduce
the compliance burden in the riskmitigating hedging exemption, others
argued that the agencies did not go far
enough. Several commenters argued that
the agencies should reduce the
enhanced documentation requirements
and go further to remove these
requirements for all banking entities.523
Another commenter urged the agencies
to eliminate the enhanced
documentation requirements altogether
in light of the proposed rule’s robust
519 See
83 FR at 33466–67.
520 See SIFMA.
521 See, e.g., State Street; FSF; ABA; BPI; and
SIFMA.
522 See, e.g., State Street; FSF; ABA; BPI; and
SIFMA.
523 See, e.g., SIFMA; JBA; ABA; BPI; FSF; and
CREFC.
PO 00000
Frm 00039
compliance framework.524 In addition, a
commenter suggested targeted
modifications to the provision,
including permitting certain types of
hedging in line with internal risk limits,
allowing aggregate assessment of
hedging, and clarifying how firms can
comply with the provision.525
In contrast, other commenters did not
support the agencies’ proposed changes
to the compliance obligations associated
with the risk-mitigating hedging
exemption.526 One commenter argued
that eliminating the correlation analysis
requirement would eliminate the
primary means used by most banks
today to ensure a hedging activity is, in
fact, offsetting risk.527 Moreover, the
same commenter argued that
eliminating the existing regulatory
requirement that banks show a hedge
‘‘demonstrably reduces’’ or
‘‘significantly mitigates’’ the risks
targeted by the hedge would be a direct
repudiation of the statute, because that
type of demonstration is required by the
statute.528 Another commenter argued
that the various changes proposed by
the agencies would lead to
uncontrollable speculations.529
d. Final Rule
i. Correlation Analysis for Section
ll.5(b)(1)(i)(C)
The agencies are adopting
§ ll.5(b)(1)(iii) as proposed, but
renumbered as § ll.5(b)(1)(i)(C). Based
on the agencies’ implementation
experience of the 2013 rule and
commenters’ feedback on the proposed
changes, the agencies are removing the
requirement that a correlation analysis
be the type of analysis used to assess
risk-mitigating hedging activities. The
agencies continue to believe, as stated in
the proposal, that allowing banking
entities to use the type of analysis that
is appropriate to the hedging activities
in question will avoid the uncertainties
discussed in the proposal without
substantially impacting the conditions
that risk-mitigating hedging activities
must meet in order to qualify for the
exemption.530
Furthermore, section 13 of the BHC
Act does not require that the analysis
used by the banking entity be a
correlation analysis. Instead, the statute
only provides that a hedging position,
524 See
518 Id.
Fmt 4701
Sfmt 4700
62011
BPI.
Credit Suisse.
526 See, e.g., Volcker Alliance; Bean; Data Boiler;
CFA; AFR; NAFCU; Merkley; Better Markets; CAP;
Systemic Risk Council; and Public Citizen.
527 See Bean.
528 See Bean.
529 See Data Boiler.
530 See 83 FR at 33465.
525 See
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technique, or strategy is permitted so
long as it is ‘‘. . . designed to reduce the
specific risks to the banking entity
. . . .’’ 531 The agencies believe the
continuing requirement that the banking
entity conduct ‘‘analysis and
independent testing designed to ensure
that the positions, techniques and
strategies that may be used for hedging
may reasonably be expected to reduce or
otherwise significantly mitigate the
specific, identifiable risk(s) being
hedged’’ will effectively implement the
statute.
The agencies anticipate that the
banking entity’s flexibility to apply the
type of analysis that is appropriate to
assess the particular hedging activity at
issue will facilitate the appropriate use
of risk-mitigating hedging under the
exemption. Regarding the comment
asserting that correlation analysis is the
primary means used by banking entities
to test whether a hedging activity is
offsetting risk, the agencies note that if
this is the case it would be reasonable
to expect that the banking entity would
use correlation analysis to satisfy the
regulatory requirements with respect to
that hedging activity. However, if
another type of analysis is more
appropriate, the banking entity would
have the flexibility to use that form of
analysis instead.
ii. Hedge Demonstrably Reduces or
Otherwise Significantly Mitigates
Specific Risks for Sections
ll.5(b)(1)(i)(C), ll.5(b)(1)(ii)(B) and
ll.5(b)(1)(ii)(D)(2)
The agencies are adopting
§ ll.5(b)(1)(iii), § ll.5(b)(2)(ii), and
§ ll.5(b)(2)(iv)(B) as proposed, but
renumbered as § ll.5(b)(1)(i)(C),
§ ll.5(b)(1)(ii)(B) and
§ ll.5(b)(1)(ii)(D)(2). As stated in the
proposal, the requirement that the
reduction or mitigation of specific risks
resulting from a risk-mitigating hedging
activity be demonstrable is not directly
required by section 13(d)(1)(C) of the
BHC Act.532 In practice, it appears that
the requirement to show that hedging
activity demonstrably reduces or
otherwise significantly mitigates a
specific, identifiable risk that develops
over time can be complex and could
potentially reduce bona fide riskmitigating hedging activity. The
agencies continue to believe that in
some circumstances, it may be difficult
for banking entities to know with
sufficient certainty that a potential
hedging activity that a banking entity
seeks to commence will continuously
demonstrably reduce or significantly
531 12
533 See
U.S.C. 1851(d)(1)(C).
83 FR at 33465.
532 See
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18:12 Nov 13, 2019
mitigate an identifiable risk after it is
implemented, even if the banking entity
is able to enter into a hedge reasonably
designed to reduce or significantly
mitigate such a risk. As stated in the
proposal, unforeseeable changes in
market conditions, event risk, sovereign
risk, and other factors that cannot be
known with certainty in advance of
undertaking a hedging transaction could
reduce or eliminate the otherwise
intended hedging benefits.533 In these
events, the requirement that a hedge
‘‘demonstrably reduce’’ or ‘‘significantly
mitigate’’ the identifiable risks could
create uncertainty with respect to the
hedge’s continued eligibility for the
exemption. In such cases, a banking
entity may determine not to enter into
what would otherwise be a reasonably
designed hedge of foreseeable risks out
of concern that the banking entity may
not be able to effectively comply with
the requirement that such a hedge
demonstrably reduces such risks due to
the possibility of unforeseen risks occur.
Therefore, the final rule removes the
‘‘demonstrably reduces or otherwise
significantly mitigates’’ specific risk
requirement from § ll.5(b)(1)(i)(C),
§ ll.5(b)(1)(ii)(B) and
§ ll.5(b)(1)(ii)(D)(2).
The agencies do not agree with a
commenter’s assertion that the
requirement that banking entities show
that a hedge ‘‘demonstrably’’ reduces or
significantly mitigates the risks is a core
requirement under section 13 of the
BHC Act. Instead, the statute expressly
permits hedging activities that are
‘‘designed to reduce the specific risks of
the banking entity.’’ 534 The final rule
maintains the requirement that hedging
activity undertaken pursuant to § ll.5
be designed to reduce or otherwise
mitigate specific, identifiable risks.
Hedging activity must also be subject to
ongoing recalibration by the banking
entity to ensure that the hedging activity
satisfies the requirement that the
activity is designed to reduce or
otherwise significantly mitigate one or
more specific, identifiable risks even
after changes in market conditions or
other factors. In light of these
requirements, the agencies do not find
it necessary to require that the hedge
‘‘demonstrably reduce’’ risk to the
banking entity on an ongoing basis.
534 12
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PO 00000
id.
U.S.C. 1851(d)(1)(C).
Frm 00040
Fmt 4701
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iii. Reduced Compliance Requirements
for Banking Entities That Do Not Have
Significant Trading Assets and
Liabilities for Section ll.5(b)(2) and
Section ll.5(c)
The agencies are adopting
§§ ll.5(b)(2) and ll.5(c) as
proposed. Consistent with the changes
in the final rule relating to the scope of
the requirements for banking entities
that do not have significant trading
assets and liabilities, the agencies are
also revising the requirements in
§§ ll.5(b)(2) and ll.5(c) for banking
entities that do not have significant
trading assets and liabilities. For these
firms, the agencies are eliminating the
requirements for a separate internal
compliance program for risk-mitigating
hedging under § ll.5(b)(1); certain of
the specific requirements of
§ ll.5(b)(2); the limits on
compensation arrangements for persons
performing risk-mitigating activities in
§ ll.5(b)(1)(iii); and the
documentation requirements for those
activities in § ll.5(c). Based on
comments received, the agencies have
determined that these requirements are
overly burdensome and complex for
banking entities with moderate trading
assets and liabilities, in light of the
reduced scale of their trading and
hedging activities.
In place of those requirements, new
§ ll.5(b)(2) requires that riskmitigating hedging activities for those
banking entities be: (i) At the inception
of the hedging activity (including any
adjustments), designed to reduce or
otherwise significantly mitigate one or
more specific, identifiable risks,
including the risks specifically
enumerated in the proposal; and (ii)
subject to ongoing recalibration, as
appropriate, to ensure that the hedge
remains designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks. The agencies
continue to believe that these tailored
requirements for banking entities
without significant trading assets and
liabilities effectively implement the
statutory requirement that the hedging
transactions be designed to reduce
specific risks the banking entity incurs.
The agencies believe that the remaining
requirements for a firm with moderate
trading assets and liabilities would be
effective in ensuring such banking
entities engage only in permissible riskmitigating hedging activities. The
agencies also note that reducing these
compliance requirements for banking
entities that do not have significant
trading assets and liabilities is unlikely
to materially increase risks to the safety
and soundness of the banking entity or
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U.S. financial stability. Therefore, the
agencies are eliminating and modifying
these requirements for banking entities
that do not have significant trading
assets and liabilities. In connection with
these changes, the final rule also
includes conforming changes to
§§ ll.5(b)(1) and ll.5(c) of the 2013
rule to make the requirements of those
sections applicable only to banking
entities that have significant trading
assets and liabilities.
iv. Reduced Documentation
Requirements for Banking Entities That
Have Significant Trading Assets and
Liabilities for Section ll.5(c)
The agencies are adopting § ll.5(c)
as proposed. The final rule retains the
enhanced documentation requirements
for banking entities that have significant
trading assets and liabilities for hedging
transactions identified in § ll.5(c)(1)
to permit evaluation of the activity.
Although this documentation
requirement results in more extensive
compliance efforts, the agencies
continue to believe it serves an
important role to prevent evasion of the
requirements of section 13 of the BHC
Act and the final rule.
The hedging transactions identified in
§ ll.5(c)(1) include hedging activity
that is not established by the specific
trading desk that creates or is
responsible for the underlying positions,
contracts, or other holdings the risks of
which the hedging activity is designed
to reduce; is effected through a financial
instrument, exposure, technique, or
strategy that is not specifically
identified in the trading desk’s written
policies and procedures as a product,
instrument, exposure, technique, or
strategy such trading desk may use for
hedging; or established to hedge
aggregated positions across two or more
trading desks. The agencies believe that
hedging transactions established at a
different trading desk, or which are not
identified in the relevant policies, may
present or reflect heightened potential
for prohibited proprietary trading. In
other words, the further removed
hedging activities are from the specific
positions, contracts, or other holdings
the banking entity intends to hedge, the
greater the danger that such activity is
not limited to hedging specific risks of
individual or aggregated positions,
contracts, or other holdings of the
banking entity. For this reason, the
agencies do not agree with commenters
who argued that the enhanced
documentation requirements should be
removed for all banking entities.
However, based on the agencies’
experience during the first several years
of implementation of the 2013 rule, it
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appears that many hedges established
by one trading desk for other affiliated
desks are often part of common hedging
strategies that are used regularly and
that do not raise the concerns of those
trades prohibited by the rule. In those
instances, the documentation
requirements of § ll.5(c) of the 2013
rule are less necessary for purposes of
evaluating the hedging activity and
preventing evasion. In weighing the
significantly reduced regulatory and
supervisory utility of additional
documentation of common hedging
trades against the complexity of
complying with the enhanced
documentation requirements, the
agencies have determined that the
documentation requirements are not
necessary in those instances. Reducing
the documentation requirement for
common hedging activity undertaken in
the normal course of business for the
benefit of one or more other trading
desks would also make beneficial riskmitigating activity more efficient and
potentially improve the timeliness of
important risk-mitigating hedging
activity, the effectiveness of which can
be time sensitive.
Therefore, § ll.5(c)(4) of the final
rule eliminates the enhanced
documentation requirement for hedging
activities that meet certain conditions.
In excluding a trading desk’s common
hedging instruments from the enhanced
documentation requirements in
§ ll.5(c), the final rule seeks to
distinguish between those financial
instruments that are commonly used for
a trading desk’s ordinary hedging
activities and those that are not. The
final rule requires the banking entity to
have in place appropriate limits so that
less common or more unusual levels of
hedging activity would still be subject to
the enhanced documentation
requirements. The final rule provides
that the enhanced documentation
requirement does not apply to
purchases and sales of financial
instruments for hedging activities that
are identified on a written list of
financial instruments pre-approved by
the banking entity that are commonly
used by the trading desk for the specific
types of hedging activity for which the
financial instrument is being purchased
or sold. In addition, at the time of the
purchase or sale of the financial
instruments, the related hedging activity
would need to comply with written,
pre-approved hedging limits for the
trading desk purchasing or selling the
financial instrument. These hedging
limits must be appropriate for the size,
types, and risks of the hedging activities
commonly undertaken by the trading
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62013
desk; the financial instruments
purchased and sold by the trading desk
for hedging activities; and the levels and
duration of the risk exposures being
hedged. These conditions on the preapproved limits are intended to provide
clarity as to the types and characteristics
of the limits needed to comply with the
final rule. The pre-approved limits
should be reasonable and set to
correspond to the type of hedging
activity commonly undertaken and at
levels consistent with the hedging
activity undertaken by the trading desk
in the normal course.
The agencies considered comments
that suggested additional targeted
modifications to the risk-mitigating
hedging requirements, but believe that
the suggested modifications would add
additional complexity and
administrative burden without
significantly changing the efficiency and
effectiveness of the final rule.
Additionally, the agencies believe that
because the final rule maintains
significant requirements for hedging
activities to qualify for the exemption, it
should not lead to uncontrollable
speculation, as one commenter warned.
4. Section ll.6(e): Permitted Trading
Activities of a Foreign Banking Entity
Section 13(d)(1)(H) of the BHC Act 535
permits certain foreign banking entities
to engage in proprietary trading that
occurs solely outside of the United
States (the foreign trading
exemption); 536 however, the statute
does not define when a foreign banking
entity’s trading occurs ‘‘solely outside of
the United States.’’ The 2013 rule
includes several conditions on the
availability of the foreign trading
exemption. Specifically, in addition to
limiting the exemption to foreign
banking entities where the purchase or
sale is made pursuant to paragraph (9)
535 Section 13(d)(1)(H) of the BHC Act permits
trading conducted by a foreign banking entity
pursuant to paragraph (9) or (13) of section 4(c) of
the BHC Act (12 U.S.C. 1843(c)), if the trading
occurs solely outside of the United States, and the
banking entity is not directly or indirectly
controlled by a banking entity that is organized
under the laws of the United States or of one or
more States. See 12 U.S.C. 1851(d)(1)(H).
536 This section’s discussion of the concept of
‘‘solely outside of the United States’’ is provided
solely for purposes of the rule’s implementation of
section 13(d)(1)(H) of the BHC Act and does not
affect a banking entity’s obligation to comply with
additional or different requirements under
applicable securities, banking, or other laws.
Among other differences, section 13 of the BHC Act
does not necessarily include the customer
protection, transparency, anti-fraud, antimanipulation, and market orderliness goals of other
statutes administered by the agencies. These other
goals or other aspects of those statutory provisions
may require different approaches to the concept of
‘‘solely outside of the United States’’ in other
contexts.
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or (13) of § ll.4(c) of the BHC Act,537
the 2013 rule provides that the foreign
trading exemption is available only
if: 538
(i) The banking entity engaging as
principal in the purchase or sale
(including any personnel of the banking
entity or its affiliate that arrange,
negotiate, or execute such purchase or
sale) is not located in the United States
or organized under the laws of the
United States or of any State.
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State.
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State.
(iv) No financing for the banking
entity’s purchase or sale is provided,
directly or indirectly, by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State (the
financing prong).
(v) The purchase or sale is not
conducted with or through any U.S.
entity,539 except if the purchase or sale
is conducted:
(A) With the foreign operations of a
U.S. entity, if no personnel of such U.S.
entity that are located in the United
States are involved in the arrangement,
negotiation or execution of such
purchase or sale (the counterparty
prong); 540
(B) with an unaffiliated market
intermediary acting as principal,
provided the transaction is promptly
cleared and settled through a clearing
agency or derivatives clearing
organization acting as a central
counterparty; or
(C) through an unaffiliated market
intermediary, provided the transaction
is conducted anonymously (i.e., each
party to the transaction is unaware of
the identity of the other party(ies)) on an
537 12 U.S.C. 1843(c)(9), (13). See 2013 rule
§ ll.6(e)(1)(i) and (ii).
538 See 2013 rule § ll.6(e).
539 ‘‘U.S. entity’’ is defined for purposes of this
provision as any entity that is, or is controlled by,
or is acting on behalf of, or at the direction of, any
other entity that is, located in the United States or
organized under the laws of the United States or of
any State. See 2013 rule § ll.6(e)(4).
540 A foreign banking entity wishing to engage in
trading activities with a U.S. entity’s foreign
affiliate generally must rely on the counterparty
prong.
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exchange or similar trading facility and
promptly cleared and settled through a
clearing agency or derivatives clearing
organization acting as a central
counterparty.
Since the adoption of the 2013 rule,
foreign banking entities have asserted
that certain of these criteria limit their
ability to make use of the statutory
exemption for trading activity that
occurs outside of the United States,
which has adversely impacted their
foreign trading operations. Additionally,
many foreign banking entities have
suggested that the full set of eligibility
criteria to rely on the exemption for
foreign trading activity are unnecessary
to accomplish the policy objectives of
section 13 of the BHC Act. This
information has raised concerns that the
current requirements for the exemption
may be overly restrictive and not
effective in permitting foreign banks to
engage in foreign trading activities
consistent with the policy objective of
the statute.
The proposal would have modified
the requirements for the foreign trading
exemption so that it would be more
usable by foreign banking entities.
Specifically, the proposal would have
retained the first three requirements of
the 2013 rule, with a modification to the
first requirement, and would have
removed the last two requirements of
§ ll.6(e)(3). As a result, § ll.6(e)(3),
as modified by the proposal, would
have required that for a foreign banking
entity to be eligible for this exemption:
(i) The banking entity engaging as
principal in the purchase or sale
(including relevant personnel) is not
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State; and
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State.
The proposal would have maintained
these three requirements in order to
ensure that the banking entity
(including any relevant personnel) that
engages in the purchase or sale as
principal or makes the decision to
purchase or sell as principal is not
located in the United States or
organized under the laws of the United
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States or any State. Furthermore, the
proposal would have retained the 2013
rule’s requirement that the purchase or
sale, including any transaction arising
from a related risk-mitigating hedging
transaction, may not be accounted for as
principal by the U.S. operations of the
foreign banking entity. However, the
proposal would have replaced the first
requirement that any personnel of the
banking entity that arrange, negotiate, or
execute such purchase or sale are not
located in the United States with one
that would restrict only the relevant
personnel engaged in the banking
entity’s decision in the purchase or sale
are not located in the United States.
Under the proposed approach, the
requirements for the foreign trading
exemption focused on whether the
banking entity that engages in or that
decides to engage in the purchase or
sale as principal (including any relevant
personnel) is located in the United
States. The proposed modifications
recognized that some limited
involvement by U.S. personnel (e.g.,
arranging or negotiating) would be
consistent with this exemption so long
as the principal risk and actions of the
purchase or sale do not take place in the
United States for purposes of section 13
of the BHC Act and the implementing
regulations.
The proposal also would have
eliminated the financing prong and the
counterparty prong. Under the proposal,
these changes would have focused the
key requirements of the foreign trading
exemption on the principal actions and
risk of the transaction. In addition, the
proposal would have removed the
financing prong to address concerns that
the fungibility of financing has made
this requirement in certain
circumstances difficult to apply in
practice to determine whether a
particular financing is tied to a
particular trade. Market participants
have raised a number of questions about
the financing prong and have indicated
that identifying whether financing has
been provided by a U.S. affiliate or
branch can be exceedingly complex, in
particular with respect to demonstrating
that financing has not been provided by
a U.S. affiliate or branch with respect to
a particular transaction. To address the
concerns raised by foreign banking
entities and other market participants,
the proposal would have amended the
exemption to focus on the principal risk
of a transaction and the location of the
actions as principal and trading
decisions, so that a foreign banking
entity would be able to make use of the
exemption so long as the risk of the
transaction is booked outside of the
United States. While the agencies
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recognize that a U.S. branch or affiliate
that extends financing could bear some
risks, the agencies note that the
proposed modifications to the foreign
trading exemption were designed to
require that the principal risks of the
transaction occur and remain solely
outside of the United States.
Similarly, foreign banking entities
have communicated to the agencies that
the counterparty prong has been overly
difficult and costly for banking entities
to monitor, track, and comply with in
practice. As a result, the agencies
proposed to remove the requirement
that any transaction with a U.S.
counterparty be executed solely with
the foreign operations of the U.S.
counterparty (including the requirement
that no personnel of the counterparty
involved in the arrangement,
negotiation, or execution may be located
in the United States) or through an
unaffiliated intermediary and an
anonymous exchange. These changes
were intended to materially reduce the
reported inefficiencies associated with
rule compliance. In addition, market
participants have indicated that this
requirement has in practice led foreign
banking entities to overly restrict the
range of counterparties with which
transactions can be conducted, as well
as disproportionately burdened
compliance resources associated with
those transactions, including with
respect to counterparties seeking to do
business with the foreign banking entity
in foreign jurisdictions.
The proposal would have removed
the counterparty prong and focused the
requirements of the foreign trading
exemption on the location of a foreign
banking entity’s decision to trade, action
as principal, and principal risk of the
purchase or sale. This proposed focus
on the location of actions and risk as
principal in the United States was
intended to align with the statute’s
definition of ‘‘proprietary trading’’ as
‘‘engaging as principal for the trading
account of the banking entity.’’ 541 The
proposal would have scaled back those
requirements that were not critical for
this determination and thus would not
be needed in the final rule. Therefore,
the proposal would have removed the
requirements of § ll.6(e)(3) since they
are less directly relevant to these
considerations.
Consistent with the 2013 rule, the
exemption under the proposal would
not have exempted the U.S. or foreign
operations of U.S. banking entities from
having to comply with the restrictions
and limitations of section 13 of the BHC
Act. Thus, for example, the U.S. and
541 See
12 U.S.C. 1851(h)(4) (emphasis added).
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foreign operations of a U.S. banking
entity that is engaged in permissible
market making-related activities or other
permitted activities may engage in those
transactions with a foreign banking
entity that is engaged in proprietary
trading in accordance with the
exemption under § ll.6(e) of the 2013
rule, so long as the U.S. banking entity
complies with the requirements of
§ ll.4(b), in the case of market
making-related activities, or other
relevant exemption applicable to the
U.S. banking entity. The proposal, like
the 2013 rule, would not have imposed
a duty on the foreign banking entity or
the U.S. banking entity to ensure that its
counterparty is conducting its activity
in conformance with section 13 and the
implementing regulations. Rather, that
obligation would have been on each
party subject to section 13 to ensure that
it is conducting its activities in
accordance with section 13 and the
implementing regulations.
The proposal’s exemption for trading
of foreign banking entities outside the
United States potentially could have
given foreign banking entities a
competitive advantage over U.S.
banking entities with respect to
permitted activities of U.S. banking
entities because foreign banking entities
could trade directly with U.S.
counterparties without being subject to
the limitations associated with the
market making-related activities
exemption or other exemptions under
the rule. This competitive disparity in
turn could create a significant potential
for regulatory arbitrage. In this respect,
the agencies sought to mitigate this
concern through other changes in the
proposal; for example, U.S. banking
entities would have continued to be able
to engage in all of the activities
permitted under the 2013 rule and the
proposal, including the simplified and
streamlined requirements for market
making and risk-mitigating hedging and
other types of trading activities.
In general, commenters supported the
proposed changes.542 However, a
number of commenters requested
further modifications to the foreign
trading exemption. For example, some
commenters requested that the agencies
clarify the definition of ‘‘relevant
personnel’’ to mean employees that
conduct risk management, and not the
traders or others associated with
executing the transaction.543 One
commenter requested clarification that
the proposed changes not constrain
542 See, e.g., ISDA; IIB; ABA; New England
Council; BVI; HSBC; EBF; Credit Suisse; JBA FSF;
and EFAMA.
543 See, e.g., HSBC and JBA.
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62015
foreign banking entities from delegating
investment authority to non-affiliated
U.S. investment advisers.544 Another
commenter supported eliminating the
conduct restriction.545 One commenter
proposed several additional
modifications, including further
simplifying the exemption to only focus
on where the transaction is booked,
clarifying certain terms (e.g., subservicing, dark pools, engaging in), and
including inter-affiliate or intra-bank
transactions in the exemption.546 This
commenter also requested that the
agencies include execution as one of the
examples of limited involvement.547
A few commenters opposed the
proposed changes to eliminate the
financing and counterparty
requirements.548 These commenters
argued that the proposed changes might
provide foreign entities with a
competitive advantage over domestic
entities.549 One commenter asserted that
the proposed changes would increase
uncertainty and could increase the
exposure of U.S. institutions to foreign
proprietary trading losses.550 This
commenter also argued that the agencies
did not provide factual data to support
the change and that the proposal was
contrary to law.551
After consideration of these
comments, the agencies are adopting the
changes to the foreign trading
exemption as proposed. The proposal’s
modifications in general sought to
balance concerns regarding competitive
impact while mitigating the concern
that an overly narrow approach to the
foreign trading exemption may cause
market bifurcations, reduce the
efficiency and liquidity of markets,
make the exemption overly restrictive to
foreign banking entities, and harm U.S.
market participants. The agencies
believe that this approach appropriately
balances one of the key objectives of
section 13 of the BHC Act by limiting
the risks that proprietary trading poses
to the U.S. financial system, while also
modifying the application of section 13
as it applies to foreign banking entities,
as required by section 13(d)(1)(H).
As noted in the preamble to the
proposal, the statute contains an
exemption that allows foreign banking
entities to engage in trading activity that
is, only for purposes of the prohibitions
of the statute, solely outside the United
544 See
EFAMA.
HSBC.
546 See JBA.
547 See JBA.
548 See, e.g., Bean; Data Boiler; and Better
Markets.
549 See, e.g., Better Markets and FSF.
550 See Bean.
551 See Bean.
545 See
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States. The statute also contains a
prohibition on proprietary trading for
U.S. banking entities regardless of
where their activity is conducted. The
statute generally prohibits U.S. banking
entities from engaging in proprietary
trading because of the perceived risks of
those activities to U.S. banking entities
and the U.S. financial system. The
modified foreign trading exemption
excludes from the statutory prohibitions
transactions where the principal risk is
booked outside of the United States and
the actions and decisions as principal
occur outside of the United States by
foreign operations of foreign banking
entities. The agencies also are
confirming that the foreign trading
exemption does not preclude a foreign
banking entity from engaging a nonaffiliated U.S. investment adviser as
long as the actions and decisions of the
banking entity as principal occur
outside of the United States. By
continuing to limit the risks of foreign
banking entities’ proprietary trading
activities to the U.S. financial system,
the agencies believe that the rule
continues to protect and promote the
safety and soundness of banking entities
and the financial stability of the United
States, while also allowing U.S. markets
to continue to operate efficiently in
conjunction with foreign markets.
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C. Subpart C—Covered Fund Activities
and Investments
1. Overview of Agencies’ Approach to
the Covered Fund Provisions
The proposal included several
proposed revisions to subpart C (the
covered fund provisions). The proposal
also sought comments on other aspects
of the covered fund provisions beyond
those changes for which specific rule
text was proposed. As described further
below, the agencies have determined to
adopt, as proposed, the changes to
subpart C for which specific rule text
was proposed. The agencies continue to
consider other aspects of the covered
fund provisions on which the agencies
sought comment in the proposal and
intend to issue a separate proposed
rulemaking that specifically addresses
those areas.
The proposal sought comment on the
2013 rule’s general approach to defining
the term ‘‘covered fund,’’ as well as the
existing exclusions from the covered
fund definition and potential new
exclusions from this definition. The
agencies received numerous comments
on these aspects of the covered fund
provisions. Some commenters
encouraged the agencies to make
significant revisions to these provisions,
such as narrowing the covered fund
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‘‘base definition’’ 552 or providing
additional exclusions from this
definition.553 Other commenters argued
that the agencies should not narrow the
covered fund definition or should retain
the definition in section 13 of the BHC
Act.554 Some commenters raised
concerns about the agencies’ ability to
finalize changes to the covered fund
provisions for which the proposal did
not provide specific rule text.555 In light
of the number and complexity of issues
under consideration, the agencies
intend to address these and other
comments received on the covered fund
provisions in a subsequent proposed
rulemaking.
In this final rule, the agencies are
adopting only those changes to the
covered fund provisions for which
specific rule text was proposed.556
Those changes are being adopted as
final without change from the proposal
for the reasons described below. While
the agencies are not including any other
changes to subpart C in this final rule,
this approach does not reflect any final
determination with respect to the
comments received on other aspects of
the covered fund provisions. The
agencies continue to consider comments
received and intend to address
additional aspects of the covered funds
provisions in the future covered funds
proposal.
2. Section ll.11: Permitted Organizing
and Offering, Underwriting, and Market
Making With Respect to a Covered Fund
Section 13(d)(1)(B) of the BHC Act
permits a banking entity to purchase
and sell securities and other
instruments described in section
13(h)(4) of the BHC Act in connection
with the banking entity’s underwriting
or market making-related activities.557
The 2013 rule provides that the
prohibition against acquiring or
retaining an ownership interest in or
sponsoring a covered fund does not
apply to a banking entity’s underwriting
or market making-related activities
involving a covered fund as long as:
• The banking entity conducts the
activities in accordance with the
requirements of the underwriting
exemption in § ll.4(a) of the 2013 rule
552 See, e.g., ABA; AIC; Center for American
Entrepreneurship; Goldman Sachs; and JBA.
553 See, e.g., Capital One et al.; Credit Suisse; and
SIFMA.
554 See, e.g., AFR and Occupy the SEC.
555 See, e.g., AFR; Bean; and Volcker Alliance.
556 In addition, consistent with changes described
in Part IV.B.1.b.i of this SUPPLEMENTARY
INFORMATION, the final rule removes references to
‘‘guidance’’ from subpart C.
557 12 U.S.C. 1851(d)(1)(B).
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or market making exemption in
§ ll.4(b) of the 2013 rule, respectively.
• The banking entity includes the
aggregate value of all ownership
interests of the covered fund acquired or
retained by the banking entity and its
affiliates for purposes of the limitation
on aggregate investments in covered
funds (the aggregate-fund limit) 558 and
capital deduction requirement; 559 and
• The banking entity includes any
ownership interest that it acquires or
retains for purposes of the limitation on
investments in a single covered fund
(the per-fund limit) if the banking entity
(i) acts as a sponsor, investment adviser
or commodity trading adviser to the
covered fund; (ii) otherwise acquires
and retains an ownership interest in the
covered fund in reliance on the
exemption for organizing and offering a
covered fund in § ll.11(a) of the 2013
rule; (iii) acquires and retains an
ownership interest in such covered fund
and is either a securitizer, as that term
is used in section 15G(a)(3) of the
Exchange Act, or is acquiring and
retaining an ownership interest in such
covered fund in compliance with
section 15G of that Act and the
implementing regulations issued
thereunder, each as permitted by
§ ll.11(b) of the 2013 rule; or (iv)
directly or indirectly, guarantees,
assumes, or otherwise insures the
obligations or performance of the
covered fund or of any covered fund in
which such fund invests.560
The proposal would have removed
the requirement that the banking entity
include for purposes of the aggregate
fund limit and capital deduction the
value of any ownership interests of a
third-party covered fund (i.e., covered
funds that the banking entity does not
advise or organize and offer pursuant to
§ ll.11 of the final rule) acquired or
retained in accordance with the
underwriting or market-making
exemptions in § ll.4. Under the
proposal, these limits, as well as the
per-fund limit, would have applied only
to a covered fund that the banking entity
organizes or offers and in which the
banking entity acquires or retains an
ownership interest pursuant to
§ ll.11(a) or (b) of the 2013 rule. The
agencies proposed this change to more
closely align the requirements for
engaging in underwriting or marketmaking-related activities with respect to
ownership interests in a covered fund
with the requirements for engaging in
these activities with respect to other
financial instruments.
rule § ll.12(a)(2)(iii).
rule § ll.12(d).
560 See 2013 rule § ll.11(c).
558 2013
559 2013
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Several commenters supported
eliminating these requirements for
underwriting and market making in
ownership interests in covered funds.561
Many of these commenters said this
proposal would reduce the compliance
burden for banking entities engaged in
client-facing underwriting and market
making activities and would facilitate
these permitted activities.562 One of
these commenters noted in particular
the difficulties for banking entities to
determine whether a third-party fund is
a covered fund subject to the limits of
the 2013 rule and to determine with
certainty whether certain non-U.S.
securities may be issued by covered
funds.563 Some of these commenters
argued that providing underwriting and
market making in the interests in such
funds increases liquidity and benefits
the marketplace generally.564 One of
these commenters also stated that this
would facilitate capital-raising activities
of covered funds and other issuers.565
Other commenters opposed this change
because they believed that it would
greatly expand banking entities’ ability
to hold ownership interests in covered
funds,566 and is contrary to section 13
of the BHC Act.567
Several commenters supported
making additional revisions to § ll.11
by eliminating the aggregate fund limit
and capital deduction for other funds,
such as affiliated funds or sponsored
funds 568 and advised funds.569 Certain
of these commenters argued that
underwriting and market making in
interests in these covered funds would
not expose banking entities to greater
risk because ownership interests in such
funds acquired in accordance with the
risk-mitigating hedging, market-making
or underwriting exemptions would
nevertheless be subject to the
restrictions contained in those
exemptions.570
The agencies are eliminating the
aggregate fund limit and the capital
deduction requirement for the value of
ownership interests in third-party
covered funds acquired or retained in
accordance with the underwriting or
market-making exemption (i.e., covered
funds that the banking entity does not
advise or organize and offer pursuant to
561 See, e.g., ABA; BPI; FSF; Goldman Sachs; IIB;
ISDA; and SIFMA.
562 See, e.g., BPI; FSF; ISDA; and SIFMA.
563 See SIFMA.
564 See ISDA.
565 See SIFMA.
566 See, e.g., AFR; Bean; and Volcker Alliance.
567 See Bean.
568 See ISDA.
569 See, e.g., BPI; ISDA; and SIFMA.
570 See, e.g., BPI and ISDA.
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§ ll.11(a) or (b) of the final rule).571
The agencies believe this change will
better align the compliance
requirements for underwriting and
market making involving covered funds
with the risks those activities entail. In
particular, the agencies understand that
it has been difficult for banking entities
to determine whether ownership
interests in covered funds are being
acquired or retained in the context of
trading activities, especially for nonU.S. issuers. Banking entities have had
to undertake an often time-consuming
process to determine whether an issuer
is a covered fund and the security
issued is an ownership interest, all for
the purpose of ensuring compliance
with the aggregate fund limit and capital
deduction requirement for the period of
time that the banking entity holds the
ownership interest as part of its
otherwise permissible underwriting and
market making activities.572 These
compliance challenges are heightened
in the case of third-party funds.
However, a banking entity can more
readily determine whether a fund is a
covered fund if the banking entity
advises or organizes and offers the fund.
Thus, the agencies are not eliminating
the aggregate fund limit and capital
deduction requirement for advised
covered funds or covered funds that the
banking entity organizes or offers. The
agencies continue to consider whether
the approach being adopted in the final
rule may be extended to other issuers,
such as funds advised by the banking
entity, and intend to address and
request additional comment on this
issue in the future proposed rulemaking.
The agencies disagree with the
commenter who argued that eliminating
the aggregate fund limit and capital
deduction is contrary to section 13 of
the BHC Act.573 An exemption from the
prohibition on acquiring or retaining an
ownership interest in a covered fund for
underwriting and market making
571 As in the proposal, this requirement is also
eliminated for underwriting and market-making
activities involving funds with respect to which the
banking entity directly or indirectly, guarantees,
assumes, or otherwise insures the obligations or
performance of the covered fund or of any covered
fund in which such fund invests. Such funds are
not organized and offered pursuant to § ll.11(a)
or (b) of the final rule and thus treatment as a thirdparty fund is more appropriate for purposes of the
underwriting and market-making exemption for
covered funds. The agencies note, however, that
other provisions of section 13 of the BHC Act, as
well as other laws and regulations, limit banking
entities’ ability to guarantee, assume, or otherwise
insure the obligations or performance of covered
funds. See 12 U.S.C. 1851(f); 12 U.S.C. 1851(d)(2);
§§ ll.14 and ll.15 of the final rule. See also 12
CFR 7.1017 (limiting authority of national bank to
act as a guarantor).
572 See SIFMA.
573 See Bean.
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62017
involving covered fund ownership
interests is consistent with and
supported by section 13 of the BHC
Act.574 Section 13(d)(1)(B) provides a
statutory exemption for underwriting
and market making activities and, by its
terms, applies to both prohibitions in
section 13(a), whether on proprietary
trading or covered fund activities.
Section 13 does not require any perfund or aggregate limits, or capital
deduction, with respect to covered fund
ownership interests acquired pursuant
to the underwriting and market making
exemption in section 13(d)(1)(B), and
eliminating these requirements with
respect to third-party funds will
improve the effectiveness of the
statutory exemption for these
activities.575
The agencies also disagree with
commenters who asserted that this
change will greatly expand banking
entities’ ability to hold ownership
interests in covered funds.576 This
exemption for underwriting and market
making involving ownership interests in
covered funds applies only to
underwriting and market making
activities conducted pursuant to the
requirements in section 13(d)(1)(B) of
the BHC Act and § ll.4 of the final
rule. This exemption is intended to
allow banking entities to engage in
permissible underwriting and market
making involving covered fund
ownership interests to the same extent
as other financial instruments. It is also
intended to increase the effectiveness of
the underwriting and market making
exemptions in § ll.4 by appropriately
limiting the covered fund
determinations a banking entity must
make in the course of these permissible
activities. For these reasons, and to limit
the potential for evasion, the exemption
for underwriting and market making
involving ownership interests in
covered funds continues to apply only
to activities that satisfy the requirements
of the underwriting or market making
exemptions in § ll.4.
One commenter argued that the
aggregate fund limit should apply only
at the global consolidated level for all
firms.577 This commenter argued that
measuring aggregate covered fund
ownership at the parent-level is a better
test of immateriality than measuring
covered fund investments at a lower
level, such as at the level of an
574 See
79 FR 5535, 5722.
quantitative limits and capital deduction
requirements in 12 U.S.C. 1851(d)(4)(B) are required
to apply only in the case of seeding investments
and other de minimis investments made pursuant
to 12 U.S.C. 1851(d)(4)(B).
576 See, e.g., AFR; Bean; and Volcker Alliance.
577 See Credit Suisse.
575 The
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intermediate holding company.578 This
commenter also said the agencies
should expand the per-fund limit to
allow bank-affiliated securitization
investment managers to rely on
applicable foreign risk retention
regulations as a basis for exceeding the
three percent per-fund limitation,
provided that those foreign regulations
are generally comparable to U.S.
requirements.579 Another commenter
asserted that the preamble to the 2013
rule indicated that direct investments
made alongside a covered fund should
be aggregated for purposes of the perfund limit in certain circumstances.580
This commenter asked the agencies to
clarify that the 2013 rule does not
prohibit banking entities from making
direct investments alongside covered
funds, regardless of whether the fund is
sponsored or the investments are
coordinated, so long as such
investments are otherwise authorized
for such banking entities (e.g., under
merchant banking authority). The
agencies continue to consider these
issues. As noted above, the agencies
expect to address and request additional
comments on these and other covered
fund provisions in the future proposed
rulemaking.
3. Section ll.13: Other Permitted
Covered Fund Activities
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a. Permitted Risk-Mitigating Hedging
Section 13(d)(1)(C) of the BHC Act
provides an exemption for riskmitigating hedging activities in
connection with and related to
individual or aggregated positions,
contracts, or other holdings of a banking
entity that are designed to reduce the
specific risks to the banking entity in
connection with and related to such
positions, contracts, or other
holdings.581 As described in the
preamble to the proposal, the 2013 rule
implemented this authority narrowly in
the context of covered fund activities.
Specifically, the 2013 rule permitted
only limited risk-mitigating hedging
activities involving ownership interests
in covered funds for hedging employee
compensation arrangements.
Like the proposal, the final rule
allows a banking entity to acquire or
retain an ownership interest in a
covered fund as a hedge when acting as
intermediary on behalf of a customer
that is not itself a banking entity to
facilitate the exposure by the customer
to the profits and losses of the covered
578 Id.
579 Id.
580 See
581 12
Goldman Sachs.
U.S.C. 1851(d)(1)(C).
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fund. This provision is consistent with
the agencies’ original 2011 proposal.582
The proposal also would have
amended § ll.13(a) to align with the
proposed modifications to § ll.5. In
particular, the proposal would have
required that a risk-mitigating hedging
transaction pursuant to § ll.13(a) be
designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks to the banking
entity. It would have removed the
requirement that the hedging
transaction ‘‘demonstrably’’ reduces or
otherwise significantly mitigates the
relevant risks, consistent with the
proposed modifications to § ll.5.583
Several commenters supported
permitting banking entities to acquire
and retain ownership interests in
covered funds as a hedge when acting
as intermediary on behalf of a
customer.584 Certain of these
commenters argued that acquiring or
retaining ownership interests in covered
funds for this purpose (fund-linked
products) is beneficial because it
accommodates banking entities’ client
facilitation and related risk management
activities.585 Two commenters noted
that restricting institutions’ ability to
find the best hedge for a transaction may
increase risks to safety and soundness
and, conversely, permitting banking
entities to use the best available hedge
for risks arising from customer
facilitation activities would promote
safety and soundness and reduce
risk.586 Several of these commenters
also argued that fund-linked products
are not a high-risk trading strategy.587
For example, one commenter argued
that the magnitude of counterparty
default risk that banking entities would
face in acquiring or retaining a covered
fund ownership interest under these
circumstances (i.e., to hedge a position
by the banking entity when acting as
intermediary on behalf of a customer
that is not itself a banking entity to
facilitate exposure by the customer to a
covered fund) is no different than any
other counterparty default risk that
banking entities face when entering into
other risk-mitigating hedges.588 Other
commenters opposed this change and
noted that, at the time the 2013 rule was
adopted, the agencies considered acting
as principal in providing exposure to
the profits and losses of a covered fund
for a customer, even if hedged by the
582 See
83 FR at 33483–84.
supra Part IV.B.3.b.ii.
584 See, e.g., ABA; BPI; FSF; Goldman Sachs; IIB;
ISDA; SIFMA; and IIB.
585 See, e.g., BPI and FSF.
586 See, e.g., FSF and SIFMA.
587 See, e.g., FSF; ISDA; and SIFMA.
588 See FSF.
583 See
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banking entity with ownership interests
of the covered fund, to constitute a highrisk trading strategy.589 One commenter
stated that the proposal did not offer
specific examples or explain why such
fund-linked products are necessary.590
Another commenter argued that the
exemption for risk-mitigating hedging
involving ownership interests in
covered funds should be further
restricted or completely removed from
the rule.591
The final rule adopts the proposed
revision without change. This
exemption is tailored to permit bona
fide customer facilitation activities and
to limit the risk incurred directly by the
banking entity. The new exemption in
§ ll.13(a) extends only to a position
taken by the banking entity when acting
as intermediary on behalf of a customer
that is not itself a banking entity to
facilitate the customer’s exposure to the
profits and losses of the covered fund.
The banking entity’s acquisition or
retention of the ownership interest as a
hedge must be designed to reduce or
otherwise significantly mitigate one or
more specific, identifiable risks arising
out of a transaction conducted solely to
accommodate a specific customer
request with respect to the covered
fund. As a result, a transaction
conducted in reliance on this exemption
must be customer-driven. A banking
entity cannot rely on this exemption to
solicit customer transactions in order to
facilitate the banking entity’s own
exposure to a covered fund.
As some commenters noted, in the
preamble to the 2013 rule, the agencies
stated that they were not adopting an
exemption for customer facilitation
activities and related hedging activities
involving ownership interests in
covered funds because these activities
could potentially expose a banking
entity to the types of risks that section
13 of the BHC Act sought to address.
However, in light of other comments
received,592 the agencies do not believe
that a banking entity’s customer
facilitation activities and related
hedging activities involving ownership
interests in covered funds necessarily
constitute high-risk trading strategies
that could threaten the safety and
soundness of the banking entity. The
agencies believe that, properly
monitored and managed, these activities
can be conducted without creating a
greater degree of risk to the banking
entity than the other customer
facilitation activities permitted by the
589 See,
e.g., AFR and Volcker Alliance.
AFR.
591 See Occupy the SEC.
592 See, e.g., FSF; ISDA; and SIFMA.
590 See
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final rule.593 In particular, these
activities remain subject to all of the
final rule’s requirements for riskmitigating hedging transactions,
including requirements that such
transactions must:
• Be designed to reduce or otherwise
significantly mitigate the specific,
identifiable risks to the banking entity;
• be made in accordance with the
banking entity’s written policies,
procedures and internal controls;
• not give rise, at the inception of the
hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
the risk-mitigating hedging
requirements; and
• be subject to continuing review,
monitoring and management by the
banking entity.594
In addition, these activities remain
subject to § ll.15 of the final rule and,
therefore, to the extent they would in
practice significantly increase the
likelihood that the banking entity would
incur a substantial financial loss or
would pose a threat to the financial
stability of the United States, they
would not be permissible. The agencies
are also adopting without change the
amendment to align § ll.13(a) with
§ ll.5 by eliminating the requirement
that a risk-mitigating hedging
transaction ‘‘demonstrably’’ reduces or
otherwise significantly mitigates the
relevant risks. The agencies are adopting
this amendment to § ll.13(a) for the
same reason the agencies are adopting
the amendment to § ll.5.
b. Permitted Covered Fund Activities
and Investments Outside of the United
States
Section 13(d)(1)(I) of the BHC Act
permits foreign banking entities to
acquire or retain an ownership interest
in, or act as sponsor to, a covered fund,
so long as those activities and
investments occur solely outside the
United States and certain other
conditions are met (the foreign fund
exemption).595 Section 13 of the BHC
e.g., final rule § ll.3(d)(11).
final rule § ll.13.
595 Section 13(d)(1)(I) of the BHC Act permits a
banking entity to acquire or retain an ownership
interest in, or have certain relationships with, a
covered fund notwithstanding the restrictions on
investments in, and relationships with, a covered
fund, if: (i) Such activity or investment is
conducted by a banking entity pursuant to
paragraph (9) or (13) of section 4(c) of the BHC Act;
(ii) the activity occurs solely outside of the United
States; (iii) no ownership interest in such fund is
offered for sale or sold to a resident of the United
States; and (iv) the banking entity is not directly or
indirectly controlled by a banking entity that is
organized under the laws of the United States or of
one or more States. See 12 U.S.C. 1851(d)(1)(I).
593 See,
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594 See
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Act does not further define ‘‘solely
outside of the United States’’ (SOTUS).
The 2013 rule established several
conditions on the availability of the
foreign fund exemption. Specifically,
the 2013 rule provided that an activity
or investment occurs solely outside the
United States for purposes of the foreign
fund exemption only if:
• The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
and is not controlled directly or
indirectly by, a banking entity that is
located in the United States or
organized under the laws of the United
States or of any State;
• The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
laws of the United States or of any State;
• The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
as principal directly or indirectly on a
consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
• No financing for the banking
entity’s ownership or sponsorship is
provided, directly or indirectly, by any
branch or affiliate that is located in the
United States or organized under the
laws of the United States or of any State
(the ‘‘financing prong’’).596
Much like the similar requirement
under the exemption for permitted
trading activities of a foreign banking
entity, the proposal would have
removed the financing prong of the
foreign fund exemption, while leaving
in place the other requirements for an
activity or investment to be considered
‘‘solely outside of the United States.’’
Removing the financing prong was
intended to streamline the requirements
of the foreign fund exemption with the
intention of improving implementation
of the statutory exemption.
Several commenters supported
removing the financing prong from the
foreign fund exemption.597 One
commenter argued that this change
would appropriately refocus the foreign
fund exemption on the location of the
activities of the banking entity as
principal.598 Another commenter argued
that the proposed changes to the foreign
final rule § ll.13(b)(4).
e.g., BPI; BVI; EBF; IIB; JBA; and New
England Council.
598 See EBF.
fund exemption, including removal of
the financing prong, could promote
international regulatory cooperation.599
Other commenters argued against
eliminating the financing prong because
it could result in a U.S. branch or
affiliate that extends financing to bear
some risks.600
The agencies are adopting the
proposal to remove the financing prong
for the same reasons described above in
section IV.B.4 for the trading outside of
the United States exemption. This
change focuses one of the key
requirements of the foreign fund
exemption on the principal actions and
risk of the transaction. Removing the
financing prong would also address
concerns that the fungibility of
financing has made this requirement in
certain circumstances difficult to apply
in practice to determine whether a
particular financing is tied to a
particular activity or investment.
Eliminating the financing prong, while
retaining the other prongs of the foreign
fund exemption, strikes a better balance
between the risks posed to U.S. banking
entities and the U.S. financial system,
on the one hand, and effectuating the
statutory exemption for activities
conducted solely outside of the United
States, on the other. The agencies note
that a U.S. banking entity’s affiliate
lending activities remain subject to
other laws and regulations—including
sections 23A and 23B of the Federal
Reserve Act and prudential safety and
soundness standards, as applicable.
One of the restrictions of the statutory
exemption for covered fund activities
conducted by foreign banking entities
solely outside the United States is the
restriction that ‘‘no ownership interest
in such hedge fund or private equity
fund is be offered for sale or sold to a
resident of the United States.601 To
implement this restriction, § ll.13(b)
of the 2013 rule requires, as one
condition of the foreign fund
exemption, that ‘‘no ownership interest
in the covered fund is offered for sale or
sold to a resident of the United States’’
(the ‘‘marketing restriction’’).602
The final rule, like the proposal,
clarifies that an ownership interest in a
covered fund is not offered for sale or
sold to a resident of the United States
for purposes of the marketing restriction
only if it is not sold and has not been
sold pursuant to an offering that targets
residents of the United States in which
the banking entity or any affiliate of the
banking entity participates. The final
596 See
599 See
597 See,
600 See,
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62019
BPI.
e.g., Better Markets and CAP.
601 See 12 U.S.C. 1851(d)(1)(I).
602 See final rule § ll.13(b)(1)(iii).
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rule, like the proposal, also clarifies that
if the banking entity or an affiliate
sponsors or serves, directly or
indirectly, as the investment manager,
investment adviser, commodity pool
operator, or commodity trading advisor
to a covered fund, then the banking
entity or affiliate will be deemed for
purposes of the marketing restriction to
participate in any offer or sale by the
covered fund of ownership interests in
the covered fund.603 This revision
adopts existing staff guidance
addressing this issue.604 Several
commenters supported this
clarification.605 Some commenters
argued that this clarification
appropriately excludes from the
marketing restriction those activities
where the risk occurs and remains
outside of the United States and reflects
the intended extraterritorial limitations
of the section 13 of the BHC Act.606 In
addition, commenters stated that
codifying the previously issued staff
guidance will provide greater clarity
and certainty for non-U.S. banking
entities making investments in third
party funds (i.e., covered funds that the
banking entity does not advise or
organize and offer pursuant to
§ ll.11(a) or (b) of the final rule) and
will enable long-term strategies in
reliance on this provision.607
The agencies are adopting this
clarification as proposed to formally
incorporate the existing staff guidance.
As staff noted in the previous staff
guidance, the marketing restriction
constrains the foreign banking entity in
connection with its own activities with
respect to covered funds rather than the
activities of unaffiliated third parties.608
This ensures that the foreign banking
entity seeking to rely on the foreign
fund exemption does not engage in an
offering of ownership interests that
targets residents of the United States.
This clarification limits the
extraterritorial application of section 13
to foreign banking entities while seeking
to ensure that the risks of covered fund
investments by foreign banking entities
occur and remain solely outside of the
United States. If the marketing
restriction were applied to the activities
of third parties, such as the sponsor of
a third-party covered fund (rather than
the foreign banking entity investing in a
third-party covered fund), the foreign
fund exemption may not be available in
certain circumstances even though the
proposal § ll.13(b)(3).
supra note 59, FAQ 13.
605 See, e.g., AIC; BPI; BVI; IIB; and EBF.
606 See, e.g., EBF and IIB.
607 See, e.g., AIC; BPI; and BVI.
608 See supra note 59, FAQ 13.
603 See
604 See
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risks and activities of a foreign banking
entity with respect to its investment in
the covered fund are solely outside the
United States.
One commenter asked the agencies to
clarify that the requirement that the
banking entity (including the relevant
personnel) that makes the decision ‘‘to
acquire or retain the ownership interest
or act as sponsor to the covered fund’’
must not be located in the United States
does not prohibit non-U.S. investment
funds from utilizing the expertise of
U.S. investment advisers under
delegation agreements.609 This
commenter noted that a foreign
investment fund may appoint a
qualified U.S. investment adviser for
providing investment management or
investment advisory services under
delegation but that the ultimate
responsibility for the investment
decisions and compliance with statutory
and contractual investment limits
remains with the foreign management
company that manages the foreign
investment fund. As stated in the
preamble to the 2013 rule, the foreign
fund exemption permits the U.S.
personnel and operations of a foreign
banking entity to act as investment
adviser to a covered fund in certain
circumstances. For example, the U.S.
personnel of a foreign banking entity
may provide investment advice and
recommend investment selections to the
manager or general partner of a covered
fund so long as the investment advisory
activity in the United States does not
result in U.S. personnel participating in
the control of the covered fund or
offering or selling an ownership interest
to a resident of the United States.610
Consistent with the foreign trading
exemption, as discussed above,611 the
agencies also are confirming that under
the final rule, the foreign fund
exemption does not preclude a foreign
banking entity from engaging a nonaffiliated U.S. investment adviser as
long as the actions and decisions of the
banking entity as principal occur
outside of the United States. The
agencies intend to address and request
further comment on additional covered
fund issues in a future proposed
rulemaking.
4. Section ll.14: Limitations on
Relationships With a Covered Fund
a. Relationships With a Covered Fund
Section 13(f) of the BHC Act provides
that, with limited exceptions, no
banking entity that serves, directly or
indirectly, as the investment manager,
609 See
BVI.
FR at 5741.
611 See supra Part IV.B.4.
610 79
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investment adviser, or sponsor to a
hedge fund or private equity fund, or
that organizes and offers a hedge fund
or private equity fund pursuant to
section 13(d)(1)(G), and no affiliate of
such entity, may enter into a transaction
with the fund, or with any other hedge
fund or private equity fund that is
controlled by such fund, that would be
a ‘‘covered transaction,’’ as defined in
section 23A of the Federal Reserve Act,
as if such banking entity and the
affiliate thereof were a member bank
and the hedge fund or private equity
fund were an affiliate thereof.612 The
2013 rule includes this prohibition as
well.613 The proposal included a request
for comment regarding the restrictions
in section 13(f) of the BHC Act and
§ ll.14 of the 2013 rule. As with the
other covered fund issues for which no
specific rule text was proposed, the
agencies continue to consider the
prohibition in section 13(f) of the BHC
Act and intend to issue a separate
proposed rulemaking that addresses this
issue.
b. Prime Brokerage Transactions
Section 13(f) of the BHC Act provides
an exemption from the prohibition on
covered transactions with a hedge fund
or private equity fund for any prime
brokerage transaction with a hedge fund
or private equity fund in which a hedge
fund or private equity fund managed,
sponsored, or advised by a banking
entity has taken an ownership interest (a
second-tier fund).614 The statute by its
terms permits a banking entity with a
relationship to a hedge fund or private
equity fund described in section 13(f) of
the BHC Act to engage in prime
brokerage transactions (that are covered
transactions) only with second-tier
funds and does not extend to hedge
funds or private equity funds more
generally.615 Under the statute, the
exemption for prime brokerage
transactions is available only so long as
certain enumerated conditions are
satisfied.616 The 2013 rule included this
exemption as well and similarly
required satisfaction of certain
enumerated conditions in order for a
banking entity to engage in permissible
prime brokerage transactions.617 The
612 See
U.S.C. 1851(f)(1).
final rule § ll.14(a)(1).
614 See U.S.C. 1851(f)(3).
615 Neither the statute nor the proposal limits
covered transactions between a banking entity and
a covered fund for which the banking entity does
not serve as investment manager, investment
adviser, or sponsor (as defined in section 13 of the
BHC Act) or have an interest in reliance on section
13(d)(1)(G) of the BHC Act. Similarly, the final rule
does not limit such covered transactions.
616 See 12 U.S.C. 1851(f)(3).
617 See final rule § ll.14(a)(2)(ii).
613 See
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2013 rule’s conditions are that (i) the
banking entity is in compliance with
each of the limitations set forth
in § ll.11 of the 2013 rule with respect
to a covered fund organized and offered
by the banking entity or any of its
affiliates; (ii) the CEO (or equivalent
officer) of the banking entity certifies in
writing annually that the banking entity
does not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests; and
(iii) the Board has not determined that
such transaction is inconsistent with the
safe and sound operation and condition
of the banking entity.
The proposal retained each of the
2013 rule’s conditions for the prime
brokerage exemption described above,
including the requirement that
certification be made to the appropriate
agency for the banking entity.618 Staffs
of the agencies previously issued
guidance explaining when a banking
entity was required to provide this
certification during the conformance
period.619 The proposal incorporated
this guidance into the rule text by
requiring banking entities to provide the
CEO certification annually no later than
March 31 of the relevant year.620 This
change was intended to provide banking
entities with certainty about when the
required certification must be provided
to the appropriate agency in order to
comply with the prime brokerage
exemption. As under the 2013 rule,
under the proposal, the CEO would
have a duty to update the certification
if the information in the certification
materially changes at any time during
the year when he or she becomes aware
of the material change.621
One commenter recommended that
the agencies expressly state that the
CEO certification for purposes of the
prime brokerage exemption is based on
a reasonable review by the CEO and is
made based on the knowledge and
reasonable belief of the CEO.622 That
commenter also requested that the
agencies clarify that the term ‘‘prime
brokerage transaction’’ includes
transactions and services commonly
provided in connection with prime
brokerage transactions, as described
under the 2013 rule, including: (1)
Lending and borrowing of financial
assets, (2) provision of secured
financing collateralized by financial
618 See
83 FR at 33486–87.
supra note 59, FAQ 18.
83 FR at 33487.
621 This duty to update the certification is
required as a condition of the statutory exemption.
See 12 U.S.C. 1851(f)(3)(A)(ii).
622 See SIFMA.
619 See
620 See
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assets, (3) repurchase and reverse
repurchase of financial assets, (4)
derivatives, (5) clearance and settlement
of transactions, (6) ‘‘give-up’’
agreements, and (7) purchase and sale of
financial assets from inventory.623
Similarly, another commenter requested
that the agencies clarify that the term
‘‘prime brokerage transaction’’ applies
to any transaction provided in
connection with custody, clearance and
settlement, securities borrowing or
lending services, trade execution,
financing, or data, operational, and
administrative support regardless of
which business line within the banking
entity conducts the business.624 The
same commenter suggested that any
prime brokerage transaction with a
second-tier covered fund should be
presumed to comply with section
ll.14 of the rule and the prime
brokerage exemption as long as it is
executed in compliance with the
requirements of Section 23B of the
Federal Reserve Act.625 In addition, one
commenter recommended limiting the
prime brokerage exemption by, for
instance, excluding financing and
securities lending and borrowing from
the prime brokerage exemption.626
The final rule adopts the proposed
revision to the prime brokerage
exemption with no changes. The
agencies believe that codifying a
deadline for CEO certification with
respect to prime brokerage transactions
will provide banking entities with
greater certainty and facilitate
supervision and review of the prime
brokerage exemption. With respect to
the other issues raised by commenters
regarding the prime brokerage
exemption in section 13(f) of the BHC
Act, the agencies continue to consider
these issues and intend to issue a
separate proposed rulemaking that
specifically addresses these issues.
D. Subpart D—Compliance Program
Requirement; Violations
1. Section ll.20: Program for
Compliance; Reporting
Section ll.20 of the 2013 rule
contains compliance program and
metrics collection and reporting
requirements. The 2013 rule was
intended to focus the most significant
compliance obligations on the largest
and most complex organizations, while
minimizing the economic impact on
small banking entities.627 To this end,
the 2013 rule included a simplified
623 See
id.
ABA.
625 See id.
626 See Occupy the SEC.
627 See 79 FR 5753.
624 See
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62021
compliance program for small banking
entities and banking entities that did not
engage in extensive trading activity.628
However, as the agencies noted in the
proposal, public feedback has indicated
that even determining whether a
banking entity is eligible for the
simplified compliance program could
require significant analysis for small
banking entities. In addition, certain
traditional banking activities of small
banks fall within the scope of the
proprietary trading and covered fund
prohibitions and exemptions, making
banks engaging in these activities
ineligible for the simplified compliance
program. As the agencies noted in the
proposal, public feedback has also
indicated that the compliance program
requirements are unduly burdensome
for larger banking entities that must
implement the rule’s enhanced
compliance program, metrics, and CEO
attestation requirements. Accordingly,
the agencies proposed to revise the
compliance program requirements to
allow greater flexibility for banking
entities in integrating the Volcker
compliance and exemption
requirements into existing compliance
programs and to focus the requirements
on the banking entities with the most
significant and complex activities.
Specifically, the agencies proposed
applying the compliance program
requirement to banking entities as
follows:
• Banking entities with significant
trading assets and liabilities. Banking
entities with significant trading assets
and liabilities would have been subject
to the six-pillar compliance program
requirement (§ ll.20(b) of the 2013
rule), the metrics reporting requirements
(§ ll.20(d) of the 2013 rule),629 the
covered fund documentation
requirements (§ ll.20(e) of the 2013
rule), and the CEO attestation
628 Banking entities did not have any compliance
program obligations under the 2013 rule if they do
not engage in any covered activities other than
trading in certain government, agency, State or
municipal obligations. § ll20(f)(1). Additionally,
banking entities with $10 billion or less in total
consolidated assets could satisfy the compliance
program requirements under the 2013 rule by
including appropriate references to the
requirements of section 13 of the BHC Act and the
implementing regulations in their existing policies
and procedures. § ll.20(f)(2).
629 As discussed below, the proposal would have
amended the Appendix A metrics requirements to
reduce compliance-related inefficiencies while
allowing for the collection of data to permit the
agencies to better monitor compliance with section
13 of the BHC Act. In addition, the proposal would
have eliminated Appendix B of the 2013 rule,
which would have resulted in Appendix A being
re-designated as the ‘‘Appendix.’’
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requirement (Appendix B of the 2013
rule).630
• Banking entities with moderate
trading assets and liabilities. Banking
entities with moderate trading assets
and liabilities would have been required
to establish the simplified compliance
program (described in § ll.20(f)(2) of
the 2013 rule) and comply with the CEO
attestation requirement.
• Banking entities with limited
trading assets and liabilities. Banking
entities with limited trading assets and
liabilities would have been presumed to
be in compliance with the proposal and
would have had no obligation to
demonstrate compliance with subpart B
and subpart C of the implementing
regulations on an ongoing basis. These
banking entities would not have been
required to demonstrate compliance
with the rule unless and until the
appropriate agency, based upon a
review of the banking entity’s activities,
determined that the banking entity
should have been treated as if it did not
have limited trading assets and
liabilities.
After reviewing all of the comments to
this section, the agencies are finalizing
these changes largely as proposed,
except for further tailoring application
of the CEO attestation requirement to
only banking entities with significant
trading assets and liabilities and
revising the notice and response
procedures in subpart D to be more
broadly applicable.
a. Compliance Program Requirements
for Banking Entities With Significant
Trading Assets and Liabilities
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i. Section 20(b)—Six-Pillar Compliance
Program
Section ll.20(b) of the 2013 rule
specifies six elements that each
compliance program required under that
section must at a minimum contain.
The six elements specified in
§ ll.20(b) are:
• Written policies and procedures
reasonably designed to document,
describe, monitor and limit trading
activities and covered fund activities
and investments conducted by the
banking entity to ensure that all
activities and investments that are
subject to section 13 of the BHC Act and
the rule comply with section 13 of the
BHC Act and the 2013 rule;
• A system of internal controls
reasonably designed to monitor
compliance with section 13 of the BHC
630 Although the proposal would have eliminated
Appendix B, as noted above, it would have
continued to apply a modified version of the CEO
attestation to banking entities without limited
trading assets and liabilities.
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Act and the rule and to prevent the
occurrence of activities or investments
that are prohibited by section 13 of the
BHC Act and the 2013 rule;
• A management framework that
clearly delineates responsibility and
accountability for compliance with
section 13 of the BHC Act and the 2013
rule and includes appropriate
management review of trading limits,
strategies, hedging activities,
investments, incentive compensation
and other matters identified in the rule
or by management as requiring
attention;
• Independent testing and audit of
the effectiveness of the compliance
program conducted periodically by
qualified personnel of the banking
entity or by a qualified outside party;
• Training for trading personnel and
managers, as well as other appropriate
personnel, to effectively implement and
enforce the compliance program; and
• Records sufficient to demonstrate
compliance with section 13 of the BHC
Act and the 2013 rule, which a banking
entity must promptly provide to the
relevant agency upon request and retain
for a period of no less than 5 years.
Under the 2013 rule, these six
elements have to be part of the required
compliance program of each banking
entity with total consolidated assets
greater than $10 billion that engages in
covered trading activities and
investments subject to section 13 of the
BHC Act and the implementing
regulations (excluding trading permitted
under § ll.6(a) of the 2013 rule).
The agencies proposed further
tailoring the compliance program
requirements to make the scale of
compliance activity required by the rule
commensurate with a banking entity’s
size and level of trading activity.
Specifically, the proposal would have
applied the six-pillar compliance
program requirements to banking
entities with significant trading assets
and liabilities and would have afforded
flexibility to integrate the § ll.20
compliance program requirements into
other compliance programs of the
banking entity. The proposal also would
have eliminated the enhanced
compliance program requirements
found in Appendix B of the 2013
rule,631 except for the CEO attestation
631 The enhanced minimum standards in
Appendix B of the 2013 rule required that the firm’s
compliance program: (1) Be reasonably designed to
identify, document, monitor, and report the trading
and covered fund activities and investments of the
banking entity; identify, monitor and promptly
address the risks of these activities and investments
and potential areas of noncompliance; and prevent
activities or investments prohibited by, or that do
not comply with, section 13 of the BHC Act and the
2013 rule; (2) establish and enforce appropriate
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Fmt 4701
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requirement discussed below. The
proposal also would have revised the
covered fund documentation
requirements in § ll.20(e), which
applied to all banking entities with
greater than $10 billion in total
consolidated assets under the 2013 rule,
to only apply to firms with significant
trading assets and liabilities.
Several commenters expressed
support for the elimination of the
enhanced compliance program
requirements in Appendix B of the 2013
rule.632 One commenter requested that
the agencies provide greater discretion
to banking entities with significant
trading assets and liabilities to tailor
their compliance programs to the size
and complexity of their activities and
structure of their business.633 A few
commenters opposed the elimination of
Appendix B of the 2013 rule.634 One
asserted that firms have already made
investments in their compliance
programs, so there was no justification
for the change.635 Another commenter
argued that the remaining controls are
not sufficient to ensure compliance with
the rule because they lack specificity.636
This commenter also asserted that
merging the Volcker Rule requirements
with the safety and soundness
compliance framework would be
problematic as the Volcker Rule
considers market supply and demand
dynamics while the safety and
soundness compliance framework
generally only considers risks.637 The
concern was that a combined program
might not adequately consider the
activities restrictions of the Volcker
Rule.
The agencies are adopting the sixpillar compliance program requirements
and retaining the covered fund
limits on the activities and investments of the
banking entity, including limits on the size, scope,
complexity, and risks of the individual activities or
investments consistent with the requirements of
section 13 of the BHC Act and the 2013 rule; (3)
subject the effectiveness of the compliance program
to periodic independent review and testing, and
ensure that the entity’s internal audit, corporate
compliance and internal control functions involved
in review and testing are effective and independent;
(4) make senior management, and others as
appropriate, accountable for the effective
implementation of the compliance program, and
ensure that the board of directors and CEO (or
equivalent) of the banking entity review the
effectiveness of the compliance program; and (5)
facilitate supervision and examination by the
agencies of the banking entity’s trading and covered
fund activities and investments.
632 See, e.g., Insurance Coalition; Real Estate
Associations; CREFC; Credit Suisse; JBA; FSF; and
ABA.
633 See Credit Suisse.
634 See, e.g., Bean; Data Boiler; and AFR.
635 See Bean.
636 See AFR.
637 Id.
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documentation requirements for
banking entities with significant trading
assets and liabilities as proposed. The
agencies continue to believe that these
banking entities are engaged in activities
at a scale that warrants the costs of
establishing and maintaining the
detailed and comprehensive compliance
program elements described in
§§ ll.20(b) and ll.20(e) of the rule.
Accordingly, the agencies believe it is
appropriate to require banking entities
with significant trading assets and
liabilities to maintain a six-pillar
compliance program to ensure that
banking entities’ activities are
conducted in compliance with section
13 of the BHC Act and the
implementing regulations. Based on
experience with the six-pillar
compliance program requirements
under the 2013 rule, the agencies
believe that such requirements are
appropriate and effective for firms with
significant trading assets and liabilities;
these standards impose certain
minimum standards, but permit the
banking entity flexibility to reasonably
design the program in light of the
banking entity’s activities. The agencies
also believe that the prescribed sixpillar compliance requirements are
consistent with the standards banking
entities use in their traditional risk
management and compliance processes.
The agencies believe that banking
entities should have discretion to tailor
their compliance programs to the
structure and activities of their
organizations. The flexibility to build on
compliance programs that already exist
at banking entities, including internal
limits, risk management systems, boardlevel governance protocols, and the
level at which compliance is monitored,
may reduce the costs and complexity of
compliance while also enabling a robust
compliance mechanism for the final
rule.
The agencies therefore believe that
removal of the specific, enhanced
minimum standards in Appendix B will
afford a banking entity considerable
flexibility to satisfy the elements of
§ ll.20 in a manner that it determines
to be most appropriate given its existing
compliance regimes, organizational
structure, and activities. Allowing
banking entities the flexibility to
integrate Volcker Rule compliance
requirements into existing compliance
programs should increase the
effectiveness of the § ll.20
requirements by eliminating duplicative
governance and oversight structures
arising from the Appendix B
requirement for a stand-alone
compliance program.
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ii. CEO Attestation Requirement
The 2013 rule included a requirement
in its Appendix B that a banking entity’s
CEO must review and annually attest in
writing to the appropriate agency that
the banking entity has in place
processes to establish, maintain,
enforce, review, test, and modify the
compliance program established
pursuant to Appendix B and § ll.20 of
the 2013 rule in a manner reasonably
designed to achieve compliance with
section 13 of the BHC Act and the
implementing regulations.
Under the proposal, Appendix B
would have been eliminated, and a
modified CEO attestation requirement
would have applied to banking entities
with significant trading assets and
liabilities or moderate trading assets and
liabilities. The agencies believed that,
while the revisions to the compliance
program requirements under the
proposal generally would simplify the
compliance program requirements, this
simplification should be balanced
against the requirement for all banking
entities to maintain compliance with
section 13 of the BHC Act and the
implementing regulations. Accordingly,
the agencies believed that applying the
CEO attestation requirement to banking
entities with meaningful trading
activities would ensure that the
compliance programs established by
these banking entities pursuant to
§ ll.20(b) or § ll.20(f)(2) of the
proposal would be reasonably designed
to achieve compliance with section 13
of the BHC Act and the implementing
regulations as proposed. The agencies
proposed limiting the CEO attestation
requirement to banking entities with
moderate trading assets and liabilities or
significant trading assets and liabilities
because, under the proposal, banking
entities with limited trading assets and
liabilities would have been subject to a
rebuttable presumption of compliance.
Thus, the agencies did not believe it
necessary to require a CEO attestation
for banking entities with limited trading
assets and liabilities as those banking
entities would not be subject to the
express requirement to maintain a
compliance program pursuant to
§ ll.20 under the proposal. Further,
the agencies proposed retaining the
2013 rule’s language concerning how
the CEO attestation requirement applies
to the U.S. operations of a foreign
banking entity. This language states
that, in the case of the U.S. operations
of a foreign banking entity, including a
U.S. branch or agency of a foreign
banking entity, the attestation may be
provided for the entire U.S. operations
of the foreign banking entity by the
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Fmt 4701
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62023
senior management officer of the U.S.
operations of the foreign banking entity
who is located in the United States.
Several commenters expressed
support for the CEO attestation
requirement and recommended that the
agencies make no changes to the
requirement or apply it to all banking
entities.638 Other commenters believed
that the CEO attestation requirement
should not apply to banking entities
with moderate trading assets and
liabilities,639 as requiring the
development of costly and burdensome
internal compliance efforts would not
be consistent with the activities or risks
of such firms.640 One commenter argued
that the CEO attestation requirement
duplicates existing quarterly reporting
process,641 and another commenter
asserted that imposing such a
requirement for firms with moderate
trading assets and liabilities would
negate the tailoring the agencies
proposed for those banking entities.642
One commenter urged the agencies to
limit the application of the compliance
program and reporting requirements to
only the U.S. operations of foreign
banking entities.643 Other requests for
modification included streamlining the
CEO attestation requirement,644 adding
a knowledge qualifier,645 and limiting
the scope to only U.S. operations.646 A
few commenters requested that the CEO
attestation be completely eliminated.647
After reviewing the comments, the
agencies have decided to retain the CEO
attestation requirement but only for
banking entities with significant trading
assets and liabilities. The agencies
continue to believe that incorporating
the CEO attestation requirement (which
was previously in Appendix B of the
2013 rule) into § ll.20(c) will help to
ensure that the compliance program
established pursuant to that section is
reasonably designed to achieve
compliance with section 13 of the BHC
Act and the implementing regulations.
However, the agencies have decided
not to apply the CEO attestation
requirement to banking entities without
significant trading assets and liabilities.
Such banking entities will still need to
comply with section 13 of the BHC Act
and the implementing regulations;
638 See, e.g., AFR; Merkley; Better Markets; and
Data Boiler.
639 See, e.g., Capital One et al.; ABA; Arvest;
BB&T; State Street; BPI; and IIB.
640 See Capital One et al.
641 See BOK.
642 See Capital One et al.
643 See IIB.
644 See, e.g., ABA and JBA.
645 See, e.g., ABA and FSF.
646 See JBA.
647 See BOK and Capital One et al.
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however, they will not need to provide
CEO attestations. This means that the
CEO attestation requirement will not be
expanded to cover banking entities that
did not need to provide CEO attestations
under the 2013 rule.648 The agencies
believe that requiring a CEO attestation
from banking entities with limited or
moderate trading assets and liabilities
would result in additional costs and
burdens that would not be
commensurate with the type of
activities or risks of these firms.
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b. Compliance Program Requirements
for Banking Entities With Moderate
Trading Assets and Liabilities
The 2013 rule provided that a banking
entity with total consolidated assets of
$10 billion or less as measured on
December 31 of the previous two years
that engages in covered activities or
investments pursuant to subpart B or
subpart C of the 2013 rule (other than
trading activities permitted under
§ ll.6(a) of the 2013 rule) may satisfy
the compliance program requirements
by including in its existing compliance
policies and procedures appropriate
references to the requirements of section
13 of the BHC Act and subpart D of the
implementing regulations and
adjustments as appropriate given the
activities, size, scope, and complexity of
the banking entity.649
The agencies proposed extending the
availability of this simplified
compliance program to banking entities
with moderate trading assets and
liabilities. The agencies believed that
streamlining the compliance program
requirements for banking entities with
moderate trading assets and liabilities
would be appropriate because the scale
and nature of the activities and
investments in which these banking
entities are engaged may not justify the
additional costs associated with
establishing the compliance program
elements under §§ ll.20(b) and (e) of
the 2013 rule. Such activities may be
appropriately managed through an
appropriately tailored simplified
compliance program. The agencies
noted that banking entities with
moderate trading assets and liabilities
would be able to incorporate their
simplified compliance program into
648 The 2013 rule applied the CEO attestation
requirement to all banking entities with total
consolidated assets of $50 billion or more (or, in the
case of a foreign banking entity, total U.S. assets of
$50 billion or more). By applying the CEO
attestation requirement to banking entities with
moderate trading assets and liabilities, the proposal
would have expanded its applicability to certain
banking entities with less than $50 billion in total
U.S. assets that were not subject to the requirement
under the 2013 rule.
649 2013 rule § ll.20(f)(2).
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existing compliance policies and
procedures and tailor their compliance
programs to the size and nature of their
activities, consistent with the approach
for banking entities with significant
trading assets and liabilities.
Other commenters expressed support
for a tailored compliance program for
banking entities with moderate trading
assets and liabilities.650 The agencies
are adopting the compliance program
requirements, as proposed, for banking
entities with moderate trading assets
and liabilities, for the aforementioned
reasons. Thus, a banking entity with
moderate trading assets and liabilities
qualifies for the simplified compliance
program under § ll.20(f)(2) of the
final rule.
c. Compliance Program Requirements
for Banking Entities With Limited
Trading Assets and Liabilities
Under the proposal, a banking entity
with limited trading assets and
liabilities would have been presumed to
be in compliance with the rule. Banking
entities with limited trading assets and
liabilities would have had no obligation
to demonstrate compliance with subpart
B and subpart C of the implementing
regulations on an ongoing basis, given
the limited scale of their trading
operations. The agencies believed, based
on experience implementing and
supervising compliance with the 2013
rule, that these banking entities
generally engage in minimal trading and
investment activities subject to section
13 of the BHC Act. Thus, the agencies
believed that the limited trading assets
and liabilities of the banking entities
qualifying for the presumption of
compliance would be unlikely to
warrant the costs of establishing a
compliance program under § ll.20 of
the 2013 rule.
Under the proposed approach, the
agencies would not have expected a
banking entity with limited trading
assets and liabilities that qualified for
the presumption of compliance to
demonstrate compliance with the
proposal on an ongoing basis in
conjunction with the agencies’ normal
supervisory and examination processes.
However, the appropriate agency would
have been able to exercise its authority
to treat the banking entity as if it did not
have limited trading assets and
liabilities if, upon review of the banking
entity’s activities, the relevant agency
determined that the banking entity
engaged in proprietary trading or
covered fund activities that were
otherwise prohibited under subpart B or
subpart C. A banking entity would have
650 See,
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Fmt 4701
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been expected to remediate any
impermissible activity upon being
notified of such determination by the
agency within a period of time deemed
appropriate by the agency.
In addition, irrespective of whether a
banking entity had engaged in activities
in violation of subpart B or C, the
relevant agency would have retained its
authority to require a banking entity to
apply the compliance program
requirements that would otherwise
apply if the banking entity had
significant or moderate trading assets
and liabilities if the relevant agency
determined that the size or complexity
of the banking entity’s trading or
investment activities, or the risk of
evasion, did not warrant a presumption
of compliance.
One commenter expressed support for
the rebuttable presumption of
compliance for banking entities with
limited trading assets and liabilities.651
Another commenter suggested
completely exempting banking entities
with limited trading assets and
liabilities from section 13 of the BHC
Act.652 One commenter requested that
the evidence that an agency would
require in response to its attempt to
rebut a presumption should not be
greater than what is required of the
banking entity under the
presumption.653 Another commenter
recommended that the agencies treat
inadvertent violations of the rule as
supervisory matters and not as
violations.654
The final rule adopts the compliance
program requirements for banking
entities with limited trading assets and
liabilities as proposed. The agencies
note that the removal of the standard
compliance program requirements in
§ ll.20 for banking entities with
limited trading assets and liabilities
does not relieve those banking entities
of the obligation to comply with the
prohibitions and other requirements of
the permitted trading activity
exemptions, to the extent that the
banking entity engages in such
activities, including RENTD
requirements for permitted
underwriting and market making, under
the final rule. The agencies believe the
presumption of compliance for banking
entities with limited trading assets and
liabilities will allow flexibility for these
banking entities to take appropriate
actions, tailored to the individual
activities in which the banking entities
engage, to comply with the rule. Such
651 See
B&F.
JBA.
653 See SIFMA.
654 See ABA.
652 See
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actions may include, for example,
integrating the requirements for
permitted trading activities under the
exemptions in § ll.4, ll.5, and
ll.6 into existing internal policies and
procedures (to the extent the banking
entity engages in such activities), or
taking other steps to satisfy the criteria
to engage in such activities under the
final rule. Regarding one commenter’s
proposal that the agencies completely
exempt banking entities with limited
trading activities, the agencies note that
section 13 of the BHC Act does not give
the agencies authority to completely
exempt banking entities from the
requirements of the Volcker Rule.
d. Notice and Response Procedures
The proposed rule included notice
and response procedures that an agency
would follow when determining
whether to treat a banking entity with
limited trading assets and liabilities as
if it did not have limited trading assets
and liabilities.655 The notice and
response procedures required the
relevant agency to provide a written
explanation of its determination and
allowed the banking entity the
opportunity to respond to the agency
with any matters that the banking entity
would have the agency consider in
reaching its determination. The
response procedures would have
required the banking entity to respond
within 30 days unless the agency
extended the time period for good cause
or if the agency shortened the time
period either with the consent of the
banking entity or because the conditions
or activities of the banking entity so
required. Failure to respond within the
applicable timeframe would have
constituted a waiver of objection to the
agency’s determination. After the close
of the response period, the agency
would have decided, based on a review
of the banking entity’s response and
other information concerning the
banking entity, whether to maintain the
agency’s determination and would have
notified the banking entity of its
decision in writing. These notice and
response procedures were similar, but
not identical to, notice and response
procedures found elsewhere in the
proposed rule.656
One commenter suggested that there
should be a consistent notice and
response process regarding all
presumptions in the final rule.657 The
agencies agree and have modified the
notice and response procedures in
proposed rule § ll.20(g)(2)(ii).
proposed rule §§ ll.3(c), ll.3(g)(2),
ll.4(a)(8)(iv), ll.4(b)(6)(iv).
657 See IIB.
655 See
656 See
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subpart D to apply more broadly to
several types of determinations under
the final rule, including determinations
and rebuttals made under §§ ll.3,
ll.4, and ll.20.658 This change will
provide consistency and enhance
transparency with respect to the
processes that an agency will follow for
certain determinations throughout the
final rule.
62025
E. Subpart E—Metrics: Appendix to Part
[•]—Reporting and Recordkeeping
Requirements
Under the 2013 rule, a banking entity
with substantial trading activity 659 must
furnish the following quantitative
measurements for each of its trading
desks engaged in covered trading
activity, calculated in accordance with
Appendix A:
• Risk and position limits and usage;
• Risk factor sensitivities;
• Value-at-risk and stressed VaR;
• Comprehensive profit and loss
attribution;
• Inventory turnover;
• Inventory aging; and
• Customer-facing trade ratio.
The proposal explained that, based on
the agencies’ evaluation of the
effectiveness of the metrics data in
monitoring covered trading activities for
compliance with section 13 of the BHC
Act and the associated reporting
costs,660 the proposed rule would have
amended Appendix A requirements to
reduce compliance-related inefficiencies
while allowing for the collection of data
to permit the agencies to better monitor
compliance with section 13 of the BHC
Act.661 Specifically, the proposed rule
would have made the following
modifications to the reporting
requirements in Appendix A:
• Limit the applicability of certain
metrics only to market making and
underwriting desks.
• Replace the Customer-Facing Trade
Ratio with a new Transaction Volumes
metric to more precisely cover types of
trading desk transactions with
counterparties.
• Replace Inventory Turnover with a
new Positions metric, which measures
the value of all securities and
derivatives positions.
• Remove the requirement to
separately report values that can be
easily calculated from other reported
quantitative measurements.
• Streamline and make consistent
value calculations for different product
types, using both notional value and
market value to facilitate better
comparison of metrics across trading
desks and banking entities.
• Eliminate inventory aging data for
derivatives because aging, as applied to
derivatives, does not appear to provide
a meaningful indicator of potential
impermissible trading activity or
excessive risk-taking.
• Require banking entities to provide
qualitative information specifying for
each trading desk the types of financial
instruments traded, the types of covered
trading activity the desk conducts, and
the legal entities into which the trading
desk books trades.
• Require a Narrative Statement
describing changes in calculation
methods, trading desk structure, or
trading desk strategies.
• Remove the paragraphs labeled
‘‘General Calculation Guidance’’ from
the regulation. The Instructions
generally would provide calculation
guidance.662
• Remove the requirement that
banking entities establish and report
limits on Stressed Value-at-Risk at the
trading desk-level because trading desks
do not typically use such limits to
manage and control risk-taking.
• Require banking entities to provide
descriptive information about their
reported metrics, including information
uniquely identifying and describing
final rule § ll.20(i).
A of the 2013 rule applies to U.S.
banking entities with trading assets and liabilities
the average gross sum of which equals or exceeds
$10 billion on a worldwide consolidated basis over
the previous four calendar quarters (excluding
trading assets and liabilities involving obligations of
or guaranteed by the United States or any agency
of the United States), and to foreign banking entities
with combined U.S. trading assets and liabilities the
average gross sum of which equals or exceeds $10
billion over the previous four calendar quarters
(excluding trading assets and liabilities involving
obligations of or guaranteed by the United States or
any agency of the United States). 2013 rule
§ ll.20(d)(1).
660 See 79 FR at 5772.
661 As previously noted in the section entitled
‘‘Enhanced Minimum Standards for Compliance
Programs,’’ the Agencies are proposing to eliminate
Appendix B of the 2013 rule. Current Appendix A
is therefore re-designated as the ‘‘Appendix’’ in the
final rule.
662 The Instructions will be available on each
agency’s respective website at the addresses
specified in the Paperwork Reduction Act section
of this SUPPLEMENTARY INFORMATION. For the SEC
and CFTC, this document represents the views of
SEC staff and CFTC staff; neither Commission has
approved nor disapproved them. The Instructions
are not a rule, regulation, or statement of the SEC
or the CFTC; and like all SEC or CFTC staff
guidance, it has no legal force or effect, does not
alter or amend applicable law, and creates no new
or additional SEC or CFTC obligations for any
person. Consistent with changes elsewhere in the
final rule and with the Federal banking agencies’
Interagency Statement Clarifying the Role of
Supervisory Guidance (Sept. 11, 2018; https://
www.federalreserve.gov/supervisionreg/srletters/
sr1805.htm, https://www.occ.gov/news-issuances/
news-releases/2018/nr-ia-2018-97a.pdf, https://
www.fdic.gov/news/news/financial/2018/
fil18049.html), the agencies are removing references
to guidance and expectations from the regulatory
text of the metrics reporting requirements.
658 See
659 Appendix
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certain risk measurements and
information identifying the
relationships of these measurements
within a trading desk and across trading
desks.
• Require electronic submission of
the Trading Desk Information,
Quantitative Measurements Identifying
Information, and each applicable
quantitative measurement in accordance
with the XML Schema specified and
published on each agency’s website.663
Several commenters objected to the
proposed rule’s modification of the
metrics. Some commenters suggested
that the proposed amendments to
metrics reporting were inappropriate in
light of the lack of public disclosure of
previously reported metrics
information, and in some cases
recommended that the agencies expand
metrics reporting requirements.664 Other
commenters recommended that the
agencies simplify or eliminate the
metrics.665 As described in detail below,
the final rule streamlines the reporting
requirements in Appendix A of the 2013
rule and adopts a limited set of the new
requirements introduced in the
proposal. Among other changes, the
final rule entirely eliminates the
stressed value-at-risk, risk factor
sensitivities, and inventory aging. Taken
together, the agencies estimate that the
revised metrics in the final rule would
result in a 67 percent reduction in the
number of data items and approximately
94 percent reduction in the total volume
of data, relative to the 2013 rule’s
reporting requirement. The agencies
believe the remaining metrics are
generally useful to help firms
demonstrate that their covered trading
activities are conducted appropriately,
and to enable the agencies to identify
activities that potentially involve
impermissible proprietary trading.
Moreover, the agencies believe that
these items do not pose a special
calculation burden because firms
generally already record these values in
the regular course of business. The
agencies expect that the changes in the
final rule will enable banking entities to
leverage calculations from their market
risk capital programs to meet the
requirements for the Volcker Rule
quantitative measurements, which will
reduce complexity and cost for banking
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663 The
staff-level Technical Specifications
Guidance describes the XML Schema. The
Technical Specifications Guidance and the XML
Schema are available on each agency’s respective
website at the addresses specified in the Paperwork
Reduction Act section of this SUPPLEMENTARY
INFORMATION.
664 See, e.g., AFR; Better Markets; Occupy the
SEC; Public Citizen; and Volcker Alliance.
665 See, e.g., ABA; FSF; IIB; New England
Council; and SIFMA.
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entities, and improve the effectiveness
of the final rule.666 As discussed above,
in order to give banking entities a
sufficient amount of time to comply
with the changes adopted, banking
entities will not be required to comply
with the final amendments until January
1, 2021 (although banking entities may
voluntarily comply, in whole or in part,
with the amendments adopted in this
release prior to the compliance date,
subject to the agencies’ completion of
necessary technological changes). By
providing an extended compliance
period, the final amendments also
should facilitate firms in integrating
these requirements into existing or
planned compliance programs.
1. Purpose
Paragraph I.c of Appendix A of the
2013 rule provides that the quantitative
measurements that are required to be
reported under the rule are not intended
to serve as a dispositive tool for
identifying permissible or
impermissible activities. The proposal
would have expanded the qualifying
language in paragraph I.c of Appendix
A to apply to all of the information
required to be reported pursuant to the
appendix, rather than only to the
quantitative measurements themselves.
In addition, the proposed rule would
have also removed paragraph I.d. in
Appendix A of the 2013 rule, which
provides that the agencies would review
the metrics data and revise the metrics
collection requirements based on that
review.
The agencies received no comments
on these proposed changes. The final
rule adopts the changes, as proposed.
The agencies believe that the trading
desk information and quantitative
measurements identifying information,
coupled with the quantitative
measurements, should assist the
agencies in monitoring compliance.
This information will be used to
monitor patterns and identify activity
that may warrant further review.
Additionally, the final rule removes
paragraph I.d. Appendix A of the 2013
rule, as the agencies have conducted
this preliminary evaluation of the
effectiveness of the quantitative
measurements collected to date and
666 The agencies anticipate the market risk capital
calculations and the Volcker Rule quantitative
measurements will align particularly closely when
the banking agencies adopt a rule implementing the
Basel Committee’s market risk capital standard in
the United States. However, the agencies note that
certain anticipated changes resulting from the Basel
market risk capital standards may still result in a
mismatch between metrics required under the
market risk capital rule and the final rule. The
agencies are aware of this potential issue and intend
to address any such discrepancies at a future date.
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have adopted modifications based on
that review.
2. Definitions
The proposed rule would have
clarified the definition of ‘‘covered
trading activity’’ by adding the phrase
‘‘in its covered trading activity’’ to
clarify that the term ‘‘covered trading
activity,’’ as used in the proposed
appendix, may include trading
conducted under § ll.3(d), ll.6(c),
ll.6(d), or ll.6(e) of the proposal.667
In addition, the proposed rule defined
two additional terms for purposes of the
appendix, ‘‘applicability’’ and ‘‘trading
day,’’ that were not defined in the 2013
rule. The proposal defined
‘‘applicability’’ to clarify when certain
metrics are required to be reported for
specific trading desks and thus make
several metrics applicable only to desks
engaged in market making or
underwriting. Finally, the proposal
defined ‘‘trading day,’’ a term used
throughout Appendix A of the 2013
rule,668 to mean a calendar day on
which a trading desk is open for trading.
Commenters supported the proposal
to define ‘‘applicability’’ in order to
clarify that certain metrics are only
applicable to desks engaged in market
making or underwriting.669 One
commenter suggested defining the scope
of ‘‘covered trading activity’’ to align
with activity covered under the Basel
Committee’s revised standard for market
risk capital.670 While the agencies
received no comments on the proposed
definition of ‘‘trading day’’ in the
regulation, several comments expressed
serious concerns with the proposed
‘‘trading day’’ definition in the 2018
Instructions,671 specifically requiring
banking entities to report metrics for
trading days when U.S. markets are
closed but non-U.S. locations may be
open.672 These commenters argued that
this would impose significant
operational costs with no commensurate
benefit to the agencies’ oversight ability.
However, the Agencies feel the
definition of trading day is appropriate
because the potential for impermissible
667 The proposed change would clarify that
banking entities would have the discretion (but not
the obligation) to report metrics with respect to a
broader range of activities.
668 Appendix A of the 2013 rule provides that the
calculation period for each quantitative
measurement is one trading day, but does not
define ‘‘trading day’’.
669 See, e.g., Credit Suisse; FSF; and JBA.
670 See JBA.
671 The definition in the Instructions require
banking entities to calculate each metric for each
calendar day on which a trading desk is open for
trading, even if the desk is closed for trading in one
jurisdiction (for example, due to a national
holiday).
672 See, e.g., ABA; CCMR; FSF; and SIFMA.
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trading activity on a desk exists on any
day when the desk is open for trading,
regardless of which markets are open.
The final rule retains the definition.
The agencies believe that the scope of
‘‘covered trading activity’’ in the final
rule is appropriate, and note that, due
to changes in the definition of trading
account, the scope of ‘‘covered trading
activity’’ will align more closely with
the scope of activities covered under the
Basel Committee’s market risk capital
standards for certain banking entities.
Therefore, the final rule adopts these
definitions as proposed.
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3. Reporting and Recordkeeping
Paragraph III.a of Appendix A of the
2013 rule required banking entities
subject to the appendix to furnish seven
quantitative metrics for all trading desks
engaged in trading activity conducted
pursuant to § ll.4, § ll.5, or § ll
.6(a) (i.e., permitted underwriting,
market making, and risk-mitigating
hedging activity and trading in certain
government obligations).673
The proposal would have made
several modifications to streamline the
reporting requirements in paragraph
III.a of Appendix A of the 2013 rule.
Specifically, the proposal would have:
(1) Replaced the Inventory Turnover
and Customer-Facing Trade Ratio
metrics with the Positions and
Transaction Volumes quantitative
measurements, respectively; (2) limited
the Inventory Aging metric to only
apply to securities 674 and changed the
name of the quantitative measurement
to the Securities Inventory Aging; (3)
added the phrase ‘‘as applicable’’ to
paragraph III.a in order to limit
application of the Positions, Transaction
Volumes, and Securities Inventory
Aging quantitative measurements to
only trading desks that rely on
§ ll.4(a) or § ll.4(b) to conduct
underwriting activity or market makingrelated activity, respectively; and (4)
inserted references in paragraph III.a to
the new qualitative information
requirements added to the appendix
(i.e., Trading Desk Information,
Quantitative Measurements Identifying
Information, and Narrative Statement
requirements).675
673 In addition, the 2013 rule permits banking
entities to optionally include trading under
§ ll.3(d), § ll.6(c), § ll.6(d), or § ll.6(e).
674 Including derivatives or securities that also
meet the 2013 rule’s definition of a derivative See
infra Part III.E.2.i.v (discussing the Securities
Inventory Aging quantitative measurement). The
definition of ‘‘security’’ and ‘‘derivative’’ are set
forth in § ll.2 of the 2013 rule. See 2013 rule
§§ ll.2 (h), (y).
675 In addition, the proposed rule would have
added to paragraph III.a. a requirement that banking
entities include file identifying information in each
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A number of commenters supported
the proposed changes to remove or
tailor certain of the metrics provided in
Appendix A of the 2013 rule, but
opposed the addition of new metrics
reporting requirements (i.e., Trading
Day definition, Trading Desk
Information, Quantitative Measurements
Identifying Information, Narrative
Statement).676 These commenters
argued that, contrary to the proposal’s
objective to streamline compliance
requirements, the new reporting
requirements would significantly
increase the overall compliance burden
and impose substantial compliance
costs on firms.677 Three commenters
argued that the agencies did not provide
reasoned cost benefit analysis to justify
the inclusion of the new metrics.678 A
few commenters recommended that the
agencies should further streamline the
current metrics to permit individual
supervisors and banking entities to
collaborate on determining which
metrics are appropriate for that specific
institution.679 One commenter
expressed concern that the agencies
intended for the newly added metrics to
replace onsite supervision and review,
as the new qualitative information
requirements often duplicate the
existing compliance program
requirements.680
Other commenters opposed all of the
proposed revisions to the metrics, with
certain limited exceptions (e.g., limiting
Inventory Aging to securities).681 Some
of these commenters argued that the
agencies should adopt an approach
focused on further streamlining the
metrics requirements included in
Appendix A of the 2013 rule.682 A few
of these commenters argued that the
proposed changes to the existing metrics
would in effect create entirely new
metrics and that the new metrics would
not provide new information that
cannot be obtained through the existing
metrics.683 Other commenters supported
only retaining the Comprehensive Profit
submission to the relevant agency pursuant to
Appendix A of the 2013 rule. Specifically, the
proposal would have required the file identifying
information to include the name of the banking
entity, the RSSD ID assigned to the top-tier banking
entity by the Board, the reporting period, and the
creation date and time.
676 See, e.g., ABA; CCMR; Credit Suisse; FSF; and
Goldman Sachs.
677 See, e.g., ABA; Credit Suisse; CCMR; and FSF.
678 See, e.g., CCMR; Public Citizen; and SIFMA.
679 See, e.g., Goldman Sachs; JBA; and States
Street (on leveraging current industry practices for
FX).
680 See SIFMA.
681 See, e.g., Data Boiler; IIB; JBA; SIFMA; and
State Street.
682 See, e.g., IIB; New England Council; SIFMA;
and State Street.
683 See, e.g., IIB and SIFMA.
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62027
and Loss Attribution and Risk
Management metrics.684 Another
commenter supported retaining the
current requirements, as any revisions
would necessitate changes to firms’
current systems and thus impose
considerable operational burdens and
costs.685 One commenter stressed the
inability of the general public to provide
informed comment on the proposed
changes as the agencies have not
publically disclosed any data related to
firms’ metrics submissions.686 Another
commenter noted that disclosing firms’
metrics submissions on an aggregated
and/or time-delayed basis would enable
the general public to understand the
impact of the Volcker Rule.687 In
contrast, other commenters urged the
agencies not to publicly disclose the
metrics data because the data is
confidential supervisory information
that could be used by competitors and
could create distortions in the capital
markets.688 Another commenter
recommended replacing the metrics
with a utility platform that would
automate and perform trade surveillance
in real time.689
As described in detail below, the final
rule focuses on streamlining the 2013
rule’s reporting requirements and only
adopts a limited set of the new
qualitative requirements introduced in
the proposal. The agencies believe the
remaining metrics are generally useful
tools to help both firms and supervisors
identify activities that potentially
involve impermissible proprietary
trading. Moreover, the agencies believe
that these items do not pose a special
calculation burden because firms
already record these values in the
regular course of business.
Finally, although the agencies are not
including any changes related to public
disclosure of the quantitative
measurements in this final rule, the
agencies will continue to consider
whether some or all of the quantitative
measurements should be publicly
disclosed, taking into account the need
to protect sensitive, confidential
information, as well as restrictions on
the agencies relating to the disclosure of
sensitive, confidential business and
supervisory information on a firmspecific basis.
4. Trading Desk Information
The proposed rule added a new
paragraph III.b to Appendix A to require
684 See, e.g., New England Council and State
Street.
685 See JBA.
686 See Public Citizen.
687 See AFR.
688 See, e.g., SIFMA and IIB.
689 See Data Boiler.
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banking entities to report certain
descriptive information for each trading
desk engaged in covered trading
activity, including the trading desk
name and identifier, the type of covered
activity conducted by the desk, a brief
description of the trading desk’s general
strategy (i.e., the method for conducting
authorized trading activities), the types
of financial instruments purchased and
sold by the trading desk, and the list of
legal entities used to book trades
including which were the main booking
entities. The proposal also would have
required firms to indicate for each
trading desk whether each calendar date
is a trading day or not a trading day and
to specify the currency used by a trading
desk as well as the conversion rate to
U.S. dollars, if applicable.
In general, most commenters opposed
requiring banking entities to report any
new information outside the scope of
the 2013 rule requirements, including
qualitative information for each trading
desk.690 These commenters argued that
the de minimis benefit to the agencies’
oversight ability did not justify the
significant operational costs associated
with the new requirements, in particular
identifying the legal entities used as
booking entities by the trading desk as
well as the financial instruments and
other products traded by the desk.691
After considering these comments, the
final rule retains a modified version of
the Trading Desk Information. The final
rule eliminates the requirement for each
trading desk to identify the financial
instruments and other products traded
by the desk. The final rule also replaces
the requirement to identify the legal
entities that serve as booking entities for
each trading desk with the simpler
requirement that the banking entity’s
submission for each trading desk list: (1)
Each agency receiving the submission
for the desk; and (2) the exemptions or
exclusions under which the desk
conducts trading activity. The
exemption/exclusion identification is
particularly necessary in light of the fact
that some of the quantitative
measurements identified below (i.e., the
customer-facing activity measurements)
are only required for desks operating
under the underwriting or market
making exemptions. The list of the
agencies that have received the
submission for a desk should facilitate
inter-agency coordination, as generally
trading desks encompass multiple legal
entities, for which more than one
agency may be the primary federal
regulator. The agencies believe that this
approach appropriately balances the
benefit to the agencies and the cost to
firms from the new reporting
obligations.
690 See, e.g., ABA; Credit Suisse; CCMR; FSF; IIB;
JBA; and SIFMA.
691 See, e.g., ABA; CCMR; and SIFMA.
692 See, e.g., ABA; CCMR; Credit Suisse; Data
Boiler; JBA; and SIFMA.
693 See SIFMA.
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5. Quantitative Measurements
Identifying Information
The proposed rule added a new
paragraph III.c. to Appendix A to
require banking entities to prepare and
provide five schedules: (i) Risk and
Position Limits Information Schedule;
(ii) Risk Factor Sensitivities Information
Schedule; (iii) Risk Factor Attribution
Information Schedule; (iv) Limit/
Sensitivity Cross-Reference Schedule;
and (v) Risk factor Sensitivity/
Attribution Schedule. The proposed
schedules would have provided
descriptive information on the
quantitative measurements on a
collective basis for all relevant trading
desks. The new proposed Schedules
would have required banking entities to
provide detailed information regarding
each limit and risk factor sensitivity
reported in quantitative measurements
as well as on the attribution of existing
position profit and loss to the risk factor
reported in the quantitative
measurements. In addition, the new
Limit/Sensitivity Cross-Reference
Schedule would have required banking
entities to cross-reference, by unique
identification label, a limit reported in
the Risk and Position Limits
Information Schedule to any associated
risk factor sensitivity reported in the
Risk Factor Sensitivities Information
Schedule.
Many commenters generally opposed
requiring banking entities to report any
new information outside the scope of
the 2013 rule requirements, including
quantitative measurements identifying
information.692 One commenter argued
that these new requirements impose
undue costs on firms without providing
any new supervisory benefit as they
duplicate existing requirements in
§ ll.20, which information the
agencies can obtain through the normal
supervisory and examination process.693
This commenter further noted that
increasing the scope of the appendix
submission may harm the agencies’
ability to effectively supervise Volcker
compliance, by increasing the
supervisory resources necessary to
review the data at the detriment of
performing normal supervision.
After considering these comments, the
final rule retains a modified version of
the Quantitative Measurements
Identifying Information that eliminates
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the Risk Factor Sensitivities Information
Schedule, the Limit/Sensitivity CrossReference Schedule and the Risk-Factor
Sensitivity/Attribution Cross-Reference
Schedule. Despite the potential benefit
to the agencies from having a deeper
understanding of the relationship
between firms’ limits and the risk factor
sensitivities, the agencies agree that the
proposed requirements could
significantly increase firms’ reporting
burden in a way not commensurate with
the potential benefits. The final rule
retains the Risk Factor Attribution
Information Schedule and a modified
version of the Risk and Position Limits
Information Schedule that includes
identification of the corresponding risk
factor attribution for certain limits
(‘‘Internal Limits Information
Schedule’’). While together these
schedules add two new reporting
elements relative to the 2013 Appendix
A (i.e., a description of the limit/risk
factor sensitivities and risk factor
attribution for certain limits), the
agencies generally expect firms to
realize a net reduction in reporting
burden from the elimination of the
duplicative reporting requirements in
the current framework. The 2013 rule
requires firms report internal limits,
including but not limited to risk and
position limits, and risk factor
sensitivities established for each trading
desk on a daily basis. As in practice,
firms often use the same limits and risk
factors for multiple desks, the 2013 rule
results in firms reporting the same limit
on a daily basis for multiple desks.
These two new schedules reduce
reporting burden by allowing firms to
submit a comprehensive list of all the
internal limits and the risk factor
sensitivities that account for a
preponderance of the profit or loss for
the trading desks. Additionally, the final
rule eliminates the requirement to
report Risk Factor Sensitivities for each
trading desk on a daily basis. Based on
the submissions received to date, the
agencies expect this change alone will
reduce the total volume of data
submitted by more than half relative to
the 2013 rule.
6. Narrative Statement
The proposed rule would have added
a new paragraph III.d. to require
banking entities to submit a Narrative
Statement in a separate electronic
document to the relevant agency that
describes any changes in calculation
methods used for its quantitative
measurements, or the trading desk
structure (e.g., adding, terminating, or
merging pre-existing desks) or strategies.
In addition, in its Narrative Statement,
a banking entity, if applicable, would
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have to explain its inability to report a
particular quantitative measurement
and to provide notice if a trading desk
changes its approach to including or
excluding products that are not
financial instruments in its metrics. The
proposed rule would have required that
banking entities that do not have any
information to report in a Narrative
Statement to submit an electronic
document stating that the firm does not
have any information to report in a
Narrative Statement.
Most commenters generally opposed
requiring banking entities to report any
new information outside the scope of
the 2013 rule requirements, including
the Narrative Statement.694 While
recognizing that currently banking
entities voluntarily provide additional
information about their metrics
submissions, one commenter argued
that requiring the Narrative Statement
would impose undue costs on banking
entities, as the agencies can already
obtain this information through the
normal supervisory process.695
After considering all comments
received, the agencies are not adopting
the narrative statement requirement in
the final rule. Rather, the final rule
retains the provision from the 2013
rule’s reporting instructions that
permits, but does not require, firms to
provide a narrative statement describing
any additional information they believe
would be helpful to the agencies in
identifying material events or changes.
Narrative statements may permit the
agencies to understand aspects of the
metrics without going back to the
banking entities to ask questions. While
the agencies anticipate that many
banking entities will continue to
voluntarily provide clarifying
information, the agencies agree that the
compliance costs associated with
requiring a separate document are not
commensurate with the potential benefit
to the agencies of receiving information
in this format from banking entities that
do not wish to provide it.
7. Frequency and Method of Required
Calculation and Reporting
The 2013 rule established a reporting
schedule in § ll.20 that required
banking entities with $50 billion or
more in trading assets and liabilities to
report the information required by
Appendix A of the 2013 rule within 10
days of the end of each calendar month.
The proposed rule would have extended
this reporting schedule for firms with
significant trading activities, as defined
694 See,
e.g., ABA; CCMR; Credit Suisse; Data
Boiler; JBA; and SIFMA.
695 See SIFMA.
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in the final rule, to be within 20 days
of the end of each calendar month.696
In general, commenters supported
extending the reporting schedule to be
within 20 days of the end of each
calendar month.697 Two commenters
suggested further extending this to 30
days.698 Of these, one commenter
recommended reducing the frequency
from monthly to quarterly in order to
better align the metrics reporting with
other regulatory reporting regimes.699
Under the final rule, metrics filers
must submit metrics on a quarterly
basis. In addition, the final rule retains
the reporting schedule of 30 days after
the end of each quarter, consistent with
the reporting schedule for quarterly
filers under the 2013 rule. Supervisory
experience has indicated that this will
reduce the incidence of errors and
improve the quality of the data in the
metrics submissions.
Appendix A of the 2013 rule did not
specify a format in which metrics
should be reported. To clarify the
formatting requirements for the data
submissions and to help ensure the
quality and consistency of data
submissions across banking entities, the
proposed rule would have required
banking entities to report all the
information contained within the
proposed appendix in accordance with
an XML Schema to be specified and
published on the relevant agency’s
website.700
Two commenters opposed
transitioning to XML format for
reporting due to the costs of changing
reporting software to switch formats.701
One commenter fully supported the use
of XML as a standardized format.702
Another commenter supported XML
and estimated the cost of switching
formats to be low compared to other
costs involved in reporting.703 Finally,
one commenter asserted that reporting
in XML could be useful in certain cases
but that it was not clear that requiring
metrics reporting in XML would be
useful. The commenter recommended
deferring the decision to adopt the XML
until after a final rule is adopted. The
§ ll.20(d) of the proposal.
e.g., FSF and Goldman Sachs.
698 See, e.g., Credit Suisse and SIFMA.
699 See SIFMA.
700 To the extent the XML Schema is updated, the
version of the XML Schema that must be used by
banking entities would be specified on the relevant
agency’s website. A banking entity must not use an
outdated version of the XML Schema to report the
Trading Desk Information, Quantitative
Measurements Identifying Information, and
applicable quantitative measurements to the
relevant agency.
701 See, e.g., Credit Suisse and JBA.
702 See Goldman Sachs.
703 See Data Boiler.
696 See
697 See,
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commenter stated that the decision of
whether to adopt the XML Schema
requirement should be subject to
separate notice and comment.704
The final rule adopts the use of XML
for reporting metrics, following the
format specified in XML Schema to be
posted on the relevant agency’s website.
The agencies acknowledge that any
changes to the metrics will impose some
switching costs on banking entities. As
a very common standard for data
transmission, XML is expected to be a
less costly format to employ than a
bespoke format. Moreover, the XML
Schema allows for clearer specification,
which should reduce
miscommunication, errors,
inconsistencies, and the need for data
resubmissions. The agencies believe the
benefits of standardization outweigh the
one-time switching costs.
8. Recordkeeping
Under paragraph III.c. of Appendix A
of the 2013 rule, a banking entity’s
reported quantitative measurements are
subject to the record retention
requirements provided in Appendix A.
Under the proposed rule, this provision
would have been moved to paragraph
III.f. and expanded to include the new
qualitative information requirements
added to the appendix (i.e., Trading
Desk Information, Quantitative
Measurements Identifying Information,
and Narrative Statement requirements).
The agencies received no comments on
these proposed changes. The final rule’s
recordkeeping requirement is being
adopted largely as proposed.705
9. Quantitative Measurements
Section IV of Appendix A of the 2013
rule sets forth the individual
quantitative measurements required by
the appendix. The proposed rule would
have added an ‘‘Applicability’’
paragraph to each quantitative
measurement to identify the trading
desks for which a banking entity would
be required to calculate and report a
particular metric based on the type of
covered trading activity conducted by
the desk. The proposed rule also would
have removed the ‘‘General Calculation
Guidance’’ paragraphs in section IV of
Appendix A of the 2013 rule for each
quantitative measurement, and provided
such guidance in the Instructions.
As noted above, commenters
generally supported the proposal to
define ‘‘applicability’’ in order to clarify
that certain metrics are only applicable
704 See
SIFMA.
recordkeeping requirement in the final
rule does not require that banking entities retain a
copy of the Narrative Statement.
705 The
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to desks engaged in market making or
underwriting.706 The agencies’ received
no comments on providing the metrics
calculation guidance in an Instructions
document and removing this guidance
from the appendix. The metrics are not
intended to serve as a dispositive tool
for identifying permissible or
impermissible activities. Thus, the
agencies believe that providing the
metrics calculation guidance in the
Instructions and not within the
regulation is more appropriate.707
Therefore, the agencies are adopting
these changes as proposed.
a. Risk-Management Measurements
i. Internal Limits and Usage
Like the 2013 rule, the proposed rule
would have applied the Risk and
Position Limits and Usage metric to all
trading desks engaged in covered
trading activities. Additionally, the
proposed rule would have removed
references to Stressed Value-at-Risk
(Stressed VaR) in the Risk and Position
Limits and Usage metric and required
banking entities to report the unique
identification label for each limit as
listed in the Risk and Position Limits
Information Schedule, the limit size
(distinguishing between the upper
bound and lower bound of the limit,
where applicable), and the value of
usage of the limit.708
In general, most commenters
supported eliminating requirements to
establish limits on Stressed VaR.709 One
commenter did not support this change,
as any revisions would necessitate
changes to firms’ current systems and
thus impose considerable operational
burdens and costs.710 Another
commenter supported further requiring
full reporting of upper and lower
bounds of risk and position limits
usage.711
The final rule largely adopts these
changes as proposed. As noted above,
the agencies believe requiring firms to
submit one consolidated Internal Limits
Information Schedule for the entire
banking entity’s covered trading
activity, rather than multiple times in
the Risk and Position Limits and Usage
metric for different trading desks, will
alleviate inefficiencies associated with
reporting redundant information and
reduce electronic file submission sizes.
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706 See,
e.g., Credit Suisse; FSF; and JBA.
supra note 662.
708 If a limit is introduced or discontinued during
a calendar month, the banking entity must report
this information for each trading day that the
trading desk used the limit during the calendar
month.
709 See, e.g., FSF and Data Boiler.
710 See JBA.
711 See Data Boiler.
707 See
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The unique identification label should
allow the agencies to efficiently obtain
the descriptive information regarding
the limit that is separately reported in
the Internal Limits Information
Schedule.712 Recognizing that firms may
establish internal limits other than risk
and position limits (e.g., inventory aging
limits), the final rule adopts an Internal
Limits Information Schedule and daily
Internal Limits and Usage quantitative
metric.
As discussed in more detail below,
the final rule removes the metrics for
Risk Factor Sensitivities. Accordingly,
the final rule also removes the cross
reference between Risk and Position
Limits and Risk Factor Sensitivities, and
the cross-reference between Risk Factor
Sensitivities and Profit and Loss Risk
Factor Attributions. These crossreferences would have provided an
essential link between the limits on
exposures to risk factors and the factors
that are demonstrably important sources
of revenue. In place of these two crossreferences, the final rule adopts an
identifier within the Internal Limits
Information Schedule indicating the
corresponding Risk Factor Attribution
when a desk measures and imposes a
limit on exposure to that risk factor.
This identifier facilitates the agencies’
review of the Internal Limits metric and
its relation to gains and losses on the
positions measured by that metric.
ii. Risk Factor Sensitivities
Like the 2013 rule, the proposed rule
would have applied the Risk Factor
Sensitivities metric to all trading desks
engaged in covered trading activities.
Under the proposal, a banking entity
would have to report for each trading
desk the unique identification label
associated with each risk factor
sensitivity of the desk, the magnitude of
the change in the risk factor, and the
aggregate change in value across all
positions of the desk given the change
in risk factor.
As discussed above in Quantitative
Measurements Identifying Information,
to reduce firms’ reporting burden the
final rule eliminates the Risk Factor
Sensitivities quantitative measurement.
iii. Value-at-Risk and Stressed Value-atRisk
The 2013 rule applies the Value-atRisk and Stressed Value-at-Risk metric
to all trading desks engaged in covered
712 Such information includes the name of the
limit, a description of the limit, the unit of
measurement for the limit, the type of limit, and
identification of the corresponding risk factor
attribution in the particular case that the limit type
is a limit on a risk factor sensitivity and profit and
loss attribution to the same risk factor is reported.
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trading activities. The proposed rule
would have modified the description of
Stressed VaR to align its calculation
with that of Value-at-Risk and clarified
that Stressed VaR is not required to be
reported for trading desks whose
covered trading activity is conducted
exclusively to hedge products excluded
from the definition of financial
instrument in § ll.3(d)(2) of the
proposal. The proposal would have also
revised the definition of Value-at-Risk to
provide that Value-at-Risk is the
measurement of the risk of future
financial loss in the value of a trading
desk’s aggregated positions at the
ninety-nine percent confidence level
over a one-day period, based on current
market conditions.713
In general, a few commenters
supported eliminating Stressed VaR,
including for non-financial instrument
hedging.714 One commenter did not
support this change, as any revisions
would necessitate changes to firms’
current systems and thus impose
considerable operational burdens and
costs.715 One commenter stated that
Stressed VaR was not a helpful metric
because it bears an attenuated
relationship to proprietary trading.716
After considering the comments
received, the agencies believe that
eliminating the Stressed VaR metric
altogether will reduce burden without
affecting the ability of the agencies to
monitor for prohibited proprietary
trading. The agencies believe that the
other metrics retained or adopted in the
final rule provide appropriate data to
monitor for prohibited proprietary
trading. To avoid duplicative or
unnecessary metrics, the final rule
eliminates the Stressed VaR metric.
b. Source-of-Revenue Measurements
i. Comprehensive Profit and Loss
Attribution
The 2013 rule requires banking
entities to calculate and report volatility
of comprehensive profit and loss. The
proposed rule would have eliminated
this requirement as the measurement
can be calculated from the profit and
loss amounts reported under the
Comprehensive Profit and Loss
Attribution metric. Additionally, the
proposed rule would have required
banking entities to provide, for one or
more factors that explain the
713 Banking entities may base their calculations of
Value-at-Risk on historical observations consistent
with other applicable regulatory requirements
relating to the calculation of Value-at-Risk. See, e.g.,
12 CFR part 3 subpart F; 12 CFR part 217 subpart
F; 12 CFR part 324 subpart F.
714 See, e.g., FSF and Data Boiler.
715 See JBA.
716 See Goldman Sachs.
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preponderance of the profit or loss
changes due to risk factor changes, a
unique identification label for the factor
and the profit or loss due to the factor
change. The proposed rule also would
have required banking entities to report
a unique identification label for the
factor so the agencies can efficiently
obtain the descriptive information
regarding the factor that is separately
reported in the Risk Factor Attribution
Information Schedule.717
In general, commenters did not
support requiring firms to attribute
profit and loss to specific risk factors.718
One commenter expressed concern that
this could disrupt firms’ current
infrastructure projects to comply with
the Basel Committee’s revised market
risk capital standards, which also
require specific alignment of risk factor
attribution and risk factor sensitivity
hierarchies.719 This commenter also
noted the limited utility of this
information for horizontal comparisons
across firms as each banking
organization defines these metrics at
different levels of granularity. Two
commenters supported eliminating the
volatility calculation, as proposed.720
After considering these comments, the
final rule adopts these changes as
proposed. Under the final rule, banking
entities will no longer be required to
report volatility for the Comprehensive
Profit and Loss metric. Banking entities
will be required to provide certain
information regarding the factors that
explain the preponderance of the profit
or loss changes due to risk factor
changes when sub-attributing
comprehensive profit and loss from
existing positions to specific and other
factors.
As in the 2013 rule and the proposal,
the final rule requires trading desks to
attribute profit and loss into: (i) Profit
and loss attributable to a trading desk’s
existing positions, and (ii) profit and
loss attributable to new positions. The
final rule retains the category for
residual profit and loss,721 but clarifies
that this is a sub-category of profit and
loss attributable to existing positions.
717 Such information includes the name of the
risk factor or other factor, a description of the risk
factor or other factor, and the change unit of the risk
factor or other factor.
718 See SIFMA.
719 See SIFMA.
720 See, e.g., Goldman Sachs and FSF.
721 As under the 2013 rule, significant
unexplained profit and loss must be escalated for
further investigation and analysis under the final
rule.
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c. Customer-Facing Activity Metrics
i. Replacement of Inventory Turnover
With Positions Metric
The 2013 rule required banking
entities to calculate and report
inventory turnover, or the turnover of a
trading desk’s inventory, over a 30-day,
60-day, and 90-day reporting period.
The proposed rule would have replaced
the Inventory Turnover metric with the
daily data underlying that metric, rather
than proposing specific calculation
periods. The proposal would have
replaced Inventory Turnover with the
daily Positions quantitative
measurement. As noted in the
Supplemental Information to the
proposed rule, positions information
that is a component of the Inventory
Turnover metric would be more useful
to the agencies, and is already tracked
by banking entities as a component of
the Inventory Turnover metric. The
proposal would have limited the scope
of applicability of the Positions metric
to trading desks that rely on § ll.4(a)
or § ll.4(b) to conduct underwriting
activity or market making-related
activity, respectively. As a result, a
trading desk that did not rely on
§ ll.4(a) or § ll.4(b) would not have
been subject to the proposed Positions
metric.722
The proposal would have also
required banking entities subject to the
appendix to separately report the market
value of all long securities positions, the
market value of all short securities
positions, the market value of all
derivatives receivables, the market value
of all derivatives payables, the notional
value of all derivatives receivables, and
the notional value of all derivatives
payables.723 Finally, the proposal also
would have clarified that positions
reported as ‘‘derivatives’’ need not be
reported as ‘‘securities,’’ thereby
clarifying the treatment of certain
positions that may have met both
definitions. This technical change
would have addressed the possibility
that a position could have been reported
in both the ‘‘securities’’ and
‘‘derivatives’’ positions, and thus been
double-counted.
A few commenters recommended that
the agencies eliminate the Positions
metric, but retain the inventory turnover
metric.724 These commenters expressed
722 For example, a trading desk that relies solely
on § ll.5 to conduct risk-mitigating hedging
activity would not have been subject to the
Positions metric under the proposed rule.
723 Under the proposal, banking entities would
have been required to report the effective notional
value of derivatives receivables and derivatives
payables for those derivatives whose stated notional
amount is leveraged.
724 See, e.g., GFMA and SIFMA.
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62031
concern that the new ‘‘Positions’’ metric
would be, in effect, a ‘‘new’’ metric that
would require reporting banking entities
to modify their systems to generate as a
standalone metric and noted that this
metric could create ‘‘false positives’’
due to daily changes in inventory that
may be driven by fluctuations in the
expectation of customer demand. Other
commenters recommended that the
agencies eliminate inventory turnover
metrics reporting requirements for
derivatives, including foreign exchange
derivatives.725 One commenter
supported the positions metric, but
recommended removing the
requirement to report market values for
derivative positions—as notional value
measures are sufficient to assess the size
of a trading desk’s derivative
inventory.726
The final rule adopts the ‘‘Positions’’
metric and eliminates the ‘‘Inventory
Turnover’’ metric consistent with the
proposal. The ‘‘Positions’’ metric is
itself a necessary component firms
already must calculate to generate the
‘‘Inventory Turnover’’ metric. Therefore,
producing the ‘‘Positions’’ metric as a
standalone figure would not require
firms to generate additional data not
produced internally today, but will
result in a more effective metrics
reporting framework. The agencies are
aware that all changes to the metrics
reporting requirements require changes
to the underlying systems required to
generate and report metrics to the
agencies. However, the Positions metric
will allow both the agencies and the
firms themselves to analyze firms’
trading activities over different time
horizons, as appropriate; the Inventory
Turnover metric, by contrast, relied on
the same underlying positions data as
the final rule requires to be reported, but
aggregated it in a manner (with 30-day,
60-day, and 90-day rolling averages) that
is more complicated than a direct
reporting of positions metrics, and is
less effective. The final rule differs from
the proposal in that it eliminates the
requirement to report the notional value
of derivatives. Removing the
requirement to report notional value of
derivative positions will avoid potential
complexity arising from using different
calculation methods for determining the
notional value for different types of
derivatives. Additionally, as the
definition of financial instrument in
section ll.3 lists securities,
derivatives and futures as distinct types
of financial instruments, the agencies
are clarifying that futures positions
725 See, e.g., GFMA; Goldman Sachs; and State
Street.
726 See e.g., Credit Suisse.
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should be reported as ‘‘derivatives,’’ and
are not expected to be broken out
separately. The agencies are making this
technical change to avoid confusion as
to whether or how to classify futures for
this metric.727
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ii. Transaction Volumes and the
Customer-Facing Trade Ratio
Paragraph IV.c.3. of Appendix A of
the 2013 rule requires banking entities
to calculate and report a CustomerFacing Trade Ratio comparing
transactions involving a counterparty
that is a customer of the trading desk to
transactions with a counterparty that is
not a customer of the desk. Appendix A
of the 2013 rule requires the CustomerFacing Trade Ratio to be computed by
measuring trades on both a trade count
basis and value basis. In addition,
Appendix A of the 2013 rule provides
that the term ‘‘customer’’ for purposes of
the Customer-Facing Trade Ratio is
defined in the same manner as the terms
‘‘client, customer, and counterparty’’
used in § ll.4(b) of the 2013 rule
describing the permitted activity
exemption for market making-related
activities. This metric is required to be
calculated on a daily basis for 30-day,
60-day, and 90-day calculation periods.
The proposed rule would have
replaced the Customer-Facing Trade
Ratio with a daily Transaction Volumes
quantitative measurement that would
allow the agencies to calculate
customer-facing trade ratios over any
period of time and to conduct more
meaningful analysis of trading desks’
customer-facing activity.728 The
proposed Transaction Volumes metric
would measure the number and
value 729 of all securities and derivatives
transactions 730 conducted by a trading
727 See final rule § ll.3(c)(1) (defining
‘‘financial instrument’’ to mean (i) a security,
including an option on a security; (ii) a derivative,
including an option on a derivative; or (iii) a
contract of sale of a commodity for future delivery,
or option on a contract of sale of a commodity for
future delivery).
728 As noted in the proposal the current
Customer-Facing Trade Ratio metric does not
provide meaningful information when a trading
desk only conducts customer-facing trading
activity. The numerator of the ratio represents
transactions with counterparties that are customers,
while the denominator represents transactions with
counterparties that are not customers. If a trading
desk only trades with customers, it will not be able
to calculate this ratio because the denominator will
be zero.
729 The proposal defined value to mean gross
market value with respect to securities, gross
notional value (i.e., the current dollar market value
of the quantity of the commodity underlying the
derivative) for commodity derivatives, and gross
notional value for all other derivatives.
730 As noted in the Positions metric preamble, in
calculating the Transactions Volume quantitative
metric, futures positions should be reported as
‘‘derivatives.’’
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desk engaged in permitted underwriting
activity or market making-related
activity under the 2013 rule with four
categories of counterparties: (i)
Customers (excluding internal
transactions); (ii) non-customers
(excluding internal transactions); (iii)
trading desks and other organizational
units where the transaction is booked
into the same banking entity; and (iv)
trading desks and other organizational
units where the transaction is booked
into an affiliated banking entity.731 The
proposed rule would have clarified that
the term ‘‘customer’’ for purposes of this
metric has the same meaning as ‘‘client,
customer, and counterparty’’ in
§ ll.4(a) for underwriting desks and in
§ ll.4(b) for market-making desks. To
reduce reporting inefficiencies, the
proposed rule would have only required
trading desks engaged in underwriting
or market making-related activity under
§ ll.4(a) or § ll.4(b) to calculate this
quantitative measurement for each
trading day. As with the Positions
metric, the proposed rule would also
have further reduced reporting volume
by replacing the 30-day, 60-day, and 90day calculation periods for each
transaction with a single daily
transaction value and count for each
type.
The proposed rule would have
required banking entities to separately
report the value and number of
securities and derivatives transactions
conducted by a trading desk with the
four categories of counterparties
described above. The proposed
classification of securities and
derivatives described above for
Positions would have also applied to
Transaction Volumes.
A few commenters opposed the
replacing the Customer-Facing Trade
Ratio with the new Transactions
Volume quantitative metric.732 These
commenters argued that the proposed
changes would effectively create an
entirely new metric, in particular by
requiring firms to classify inter-affiliate
transactions within the prescribed
categories. One commenter also asserted
that distinguishing trades that occur
across banking entities from those
within a single banking entity would
not provide any informational value to
the agencies in monitoring compliance
with section 13 of the BHC Act.733 One
commenter supported the proposal, but
731 The proposal noted that in order to avoid
double-counting transactions, these four categories
would be exclusive of each other (i.e., a transaction
could only be reported in one category).
732 See, e.g., IIB and SIFMA.
733 See SIFMA.
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also recommended excluding interaffiliate transactions.734
The final rule adopts the proposed
change to add a category of counterparty
for desk-to-desk transactions within the
same legal entity and transactions
between affiliates (collectively, Internal
Transactions). In order to connect the
transactions metric with the other
quantitate measurements, for example
risk, profit and loss, and positions, it is
important for transactions metrics to
include all transactions conducted by
the desk, including: (i) Desk-to-desk
transfers within the same legal entity;
(ii) transactions between affiliates; and
(iii) transactions with non-affiliated
external counterparties. It is also
important for supervisors to be able to
distinguish Internal Transactions from
transactions with external non-affiliated
counterparties because, based on
supervisory experience under the 2013
rule, firms report these transactions
inconsistently depending on a desk’s
purpose and business model.735
Considering the trading activities of a
desk without Internal Transactions may
not give a complete picture of the desk’s
positions, risk exposure or trading
strategies. To understand the activity of
the desk the agencies need to observe its
Internal Transactions.
Transactions between one trading
desk and another trading desk in which
the second desk books the position in
the same banking entity as the first are
not purchases or sales of financial
instruments subject to the rule,
including the prohibition on proprietary
trading in § ll.3. However, in practice
many trading desks book positions into
multiple affiliated banking entities and
also engage in desk-to-desk transactions
within the same legal entity.
Distinguishing Internal Transactions
that move positions to new legal entities
from desk-to-desk transactions that
occur purely within the same legal
entity would require an additional layer
of recordkeeping. The agencies agree
that the benefit of distinguishing trades
across affiliated banking entities from
desk-to-desk transactions within the
same legal entity does not justify the
734 See,
e.g., Credit Suisse.
Transactions are used for a number of
reasons, including to transfer risk to a desk better
equipped to manage the position’s risk; to allow a
desk with better market access or specialized
market knowledge to facilitate another desk better
equipped to face customers; or to allocate funding
costs via transfer pricing, in which case one desk
treats other internal desks or affiliate desks in much
the same way as external clients. Supervisory
experience has shown that, depending on the
purpose of the internal transaction, banking entities
sometimes report these internal transactions as
transactions with customers, sometimes as
transactions with non-customers, and sometimes do
not report them at all.
735 Internal
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been added as a potential type of limit
under the Internal Limits Information
Schedule.
extra record-keeping costs. The final
rule consolidates these two proposed
categories into one category,
transactions with trading desks and
other organizational units where the
transaction is booked into either the
same banking entity or an affiliated
banking entity.
V. Administrative Law Matters
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d. Securities Inventory Aging
The 2013 rule requires all trading
desks engaged in covered trading
activities to report Inventory Aging
metrics for their securities and
derivative positions. The proposed rule
would have only required trading desks
that relied on § ll.4(a) or § ll.4(b) to
conduct underwriting or market
making-related activity to report
Inventory Aging and limited the scope
of this metric to only securities
positions.736 To reflect the revised
scope, the proposed rule would have
revised the name of this metric to be
Securities Inventory Aging. Finally, the
proposal would have required a banking
entity to calculate and report the
Securities Inventory Aging metric
according to a specific set of age ranges.
Specifically, banking entities would
have to calculate and report the market
value of security assets and security
liabilities over the following holding
periods: 0–30 calendar days; 31–60
calendar days; 61–90 calendar days; 91–
180 calendar days; 181–360 calendar
days; and greater than 360 calendar
days.
In general, commenters supported
reducing the Inventory Aging metric, as
inventory aging data is not readily
available or particularly useful for
derivative positions.737 After
consideration of comments and in light
of the general desire to reduce reporting
burden, the agencies believe that the
Inventory Aging metric may be overly
prescriptive as an indicator of
compliance with the rule. Therefore, the
final rule no longer requires the
Inventory Aging metric for all desks and
position types. For those desks where
banking entities identify inventory aging
as a meaningful control, the entities
should report their internal limits on
inventory aging under the Internal
Limits and Usage metric and
consequently ‘‘Inventory Aging’’ has
736 The proposed Securities Inventory Aging
metric would not require banking entities to
prepare an aging schedule for derivatives or include
in its securities aging schedules those ‘‘securities’’
that are also ‘‘derivatives,’’ as those terms are
defined under the 2013 rule. See 2013 rule
§§ ll.2(h), (y). See also supra Part III.E.2.i
(discussing the classification of securities and
derivatives for purposes of the proposed Positions
quantitative measurement).
737 See, e.g., Data Boiler; Credit Suisse; FSF;
Goldman Sachs, GFMA; and State Street.
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A. Use of Plain Language
Section 722 of the Gramm-LeachBliley Act 738 requires the OCC, Board,
and FDIC (Federal banking agencies) to
use plain language in all proposed and
final rules published after January 1,
2000. The Federal banking agencies
have sought to present the proposed
rule in a simple and straightforward
manner and did not receive any
comments on plain language.
B. Paperwork Reduction Act
Certain provisions of the final rule
contain ‘‘collection of information’’
requirements within the meaning of the
Paperwork Reduction Act (PRA) of 1995
(44 U.S.C. 3501–3521). In accordance
with the requirements of the PRA, the
agencies may not conduct or sponsor,
and a respondent is not required to
respond to, an information collection
unless it displays a currently valid
Office of Management and Budget
(OMB) control number. The agencies
reviewed the final rule and determined
that the final rule revises certain
reporting and recordkeeping
requirements that have been previously
cleared under various OMB control
numbers. The agencies did not receive
any specific comments on the PRA. The
agencies are extending for three years,
with revision, these information
collections. The information collection
requirements contained in this final rule
have been submitted by the OCC and
FDIC to OMB for review and approval
under section 3507(d) of the PRA (44
U.S.C. 3507(d)) and section 1320.11 of
the OMB’s implementing regulations (5
CFR 1320). The Board reviewed the
final rule under the authority delegated
to the Board by OMB. The Board will
submit information collection burden
estimates to OMB and the submission
will include burden for Federal Reservesupervised institutions, as well as
burden for OCC-, FDIC-, SEC-, and
CFTC-supervised institutions under a
holding company. The OCC and the
FDIC will take burden for banking
entities that are not under a holding
company.
Abstract
Section 13 to the BHC Act generally
prohibits any banking entity from
engaging in proprietary trading or from
acquiring or retaining an ownership
interest in, sponsoring, or having certain
738 Public Law 106–102, section 722, 113 Stat.
1338, 1471 (1999).
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62033
relationships with a covered fund,
subject to certain exemptions. The
exemptions allow certain types of
permissible trading activities such as
underwriting, market making, and riskmitigating hedging, among others. The
2013 rule implementing section 13
became effective on April 1, 2014.
Section ll.20(d) and Appendix A of
the 2013 final rule require certain of the
largest banking entities to report to the
appropriate agency certain quantitative
measurements.
Current Actions
This final rule contains requirements
subject to the PRA and the changes
relative to the 2013 rule are discussed
herein. The new and modified reporting
requirements are found in sections
ll.4(c)(3)(i), ll.20(d), ll.20(i), and
the Appendix. The new and modified
recordkeeping requirements are found
in sections, ll.3(d)(3), ll.4(c)(3)(i),
ll.5(c), ll.20(b), ll.20(c), ll.20
(d), ll.20(e), ll.20(f), and the
Appendix. The modified information
collection requirements 739 would
implement section 13 of the BHC Act.
The respondents are for-profit financial
institutions, including small businesses.
A covered entity must retain these
records for a period that is no less than
5 years in a form that allows it to
promptly produce such records to the
relevant agency on request.
Reporting Requirements
Section ll.4(c)(3)(i) requires a
banking entity to make available to the
agency upon request records regarding
(1) any limit that is exceeded and (2)
any temporary or permanent increase to
any limit(s), in each case in the form
and manner as directed by the primary
financial regulatory agency. The
agencies estimate that the average time
per response would be 15 minutes.
Section ll.20(d) is modified by
extending the reporting period for
certain banking entities from within 10
days of the end of each calendar month
to 30 days of the end of each calendar
quarter. The threshold for reporting
under section ll.20(d) is modified
from $10 billion or more in trading
assets and liabilities to $20 billion or
more in trading assets and liabilities.
The metrics reporting changes to the
Appendix would impact the reporting
burden under section ll_.20(d). The
agencies estimate that the current
average hours per response will
739 In an effort to provide transparency, the total
cumulative burden for each agency is shown. In
addition to the changes resulting from this final
rule, the agencies are also applying a conforming
methodology for calculating the burden estimates in
order to be consistent across the agencies.
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decrease by 14 hours (decrease 40 hours
for initial set-up).
Sections ll.3(b)(4), ll.4(c)(4),
ll.20(g)(2), and ll.20(h) would
implicate the notice and response
procedures pursuant to section
ll.20(i) that an agency would follow
when rebutting a presumption or
exercising a reservation of authority.
The agencies estimate that the average
hours per response would be 20 hours.
Recordkeeping Requirements
Section ll.3(d)(3) would expand the
scope of the recordkeeping to include
foreign exchange forward (as that term
is defined in section 1a(24) of the
Commodity Exchange Act (7 U.S.C.
1a(24)), foreign exchange swap (as that
term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C.
1a(25)), or cross-currency swap. The
agencies estimate that the current
average hour per response will not
change.
Section ll.4(c)(3)(i) requires a
banking entity to maintain records
regarding (1) any limit that is exceeded
and (2) any temporary or permanent
increase to any limit(s), in each case in
the form and manner as directed by the
primary financial regulatory agency.
The agencies estimate that the average
time per response would be 15 minutes.
Section ll.5(c) is modified by
reducing the requirements for banking
entities that do not have significant
trading assets and liabilities and
eliminating documentation
requirements for certain hedging
activities. The agencies estimate that the
current average hours per response will
decrease by 20 hours (decrease 10 hours
for initial set-up).
Section ll.20(b) is modified by
limiting the requirement only to
banking entities with significant trading
assets and liabilities. The agencies
estimate that the current average hour
per response will not change.
Section ll.20(c) is modified by
limiting the CEO attestation requirement
to a banking entity that has significant
trading assets and liabilities. The
agencies estimate that the current
average hours per response will
decrease by 1,100 hours (decrease 3,300
hours for initial set-up).
Section ll.20(d) is modified by
extending the time period for reporting
for certain banking entities from within
10 days of the end of each calendar
month to 30 days of the end of each
calendar quarter. The agencies estimate
that the current average hours per
response will decrease by 3 hours.
Section ll.20(e) is modified by
limiting the requirement to banking
entities with significant trading assets
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and liabilities. The agencies estimate
that the current average hours per
response will not change.
Section ll.20(f)(2) is modified by
limiting the requirement to banking
entities with moderate trading assets
and liabilities. The agencies estimate
that the current average hours per
response will not change.
The Instructions for Preparing and
Submitting Quantitative Measurement
Information, Technical Specifications
Guidance, and XML Schema will be
available on each agency’s public
website:
• OCC: https://www.occ.treas.gov/
topics/capital-markets/financialmarkets/trading/volcker-ruleimplementation/index-volcker-ruleimplementation.html;
• Board: https://www.federal
reserve.gov/apps/reportforms/
review.aspx;
• FDIC: https://www.fdic.gov/
regulations/reform/volcker/;
• CFTC: https://www.cftc.gov/
LawRegulation/DoddFrankAct/
Rulemakings/DF_28_VolckerRule/
index.htm; and
• SEC: https://www.sec.gov/
structureddata/dera_taxonomies.
Proposed Revision, With Extension, of
the Following Information Collections
Estimated average hours per response:
Reporting
Section ll.4(c)(3)(i)—0.25 hours for
an average of 20 times per year.
Section ll.12(e)—20 hours (Initial
set-up 50 hours) for an average of 10
times per year.
Section ll.20(d)—41 hours (Initial
set-up 125 hours) quarterly.
Section ll.20(i)—20 hours.
Recordkeeping
Section ll.3(d)(3)—1 hour (Initial
set-up 3 hours).
Section ll.4(b)(3)(i)(A)—2 hours
quarterly.
Section ll.4(c)(3)(i)—0.25 hours for
an average of 40 times per year.
Section ll.5(c)—80 hours (Initial
setup 40 hours).
Section ll.11(a)(2)—10 hours.
Section ll.20(b)—265 hours (Initial
set-up 795 hours).
Section ll.20(c)—100 hours (Initial
set-up 300 hours).
Section ll.20(d)– 10 hours.
Section ll.20(e)—200 hours.
Section ll.20(f)(1)—8 hours.
Section ll.20(f)(2)—40 hours
(Initial set-up 100 hours).
Disclosure
Section ll.11(a)(8)(i)—0.1 hours for
an average of 26 times per year.
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OCC
Title of Information Collection:
Reporting, Recordkeeping, and
Disclosure Requirements Associated
with Restrictions on Proprietary Trading
and Certain Relationships with Hedge
Funds and Private Equity Funds.
Frequency: Annual, quarterly, and
event driven.
Affected Public: Businesses or other
for-profit.
Respondents: National banks, state
member banks, state nonmember banks,
and state and federal savings
associations.
OMB control number: 1557–0309.
Estimated number of respondents: 39.
Proposed revisions estimated annual
burden: ¥3,503 hours.
Estimated annual burden hours:
19,823 hours (3,482 hours for initial setup and 16,341 hours for ongoing).
Board
Title of Information Collection:
Reporting, Recordkeeping, and
Disclosure Requirements Associated
with Regulation VV.
Frequency: Annual, quarterly, and
event driven.
Affected Public: Businesses or other
for-profit.
Respondents: State member banks,
bank holding companies, savings and
loan holding companies, foreign
banking organizations, U.S. State
branches or agencies of foreign banks,
and other holding companies that
control an insured depository
institution and any subsidiary of the
foregoing other than a subsidiary for
which the OCC, FDIC, CFTC, or SEC is
the primary financial regulatory agency.
The Board will take burden for all
institutions under a holding company
including:
• OCC-supervised institutions,
• FDIC-supervised institutions,
• Banking entities for which the
CFTC is the primary financial regulatory
agency, as defined in section 2(12)(C) of
the Dodd-Frank Act, and
• Banking entities for which the SEC
is the primary financial regulatory
agency, as defined in section 2(12)(B) of
the Dodd-Frank Act.
Legal authorization and
confidentiality: This information
collection is authorized by section 13 of
the BHC Act (12 U.S.C. 1851(b)(2) and
12 U.S.C. 1851(e)(1)). The information
collection is required in order for
covered entities to obtain the benefit of
engaging in certain types of proprietary
trading or investing in, sponsoring, or
having certain relationships with a
hedge fund or private equity fund,
under the restrictions set forth in
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section 13 and the final rule. If a
respondent considers the information to
be trade secrets and/or privileged such
information could be withheld from the
public under the authority of the
Freedom of Information Act (5 U.S.C.
552(b)(4)). Additionally, to the extent
that such information may be contained
in an examination report such
information could also be withheld from
the public (5 U.S.C. 552 (b)(8)).
Agency form number: FR VV.
OMB control number: 7100–0360.
Estimated number of respondents:
255.
Proposed revisions estimated annual
burden: ¥169,466 hours.
Estimated annual burden hours:
31,044 hours (4,035 hours for initial setup and 27,009 hours for ongoing).
FDIC
Title of Information Collection:
Volcker Rule Restrictions on Proprietary
Trading and Relationships with Hedge
Funds and Private Equity Funds.
Frequency: Annual, quarterly, and
event driven.
Affected Public: Businesses or other
for-profit.
Respondents: State nonmember
banks, state savings associations, and
certain subsidiaries of those entities.
OMB control number: 3064–0184.
Estimated number of respondents: 13.
Proposed revisions estimated annual
burden: ¥15,172 hours.
Estimated annual burden hours: 3,115
hours (1,656 hours for initial set-up and
1,459 hours for ongoing).
C. Regulatory Flexibility Act Analysis
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OCC: The Regulatory Flexibility Act,
5 U.S.C. 601 et seq., (RFA), requires an
agency, in connection with a final rule,
to prepare a Final Regulatory Flexibility
Analysis describing the impact of the
rule on small entities (defined by the
SBA for purposes of the RFA to include
commercial banks and savings
institutions with total assets of $600
million or less and trust companies with
total assets of $41.5 million or less) or
to certify that the rule will not have a
significant economic impact on a
substantial number of small entities.
The OCC currently supervises
approximately 782 small entities.740
740 The number of small entities supervised by
the OCC is determined using the SBA’s size
thresholds for commercial banks and savings
institutions, and trust companies, which are $600
million and $41.5 million, respectively. Consistent
with the General Principles of Affiliation 13 CFR
121.103(a), the OCC counts the assets of affiliated
financial institutions when determining if the OCC
should classify an OCC-supervised institution a
small entity. The OCC used December 31, 2018, to
determine size because a ‘‘financial institution’s
assets are determined by averaging the assets
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Under the EGRRCPA, banking entities
with total consolidated assets of $10
billion or less generally are not
‘‘banking entities’’ within the scope of
Section 13 of the BHCA if their trading
assets and trading liabilities do not
exceed 5 percent of their total
consolidated assets. Thus, the final rule
will not impact any OCC-supervised
small entities. Therefore, the OCC
certifies that the final rule will not have
a significant impact on a substantial
number of OCC-supervised small
entities.
Board: The RFA requires an agency to
either provide a regulatory flexibility
analysis with a rule or certify that the
rule will not have a significant
economic impact on a substantial
number of small entities. The U.S. Small
Business Administration (SBA)
establishes size standards that define
which entities are small businesses for
purposes of the RFA.741 Except as
otherwise specified below, the size
standard to be considered a small
business for banking entities subject to
the proposal is $600 million or less in
consolidated assets.742
The Board has considered the
potential impact of the proposed rule on
small entities in accordance with the
RFA. Based on the Board’s analysis, and
for the reasons stated below, the Board
believes that this proposed rule will not
have a significant economic impact on
a substantial of number of small entities.
No comments were received related to
the Board’s initial RFA analysis, which
was published with the proposal.
As discussed in the SUPPLEMENTARY
INFORMATION, the agencies are revising
the 2013 rule in order to provide clarity
to banking entities about what activities
are prohibited, reduce compliance costs,
and improve the ability of the agencies
to make supervisory assessments
regarding compliance relative to the
2013 rule. The agencies are explicitly
authorized under section 13(b)(2) of the
BHC Act to adopt rules implementing
section 13.743
The Board’s rule generally applies to
state-chartered banks that are members
of the Federal Reserve System, bank
holding companies, foreign banking
reported on its four quarterly financial statements
for the preceding year.’’ See footnote 8 of the U.S.
Small Business Administration’s Table of Size
Standards.
741 U.S. SBA, Table of Small Business Size
Standards Matched to North American Industry
Classification System Codes, available at https://
www.sba.gov/sites/default/files/files/Size_
Standards_Table.pdf.
742 See id. Pursuant to SBA regulations, the asset
size of a concern includes the assets of the concern
whose size is at issue and all of its domestic and
foreign affiliates. 13 CFR 121.103(6).
743 12 U.S.C. 1851(b)(2).
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62035
organizations, and nonbank financial
companies supervised by the Board
(collectively, Board-regulated entities).
However, EGRRCPA, which was
enacted on May 24, 2018, amended
section 13 of the BHC Act and modified
the scope of the definition of banking
entity by amending the term ‘‘insured
depository institution’’ to exclude
certain community banks.744 The Board
is not aware of any Board-regulated
entities that meet the SBA’s definition
of ‘‘small entity’’ that are subject to
section 13 of the BHC Act and the rule
following the enactment of EGRRCPA.
Furthermore, to the extent that any
Board-regulated entities that meet the
definition of ‘‘small entity’’ are or
become subject to section 13 of the BHC
Act and the rule, the Board does not
expect the total number of such entities
to be substantial. Accordingly, the
Board’s rule is not expected to have a
significant economic impact on a
substantial number of small entities.
The Board has not identified any
federal statutes or regulations that
would duplicate, overlap, or conflict
with the proposed revisions, and the
Board is not aware of any significant
alternatives to the rule that would
reduce the economic impact on Boardregulated small entities.
FDIC
(a) Regulatory Flexibility Analysis
The RFA generally requires an
agency, in connection with a final rule,
to prepare and make available for public
comment a final regulatory flexibility
analysis that describes the impact of a
rule on small entities.745 However, a
regulatory flexibility analysis is not
required if the agency certifies that the
rule will not have a significant
economic impact on a substantial
number of small entities. The SBA has
defined ‘‘small entities’’ to include
banking organizations with total assets
of less than or equal to $600 million.746
744 Under EGRRCPA, a community bank and its
affiliates are generally excluded from the definition
of banking entity, and thus section 13 of the BHC
Act, if the bank and all companies that control the
bank have total consolidated assets equal to $10
billion or less and trading assets and liabilities
equal to 5 percent or less of total consolidated
assets.
745 5 U.S.C. 601 et seq.
746 The SBA defines a small banking organization
as having $600 million or less in assets, where an
organization’s ‘‘assets are determined by averaging
the assets reported on its four quarterly financial
statements for the preceding year.’’ See 13 CFR
121.201 (as amended by 84 FR 34261, effective
August 19, 2019). In its determination, the ‘‘SBA
counts the receipts, employees, or other measure of
size of the concern whose size is at issue and all
of its domestic and foreign affiliates.’’ See 13 CFR
121.103. Following these regulations, the FDIC uses
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Generally, the FDIC considers a
significant effect to be a quantified effect
in excess of 5 percent of total annual
salaries and benefits per institution, or
2.5 percent of total noninterest
expenses. The FDIC believes that effects
in excess of these thresholds typically
represent significant effects for FDICsupervised institutions. As discussed
further below, the FDIC certifies that
this final rule will not have a significant
economic impact on a substantial
number of FDIC-supervised small
entities.
(b) Reasons for and Policy Objectives of
the Final Rule
The agencies are issuing this final rule
to amend the 2013 rule in order to
provide banking entities with additional
clarity and certainty about what
activities are prohibited and seek to
improve the efficacy of the regulations
where possible. The agencies
acknowledge that many banking entities
have found certain aspects of the 2013
rule to be complex or difficult to apply
in practice. This final rule amends the
2013 rule to make its requirements more
efficient.
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(c) Description of the Rule
First, the FDIC is amending its
regulations to tailor the application of
the final rule based on the size and
scope of a banking entity’s trading
activities. In particular, the FDIC aims to
further reduce compliance obligations
for firms that do not have large trading
operations and therefore reduce costs
and uncertainty faced by firms in
complying with the final rule, relative to
their amount of trading activity. In
addition to tailoring the application of
the final rule, the FDIC is also
streamlining and clarifying for all
banking entities certain definitions and
requirements related to the proprietary
trading prohibition and limitations on
covered fund activities and investments.
Finally, the FDIC is reducing reporting,
recordkeeping, and compliance program
requirements for all banking entities and
expanding tailoring to make the scale of
compliance activity required by the rule
commensurate with a banking entity’s
size and level of trading activity.
(d) Other Statutes and Federal Rules
On May 24, 2018, EGRRCPA was
enacted, which, among other things,
amends section 13 of the BHC Act. As
a result, section 13 excludes from the
definition of ‘‘banking entity’’ any
institution that, together with their
a covered entity’s affiliated and acquired assets,
averaged over the preceding four quarters, to
determine whether the covered entity is ‘‘small’’ for
the purposes of RFA.
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affiliates and subsidiaries, has: (1) Total
assets of $10 billion or less, and (2)
trading assets and liabilities that
comprise 5 percent or less of total
assets.
The FDIC has not otherwise identified
any likely duplication, overlap, and/or
potential conflict between this final rule
and any other federal rule.
(e) Small Entities Affected
The FDIC supervises 3,465 depository
institutions,747 of which, 2,705 are
defined as small banking organizations
according to the RFA.748 Almost all
FDIC-supervised small banking entities
are exempt from the requirements of
section 13 of the BHC Act, pursuant to
EGRRCPA, and hence the final rule does
not affect them.
Only one FDIC-supervised small
banking entity is not exempt from the
requirements of section 13 of the BHC
Act under EGRRCPA because it has
trading assets and liabilities greater than
five percent of total consolidated assets.
This bank has trading activity at levels
that would place it in the final rule’s
limited trading assets and liabilities
compliance category, and it thus could
benefit from the final rule which
contains a rebuttable presumption of
compliance for such banking entities.
The FDIC estimates that banks with
limited trading will save, on average,
$115,233 from the reduced burden of
this rule. This amount is far less than 5
percent of total salaries and 2.5 percent
of total non-interest expenses for this
one institution.
Consequently, the FDIC does not
believe that this rule will have a
significant economic impact on a
substantial number of small entities.
(f) Certification Statement
Section 13 of the BHC Act, as
amended by EGRRCPA, exempts all but
one of the 2,705 FDIC-supervised small
banking entities from compliance with
section 13 of the BHC Act. Therefore,
the FDIC certifies that this final rule will
not have a significant economic impact
on a substantial number of FDICsupervised small banking entities.
CFTC: Pursuant to 5 U.S.C. 605(b), the
CFTC hereby certifies that the
amendments to the 2013 final rule will
not have a significant economic impact
on a substantial number of small entities
for which the CFTC is the primary
financial regulatory agency.
As discussed in this SUPPLEMENTARY
INFORMATION, the Agencies are revising
the 2013 final rule in order to provide
747 Categories of FDIC-supervised depository
institutions are set forth in 12 U.S.C. 1813(q)(2).
748 FDIC Call Report, March 31, 2019.
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clarity to banking entities about what
activities are prohibited, reduce
compliance costs, and improve the
ability of the Agencies to make
assessments regarding compliance
relative to the 2013 final rule. To
minimize the costs associated with the
2013 final rule, the Agencies are
simplifying and tailoring the rule to
allow banking entities to more
efficiently provide financial services in
a manner that is consistent with the
requirements of section 13 of the BHC
Act.
The revisions will generally apply to
banking entities, including certain
CFTC-registered entities. These entities
include bank-affiliated CFTC-registered
swap dealers, futures commission
merchants, commodity trading advisors
and commodity pool operators.749 The
CFTC has previously determined that
swap dealers, futures commission
merchants and commodity pool
operators are not small entities for
purposes of the RFA and, therefore, the
requirements of the RFA do not apply
to those entities.750 As for commodity
trading advisors, the CFTC has found it
appropriate to consider whether such
registrants should be deemed small
entities for purposes of the RFA on a
case-by-case basis, in the context of the
particular regulation at issue.751
In the context of the revisions to the
2013 final rule, the CFTC believes it is
unlikely that a substantial number of the
commodity trading advisors that are
potentially affected are small entities for
purposes of the RFA. In this regard, the
CFTC notes that only commodity
trading advisors that are registered with
the CFTC are covered by the 2013 final
rule, and generally those that are
registered have larger businesses.
Similarly, the 2013 final rule applies to
only those commodity trading advisors
that are affiliated with banks that are
within the scope of the Volcker Rule,
which the CFTC expects are larger
businesses.752
749 The revisions may also apply to other types of
CFTC registrants that are banking entities, such as
introducing brokers, but the CFTC believes it is
unlikely that such other registrants will have
significant activities that would implicate the
revisions. See 2013 final rule (CFTC), 79 FR 5808
at 5813 (Jan. 31, 2014).
750 See Policy Statement and Establishment of
Definitions of ‘‘Small Entities’’ for Purposes of the
Regulatory Flexibility Act, 47 FR 18618 (Apr. 30,
1982) (futures commission merchants and
commodity pool operators); and Registration of
Swap Dealers and Major Swap Participants, 77 FR
2613, 2620 (Jan. 19, 2012) (swap dealers and major
swap participants).
751 See Policy Statement and Establishment of
Definitions of ‘‘Small Entities’’ for Purposes of the
Regulatory Flexibility Act, 47 FR 18618, 18620
(Apr. 30, 1982).
752 In this regard, the CFTC notes that the
agencies recently revised the 2013 final rule in
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The CFTC requested that commenters
address whether any CFTC registrants
covered by the proposed revisions to the
2013 final rule are small entities for
purposes of the RFA. The CFTC did not
receive any public comments on this or
any other aspect of the RFA as it relates
to the rule.
Because the CFTC believes there are
not a substantial number of commodity
trading advisors within the scope of the
Volcker Rule that are small entities for
purposes of the RFA, and the other
CFTC registrants that may be affected by
the proposed revisions have been
determined not to be small entities, the
CFTC believes that the revisions to the
2013 final rule will not have a
significant economic impact on a
substantial number of small entities for
which the CFTC is the primary financial
regulatory agency.
SEC: In the proposal, the SEC certified
that, pursuant to 5 U.S.C. 605(b), the
proposal would not, if adopted, have a
significant economic impact on a
substantial number of small entities.
Although the SEC solicited written
comments regarding this certification,
no commenters responded to this
request.
As discussed in the SUPPLEMENTARY
INFORMATION, the Agencies are adopting
revisions to the 2013 rule that are
intended to provide banking entities
with clarity about what activities are
prohibited and improve supervision and
implementation of section 13 of the
BHC Act.
The revisions the agencies are
adopting today will generally apply to
banking entities, including certain SECregistered entities.753 These entities
include SEC-registered broker-dealers,
investment advisers, security-based
swap dealers, and major security-based
swap participants that are affiliates or
subsidiaries of an insured depository
institution.754 Based on information in
filings submitted by these entities, the
SEC believes that there are no banking
entity registered investment advisers,755
order to be consistent with statutory amendments
made by EGRRCPA to section 13 of the BHC Act.
The general result of one of these statutory revisions
was to exclude community banks and their affiliates
and subsidiaries from the scope of the Volcker Rule.
See 84 FR 35008. The CFTC believes this exclusion
lessens the likelihood that any commodity trading
advisors that remain within the scope of the
Volcker Rule are small entities.
753 The SEC’s Economic Analysis, below,
discusses the economic effects of the final
amendments. See SEC Economic Analysis, supra
Part V.F.
754 See 2013 rule § _.2(c) (definition of banking
entity); 2013 rule § _.2(r) as amended (definition of
insured depository institution).
755 For the purposes of an SEC rulemaking in
connection with the RFA, an investment adviser
generally is a small entity if it: (1) Has assets under
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broker-dealers,756 security-based swap
dealers, or major security-based swap
participants that are small entities for
purposes of the RFA.757 For this reason,
the SEC certifies that the rule, as
adopted, will not have a significant
economic impact on a substantial
number of small entities.
D. Riegle Community Development and
Regulatory Improvement Act
Section 302(a) of the Riegle
Community Development and
Regulatory Improvement Act of 1994
(RCDRIA) 758 requires that each Federal
banking agency, in determining the
effective date and administrative
compliance requirements for new
regulations that impose additional
reporting, disclosure, or other
requirements on insured depository
institutions, consider, consistent with
principles of safety and soundness and
the public interest, any administrative
burdens that such regulations would
place on depository institutions,
including small depository institutions,
management having a total value of less than $25
million; (2) did not have total assets of $5 million
or more on the last day of the most recent fiscal
year; and (3) does not control, is not controlled by,
and is not under common control with another
investment adviser that has assets under
management of $25 million or more, or any person
(other than a natural person) that had total assets
of $5 million or more on the last day of its most
recent fiscal year. See 17 CFR 275.0–7.
756 For the purposes of an SEC rulemaking in
connection with the RFA, a broker-dealer will be
deemed a small entity if it: (1) Had total capital (net
worth plus subordinated liabilities) of less than
$500,000 on the date in the prior fiscal year as of
which its audited financial statements were
prepared pursuant to 17 CFR 240.17a–5(d), or, if not
required to file such statements, had total capital
(net worth plus subordinated liabilities) of less than
$500,000 on the last day of the preceding fiscal year
(or in the time that it has been in business, if
shorter); and (2) is not affiliated with any person
(other than a natural person) that is not a small
business or small organization. See 17 CFR 240.0–
10(c). Under the standards adopted by the SBA,
small entities also include entities engaged in
financial investments and related activities with
$38.5 million or less in annual receipts. See 13 CFR
121.201 (Subsector 523).
757 Based on SEC analysis of Form ADV data, the
SEC believes that there are not a substantial number
of registered investment advisers affected by the
proposal that qualify as small entities under RFA.
Based on SEC analysis of broker-dealer FOCUS
filings and NIC relationship data, the SEC believes
that there are no SEC-registered broker-dealers
affected by the proposal that qualify as small
entities under RFA. With respect to security-based
swap dealers and major security-based swap
participants, based on feedback from market
participants and information about the securitybased swap markets, the Commission believes that
the types of entities that would engage in more than
a de minimis amount of dealing activity involving
security-based swaps—which generally would be
large financial institutions—would not be ‘‘small
entities’’ for purposes of the RFA. See Regulation
SBSR—Reporting and Dissemination of SecurityBased Swap Information, 81 FR 53546, 53553 (Aug.
12, 2016).
758 12 U.S.C. 4802(a).
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62037
and customers of depository
institutions, as well as the benefits of
such regulations. The agencies have
considered comment on these matters in
other parts of this SUPPLEMENTARY
INFORMATION.
In addition, under section 302(b) of
the RCDRIA, new regulations that
impose additional reporting,
disclosures, or other new requirements
on insured depository institutions
generally must take effect on the first
day of a calendar quarter that begins on
or after the date on which the
regulations are published in final
form.759 Therefore, the effective date for
the OCC, Board, and FDIC is January 1,
2020, the first day of the calendar
quarter.760
E. OCC Unfunded Mandates Reform Act
Determination
The OCC has analyzed the rule under
the factors set forth in the Unfunded
Mandates Reform Act of 1995 (UMRA)
(2 U.S.C. 1532). Under this analysis, the
OCC considered whether the rule
includes a Federal mandate that may
result in the expenditure by State, local,
and Tribal governments, in the
aggregate, or by the private sector, of
$100 million or more in any one year
(adjusted for inflation). The cost
estimate for the final rule is
approximately $4.1 million in the first
year. Therefore, the OCC finds that the
final rule does not trigger the UMRA
cost threshold. Accordingly, the OCC
has not prepared the written statement
described in section 202 of the UMRA.
F. SEC Economic Analysis
1. Broad Economic Considerations
a. Scope
As discussed above, section 13 of the
Bank Holding Company (BHC) Act
generally prohibits banking entities
from engaging in proprietary trading
and from acquiring or retaining an
ownership interest in, sponsoring, or
having certain relationships with a
hedge fund or private equity fund
(covered funds), subject to certain
exemptions. Section 13(h)(1) of the BHC
Act defines the term ‘‘banking entity’’ to
include (i) any insured depository
institution (as defined by statute), (ii)
any company that controls an insured
depository institution, (iii) any company
that is treated as a bank holding
company for purposes of section 8 of the
759 12
U.S.C. 4802(b).
the Administrative Procedure
Act generally requires that the effective date of a
rule be no less than 30 days after publication in the
Federal Register. 5 U.S.C. 553(d)(1). The effective
date, January 1, 2020, will be more than 30 days
after publication in the Federal Register.
760 Additionally,
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International Banking Act of 1978, and
(iv) any affiliate or subsidiary of such an
entity.761 In addition, as discussed
above, the Economic Growth,
Regulatory Relief, and Consumer
Protection Act (EGRRCPA), enacted on
May 24, 2018, amended section 13 of
the BHC Act to exclude from the
definition of ‘‘insured depository
institution’’ any institution that does not
have and is not controlled by a company
that has (1) more than $10 billion in
total consolidated assets; and (2) total
trading assets and trading liabilities, as
reported on the most recent applicable
regulatory filing filed by the institution,
that are more than 5% of total
consolidated assets.762
Certain SEC-regulated entities, such
as broker-dealers, security-based swap
dealers (SBSDs), and registered
investment advisers (RIAs) affiliated
with a banking entity, fall under the
definition of ‘‘banking entity’’ and are
subject to the prohibitions of section 13
of the BHC Act.763 This economic
analysis is limited to areas within the
scope of the SEC’s function as the
primary securities markets regulator in
the United States. In particular, the
SEC’s economic analysis is focused on
the potential effects of the final rule on
SEC registrants, in their capacity as
such, the functioning and efficiency of
the securities markets, investor
protection, and capital formation. SEC
registrants affected by the final rule
include SEC-registered broker-dealers,
SBSDs, and RIAs. Thus, the below
761 See
12 U.S.C. 1851(h)(1).
and other aspects of the regulatory
baseline against which the SEC is assessing the
economic effects of the final rule on SEC banking
entities are discussed in the economic baseline. On
July 22, 2019, the agencies adopted a final rule
amending the definition of ‘‘insured depository
institution’’ in a manner consistent with EGRRCPA.
763 Throughout this economic analysis, the term
‘‘banking entity’’ generally refers only to banking
entities for which the SEC is the primary financial
regulatory agency unless otherwise noted. While
section 13 of the BHC Act and its associated rules
apply to a broader set of banking entities, this
economic analysis is limited to those banking
entities for which the SEC is the primary financial
regulatory agency as defined in Section 2(12)(B) of
the Dodd-Frank Act. See 12 U.S.C. 1851(b)(2); 12
U.S.C. 5301(12)(B).
Compliance with SBSD registration requirements
is not yet required and there are currently no
registered SBSDs. However, the SEC has previously
estimated that as many as 50 entities may
potentially register as SBSDs and that as many as
16 of these entities may already be SEC-registered
broker-dealers. See Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and
Major Security-Based Swap Participants and Capital
and Segregation Requirements for Broker-Dealers,
Exchange Act Release No. 86175 (June 21, 2019), 84
FR at 43872 (Aug. 22, 2019), (henceforth ‘‘Capital,
Margin, and Segregation Adopting Release’’).
For the purposes of this economic analysis, the
term ‘‘dealer’’ generally refers to SEC-registered
broker-dealers and SBSDs.
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762 These
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analysis does not consider brokerdealers, SBSDs, and investment advisers
that are not banking entities, or banking
entities that are not SEC registrants, in
either case for purposes of section 13 of
the BHC Act, beyond the potential
spillover effects on these entities and
effects on efficiency, competition,
investor protection, and capital
formation in securities markets. Other
sections of this SUPPLEMENTARY
INFORMATION discuss the effects of the
final rule on banking entities not
overseen by the SEC for purposes of
section 13 of the BHC Act.
In the proposal, the SEC solicited
comment on all aspects of the costs and
benefits associated with the proposed
amendments for SEC registrants,
including any spillover effects the
proposed amendments may have on
efficiency, competition, and capital
formation in securities markets. The
SEC has considered these comments, as
discussed in greater detail in the
sections that follow.
b. Economic Effects and Justification
As stated in the proposal, in
implementing section 13 of the BHC
Act, the agencies sought to increase the
safety and soundness of banking
entities, promote financial stability, and
reduce conflicts of interest between
banking entities and their customers.
In the proposal, the SEC recognized a
number of effects of the 2013 rule.764
The SEC continues to recognize that
distinguishing between permissible and
prohibited activities may be complex
and costly for some firms,765 which may
impede the conduct of permissible
activities.766 The SEC continues to
believe that the 2013 rule may have
resulted in a complex and costly
compliance regime that is unduly
restrictive and burdensome for some
banking entities, particularly smaller
firms that do not qualify for the
simplified compliance regime.767 Since
the 2013 rule became effective, new
estimates regarding compliance burdens
and new information about the various
effects of the 2013 rule have become
available.768 The passage of time has
also enabled an assessment of the value
of individual requirements that enable
SEC oversight, such as the requirement
to report certain quantitative metrics,
relative to reporting and other
compliance burdens.769
764 See
83 FR at 33520–33552.
e.g., 83 FR at 33521.
766 See, e.g., 83 FR at 33532.
767 Id.
768 See, e.g., 83 FR at 33522.
769 Id.
765 See,
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Fmt 4701
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As discussed below, a number of
commenters have indicated that the
proposed amendments would have
altered the scope of permissible
activities and compliance requirements
of the 2013 rule in a way that
significantly affects the economic costs
and benefits of the 2013 rule. In
addition, commenters offered a variety
of views on the baseline economic
effects, which include section 13 of the
BHC Act, the 2013 rule, sections 203
and 204 of EGRRCPA and conforming
amendments, and current practices of
banking entities aimed at compliance
with these regulations.770 As part of the
proposal’s economic baseline, the SEC
discussed the effects of the agencies’
2013 rule.771 The economic baseline
section below discusses these effects in
greater detail.
The final rule includes amendments
that impact the scope of permitted
activities for all or a subset of banking
entities (e.g., trading account definition,
underwriting and market making, and
trading and investing activities by
foreign banking entities), and
amendments that simplify, tailor, or
eliminate the application of certain
aspects of the 2013 rule intended to
reduce compliance and reporting
burdens while preserving and, in some
cases, enhancing the effectiveness of the
2013 rule. Many of the final
amendments seek to provide greater
clarity and certainty about which
activities are permitted under the 2013
rule, which may increase the ability and
willingness of banking entities to engage
in permitted activities, and to promote
the effective allocation of compliance
resources.
Broadly, the SEC believes that a
greater ability and willingness to engage
in permitted activities would benefit the
parties to those transactions and capital
markets as a whole. Reduced
compliance costs may translate into
increased willingness of banking
entities to engage in activities that
facilitate risk-sharing and capital
formation, such as underwriting
securities and making markets.
Accordingly, the rule may also benefit
clients, customers, and counterparties in
the form of an increased ability to
transact with banking entities.
The SEC continues to recognize that
some of these changes may also, in
certain circumstances, increase
activities involving risk exposure or
increase the incidence of conflicts of
interest among some market
participants. The returns and risks from
770 See, e.g., Occupy the SEC; Better Markets;
SIFMA and Center for American Entrepreneurship.
771 See 83 FR at 33520–33521.
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the activities of banking entities may
flow through to their investors. In
general, to the extent that the final rule
increases or decreases the scope of
permissible activities, the final rule may
dampen or magnify some of the
economic tensions inherent in this
rulemaking. As discussed above, various
aspects of the final rule are designed to
ensure that the prudential objectives of
the rule are not diminished. Moreover,
amendments adopted as part of the final
rule that redefine the scope of entities
subject to certain provisions of the 2013
rule may have an effect on competition,
allocative efficiency, and capital
formation. Where the final rule reduces
burdens on some groups of market
participants (e.g., on banking entities
without significant trading assets and
liabilities and certain foreign banking
entities), the final rule is expected to
increase competition and trading
activity in related market segments.
Other amendments to the 2013 rule
reduce compliance program, reporting,
and documentation requirements for
some banking entities. The SEC believes
that these amendments may reduce the
compliance burdens of SEC-regulated
banking entities, which may enhance
competition, trading activity, and
capital formation. The SEC recognizes
that these amendments may alter the
mix of tools available for regulatory
oversight and supervision. However, the
SEC believes that the final rule as a
whole is unlikely to reduce the efficacy
of the agencies’ regulatory oversight.772
Further, under the final rule, banking
entities (other than banking entities
with limited trading assets and
liabilities for which the presumption of
compliance has not been rebutted) are
still required to develop and provide for
the continued administration of a
compliance program that is reasonably
designed to ensure and monitor
compliance with the prohibitions and
restrictions set forth in section 13 of the
BHC Act. Finally, the final rule does not
change the scope of entities subject to
the statutory obligations and
prohibitions of section 13 of the BHC
Act.
c. Analytical Approach
The SEC’s economic analysis is
informed by research on the effects of
section 13 of the BHC Act and the 2013
rule and on related incentives conflicts,
by comments received by the agencies
from a variety of interested parties, and
by the agencies’ experience
administering the 2013 rule since its
adoption. Throughout this economic
analysis, the SEC discusses how
772 See,
e.g., sections IV.B.2 and IV.D.1.
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different market participants may
respond to various aspects of the final
rule and considers the potential effects
of the final rule on activities by banking
entities that involve risk, on their
willingness and ability to engage in
client-facilitation activities, and on
competition, market quality, and capital
formation, as informed, among other
things, by research and comment letters.
The SEC’s analysis also recognizes that
the overall risk exposure of banking
entities may arise out of a combination
of activities, including proprietary
trading, market making, and traditional
banking, as well as the volume and
structure of hedging and other riskmitigating activities. As discussed
further below, the SEC recognizes the
complex baseline effects of section 13 of
the BHC Act, as amended by sections
203 and 204 of EGRRCPA, and
implementing rules, on overall levels
and structure of banking entity risk
exposures.
The SEC also considered the investor
protection implications of the final rule.
Broadly, the SEC notes that market
liquidity can be important to investors
as it may enable investors to exit (in a
timely manner and at an acceptable
price) from their positions in
instruments, products, and portfolios.
At the same time, excessive risk
exposures of banking entities can
adversely affect markets and, therefore,
investors.
The final rule tailors, removes, or
alters the scope of various requirements
in the 2013 rule and adds certain new
requirements. Since section 13 of the
BHC Act and the 2013 rule combined a
number of different requirements, and,
as discussed above, the type and level
of risk exposure of a banking entity is
the result of a combination of
activities,773 it is difficult to attribute
the observed effects to a specific
provision or set of requirements. In
addition, analysis of the effects of the
implementation of the 2013 rule is
confounded by macroeconomic factors,
other policy interventions, and postcrisis changes to market participants’
risk aversion and return expectations.
Because of the extended timeline of
implementation of section 13 of the
BHC Act and the overlap of the 2013
rule period with other post-crisis
changes affecting the same group or
certain sub-groups of SEC registrants,
the SEC cannot rely on typical
quantitative methods that might
otherwise enable causal attribution and
quantification of the effects of section 13
of the BHC Act and the 2013 rule on
measures of capital formation, liquidity,
773 See,
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62039
competition, and informational or
allocative efficiency. Moreover,
empirical measures of capital formation
or liquidity do not reflect issuance and
transaction activity that does not occur
as a result of the 2013 rule. Accordingly,
it is difficult to quantify the primary
issuance and secondary market liquidity
that would have been observed
following the financial crisis absent
various provisions of Section 13 of the
BHC Act and the 2013 final rule.
Importantly, the existing securities
markets—including market participants,
their business models, market structure,
etc.—differ in significant ways from the
securities markets that existed prior to
enactment of Section 13 of the BHC Act
and the implementation of the 2013
rule. For example, the role of dealers in
intermediating trading activity has
changed in important ways, including
the following: In recent years, on both
an absolute and relative basis bankdealers generally committed less capital
to intermediation activities while
nonbanking dealers generally
committed more; the volume and
profitability of certain trading activities
after the financial crisis may have
decreased for bank-dealers while it may
have increased for other intermediaries,
including nonbanking entities that
provide intraday liquidity using
sophisticated electronic trading
algorithms and high speed access to
data and trading venues; and the
introduction of alternative credit
markets may have contributed to
liquidity fragmentation across markets
while potentially increasing access to
capital.774
Where possible, this analysis attempts
to quantify the costs and benefits
expected to result from the final rule. In
many cases, however, the SEC is unable
to quantify these potential economic
effects. Some of the primary economic
effects, such as the effect on incentives
that may give rise to conflicts of interest
in various regulated entities and the
efficacy of regulatory oversight under
various compliance regimes, are
inherently difficult to quantify.
Moreover, some of the benefits of the
2013 rule’s prohibitions that are being
amended here, such as potential
benefits for resilience during a crisis, are
less readily observable under strong
economic conditions and cannot be
isolated from the effects of other postcrisis regulatory efforts intended to
enhance resilience. Lastly, because of
overlapping implementation periods of
various post-crisis regulations affecting
774 See Sec. & Exch. Comm’n, Access To Capital
And Market Liquidity, (2017) [hereinafter SEC
Report 2017].
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the same group or certain sub-groups of
SEC registrants, the long
implementation timeline of the 2013
rule, and the fact that many market
participants changed their behavior in
anticipation of future changes in
regulation, it is difficult to quantify the
net economic effects of individual
amendments to the 2013 rule adopted
here.
In some instances, the SEC lacks the
information or data necessary to provide
reasonable estimates for the economic
effects of the final rule. For example, the
SEC lacks information and data, and
commenters have not provided such
information or data, to allow a
quantification of (1) the volume of
trading activity that does not occur
because of uncertainty about how to
demonstrate that underwriting or
market making activities satisfy the
reasonably expected near-term demand
(RENTD) requirement; (2) the extent to
which internal limits may capture
expected customer demand; (3) how
accurately correlation analysis reflects
underlying exposures of banking
entities with, and without, significant
trading assets and liabilities in normal
times and in times of market stress; (4)
the feasibility and costs of
reorganization that may enable some
U.S. banking entities to become foreign
banking entities for the purposes of
relying on the foreign trading
exemption; and (5) the extent of the
overall risk reduction (if any) caused by
the 2013 rule. Where the SEC cannot
quantify the relevant economic effects,
the SEC discusses them in qualitative
terms.
2. Baseline
The baseline against which the SEC is
assessing the economic effects of the
final rule includes the legal and
regulatory framework as it exists at the
time of this release and current practices
aimed at compliance with these
regulations.
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a. Regulation
The regulatory baseline includes
section 13 of the BHC Act, as amended
by EGRRCPA, and the 2013 rule, as
amended by the agencies’ amendments
conforming to EGRRCPA. Further, the
baseline accounts for the fact that since
the adoption of the 2013 rule, the staffs
of the agencies have provided FAQ
responses to questions about the 2013
rule.775 In addition, the federal banking
agencies released a 2019 policy
775 See
https://www.sec.gov/divisions/marketreg/
faq-volcker-rule-section13.htm, originally published
on June 10, 2014, and most recently updated on
March 4, 2016.
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statement with respect to foreign
excluded funds.776
The subsections below discuss in
greater detail the legal and regulatory
baseline applicable to entities that are
registered with the SEC and that the
SEC oversees for purposes of section 13
of the BHC Act. In particular, the SEC
discusses the exemptions for
permissible underwriting and market
making-related activities, risk-mitigating
hedging, and foreign trading;
requirements and exemptions related to
covered funds; compliance and metrics
reporting requirements; and sections of
EGRRCPA and conforming amendments
that exempt certain banking entities
from section 13 of the BHC Act and the
2013 rule.
i. The 2013 Rule
(1) Definition of the Trading Account
The scope of prohibited proprietary
trading activity is determined by the
definition of ‘‘trading account’’ and
related exclusions.777 As discussed in
detail in section IV.B.1.a, the 2013 rule’s
definition of trading account includes
three prongs: The short-term intent
prong, the market risk capital rule
prong, and the dealer prong. In addition,
the 2013 rule includes a rebuttable
presumption, under which a purchase
(or sale) of a financial instrument is
presumed to be for the trading account
under the short-term intent prong if the
banking entity holds the financial
instrument for fewer than 60 days or
substantially transfers the risk of the
financial instrument within 60 days of
the purchase (or sale).
The 2013 rule provides several
exclusions from the definition of
proprietary trading in section
§ ll.3(d). In particular, under certain
conditions, the 2013 rule excludes from
the definition of proprietary trading any
purchases or sales that arise under a
repurchase or reverse repurchase
agreement or under a transaction in
which the banking entity lends or
borrows a security temporarily, any
purchase or sale of a security for the
purpose of liquidity management in
accordance with a documented liquidity
management plan,778 any purchase or
776 See Statement regarding Treatment of Certain
Foreign Funds under the Rules Implementing
Section 13 of the Bank Holding Company Act (July
17, 2019), available at https://
www.federalreserve.gov/newsevents/pressreleases/
files/bcreg20190717a1.pdf. This policy statement
continued the position of the Federal banking
agencies that was released on July 21, 2017, and the
position that the agencies expressed in the
proposal. See 83 FR 33444.
777 This aspect of the baseline is discussed in
section V.F.3.b.
778 This aspect of the baseline is discussed in
section IV.B.1.b.i.
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sale by a banking entity that is a
derivatives clearing organization or a
clearing agency in connection with
clearing financial instruments, any
excluded clearing activities, any
purchase or sale that satisfies an
existing delivery obligation or an
obligation in connection with a judicial,
administrative, self-regulatory
organization, or arbitration proceeding,
any purchase or sale by a banking entity
that is acting solely as agent, broker, or
custodian, any purchase or sale through
a deferred compensation, stock-bonus,
profit-sharing, or pension plan, and any
purchase or sale in the ordinary course
of collecting a debt previously
contracted in good faith.
In addition, section § ll.3(e)(13) of
the 2013 rule defines ‘‘trading desk’’ as
the smallest discrete unit of
organization of a banking entity that
purchases or sells financial instruments
for the trading account of the banking
entity or an affiliate thereof, and applies
certain requirements at the ‘‘trading
desk’’-level of organization.779
(2) Exemption for Underwriting and
Market Making-Related Activity
Section 13(d)(1)(B) of the BHC Act
contains an exemption from the
prohibition on proprietary trading for
underwriting and market making-related
activities. Under the 2013 rule, all
banking entities with covered activities
must satisfy several requirements with
respect to their underwriting activities
to qualify for the exemption for
underwriting activities, discussed in
detail in section IV.B.2.a above.780 In
addition, under the current baseline, all
banking entities with covered activities
must satisfy six requirements with
respect to their market making-related
activities to qualify for the exemption
for market making-related activities, as
discussed in section IV.B.2.a.781
The SEC also notes that, under the
baseline, an organizational unit or a
trading desk of another banking entity
that has consolidated trading assets and
liabilities of $50 billion or more is
generally not considered a client,
customer, or counterparty for the
purposes of the RENTD requirement.782
Thus, such demand does not contribute
to RENTD unless such demand is
affected through an anonymous trading
facility or unless the trading desk
documents how and why the
organizational unit of said large banking
entity should be treated as a client,
779 See 2013 rule §§ ll.4, ll.5, App. A., App.
B; final rule §§ ll.4, ll.5, App. A.
780 See 2013 rule § ll.4 (a).
781 See 2013 rule § ll.4 (b).
782 See 2013 rule § ll.4 (b)(3)(i).
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customer, or counterparty. To the extent
that such documentation requirements
increase the cost of intermediating
interdealer transactions, this
requirement may affect the volume and
cost of interdealer trading.
(3) Exemption for Risk-Mitigating
Hedging
Under the baseline, certain riskmitigating hedging activities may be
exempt from the restriction on
proprietary trading under the riskmitigating hedging exemption. To make
use of this exemption, the 2013 rule
requires all banking entities to comply
with a comprehensive and multi-faceted
set of requirements, including (1) the
establishment, implementation, and
maintenance of an internal compliance
program; (2) satisfaction of various
criteria for hedging activities; and (3)
the existence of compensation
arrangements for persons performing
risk-mitigating hedging activities that
are designed not to reward or
incentivize prohibited proprietary
trading. In addition, certain activities
under the exemption for risk-mitigating
hedging are subject to documentation
requirements.783
Specifically, the 2013 rule requires
that a banking entity seeking to rely on
the exemption for risk-mitigating
hedging must establish, implement,
maintain, and enforce an internal
compliance program that includes
reasonably designed written policies
and procedures regarding the positions,
techniques, and strategies that may be
used for hedging, including
documentation indicating what
positions, contracts, or other holdings a
particular trading desk may use in its
risk-mitigating hedging activities, as
well as position and aging limits with
respect to such positions, contracts, or
other holdings. The compliance
program must also provide for internal
controls and ongoing monitoring,
management, and authorization
procedures, including relevant
escalation procedures. In addition, the
2013 rule requires that all banking
entities, as part of their compliance
program, must conduct analysis,
including correlation analysis, and
independent testing designed to ensure
that the positions, techniques, and
strategies that may be used for hedging
are designed to reduce or otherwise
significantly mitigate and demonstrably
reduce or otherwise significantly
mitigate the specific, identifiable risk(s)
being hedged.
The 2013 rule does not require a
banking entity to prove correlation
783 See
2013 rule § ll.5.
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mathematically—rather, the nature and
extent of the correlation analysis should
be dependent on the facts and
circumstances of the hedge and the
underlying risks targeted. Moreover, if
correlation cannot be demonstrated, the
analysis needs to state the reason and
explain how the proposed hedging
position, technique, or strategy is
designed to reduce or significantly
mitigate risk and how that reduction or
mitigation can be demonstrated without
correlation.784 In the proposal, the SEC
referenced market participants’ estimate
that the inability to perform correlation
analysis, for instance, for non-trading
assets such as mortgage servicing assets,
can add as much as 2% of the asset
value to the cost of hedging.785
To qualify for the exemption for riskmitigating hedging, the hedging activity,
both at inception and at the time of any
adjustment to the hedging activity, must
be designed to reduce or otherwise
significantly mitigate and demonstrably
reduce or significantly mitigate one or
more specific identifiable risks.786
Hedging activities also must not give
rise, at the inception of the hedge, to
any significant new or additional risk
that is not itself hedged
contemporaneously. Additionally, the
hedging activity must be subject to
continuing review, monitoring, and
management by the banking entity,
including ongoing recalibration of the
hedging activity to ensure that the
hedging activity satisfies the
requirements for the exemption and
does not constitute prohibited
proprietary trading.
Finally, the 2013 rule requires
banking entities to document and retain
information related to the purchase or
sale of hedging instruments that are
either (1) established by a trading desk
that is different from the trading desk
establishing or responsible for the risks
being hedged; (2) established by the
specific trading desk establishing or
responsible for the risks being hedged
but that are effected through means not
specifically identified in the trading
desk’s written policies and procedures;
or (3) established to hedge aggregate
positions across two or more trading
784 See
79 FR 5631.
83 FR at 33534 citing to note 18 regarding
Notice Seeking Public Input on the Volcker Rule
(August 2017), available at https://www.occ.gov/
news-issuances/news-releases/2017/nr-occ-201789a.pdf. Corresponding comment letters are
available at https://www.regulations.gov/docket
Browser?rpp=25&so=DESC&sb=comment
DueDate&po=0&dct=PS&D=OCC-2017-0014. Letter
from BOK Financial can be accessed directly at
https://www.regulations.gov/document?D=OCC2017-0014-0016.
786 See 2013 rule § ll.5(b)(2)(ii).
785 See
PO 00000
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62041
desks. 787 The documentation must
include the specific identifiable risks
being hedged, the specific riskmitigating strategy that is being
implemented, and the trading desk that
is establishing and responsible for the
hedge. These records must be retained
for a period of not less than 5 years in
a form that allows them to be promptly
produced if requested.788
(4) Exemption for Foreign Trading
Under the 2013 rule, a foreign
banking entity that has a branch,
agency, or subsidiary located in the
United States (and is not itself located
in the United States) is subject to the
proprietary trading prohibitions and
related compliance requirements unless
the transaction meets five criteria.789
First, a branch, agency, or subsidiary of
a foreign banking organization that is
located in the United States or
organized under the laws of the United
States or of any state may not engage as
principal in the purchase or sale of
financial instruments (including any
personnel that arrange, negotiate, or
execute a purchase or sale). Second, the
banking entity (including relevant
personnel) that makes the decision to
engage in the transaction must not be
located in the United States or
organized under the laws of the United
States or of any state. Third, the
transaction, including any transaction
arising from risk-mitigating hedging
related to the transaction, must not be
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any state. Fourth,
no financing for the transaction can be
provided by any branch or affiliate of a
foreign banking entity that is located in
the United States or organized under the
laws of the United States or of any state
(the financing prong). Fifth, the
transaction must generally not be
conducted with or through any U.S.
entity (the counterparty prong), unless
(1) no personnel of a U.S. entity that are
located in the United States are
involved in the arrangement,
negotiation, or execution of such
transaction; (2) the transaction is with
an unaffiliated U.S. market intermediary
acting as principal and is promptly
cleared and settled through a central
counterparty; or (3) the transaction is
executed through an unaffiliated U.S.
market intermediary acting as agent,
conducted anonymously through an
2013 rule § ll.5(c)(1).
2013 rule § ll.5(c)(3). See also 2013 rule
§ ll.20(b)(6).
789 See 2013 rule § ll.6(e).
787 See
788 See
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exchange or similar trading facility, and
is promptly cleared and settled through
a central counterparty.790
(5) Covered Funds
The 2013 rule generally defines
covered funds as issuers that would be
investment companies but for section
3(c)(1) or 3(c)(7) of the Investment
Company Act of 1940 and then excludes
specific types of entities from the
definition. As described above, the 2013
rule provides for market making and
hedging exemptions to the prohibition
on proprietary trading. However, the
2013 rule places additional restrictions
on the amount of underwriting, market
making, and hedging a banking entity
can engage in when those transactions
involve covered funds. For underwriting
and market making transactions in
covered funds, if the banking entity
sponsors or advises a covered fund, or
acts in any of the other capacities
specified in § ll.11(c)(2) of the 2013
rule, then any ownership interests
acquired or retained by the banking
entity and its affiliates in connection
with underwriting and market makingrelated activities for that particular
covered fund must be included in the
per-fund and aggregate covered fund
investment limits in § ll.12 of the
2013 rule and is subject to the capital
deduction provided in § ll.12(d) of
the 2013 rule.791 Additionally, a
banking entity’s aggregate investment in
all covered funds is limited to 3% of a
banking entity’s tier 1 capital, and
banking entities must include all
ownership interests in covered funds
acquired or retained in connection with
underwriting and market making-related
activities for purposes of this
calculation.792 Moreover, under the
2013 rule, the exemption for riskmitigating hedging activities related to
covered funds is available only for
transactions that mitigate risks
associated with the compensation of a
banking entity employee or an affiliate
that provides advisory or other services
to the covered fund.793
Under the 2013 rule, foreign banking
entities can acquire or retain an
ownership interest in, or act as sponsor
to, a covered fund, so long as those
activities and investments occur solely
outside of the United States, no
ownership interest in such fund is
offered for sale or sold to a resident of
the United States (the marketing
restriction), and certain other conditions
2013 rule § ll.6(e)(3).
2013 rule § ll.12(a)(2)(ii); see also
§ ll.11(c)(2).
792 See 2013 rule § ll.12(a)(2)(iii); see also
§ ll.11(c)(3).
793 See 2013 rule § ll.13(a).
790 See
791 See
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are met. Under the 2013 rule, an activity
or investment occurs solely outside of
the United States if (1) the banking
entity is not itself, and is not controlled
directly or indirectly by, a banking
entity that is located in the United
States or established under the laws of
the United States or of any state; (2) the
banking entity (and relevant personnel)
that makes the decision to acquire or
retain the ownership interest or act as
sponsor to the covered fund is not
located in the United States or
organized under the laws of the United
States or of any state; (3) the investment
or sponsorship, including any riskmitigating hedging transaction related to
an ownership interest, is not accounted
for as principal by any U.S. branch or
affiliate; and (4) no financing is
provided, directly or indirectly, by any
U.S. branch or affiliate. In addition, the
staffs of the agencies have issued FAQs
concerning the requirement that no
ownership interest in such fund is
offered for sale or sold to a resident of
the United States.794
(6) Compliance Program
For compliance purposes, the 2013
rule differentiates banking entities on
the basis of certain thresholds,
including the amount of the banking
entity’s consolidated trading assets and
liabilities and total consolidated assets.
More specifically, U.S. banking entities
that have, together with affiliates and
subsidiaries, trading assets and
liabilities (excluding trading assets and
liabilities involving obligations of or
guaranteed by the United States or any
agency of the United States) the average
gross sum of which—on a worldwide
consolidated basis, over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters—equals $10
billion or more are subject to reporting
requirements of Appendix A under the
2013 rule. Banking entities that have
$50 billion or more in total consolidated
assets as of the previous calendar year
end and banking entities with over $10
billion in consolidated trading assets
and liabilities are subject to the
requirement to adopt an enhanced
compliance program pursuant to
Appendix B of the 2013 rule.
Additionally, banking entities that
engage in covered activities and that
have total consolidated assets of $10
billion or less as reported on December
31 of the previous 2 calendar years
794 See Responses to Frequently Asked Questions
Regarding the Commission’s Rule under Section 13
of the Bank Holding Company Act, June 10, 2014,
updated March 4, 2016, available at https://
www.sec.gov/divisions/marketreg/faq-volcker-rulesection13.htm.
PO 00000
Frm 00070
Fmt 4701
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qualify for the simplified compliance
regime.
The 2013 rule emphasized the
importance of a strong compliance
program and sought to tailor the
compliance program to the size of
banking entities and the size of their
trading activity. As noted in the
preamble to the 2013 rule, the agencies
believed it was necessary to balance
compliance burdens posed on smaller
banking entities with specificity and
rigor necessary for large and complex
banking organizations facing high
compliance risks. As a result, the
compliance regime under the 2013 rule
is progressively more stringent with the
size of covered activities and/or balance
sheet of banking entities.
Under the 2013 rule, all banking
entities with covered activities must
develop and maintain a compliance
program that is reasonably designed to
ensure and monitor compliance with
section 13 of the BHC Act and the
implementing regulations. The terms,
scope, and detail of the compliance
program depend on the types, size,
scope, and complexity of activities and
business structure of the banking
entity.795
Under the 2013 rule, banking entities
that qualify for the simplified
compliance program (banking entities
that have total consolidated assets of
less than $10 billion) are able to
incorporate compliance with the 2013
rule into their regular compliance
policies and procedures by reference,
adjusting as appropriate given the
entities’ activities, size, scope, and
complexity.796
All other banking entities with
covered activities are, at a minimum,
required to implement a six-pillar
compliance program. The six pillars
include (1) written policies and
procedures reasonably designed to
document, describe, monitor and limit
proprietary trading and covered fund
activities and investments for
compliance; (2) a system of internal
controls reasonably designed to monitor
compliance; (3) a management
framework that clearly delineates
responsibility and accountability for
compliance, including management
review of trading limits, strategies,
hedging activities, investments, and
incentive compensation; (4)
independent testing and audit of the
effectiveness of the compliance
program; (5) training for personnel to
2013 rule § ll.20(a).
2013 rule § ll.20(f). Note that if an
entity does not have any covered activities, it is not
required to establish a compliance program until it
begins to engage in covered activity.
795 See
796 See
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effectively implement and enforce the
compliance program; and (6)
recordkeeping sufficient to demonstrate
compliance.797
In addition, under the 2013 rule,
banking entities with covered activities
that do not qualify as those with modest
activity (banking entities that have total
consolidated assets in excess of $10
billion) and that are either subject to the
reporting requirements of Appendix A
or have more than $50 billion in total
consolidated total assets as of the
previous calendar year end are required
to comply with the enhanced minimum
standards for compliance as specified in
Appendix B of the 2013 rule.798
Appendix B requires the compliance
program of the banking entities that are
subject to it to (1) be reasonably
designed to supervise the permitted
trading and covered fund activities and
investments, identify and monitor the
risks of those activities and potential
areas of noncompliance, and prevent
prohibited activities and investments;
(2) establish and enforce appropriate
limits on the covered activities and
investments, including limits on the
size, scope, complexity, and risks of the
individual activities or investments
consistent with the requirements of
section 13 of the BHC Act and the 2013
rule; (3) subject the compliance program
to periodic independent review and
testing and ensure the entity’s internal
audit, compliance, and internal control
functions are effective and independent;
(4) make senior management and others
accountable for the effective
implementation of the compliance
program, and ensure that the chief
executive officer and board of directors
review the program; and (5) facilitate
supervision and examination by the
agencies.
Additionally, under the 2013 rule,
any banking entity that has more than
$10 billion in total consolidated assets
as reported in the previous 2 calendar
years is required to maintain additional
records related to covered funds. In
particular, a banking entity must
document the exclusions or exemptions
relied on by each fund sponsored by the
banking entity (including all
subsidiaries and affiliates) in
determining that such fund is not a
covered fund, including documentation
that supports such determination; for
each seeding vehicle that will become a
registered investment company or SECregulated business development
company, a written plan documenting
the banking entity’s determination that
the seeding vehicle will become a
797 See
798 See
2013 rule § ll.20(b).
2013 rule § ll.20(c) and Appendix B.
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registered investment company or SECregulated business development
company, the period of time during
which the vehicle will operate as a
seeding vehicle, and the banking
entity’s plan to market the vehicle to
third-party investors and convert it into
a registered investment company or
SEC-regulated business development
company within the time period
specified.799
(7) Metrics
Under Appendix A of the 2013 rule,
banking entities with trading assets and
liabilities (excluding trading assets and
liabilities involving obligations of or
guaranteed by the United States or any
agency of the United States) the average
gross sum of which—on a worldwide
consolidated basis, over the four
previous quarters, as measured by the
last day of each of the four prior
calendar quarters—equals or exceeds
$10 billion to meet requirements
concerning recording and reporting
certain measurements for each trading
desk engaged in covered trading
activity.800 Banking entities subject to
Appendix A are required to record and
report the following quantitative
measurements for each trading day and
for each trading desk engaged in
covered trading activities: (i) Risk and
Position Limits and Usage; (ii) Risk
Factor Sensitivities; (iii) Value-at-Risk
and Stress Value-at-Risk; (iv)
Comprehensive Profit and Loss
Attribution; (v) Inventory Turnover; (vi)
Inventory Aging; and (vii) CustomerFacing Trade Ratio.
The metrics reporting requirements
are intended to assist banking entities,
the SEC, and other regulators in
achieving the following: A better
understanding of the scope, type, and
profile of covered trading activities;
identification of covered trading
activities that warrant further review or
examination by the banking entity to
verify compliance with the rule’s
proprietary trading restrictions;
evaluation of whether the covered
trading activities of trading desks
engaged in permitted activities are
consistent with the provisions of the
permitted activity exemptions;
evaluation of whether the covered
trading activities of trading desks that
are engaged in permitted trading
activities (i.e., underwriting and market
making-related activity, risk-mitigating
hedging, or trading in certain
government obligations) are consistent
with the requirement that such activity
not result, directly or indirectly, in a
799 See
800 See
PO 00000
2013 rule § ll.20(e).
2013 rule § ll.20(d) and Appendix A.
Frm 00071
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62043
material exposure to high-risk assets or
high-risk trading strategies;
identification of the profile of particular
covered trading activities of the banking
entity, and its individual trading desks,
to help establish the appropriate
frequency and scope of the SEC’s
examinations of such activity; and the
assessment and addressing of the risks
associated with the banking entity’s
covered trading activities.801
Under the 2013 rule, banking entities
with significant trading assets and
liabilities (Group A entities) and with
moderate trading assets and liabilities
(Group B entities) that have less than
$50 billion in consolidated trading
assets and liabilities are required to
report metrics for each quarter within 30
days of the end of that quarter. In
contrast, Group A and Group B banking
entities with total trading assets and
liabilities equal to or above $50 billion
are required to report metrics more
frequently—each month within 10 days
of the end of that month.802
ii. EGRRCPA and Conforming
Amendments
In accordance with section 203 of
EGRRCPA,803 the agencies amended the
definition of ‘‘insured depository
institution’’ in § ll.2(r) of the 2013
rule to exclude an institution if it, and
every entity that controls it, has both (1)
$10 billion or less in total consolidated
assets and (2) total consolidated trading
assets and liabilities that are 5% or less
of its total consolidated assets. The
agencies also amended the 2013 rule to
reflect the changes made by section 204
of EGRRCPA. That provision modified
section 13 of the BHC Act to permit, in
certain circumstances, bank-affiliated
investment advisers to share their name
with the hedge funds or private equity
funds they organize and offer.
As discussed elsewhere,804 certain
SEC-regulated entities, such as dealers
and RIAs, fell under the definition of
‘‘banking entity’’ for the purposes of
section 13 of the BHC Act before the
enactment of EGRRCPA and qualified
for the final amendments implementing
2013 rule § ll.20 and Appendix A.
2013 rule § ll.20(d)(3).
803 Specifically, section 203 of EGRRCPA
provides that the term ‘‘insured depository
institution,’’ for purposes of the definition of
‘‘banking entity’’ in section 13(h)(1) of the BHC Act
(12 U.S.C. 1851(h)(1)), does not include an insured
depository institution that does not have, and is not
controlled by a company that has (1) more than $10
billion in total consolidated assets; and (2) total
trading assets and trading liabilities, as reported on
the most recent applicable regulatory filing filed by
the institution, that are more than 5% of total
consolidated assets.
804 See EGRRCPA Conforming Amendments
Adopting Release, 84 FR at 35008.
801 See
802 See
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sections 203 and 204 of EGRRCPA.805
Therefore, the economic baseline
against which the SEC is assessing the
final rule incorporates the economic
effects of sections 203 and 204 of
EGRRCPA, as analyzed in the agencies’
release adopting the conforming
amendments.806
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b. Response to Commenters Regarding
Economic Baseline and Effects of
Section 13 of the BHC Act and the 2013
Rule
In the proposal, the SEC described the
baseline effects of the 2013 rule 807 and
recognized that amendments that
increase or decrease the scope of
permissible activities may magnify or
attenuate the baseline economic effects
of the 2013 rule.808 The SEC also noted
that amendments that decrease (or
increase) compliance program and
reporting obligations could alter the
economic effects toward (or away from)
competition, trading activity, and
capital formation on the one hand, and
against (or in favor of) regulatory and
internal oversight on the other.
However, the SEC noted that the
proposed amendments may enhance
trading liquidity and capital formation
and that some of the proposed changes
need not reduce the efficacy of the
regulation or the agencies’ regulatory
oversight.809
A number of commenters, however,
have indicated that the proposed
amendments would have changed the
scope of permissible activities and the
compliance regime in the 2013 rule in
a manner that significantly alters the
costs and benefits of that rule and
offered a variety of assessments of the
baseline economic effects of section 13
of the BHC Act and the 2013 rule.810 In
response to those comments, this
section expands the discussion of the
baseline and supplements the analysis
in the proposal with a discussion of the
comments received by the agencies and,
in response to comments, recent
research on that topic. In the 2013 rule,
the agencies sought to increase the
805 The SEC continues to believe that all bankaffiliated entities that may register with the SEC as
security-based swap dealers and major securitybased swap participants were unaffected by section
203 of EGRRCPA or the conforming amendments
because of the size of their balance sheets and the
amount of trading activity of their affiliated banking
entities. The SEC’s analysis was based on DTCC
Derivatives Repository Limited Trade Information
Warehouse (TIW) data on single-name creditdefault swaps.
806 See EGRRCPA Conforming Amendments
Adopting Release, 84 FR at 35008.
807 See 83 FR at 33520–33521.
808 See 83 FR at 33521.
809 Id.
810 See, e.g., Occupy the SEC, Better Markets,
SIFMA, Center for American Entrepreneurship.
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safety and soundness of banking entities
and to promote financial stability,811
and to reduce conflicts of interest
between banking entities and their
customers, clients, and
counterparties,812 while preserving the
provision of valuable client-oriented
services 813 and mitigating unnecessary
compliance burdens and related
competitive effects.814 Accordingly, the
sections that follow address the SEC’s
understanding of the baseline effects of
section 13 of the BHC Act and the 2013
rule on (a) risk exposures, (b) conflicts
of interest between banking entities and
their customers and counterparties, (c)
client-oriented financial services and
market quality, and (d) compliance
burdens and competition.
The SEC’s analysis of these various
effects reflects comments received,
academic research, and the SEC’s
experience overseeing registered entities
for purposes of section 13 of the BHC
Act. Importantly, research studies cited
below are limited to their specific
settings and are subject to various
methodological and measurement
limitations, as discussed in the sections
that follow. Moreover, as described
below, some studies empirically
examine the relevant effects around the
implementation of the 2013 rule, while
others focus on the anticipatory
response of market participants around
the enactment of section 13 of the BHC
Act and prior to the effective date of the
2013 rule. As a result, the SEC
recognizes that these findings may have
limited generalizability and may or may
not extend to various groups of SEC
registrants.
As discussed below, some research
suggests that section 13 of the BHC Act
and the 2013 rule may have reduced
risk exposures of banking entities
related to trading, but may not have
reduced the overall exposure to risk of
some banking entities. Other research
suggests that the 2013 rule may have
partly mitigated certain conflicts of
interest between banking entities and
clients in a limited set of banking entityclient relationships. Moreover, some
research suggests that the 2013 rule
imposed large compliance costs that
may have disproportionately affected
smaller banking entities and may have
decreased the willingness and ability of
banking entities to engage in certain
client facilitation activities.
811 See, e.g., 79 FR at 5666, 79 FR at 5574, 79 FR
at 5541.
812 See, e.g., 79 FR at 5659.
813 See, e.g., 79 FR at 5541.
814 See, e.g., 79 FR at 5541, 79 FR at 5584, 79 FR
at 5616, 79 FR at 5671, 79 FR at 5673, 79 FR at
5675, 79 FR at 5713.
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In addition, commenters suggested
that the agencies must consider the
effects of the 2013 rule and proposed
amendments in light of the overall
effects of new requirements on banking
entities, including Basel III, regulations
of systemically important financial
institutions, the SEC’s money market
reform, and the liquidity coverage
ratio.815 Where relevant, the analysis
that follows discusses the direct effects
of section 13 of the BHC Act, the 2013
rule, sections 203 and 204 of EGRRCPA
and conforming amendments, and the
final rule, as well as how they may
interact with the effects of other related
financial regulations.
i. Risk Exposure
As discussed in the proposal, in
implementing section 13 of the BHC
Act, the agencies sought to increase the
safety and soundness of banking entities
and to promote financial stability,
among other things.816 The regulatory
regime created by the 2013 rule was
intended to enhance regulatory
oversight and compliance with the
substantive prohibitions in section 13 of
the BHC Act.817
In response to the proposal, some
commenters indicated that the benefits
from the statutory prohibition in section
13 of the BHC Act and implementing
rules on proprietary trading include
reduced banking profits resulting from
proprietary trading and corresponding
reductions in the costs associated with
bailouts; 818 prudent risk management
that makes job-creating functions of
banks more viable; 819 greater financial
stability; 820 dampened bubbles in
products such as synthetic
collateralized debt obligations,821 and
reduced highly risky bank trading
activities and hedge fund and private
equity investments that can threaten
financial stability.822 Other commenters
stated that proprietary trading was not
the cause of the 2007–2008 financial
crisis and that almost every financial
crisis in history has been driven by
classic extensions of credit; 823 that
rather than reducing systemic risk,
section 13 of the BHC Act and the
implementing rules harm the healthy
functioning of the financial services
815 See CCMC; Oonagh McDonald; JBA; Occupy
the SEC and Systemic Risk Council.
816 See, e.g., 79 FR at 5666, 79 FR at 5574, 79 FR
at 5541, 79 FR at 5659. See also Senators Merkley
et al.
817 See, e.g., 83 FR at 33520.
818 See, e.g., Occupy the SEC.
819 Id.
820 See, e.g., Better Markets and NAFCU.
821 See, e.g., Volcker Alliance.
822 See, e.g., CAP.
823 See, e.g., American Action Forum.
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industry; 824 and that section 13 of the
BHC Act and the implementing rules are
no longer necessary given Basel III
capital requirements, stress testing, and
liquidity coverage ratio rules that
promote short-term resilience of bank
risk profiles.825
In response to the comments
discussed above, the SEC has analyzed
relevant academic research on these
issues. Most existing qualitative analysis
and quantitative research on moral
hazard,826 incentives to increase risk
exposures that arise out of deposit
insurance 827 and implicit bailout
guarantees,828 and systemic risk
implications of proprietary trading do
not explicitly analyze the effects of
section 13 of the BHC Act or of the 2013
rule.829
Several recent academic studies
examined the baseline effects of section
13 of the BHC Act and implementing
regulations on activities by banking
entities that involve market risk. As
discussed in detail below, this research
suggests that, although section 13 of the
BHC Act and the 2013 rule may have
reduced risk exposure related to trading,
it is not clear that the 2013 rule reduced
the overall risk of individual banking
entities and potentially of banking
entities as a whole.
824 See,
825 See
e.g., American Action Forum and CAP.
Oonagh McDonald. See also infra note
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849.
826 A classic definition of moral hazard is ‘‘the
loss exposure of an insurer (the FDIC) that results
from the character or circumstances of the insured’’
(here, the banking entity). See Anthony Saunders &
Marcia Cornett, Financial Institutions Management:
A Risk Management Approach, 573 (8th ed. 2014)
p. 573.
827 Saunders and Cornett (2014) discusses how
deposit insurance reduces the risks of depositors or
other liability holders engaging in a run on a
banking entity and the related costs of a banking
entity’s failure. However, if the risk of bank failure
is not adequately priced in the insurance premium
paid by the banking entity, deposit insurance can
create incentives to engage in more risky activities.
Moreover, even absent deposit insurance, the
limited liability of a banking entity’s shareholders
still creates incentives to risk shift at the expense
of depositors, bondholders, and other fixed
claimants. See Saunders and Cornett (2014), ch. 19.
828 Deposit insurance and implicit bailout
guarantees may give rise to risk taking incentives
that are not specific to proprietary trading. In other
words, even in the absence of proprietary trading,
both deposit insurance and implicit bailout
guarantees may create incentives for banking
entities to increase risk exposures from permissible
activities such as lending, underwriting, and market
making. Thus, a prohibition of proprietary trading
need not by itself reduce moral hazard or overall
risk exposures of banking entities if banking entities
increase risk exposures from other activities during
the same time.
829 For a literature review, see, e.g., Sylvain,
Benoit et al., Where the Risks Lie: A Survey on
Systemic Risk, 21 Rev. Fin. 109 (2017). See also 83
FR 33533 note 350.
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For example, one study 830 compares
changes in equity returns and CDS
spreads of 93 U.S. listed banks affected
by post-crisis financial reforms and of
those that were not. Specifically, the
study finds that news concerning the
potential enactment of substantive
prohibitions in section 13 of the BHC
Act 831 led to a rise in credit default
swap (CDS) spreads (by as much as 17–
18 basis points) and to a decrease in
equity prices (statistically significant in
most specifications). The paper
interprets the results as an indication
that the proprietary trading prohibition
reduced bank profitability because of
the spinoffs of profitable trading and
swap desks. In an additional analysis,
the paper finds that these effects were
more significant for investment banks,
for banks that are more likely to be
systemically important,832 and for banks
that are closer to default. Notably, the
paper does not examine changes in
specific types of risky activities, so it is
possible that the observed effects may
have occurred for reasons unrelated to
the proprietary trading prohibitions.833
While the paper concludes that the
reforms reduced bail-out expectations,
the rise in CDS spreads and the decrease
in equity prices are also consistent with
the interpretation that market
participants reacted to the event as a
change increasing the risk to banking
entities, for instance because of the
expected shift to risk taking through
lending or reduced hedging of lending
activities with trading activities. For
instance, a shift away from trading
activity and toward more illiquid and
potentially less diversified lending or
trading activities may have increased
banking entities’ exposure to liquidity
and counterparty risks, and this risk
830 See Alexander Scha
¨ fer et al., Financial Sector
Reform after the Subprime Crisis: Has Anything
Happened?, 20 Rev. Fin. 77 (2016).
831 Specifically, the paper performs an event
study around January 21, 2010, when President
Obama announced support for Volcker Rule-type
restrictions on proprietary trading by banking
entities. See Remarks by the President on Financial
Reform, Office of the Press Secretary, The White
House, January 21, 2010, available at https://
obamawhitehouse.archives.gov/the-press-office/
remarks-president-financial-reform, last accessed 6/
27/2019.
832 Specifically, the paper measured systemic
importance on the basis of the Financial Stability
Board’s list of 29 global systemically important
financial institutions published on November 4,
2011. See Financial Stability Board Identifies 29
Global SIFIs and Announces Agreed Policy
Measures, Mondaq, November 4, 2011, last accessed
7/9/2013.
833 Another study by Gropp et al. (2011) finds that
government guarantees can increase risk-taking
incentives in competitor, but not in protected,
banks. See Reint Gropp et al., Competition, RiskShifting, and Public Bailout Policies, 24 Rev. Fin.
Stud. 2084 (2011).
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62045
may have been priced in higher CDS
spreads of banking entities.
In contrast, another paper 834
examines the cumulative market
reaction to 15 events related to section
13 of the BHC Act using a sample of 784
listed banks and seeks to distinguish the
events from announcements
surrounding Orderly Liquidation
Authority events. The paper finds
significant negative cumulative
abnormal equity returns (¥11.97%) for
targeted banks,835 consistent with
targeted banks losing out on profitable
opportunities, and positive cumulative
abnormal returns (7.1%) for nontargeted banks. Similarly, the paper
estimates that targeted banks
experienced a 0.021% increase in CDS
spreads, consistent with the changes
making targeted banks riskier, whereas
non-targeted banks experienced a
decline in CDS spreads of ¥0.049%. In
addition, banks with a higher measure
of systemic risk (marginal expected
shortfall), higher illiquidity (Amihud
(2002) 836 measure and the bid-ask
spread), and worse reporting quality
(abnormal loan loss provisions)
experienced more negative market
reactions to events surrounding section
13 of the BHC Act and the 2013 rule. On
aggregate, the paper finds that equity
returns rose and CDS spreads declined
for sample banks, and concludes that
the rule targeted larger institutions and
enhanced the relative position of
smaller banks.
Four factors limit the interpretation of
this paper’s results. First, the validity of
inference from event studies is affected
by the presence of confounding events
on announcement days. While a study
of a greater number of event days may
provide a more complete picture of
market responses to even minor
announcements concerning the reform
of interest, it increases the likelihood of
confounding events occurring on event
days, ceteris paribus. Second, the
proprietary trading prohibitions scoped
in all, not just a subset of, banking
entities, while the paper hypothesizes
differential effects of the proprietary
trading prohibition on targeted and nontargeted banks. As a result, the
measurement of targeted banks may
simply be capturing prior performance
of an institution during times of severe
834 See Fayez Elayan et al., The Impact of the
Volcker Rule on Targeted Banks, Systemic Risk,
Liquidity, and Financial Reporting Quality, 96 J.
Econ. & Bus. 69 (2018).
835 The paper defines targeted banks as banks that
issued or had exposure to mortgage-backed
securities or other securitized products or had other
asset write-downs reported in news sources.
836 See Amihud Yakov, Illiquidity and Stock
Returns: Cross-section and Time Series Effects, 5 J.
Fin Markets 31 (2002).
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stress or the likelihood of an institution
being affected by other regulatory
restrictions or sanctions and not
necessarily the degree of exposure to the
proprietary trading prohibition. Third,
since the management of bank balance
sheets and risk exposures can take
several quarters, narrow event windows
may reflect market participants’
expectations but may not be informative
about ex-post changes in risky bank
activities in response to the event.837
Finally, all but one event considered in
this study relate to the substantive
prohibitions in section 13 of the BHC
Act (and not the agencies’ implementing
rules), and all of the events examined in
this study precede the adoption of the
2013 rule.
A recent paper uses regulatory data on
net trading profits reported by bank
holding companies to the Federal
Reserve under the Market Risk Capital
Rule and examines the risk-taking of
U.S. banks via trading books before and
after the 2013 rule.838 The paper finds
that, prior to 2014, U.S. banks had
significant exposures to equity risk
factors through their trading books, but
that such trading exposures declined
after the implementing regulations. The
paper also finds that, in response to the
2013 rule, the trading desks of U.S.
banks have decreased their exposures to
interest rate risk but not to credit risk.
Consistent with bank reliance on certain
exemptions with respect to
commodities, foreign exchange, and
currency trading, U.S. banks also
continue to be exposed to currency risk.
Importantly, post-2013 rule credit and
dollar risk exposures are far less
significant in magnitude compared to
pre-2013 rule exposure to equity risk
factors. The paper concludes that the
ban on proprietary trading was effective
in curtailing large exposures. These
results seem to suggest that holding
companies significantly reduced their
exposure to risk from trading activities.
Four considerations limit the
interpretation of these results. First, the
paper’s tests focus on data aggregated to
the weekly frequency, and it is not clear
if the results would continue to hold
using daily, monthly, or quarterly
frequencies. For example, the results
appear inconsistent with other research
analyzing FR Y–9C data on trends in
837 For example, see the below discussion of a
study by Keppo and Korte (2018) examining
changes in bank risk taking over a 10 quarter period
and finding that banks did not decrease risk-taking.
838 See Antonio Falato et al., ‘‘Banks as Regulated
Traders,’’ Finance Fin. & Econ. Discussion Series
2019–005, Washington: Board of Governors of the
Fed. Reserve System (2019), available at https://
doi.org/10.17016/FEDS.2019.005, last accessed 5/
20/2019.
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quarterly trading positions and trading
revenues, which does not find
significant changes in equity profits and
losses after the 2013 rule.839 Second,
anticipatory compliance and
confounding regulatory and
macroeconomic events (unaccounted for
in the paper) complicate definitive
causal inference. Third, the paper does
not examine the possibility that, since
higher risk is generally compensated
with higher expected returns,840
banking entities may have offset risk
reductions in their trading books by
shifting risk into illiquid banking books.
Fourth, the paper also does not test
changes in the total amount of risk on
bank balance sheets before and after the
relevant regulatory shocks or consider
the effects of the implementing
regulations on the overall risk of U.S.
banking entities.
Another study empirically examines
the effects of the substantive
prohibitions of section 13 of the BHC
Act on the returns and overall risk of
publicly traded U.S. bank holding
companies before and after the third
quarter of 2010.841 Consistent with the
papers discussed above, this paper finds
that most affected bank holding
companies, i.e. those with the largest
trading books before 2010, reduced
trading books relative to total assets by
2.34% more than other bank holding
companies. However, this result is
generally consistent with mean
reversion in trading activity by banks
that may have suffered the greatest
trading losses during the crisis. In
addition, the paper does not directly
distinguish between proprietary trading
and client facilitation trading or hedging
trading. Although the paper finds a
decline in trading activity and a general
decline in overall bank risk (measured
839 See Begenau, 2019, Discussion of ‘‘Banks as
Regulated Traders,’’ NBER CF Spring meeting, April
12, available at https://
begenau.people.stanford.edu/sites/g/files/
sbiybj1926/f/nber_cfspring2019_begenau_disc.pdf,
last accessed 07/15/2019. See also Juliane Begenau
et al., Banks’ Risk Exposures, (Nat’l Bureau of Econ.
Research, Working Paper No. 21334, 2015) available
at https://www.nber.org/papers/w21334, last
accessed 07/15/2019.
840 This effect is commonly known as the ‘‘riskreturn tradeoff’’: If an investor is willing to take on
risk, there is a reward of higher expected returns.
See ZVI Bodie et al., Investments, G–11 (9th ed.
2011).
841 See Jussi Keppo & Josef Korte, Risk Targeting
and Policy Illusions—Evidence from the
Announcement of the Volcker Rule, 64 Mgmt. Sci.
215 (2018). Also cited as an example of
‘‘pathbreaking work assessing the many costs and
benefits of the Rule’’ in Robert J. Jackson Jr.,
‘‘Proposed Amendments to the Volcker Rule,’’
Securities and Exchange Commission, June 5, 2018,
note 21 available at https://www.sec.gov/news/
public-statement/jackson-statement-proposedamendments-volcker-rule.
PO 00000
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by the z-score),842 the paper does not
find a pronounced effect on most
affected bank holding companies; in
fact, some of the results suggest that
most affected banks became riskier than
less affected banks. The paper finds that
the channel for this effect on overall risk
is an increase in asset return volatility
of affected bank holding companies. In
addition, the paper finds no significant
differences in the volatility of bank
stock prices and liquidity ratios of
affected and unaffected entities. The
paper concludes that the risk taking
incentives of banking entities have not
changed and that affected banks have
been able to maintain their levels of risk
taking by becoming less likely to use
remaining trading assets to hedge
banking book returns.843 The SEC notes
that the sample period of the paper ends
prior to the full effective date of the
2013 final rule, which may partly limit
the interpretation of these results.
Another recent paper 844 uses
structural methods to isolate and
estimate the effects of the limitation of
bank proprietary trading in section 13 of
the BHC Act on the probability of bank
defaults, earnings, and the value of their
equity. Using a model calibrated to the
data from a sample of 34 of the most
affected U.S. banks, this paper finds that
banks—and particularly banks most
affected by section 13 of the BHC Act—
842 The z-score is one of the most popular
multiple discriminant analysis models of
bankruptcy, originally developed by Altman (1968)
and updated frequently since. Multiple
discriminant analysis consists of identifying a
linear combination of accounting measures that
provides the best fit for the observed default and
non-default outcomes in a particular sample of
firms. The variables that enter into the z-score
include: The ratio of working capital to total assets;
retained earnings to total assets; earnings before
interest and taxes to total assets; market value of
equity to total liabilities; and net sales to total
assets. While the weights on these components of
the z-score are periodically recalibrated using more
recent samples, all components enter with a
positive sign, such that an increase in each of the
variables decreases the probability of bankruptcy.
See Phillippe Jorion, GARP Financial Risk Manager
Handbook: Frm Part I/Part II, 475 (2011).
843 In another context, Keppo and Korte (2018)
also find that, after the passage of the GrammLeach-Bliley Act that repealed the Glass-Steagall
Act, the overall risk (measured by the z-score) of
affected banks relative to unaffected banks did not
change. In that context, the paper finds that affected
banks did significantly increase their trading risk
and decrease the risk of their banking book.
844 See Sohhyun Chung et al., The Impact of
Volcker Rule on Bank Profits and Default
Probabilities, (SSRN Working Paper, Feb. 27, 2019),
available at https://papers.ssrn.com/sol3/
papers.cfm?abstract_id=2167773, last accessed 4/
23/2019
Also cited in Robert J. Jackson Jr., ‘‘Proposed
Amendments to the Volcker Rule,’’ Securities and
Exchange Commission, June 5, 2018, note 22
available at https://www.sec.gov/news/publicstatement/jackson-statement-proposedamendments-volcker-rule.
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may have become riskier after the
statutory change. In the model, the key
mechanism behind this effect is the
banks’ ability to respond to shocks:
Since the rule leads to a reduction in the
size of the trading book and increases
the relative weight of an illiquid
banking book, banks face greater
difficulties scaling down the bank book
when faced with negative earnings
shocks after the rule. The model
assumes no implementation costs, as the
costs were sunk when the statutory
prohibition came into effect and yields
an estimate of between ¥0.72% and
56.72% increase in average bank default
probability after the law. This estimate
range may suggest that the overall risk
of some banks may have increased, in
some cases, after the law. In the model,
banks for which a small trading book is
optimal, banks with a profitable and
low-risk bank book, and banks that take
more risk through leverage, do not
experience this rise in the default risk
after the proprietary trading prohibition.
Because the banking book is more
profitable and volatile than the trading
book for most affected banks, the paper
actually estimates no significant
decrease and, in some cases, an increase
in banks’ expected earnings and
earnings volatility (a range of ¥0.04%
to 0.73% depending on calibration).845
An important caveat for the
interpretation of these results is the
sensitivity of the estimates to modeling
assumptions, the limited sample used in
model calibration, and the extremely
broad range of estimates of an increase
in average bank default probability after
the law.
Finally, a recent paper 846 identified
three potential channels behind the
effects of section 13 of the BHC Act and
the 2013 rule on risky activities of bank
holding companies: (i) Risks from
proprietary trading activity itself, (ii)
risk from a lack of diversification of
bank revenue (trading and non-trading
revenue), and (iii) risk from similarity
among banks. The paper measures
overall risk with the z-score (as well as
volatility in returns, revenues, and
returns on assets) and systemic risk with
845 The estimate of ¥0.04% was obtained using
parameters for ‘‘median hedge fund banks,’’
calculated as the median of the 34 sample banks,
for which the drift and volatility of the trading
earnings were estimated from Credit Suisse Long/
Short Equity Hedge Fund Index data for 2000
through the beginning of 2010. The estimate of
0.73% was obtained using drift and trading
earnings volatility for an asset-weighted mean of
sample banks.
846 See Christina Bui and Talis Putnins, The
Intended and Unintended Effects of the Volcker
Rule, (Aug. 31, 2018) (working paper), available at
https://fmaconferences.org/SanDiego/Papers/
Volcker_SubmissionFMA.pdf, last accessed 4/23/
2019.
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marginal expected shortfall (average
stock return of each bank holding
company during bottom 5th percentile
shocks to 1-year market returns; it also
measures marginal expected shortfall for
the financial industry, and tail beta) 847
and documents two main results. First,
an index of bank revenue diversification
reduces measures of bank and systemic
risk, while similarity across banks
increases systemic risk, and trading
activity increases both. Second, the
2013 rule reduced risks from trading
activity of affected banks, reduced the
diversification of bank revenue of
affected banks, and increased similarity
across banks.
The interpretation of these results
may be limited because of respective
methodologies, measurement,
identifying assumptions, and residual
confounding, as well as the general
limitations noted at the outset.
However, these results are broadly
consistent with other research that finds
that banking entities can respond to
regulations by risk shifting within an
asset class while remaining in
compliance 848 and that the
implementation of other financial
reforms can create effects inconsistent
with the regulators’ intentions.849
Some commenters indicated that
restricting pay practices of banking
entities may effectively reduce
proprietary trading cross-subsidized by
taxpayers and accordingly lower the
risks of banking entities.850 While the
847 Acharya et al. (2017) finds that a bank’s
impact on systemic expected shortfall is affected by
its marginal expected shortfall and leverage. See
Viral Acharya et al., Measuring Systemic Risk, 30
Rev. Fin. Stud. 2 (2017).
848 See Ran Duchin and Denis Sosyura, Safer
Ratios, Riskier Portfolios: Banks’ Response to
Government Aid, 113 J. Fin. Econ. 1 (2014).
849 For example, Sundaresan and Xiao (2019)
show that the interaction of liquidity requirements
of Basel III and the money market fund reform may
have increased the reliance of private financial
institutions on liquidity provided by Federal Home
Loan Banks that enjoy an implicit government
guarantee. The paper concludes that the rules
increased the role of a government-sponsored
enterprise in the aggregate liquidity transformation
and the reliance of private institutions on public
liquidity backstops. In another context, Baghai et al.
(2019) finds that following the money market fund
reforms, safer funds exited the industry, the
remaining funds increased their portfolio risk, and
issuers with lower credit risk experienced a
reduced access to money market funding. See
Suresh Sundaresan and Kairong Xiao, Unintended
Consequences of Post-Crisis Liquidity Regulation
(Aug. 9, 2019) (working paper) last accessed 8/29/
2019. See also Ramin Baghai et al., Liability
Structure and Risk-Taking: Evidence from the
Money Market Fund Industry, (Aug. 18, 2019)
(working paper) last accessed 8/29/2019.
850 See, e.g., CAP and Public Citizen, citing Robert
J. Jackson Jr., ‘‘Proposed Amendments to the
Volcker Rule,’’ Securities and Exchange
Commission, June 5, 2018, available at https://
www.sec.gov/news/public-statement/jackson-
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62047
final rule does not amend existing
requirements or impose new
requirements related to compensation
practices of banking entities, the SEC
notes two incentive effects relevant for
the consideration of these issues. First,
as discussed above, proprietary trading
is one of many activities through which
a banking entity can take risk. Both
deposit insurance and implicit
government bailout guarantees
incentivize risk taking that is not
specific to proprietary trading. Even in
the absence of proprietary trading,
deposit insurance and implicit bailout
guarantees may lead banking entities to
take greater risks through lending and
permitted underwriting and market
making, among other things. As a result,
a prohibition on proprietary trading
need not by itself reduce the overall risk
of banking entities if banking entities
increase risk through other activities
during the same time.
Second, the incentives to take on
greater risks described above are those
of both a banking entity’s shareholders
who are residual claimants on the
banking entity’s assets and management.
Under limited liability, all shareholders
enjoy a limited downside (at worst,
shareholders stand to lose their
investment) and an unlimited upside if
the firm performs well (the value of
shareholders’ equity depends on the
value of the assets net of the value of
fixed claims, such as claims of
debtholders, depositors, and
employees).851 Thus, the incentives of
banking entities to take on greater risks
discussed above may persist so long as
any restrictions on pay practices leave
the incentives of a banking entity’s
management and employees even partly
aligned with those of shareholders.
ii. Conflicts of Interest
As discussed in the proposal, in
implementing section 13 of the BHC
Act, the agencies also sought to reduce
conflicts of interest between banking
entities and their customers.852 Some
commenters indicated that bank trading
activities and interests in hedge funds
and private equity funds resulted in
statement-proposed-amendments-volcker-rule on
potential effects of pay practices on proprietary
trading.
851 See, e.g., Jonathan Berk & Peter DeMarzo,
Corporate Finance, 552–53 (3rd ed. 2014),
discussing how leverage can (1) incentivize
shareholders to shift from lower-risk to higher-risk
assets (the ‘‘asset substitution’’ problem); and (2)
induce shareholders to undertake negative net
present value, but sufficiently risky projects (the
‘‘over-investment’’ problem). See also Michael
Jensen and William Meckling, Theory of the Firm:
Managerial Behavior, Agency Costs and Ownership
Structure, 3 J. Fin. Econ. 305 (1976).
852 See, e.g., 79 FR at 5659.
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significant conflicts of interest between
banks and their customers.853 One
commenter also indicated that the
agencies should amend the provisions
concerning material conflicts of interest
by permitting banking entities to rely on
information barriers under certain
circumstances.854
In response to these comments, the
SEC reviewed relevant research on
conflicts of interest between banking
entities and their customers. As
discussed below, related research
generally examines trading of banking
entities in stocks, bonds, or options of
their advisory and underwriting clients.
While the findings are somewhat mixed
and limited to their specific empirical
settings, this research is consistent with
the presence of such conflicts in certain
groups of merger and acquisition (M&A)
deals. In addition, one study finds that
a narrow type of conflicts of interest
between banking entities and their
clients may have decreased after the
implementation of the 2013 rule.
Specifically, a recent study 855
examines both the presence of conflicts
of interest between advisor banks and
their customers based on banks’ options
holdings, and changes in such trading
activity around the implementation of
the Volcker Rule. The paper documents
three main results. First, the paper finds
that merger advisors tend to increase
their holdings in call options relative to
put options in merger targets during the
quarter before the announcement.
Second, merger advisors are
significantly more likely to increase put
option holdings in the acquirer firm.856
In combination with the literature’s
general finding of average negative
announcement returns in acquirer firms
and positive announcement returns in
target firms, the paper argues that these
results are suggestive of informed
trading by advisor banks on client firms.
Third, within the subsample of affected
deals (deals in which one or more
advisor banks ceased proprietary trading
operations around the enactment of
section 13 of the BHC Act) after 2011,
the paper finds that advisors did not
increase their net call option holdings
on target firms before merger
announcements. The paper concludes
that, in this narrow setting, the Volcker
Rule may have decreased banks’ options
trading on client information.
853 See,
e.g., CAP.
SIFMA.
855 See Michelle Lowry et al., Informed Trading
By Advisor Banks: Evidence from Options Holdings,
32 Rev. Fin. Stud 605 (2018).
856 To the degree that some advisor banks may
have an underlying (long) risk exposure to acquirer
firms’ equity, buying put options is also consistent
with risk-mitigating hedging.
854 See
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Importantly, the paper finds that some
of this bank activity was replaced by
hedge fund activity: Specifically, hedge
funds increased their informed trading
in options of M&A client firms around
the same time in the same subsample of
deals.
The SEC is also aware of a broader
body of research that empirically tests
the existence and magnitude of conflicts
of interest between banks and their
customers in the context of advising and
underwriting relationships and that
does not directly empirically test the
effects of section 13 of the BHC Act or
the 2013 rule on the presence or
magnitude of such conflicts. One article
in the legal literature 857 empirically
measures the profitability of trading by
banks that have advisory clients and are
subject to reporting requirements as
temporary insiders. They document that
such trading by banks in the stocks of
advisory clients is profitable (with an
estimated average 25% return on their
trades), that the trading centers around
adverse events, and that the elimination
of Glass-Steagall restrictions in 2002
was associated with more frequent and
more profitable trading. However, the
paper does not empirically test the
effects of section 13 of the BHC Act or
of the 2013 rule.
Finance research on this type of
conflict of interest between banks and
their customers finds mixed effects. One
of the earlier papers 858 examines
trading in M&A target firms by the
advisor banks of bidders and links
advisor pre-announcement stakes in
target firms with the probability of deal
success and with the target premium.
They document positive returns of this
trading strategy and conclude that
advisors acquire positions in deals of
their advisory clients, as well as
influence deal outcomes. Since such
advisor behavior benefits the bidder, the
authors recognize that they cannot rule
out the alternative explanation that the
bidder’s board retains the advisor with
strong incentives for deal completion.
Outside of the M&A context, other
work 859 explores the trading activity of
IPO underwriters and finds that lead
857 See Sureyya Avci et al., Eliminating Conflicts
of Interests in Banks: The Significance of the
Volcker Rule, 35 Yale J. Reg. 343 (2017). Also cited
in Robert J. Jackson Jr., ‘‘Proposed Amendments to
the Volcker Rule,’’ Securities and Exchange
Commission, June 5, 2018, note 20, available at
https://www.sec.gov/news/public-statement/
jackson-statement-proposed-amendments-volckerrule.
858 See Andriy Bodnaruk et al., Investment Banks
as Insiders and the Market for Corporate Control,
22 Rev. Fin. Stud. 4989 (2009).
859 See Yao-Min Chiang et al., The Information
Advantage of Underwriters in IPOs, Mgmt. Sci.
(forthcoming 2019).
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underwriter trades in IPO firms are
associated with subsequent IPO
abnormal returns.
Another study 860 focuses on bond
trading and uses a sample covering 1994
through 2006 to examine the trading of
bond dealers affiliated with M&A
advisory banks with insurance
companies. The study finds weak
evidence that when affiliated dealers are
one side of a bond transaction, they earn
higher bond returns than unaffiliated
dealers, and that affiliated dealers sell
more of the bonds that may lose value
ahead of bad news than unaffiliated
dealers. The paper observes only a
subset of such dealer trades with
insurance companies and is unable to
evaluate whether affiliated dealers are
net buyers or sellers of affected bonds
before bad news. The study concludes
that there is weak and suggestive
evidence that transfer of information
within financial institutions is one of
the potential information sources before
public announcements.
Similarly, another paper 861 finds no
evidence of information leakage because
of investment bank M&A advisory,
underwriting, or lending relationships
from 1997 through 2002. Specifically,
the paper finds no evidence that
investment bank clients buy shares in
takeover targets in advised deals.
Similarly, bank clients with previous
underwriter or lending relationships do
not trade or earn abnormal returns
before earnings announcements. The
paper also examines market making
imbalances and investment returns by
connected brokerage houses and finds
that they do not trade profitably ahead
of earnings announcements by their
IPO, SEO, M&A client, or borrower
firms. The paper concludes that neither
brokerage houses nor their clients trade
on inside information available to the
brokerage because of their market
making or advising roles.
The SEC continues to note that the
above studies are limited to their
specific empirical settings and, as can
be seen above, different empirical
design, measurement, and identification
approaches limit inference in each of
the papers discussed above. Moreover,
the SEC continues to note that the scope
of this economic analysis is limited to
SEC registrants, investors in securities
markets, and the functioning of
securities markets. While the research
discussed above does not focus
860 See Semi Kedia and Xing Zhou, Informed
Trading Around Acquisitions: Evidence From
Corporate Bonds, 18 J. Fin. Mkt. 182 (2014).
861 See John M. Griffin et al., Examining the Dark
Side of Financial Markets: Do Institutions Trade on
Information from Investment Bank Connections, 25
J. Fin. Econ. 2155 (2012).
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specifically on banking entities that are
SEC registrants, some of the incentive
effects and conflicts of interest
discussed above may extend to banking
entities overseen by the SEC.
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iii. Client-Oriented Services and Market
Quality
In the 2013 rule, the agencies
recognized that client-oriented financial
services, such as underwriting and
market making, are critical to capital
formation and can facilitate the
provision of market liquidity and that
the ability to hedge is fundamental to
prudent risk management as well as
capital formation.862
In the proposal, the agencies stated
that compliance with the conditions of
the underwriting and market making
exemptions under the 2013 rule, such as
RENTD, creates ambiguity for some
market participants, is over-reliant on
historical demand, and necessitates an
accurate calibration of RENTD for
different asset classes, time periods, and
market conditions.863 Since forecasting
future customer demand involves
uncertainty, particularly in less liquid
and more volatile instruments and
products, banking entity affiliated
dealers face uncertainty about the
ability to rely on the underwriting and
market making exemptions. This
uncertainty can reduce a banking
entity’s willingness to engage in
principal transactions 864 with
customers, which, along with reducing
profits, may reduce the volume of
transactions intermediated by banking
entities.865
Moreover, consistent with the views
of some commenters,866 the SEC
believes that, as a baseline matter, the
2013 rule creates significant uncertainty
among market participants regarding
their ability to rely on the riskmitigating hedging exemption. For
example, there may be considerable
uncertainty regarding whether a
potential hedging activity will continue
to demonstrably reduce or significantly
mitigate an identifiable risk after it is
implemented.867 Unforeseeable changes
in market conditions and other factors
could reduce or eliminate the intended
risk-mitigating effect of the hedging
activity, making it difficult for a banking
entity to comply with the continuous
862 See, e.g., 79 FR at 5541, 79 FR at 5546, 79 FR
at 5561.
863 See, e.g., 83 FR at 33532.
864 Dealers can trade as agents, matching
customer buys to customer sells, or as principals,
absorbing customer buys and customer sells into
inventory and committing the necessary capital.
865 See, e.g., 83 FR at 33532.
866 See, e.g., ABA.
867 See, e.g., 83 FR at 33465.
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requirement that the hedging activity
demonstrably reduce or significantly
mitigate specific, identifiable risks.868
According to commenters, uncertainty
and compliance burdens related to the
risk-mitigating hedging exemption are
leading to less timely, less flexible, and
less efficient hedging.869
The SEC continues to recognize that
SEC-regulated entities routinely engage
in both static and dynamic hedging at
the portfolio (not the transaction) level
and monitor and reevaluate on an
ongoing basis aggregate portfolio risk
exposures, rather than the risk exposure
of individual transactions.870 Dynamic
hedging may be particularly common
among dealers with large derivative
portfolios, especially when the values of
these portfolios are nonlinear functions
of the prices of the underlying assets
(e.g., gamma hedging of options).871 As
a baseline matter, the SEC notes that the
2013 rule permits dynamic hedging.
However, the 2013 rule requires the
banking entity to document and support
its decisions regarding individual
hedging transactions, strategies, and
techniques for ongoing activity in the
same manner as for its initial activities,
rather than permitting a banking entity
to provide documentation for the
hedging decisions regarding a portfolio
as a whole.
The agencies have received a number
of comments concerning the baseline
effects of section 13 of the BHC Act and
the 2013 rule on client facilitation
activities, hedging, and market quality.
The agencies received comments that
the 2013 rule maintains the depth and
liquidity of U.S. capital markets and
that market liquidity remains within
historical norms; 872 that there is no
clear evidence that the 2013 rule has
affected liquidity at a level that should
cause concern; 873 and that liquidity
may signal a bubble and should not be
a key or even a major metric in assessing
the effects of reforms.874 Other
commenters stated that the 2013 rule
has imperiled valuable market making
and risk-mitigating hedging and reduced
market liquidity; 875 that the
prescriptive nature of the 2013 rule has
raised costs of providing liquidity,
which has been passed along to
investors and may have exacerbated
dislocations,876 and that less liquid
capital markets have made it difficult
868 Id.
869 See,
870 See,
e.g., JBA and SIFMA.
e.g., 83 FR at 33535.
871 Id.
872 See,
e.g., NAFCU and CAP.
e.g., AFR and Occupy the SEC.
874 See, e.g., Public Citizen.
875 See, e.g., SIFMA and American Action Forum.
876 See, e.g., FSF and SIFMA.
873 See,
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for derivative end-users to raise capital
in times of stress.877
The role of dealers in market making
and client facilitation may be more
significant in dealer markets, such as
derivative and corporate bond markets.
The SEC has elsewhere discussed
several key changes in liquidity in bond
markets and security-based swaps after
the financial crisis. For example, the
SEC found that, in corporate bond
markets, although estimated average
transaction costs have decreased,
trading activity has become more
concentrated in less complex bonds and
bonds with large issue sizes; that
transaction costs have increased for
some subgroups of corporate bonds; and
that dealers have, in aggregate, reduced
their capital commitment since its 2007
peak, consistent with the claim that the
Volcker Rule and other reforms
potentially reduced the liquidity
provision in corporate bonds.878 The
SEC recognizes difficulties in causal
attribution of the various provisions of
section 13 of the BHC Act and the 2013
rule and notes that some studies do not
find significant structural breaks
associated with post-crisis financial
regulations in several measures of
market liquidity.879 However, the SEC
continues to be informed by both
comments discussed above and a body
of research drawing causal inference
concerning the adverse effects of section
13 of the BHC Act and the 2013 rule on
dealer provision of liquidity and on the
risk of market dislocations in times of
stress.880
Importantly, the 2013 rule included a
large number of requirements and
provisions, and aspects of the 2013 rule
most likely to affect banking entities’
client facilitation activity (such as the
RENTD requirement for the
underwriting and market making
exemptions) are not quantifiable or
subject to public or regulatory reporting.
As a result, existing research primarily
seeks to document trends in various
aspects of market liquidity in general
and the effects of section 13 of the BHC
877 See,
e.g., Coalition for Derivative End Users.
SEC Report 2017, supra note 774, for a
detailed data analysis and literature survey.
879 See, e.g., Francesco Trebbi and Kairong Xiao,
2018, Regulation and Market Liquidity, 6 Mgmt.
Sci. 1949 (2019). The generalizability of the paper’s
result is limited by the sample period, which ends
in December 2014 and before the full
implementation of the 2013 rule. For more
methodological limitations of this paper, such as
heuristic choices of parameters, and crucial
assumptions, as well as other issues, see SEC Report
2017, supra note 774, at 118–119. See also Tobias
Adrian et al., Liquidity, Leverage, and Regulation 10
Years After the Global Financial Crisis, 10 Ann.
Rev. Fin. Econ. 1 (2018).
880 Id. See also 83 FR at 33520–33522, 33532–
33533.
878 See
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Federal Register / Vol. 84, No. 220 / Thursday, November 14, 2019 / Rules and Regulations
Act and the 2013 rule on dimensions of
market liquidity in particular. However,
the most likely channels for the below
effects of section 13 of the BHC Act and
the 2013 rule on client facilitation
activities are the requirements for the
exemptions (such as RENTD) and
uncertainty around the ability to rely on
exemptions for client facilitation
activities.
As discussed below, several studies
show significant declines in various
measures of liquidity after the financial
crisis and post-crisis reforms, including
a recent study that ties the effects to the
underwriting exemption of the 2013
rule. In addition, some research that
reconciles the deterioration in dealer
liquidity provision with improvements
in price-based measures of liquidity
attributes those effects to the reduced
willingness of dealers to provide
liquidity on a principal basis after
implementation of the 2013 rule.
Further, existing research suggests that
the 2013 rule resulted in reduced
liquidity during times of stress, with an
increase in liquidity provision by
dealers unaffiliated with banks failing to
fully offset the reduction in liquidity
provision by bank-affiliated dealers.
Moreover, some research suggests that
post-crisis financial reforms led to
persistent deviations from no-arbitrage
conditions across markets, with the
effect driven by banking entities and
levered nonbanking entities that rely on
systemically important banking entities
for funding liquidity. Finally, new
evidence indicates that post-crisis
financial regulations may also be having
effects on the co-movement in liquidity
metrics across markets. Though the
research discussed below is unable to
attribute observed trends to specific
provisions of the 2013 rule, these
findings are largely consistent with the
claim that the 2013 rule had adverse
effects on certain aspects of client
facilitation activity by banking entities,
as discussed below.
A number of studies documented
declines in several dimensions of
liquidity after the financial crisis and
post-crisis reforms. For example, one
study 881 finds that the willingness of
dealers to commit capital overnight,
turnover, the frequency of block trades,
and average trade size have all declined
after the financial crisis. Importantly,
the paper finds that the shift away from
market-makers absorbing customer
imbalances and toward agency trading
was most acute when banks were
881 See Hendrik Bessembinder et al., Capital
Commitment and Illiquidity in Corporate Bonds, 73
J. Fin. 1615 (2018). For a more detailed discussion
of the paper’s limitations and caveats, see SEC
Report 2017, supra note 774, at 101–104.
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required to comply with the proprietary
trading prohibition. Further, the paper
finds that these declines in dealer
provision of liquidity stem from bankaffiliated dealers. The paper concludes
that post-crisis banking regulations,
including the 2013 rule, contributed to
the reductions in turnover, trade size,
frequency of block trades, and the
willingness of dealers to commit capital.
Another paper 882 examines the cost
of immediacy in corporate bonds, using
index exclusions as a setting in which
uninformed traders exogenously
demand immediacy. The paper finds
that the cost of immediacy has more
than doubled and that dealers revert
back to target inventory far more quickly
after the 2007–2008 financial crisis. The
paper finds that this post-crisis dealer
behavior is most severe for bank dealers
and concludes that such changes are
consistent with the effects of the
Volcker Rule.
Research on changes in liquidity
around the post-crisis reforms,
including the 2013 rule, presents two
seemingly contradictory results: On the
one hand, price-based measures of
liquidity (such as the bid-ask spread)
have improved; on the other hand,
measures of dealer liquidity supply
have significantly worsened.883 A few
studies seek to reconcile these two
effects. One paper 884 focuses on dealers’
willingness to provide liquidity in
certain types of bonds out of inventory.
The paper finds that, when transacting
in riskier and less liquid bonds, dealers
are significantly more likely to offset
trades on the same day instead of
committing capital overnight.
Specifically, the paper documents that
dealers offset approximately 75% of
trades in the lowest-rated, least-activelytraded bonds, but only 55% of trades in
the highest-credit-quality, most-activelytraded bonds. In addition, liquidity
provision out of inventory involves risk
to the dealer—a risk that is priced in
higher transaction costs. As a result, a
decline in transaction costs in observed
trades may be a reflection of the decline
in dealers’ willingness to take certain
groups of bonds into inventory.
Another study 885 finds that, after the
post-crisis banking regulations,
882 See Jens Dick-Nielsen and Marco Rossi, The
Cost of Immediacy for Corporate Bonds, 32 Rev.
Fin. Stud 1 (2019). For a more detailed discussion,
see SEC Report 2017, supra note 774, at 112–13.
883 See, e.g., SEC Report 2017, supra note 774, at
100–105.
884 See Michael Goldstein and Edith Hotchkiss,
Providing Liquidity in an Illiquid Market: Dealer
Behavior in U.S. Corporate Bonds, J. Fin. Econ.
(2019) (in press) (accepted manuscript). See also,
e.g., SEC Report 2017, supra note 774, at 106–107.
885 See Jaewon Choi and Yesol Huh, Customer
Liquidity Provision: Implications for Corporate
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including the 2013 rule, customer
provision of liquidity has increased and,
as a result, the paper posits that bid-ask
spread measures will necessarily
underestimate the cost of dealer
liquidity provision. The paper estimates
that, for a subset of large liquidity
demanding customer trades in which
dealers provide liquidity from their
inventory, customers pay between 35%
and 65% higher spreads after the crisis
than before the crisis.886 The paper
concludes that a large portion of
liquidity provision has moved from
dealers to large asset managers and that
the effect is consistent with the effects
of tighter banking regulations.
A recent paper 887 focuses on the
effects of the underwriting exemption of
the 2013 rule on trading by affected
dealers. Specifically, the paper
examines changes in the trading and
liquidity of newly issued bonds that
affected dealers have underwritten
relative to bonds that the dealers have
not underwritten around the
implementation and conformance of the
2013 rule. This empirical design
accounts for potentially confounding
dealer effects (as dealers trade in bonds
that they both underwrite and bonds
that they do not) and bond effects (as
both underwriters and non-underwriters
trade in a given bond), and isolates the
effects of the underwriting exemption in
the 2013 rule from the effects of other
bank regulations during the
implementation period of the 2013 rule.
The paper estimates that dealer markups
have increased by between 42 and 43
basis points for fast roundtrip trades (15
minutes or less) after April 2014, but
finds that the effect is transitional and
disappears after August of 2015.
However, the paper estimates that the
adverse effects on dealer markups for
slower roundtrip trades of between 15
minutes and 1 day—trades that involve
dealers absorbing trades into
inventory—are both economically
significant and persist past the
Bond Transaction Costs, (Aug. 1, 2019) (working
paper), last accessed 8/27/2019). For a more
detailed discussion, see, e.g., SEC Report 2017,
supra note 774, at 117.
886 In contrast, Bessembinder et al. (2016) focuses
on dealer-to-customer principal trades and finds the
average transaction cost, particularly for small
trades (less than $100,000) and large trades (over
$1,000,000), is lowest in the pre-crisis and
regulation periods. As the SEC stated elsewhere, the
difference between these two results may stem from
different proxies for transaction costs and the
measurement of principal trading activity.
887 See Meraj Allahrakha et al., The Effects of the
Volcker Rule on Corporate Bond Trading: Evidence
from the Underwriting Exemption (Off. of Fin.
Research Working Paper 19–02, 2019) available at
https://www.financialresearch.gov/working-papers/
files/OFRwp-19-02_the-effects-of-the-volcker-ruleon-corporate-bond-trading.pdf, last accessed 8/9/
2019.
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implementation period (a range of 27–
43 bps increase between April 2014 and
July 2015, and a range of 18–35 basis
point effect after July 2015).888 To rule
out the selection explanation (that
dealers post-2013 rule simply prearrange more trades so the nonprearranged trades become costlier), the
paper tests changes in short-term, noninventory trades. The paper finds an
increase in such trades around the
effective date of the 2013 rule, but no
differences when conditioning on dealer
underwriting activity, and concludes
that endogenous selection of time in
inventory cannot explain the above
results. Moreover, the paper finds that
nonbanking dealers enjoy a significant
increase in market share after the
conformance period, while bankaffiliated dealers lose market share.
Finally, the paper concludes that the
2013 rule increased dealer trading risk
on short round-trip trades (15 minutes
or less), estimating that the standard
deviation of covered dealers’ markups
on corporate bonds has risen by
between 0.09 and 0.1.
These results are subject to three
primary caveats. First, the paper relies
on a relatively narrow measure of risk
(the standard deviation of dealer profits
at the bond-month level). Unlike other
research discussed in this section, the
paper does not examine changes in the
overall volume of trading activity,
measures of downside risk at the
individual banking entity level, or
commonality of risk exposures among
affected and unaffected dealers. Second,
some of the paper’s tests are affected by
small sample sizes, limiting inference
related to transitional and permanent
effects of the 2013 rule in certain trades
(including the 15 minute–1 day
subsample and the 60–90 day
subsample). Third, the paper recognizes
that these results are specific to dealer
provision of liquidity in the corporate
bond market, and may not extend to
trading by affected firms in other asset
classes.
Other research helps inform the SEC’s
understanding of the effects of section
13 of the BHC Act and the 2013 rule on
liquidity in times of stress. Specifically,
there is growing evidence that liquidity
provision in times of stress may be
adversely affected by post-crisis reforms
888 The paper also finds an increase of between
8% and 14% in dealer markups on trades around
the 60-day cutoff for the rebuttable presumption in
the 2013 rule. The paper acknowledges that this
result could be consistent with dealers conducting
profitable proprietary trades and holding positions
past the 60-day rebuttable presumption window but
is cautious in interpreting the result given the
methodological limitations of its empirical design
and very small sample size that does not allow
conclusive inference.
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in general and the Volcker Rule in
particular. Two studies directly test the
effects of the Volcker Rule on market
making by dealers in times of stress.
One of the papers 889 examines liquidity
during corporate bond downgrades that
result in selling by certain institutions.
The paper suggests that dealers affected
by the Volcker Rule decreased market
making in newly downgraded bonds,
and that unaffected dealers have not
fully offset this decline. Moreover, the
paper rules out the alternative
explanation that these changes are
attributable to other financial reforms,
finding that the same effects are present
for dealers affected by the Volcker Rule
but not constrained by Basel III and
Comprehensive Capital Analysis and
Review (CCAR) regulations. The paper
isolates the effect in a relatively small
sample of bonds experiencing relatively
large stress events (under normal
aggregate conditions). This
methodological design reflects the
common tradeoff between a narrower
empirical setting that enables causal
inference, and a larger sample that is
less amenable to causal
interpretations.890
A related study 891 compares liquidity
during times of stress before and after
the crisis, and defines times of stress on
the basis of extreme increases in marketwide volatility (measured by the VIX
index), bond yield drops, and credit
rating downgrades from investment
grade to speculative grade. While the
study does not find that price-based
liquidity measures decreased around
idiosyncratic shocks, the study does
find that the price impact of large trades
surrounding market-wide shocks has
increased after the post-crisis financial
reforms relative to the pre-crisis
period.892
A recent report by the International
Organization of Securities Commissions
(IOSCO)’s Committee on Emerging Risks
examined changes in bond market
liquidity focusing on stressed
conditions.893 The report notes that the
889 See Jack Bao et al., The Volcker Rule and
Corporate Bond Market Making in Times of Stress,
130 J. Fin. Econ. 95 (2018).
890 For a fulsome discussion of this and other
issues and limitations, see SEC Report 2017, supra
note 774, at 109–11.
891 See Mike Anderson & Rene
´ Stulz, Is PostCrisis Bond Liquidity Lower? (Dice Ctr. Working
Paper 2017–09, 2017) last accessed 6/3/2019.
892 Consistent with these results, Goldstein and
Hotchkiss (2019) finds that on days with large VIX
increases, dealers tend to offset trades more quickly
even for highly rated bonds that they normally
would take into inventory. For a more detailed
discussion, see SEC Report 2017, supra note 774,
at 114–15.
893 See OICU–IOSCO, 2019, Liquidity in
Corporate Bond Markets Under Stressed
Conditions, FR079/2019, May. Available at https://
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most significant effect of post-crisis
financial reforms and reduction in
dealer risk appetite is the decline in the
capacity of dealers to intermediate
transactions on a principal basis,
combined with a drastic increase in the
size of the market. The report concludes
that such effects mean the lack of
liquidity in times of stress is likely to be
more acute than in past episodes of
stressed conditions.
One of the important results
identified in this literature is the finding
that nonbank dealers may step in but
may not fully offset the decline in the
liquidity provision of bank dealers
caused by section 13 of the BHC Act and
the 2013 rule.894 New research suggests
that the fundamental mechanism behind
this result may be the effect of other
post-crisis regulations on the ability of
bank dealers to provide funding
liquidity to nonbank intermediaries.895
Specifically, the paper examines the
interplay between post-crisis bank
regulations, including the Volcker Rule,
the supplementary leverage ratio, the
liquidity coverage ratio, and the net
stable funding ratio, and their effects on
the ability of nonbank intermediaries to
arbitrage away mispricing. The paper
finds that the profitability of classic
arbitrage trades (on-the-run/off-the-run,
Treasury-interest swap, CDS-bond basis,
and single name-index CDS arbitrage
trades) is significantly lower under the
supplementary leverage ratio, liquidity
coverage ratio, and net stable funding
ratio components of Basel III compared
with Basel II. In addition, using a
differences-in-differences estimation,
the paper finds that levered hedge funds
relying on prime brokers that are
identified in the paper as globally
systemically important banks
experience lower abnormal returns and
a decline in assets under management.
The paper concludes that the effects of
post-crisis regulations affect not only
bank intermediation but also the ability
of private funds to rely on banks for
funding liquidity supporting arbitrage
strategies. The paper notes that the
supplementary leverage ratio and the
net stable funding ratio disincentivize
www.iosco.org/library/pubdocs/pdf/
IOSCOPD634.pdf, last accessed 7/1/2019.
894 As discussed above, when examining
informed trading of advisor banks in options on the
stocks of client firms, Lowry et al. (2018) finds that
informed trading by hedge funds increases
simultaneously with a decrease in informed trading
by banks around the enactment of section 13 of the
BHC Act. See Michelle Lowry et al., Informed
Trading By Advisor Banks: Evidence from Options
Holdings, 32 Rev. Fin. Stud 605 (2018).
895 See Boyarchenko, Eisenbach, Gupta, Shachar,
and Van Tassel, 2018, ‘‘Bank Intermediated
Arbitrage,’’ Federal Reserve Bank of New York Staff
Report No. 858, last accessed 6/3/2019.
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low margin activities and a reliance on
short-term funding, such as repo, and
that the liquidity coverage ratio
incentivizes holdings of more liquid
securities. The paper concludes that
Basel III is the regulation with the
biggest effect on the profitability of
trades exploiting arbitrage
opportunities.896
Post-crisis regulations may also be
having effects on the co-movement 897 in
liquidity metrics across markets. A
recent paper 898 exploring this issue
posits two channels for this increased
co-movement in liquidity. First,
liquidity supply is capital intensive, and
absorbing trades into inventory in one
risky asset class may use up the capital
capacity of a dealer to provide liquidity
in other assets. Basel III and liquidity
requirements for banks may aggravate
this effect. Second, bank dealers may
face uncertainty about their ability to
rely on the market making exemption in
the 2013 rule, as the distinctions
between prohibited proprietary trading
and permissible market making may
often be unclear. As discussed above,
prior studies suggest that the 2013 rule
may have reduced the inventory
capacity of bank dealers. Empirically,
the paper documents that co-movement
among measures of illiquidity of stock,
bond, and CDS markets has risen
significantly after the 2007–2008
financial crisis, particularly during the
regulatory implementation period. For
example, the regulatory period is
characterized by a much larger fraction
of firms exhibiting positive pairwise
correlations between measures of
illiquidity. The paper concludes that the
2013 rule and the tightening of capital
and liquidity regulations reduced the
inventory capacity of market makers,
resulting in higher co-movement in
liquidity across various financial
markets. Importantly, the paper argues
that these results are not consistent with
896 These findings are also consistent with
another paper that finds an exogenous increase in
the leverage ratio constraint in the UK to have
reduced repo market liquidity—an effect especially
pronounced in transactions between dealers and
small customers. See Antonis Kotidis and Neeltje
Horen, Repo Market Functioning: The Role of
Capital Regulation (2018) (working paper) last
accessed June 3, 2019.
897 Co-movement in two variables generally refers
to a positive correlation of changes in the two
variables over time. For example, co-movement in
returns refers to a pattern of positive correlation in
returns among different securities or asset classes.
Similarly, co-movement in liquidity metrics
suggests a positive correlation of changes in
liquidity metrics. See, e.g., Nicholas Barberis et al.,
Co-movement, 75 J. Fin. Econ. 283 (2005).
898 See Xinjie Wang et al., Do Post-Crisis
Regulations Affect Market Liquidity? Evidence from
the Co-Movement of Stock, Bond, and CDS
Illiquidity (2018) (working paper) last accessed 6/3/
2019.
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increased electronic trading as that
would have resulted in a reduced
reliance on market makers and an
increased reliance on customers, which
should have reduced (instead of
increased) co-movement in liquidity
across markets.
With respect to liquidity in the dealercentric, single-name CDS market, the
SEC elsewhere found that, while dealercustomer activity and various trading
activity metrics have generally remained
stable, interdealer trading, trade sizes,
number of quotes, and quoted spreads
for certain illiquid borrowers have
worsened since 2010.899 In addition, a
recent paper 900 seeks to tie financial
reforms to trends in liquidity in the
single-name CDS markets. Specifically,
the paper finds that the sample period
(2010 through 2016) saw a decline in
interdealer trading, a decrease in net
dealer inventories, and a decline in
customer transaction volume. In
addition, bid-ask spreads in later years
are more heavily dependent on
individual dealer inventories rather
than aggregate inventories of all dealers.
Notably, the paper does not estimate the
optimal volume of trading activity.
Overall, the paper concludes that
increased costs of market making have
affected liquidity provision in the
single-name CDS market.
While these studies are necessarily
limited in scope, methodology, and
measurement, their results may indicate
that section 13 of the BHC Act and the
2013 rule may have reduced dealer
provision of liquidity, particularly in
times of stress.901 There is little
empirical evidence concerning whether
customers will continue to provide
liquidity in times of severe market
stress, possibly since such empirical
settings are scarce in the post-crisis
period. One recent paper builds a
theoretical model 902 that suggests that
constraints on dealer balance sheets
may benefit customers and reduce
transaction costs as they can induce
dealers to invest in technology designed
to match customers to each other.
However, this model does not explicitly
examine dealer behavior in times of
stress. In addition, the results rely on
899 See
SEC Report 2017, supra note 774.
Mark Paddrik and Stathis Tompaidis,
Market Making Costs and Liquidity: Evidence from
CDS Markets (Off. of Fin. Research Working Paper
19–01, 2019) available at https://
www.financialresearch.gov/working-papers/files/
OFRwp-19-01_Market-Making-Costs-and-LiquidityEvidence-from-CDS-Markets.pdf, last accessed 7/5/
2019.
901 See, e.g., supra notes 881, 887, 889, and 891.
902 See Gideon Saar et al., From Market Making
to Matchmaking: Does Bank Regulation Harm
Market Liquidity? (May 22, 2019) (working paper)
last accessed June 3, 2019.
strong modeling assumptions. The
model assumes that only bank dealers
are able to develop technology to match
customers and assumes away the role of
an inter-dealer market or competition
among dealers in the interdealer market.
If these assumptions are violated, it is
unclear whether the results will
continue to hold. For example, if
nonbank dealers (as well as bank
dealers) can develop customer matching
technology, constraining dealer balance
sheets may not be necessary for the
development of technology matching
customers to other customers or the
disintermediation of trading, with its
resulting welfare improvements.
Similarly, in the presence of an
interdealer market, constraining dealer
balance sheets may benefit customers by
facilitating customer-to-customer
trading but may also reduce the ability
of dealers to demand liquidity from
other dealers.
Moreover, as discussed above,
existing research suggests that nondealer institutions may be constrained
in their ability to secure funding from
prime brokers that are affected by postcrisis regulations, limiting the ability of
non-dealers to arbitrage away
mispricings. It is even less clear whether
customers would be willing and able to
secure funding liquidity and stand on
the buy side of customer sells during
severe market stress across asset
markets.
Finally, the agencies also received
comment that end-users are increasingly
finding that their bank counterparties
have reduced short-term lending and
repo activity, while other end-users are
experiencing higher discounts to posted
collateral as a result of the 2013 rule.903
The SEC is informed by research on the
effects of the constraints dealers face as
a result of post-crisis regulations and
liquidity provision.904 One particular
study on this issue 905 finds that dealer
balance sheet constraints have broad
market-wide effects on bond liquidity
beyond the liquidity of bonds with a
particular credit rating, sector, or issue
size. The paper finds that, prior to the
crisis, bonds were more liquid when
they were traded by more levered
dealers, dealers with higher return on
assets and lower vulnerability
900 See
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903 See
Coalition for Derivatives End Users.
a more general model of the links between
repo market frictions and liquidity in underlying
cash markets see, e.g., Yesol Huh and Sebastian
Infante, Bond Market Intermediation and the Role
of Repo (Oct. 22, 2018) (working paper) last
accessed 6/3/2019.
905 See Tobias Adrian et al., Dealer Balance
Sheets and Bond Liquidity Provision, 89 J. Monetary
Econ. 92 (2017).
See also SEC Report 2017, supra note 774, at 115–
16.
904 For
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(measured by conditional value-atrisk),906 dealers with lower riskweighted assets, and dealers with
relatively low reliance on repo.
However, during the rule
implementation period (post-2014)
these results have reversed, and bonds
are more liquid when they are traded by
less-levered dealers, dealers with lower
return on assets, dealers with higher
risk-weighted assets, and dealers with
more reliance on repo funding. Finally,
unlike the pre-crisis period, during the
rule implementation period (post-2014),
dealers with more reliance on repo
funding, with higher trading revenues,
with larger maturity mismatches, with
higher measures of vulnerability, and
with fewer assets held as loans are less
likely to accommodate customer order
flow and are more likely to access the
interdealer market instead. Though
these results do not speak to dealer
behavior in times of stress, they are
based on a substantially larger sample
compared with the discussed above
work showing liquidity declines in
times of stress. Overall, while the paper
does not delineate the effects of the
Volcker Rule from other post-crisis
regulations (such as the supplemental
leverage ratio), the paper’s findings
indicate that tightening of dealer
balance sheet constraints due to the
package of post-crisis financial
regulations may adversely affect the
ability of affected dealers to
intermediate customer trading in bond
markets.
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The SEC also recognizes that the
effects of the 2013 rule on the ability
and willingness of banks to engage in
repo activity may be compounded by
other post-crisis reforms. For example,
one study 907 focuses on the effects of
the liquidity coverage ratio, exploiting
cross-country differences in the
implementation of the rule. The paper
finds that, as a result of the liquidity
coverage ratio, U.S. dealers reduced
their reliance on repo in funding highquality liquid assets by more, and
increased the maturity of lower-quality906 See Tobias Adrian and Markus Brunnermeier,
CoVar, 106 Am. Econ. Rev. 1705 (2016).
907 See Marco Macchiavelli and Luke Pettit,
Liquidity Regulation and Financial Intermediaries
(Jul. 29, 2019) (working paper) last accessed 8/29/
2019.
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collateral repos by more, than did
foreign dealers.
Importantly, reduced ability and
willingness to engage in repo activity
are likely to have downstream effects on
customers and market quality. For
example, a paper 908 recently showed
that dealers’ ability to rely on repos to
finance bond inventory has an effect on
bid-ask spreads and bond transaction
costs; that dealers with less access to
funding liquidity are less likely to
provide liquidity on a principal basis
and are more likely to trade on an
agency basis instead; and that funding
liquidity has causal effects on bond
market liquidity.
As discussed above, corporate bond
dealers, particularly bank-affiliated
dealers, may have, on aggregate,
reduced their capital commitment postcrisis—a result that is consistent with a
reduction in liquidity provision in
corporate bonds because of the 2013
rule. In addition, the 2013 rule may
have resulted in many corporate bond
dealers shifting from trading in a
principal capacity to agency trading.
Moreover, corporate bond dealers may
decrease liquidity provision during
certain times of stress in general (e.g.,
during a financial crisis) 909 and after
the 2013 rule in particular, as discussed
above. Nonbank dealers and non-dealer
intermediaries may not have fully offset
the shortfall in liquidity provision,
partly because of their reliance on
funding from financial institutions
affected by post-crisis financial reforms.
The SEC recognizes that the effects of
the 2013 rule on the activities of
banking entities and conflicts of interest
may flow through to SEC-registered
dealers and investment advisers
affiliated with banks and bank holding
companies directly (if banks and
holding companies transact through
their dealer affiliates) and indirectly
(e.g., through effects on capital
908 See Marco Macchiavelli and Xing Zhou,
Funding Liquidity and Market Liquidity: The
Broker-Dealer Perspective (Jul. 17, 2019) (working
paper) last accessed 8/29/2019.
909 Dealers provide less liquidity to clients and
peripheral dealers during stress times; during the
peak of the crisis, core dealers charged higher
spreads to peripheral dealers and clients but lower
spreads to dealers with whom they had strong ties.
See Marco Di Maggio et al., The Value of Trading
Relationships in Turbulent Times, 124 J. Fin. Econ.
266 (2017). See also Jaewon Choi and Or Shachar,
Did Liquidity Providers Become Liquidity Seekers?
(Oct., 2013), New York Fed Staff Report No. 650.
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62053
requirements, profitability, compliance
systems, and policies and procedures),
and may have an effect on securities
markets. As discussed in the
proposal,910 the presence and
magnitude of spillover effects across
different types of financial institutions
vary over time and may be more
significant in times of stress.911
iv. Compliance Burdens, Profitability,
and Competitive Effects
In the proposal, the SEC recognized
that the scope and breadth of the
compliance obligations impose costs on
banking entities, which may be
particularly important for smaller
entities.912 The SEC noted commenters’
estimates that banking entities may have
added as many as 2,500 pages of
policies, procedures, mandates, and
controls per institution for the purposes
of compliance with the 2013 rule, which
need to be monitored and updated on an
ongoing basis, and that some banking
entities may spend, on average, more
than 10,000 hours on training each year.
In terms of ongoing costs, in the
proposal the SEC noted a market
participant’s estimate that some banking
entities may have 15 regularly meeting
committees and forums, with as many
as 50 participants per institution
dedicated to compliance with the 2013
rule.
In connection with the proposal, the
agencies have received a number of
comments on the compliance burdens of
the 2013 rule. Some commenters
presented trends in bank profitability,
trading revenue, and loan growth,
arguing that the proposed amendments
are unnecessary.913 Others indicated
that the Volcker Rule may reduce bank
profits due to the elimination of
proprietary trading but that lost profits
are not costs but intended regulatory
effects of section 13 of the BHC Act.914
910 See
83 FR at 33534.
e.g., Monica Billio et al., Econometric
Measures of Connectedness and Systemic Risk in
the Finance and Insurance Sectors, 104 J. Fin. Econ.
535 (2012). See also Zeno Adams et al., Spillover
Effects Among Financial Institutions: A StateDependent Sensitivity Value at Risk Approach
(SDSVar), 49 J. Fin. & Quantitative Analysis 575
(2014). See also Adrian and Brunnermeier (2016)
supra note 906.
912 See, e.g., 83 FR at 33550.
913 See, e.g., Volcker Alliance and AFR.
914 See, e.g., Occupy the SEC.
911 See,
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In response to those comments, the
SEC continues to note that the scope of
this economic analysis is limited to SEC
registrants, and securities markets and
their participants. Importantly, trends in
profitability are not informative of the
direct causal effect on profitability or
compliance burdens of section 13 of the
BHC Act or of the 2013 rule, since there
is no data about the amount of revenue
or compliance burdens that would have
occurred in the absence of the 2013 rule.
Moreover, the agencies have received a
number of comments pointing to large
and significant burdens of section 13 of
the BHC Act and various components of
the agencies’ 2013 rule. For example,
one commenter estimated that
proprietary trading requirements related
to RENTD involved annual costs of as
much as about $513 million; that the
metrics-related policies and procedures
requirements involved initial burdens of
approximately $41.5 million; that total
compliance expenditures of affected
entities (including with respect to
covered funds) totaled between $402
million and $541 million; and that
covered funds requirements involved a
cost of between $152 million and $690
million.915 Another commenter
estimated that, for at least one banking
entity, sorting counterparties into
customers and non-customers for the
purposes of calculating RENTD requires
dozens of employees spending
thousands of hours in initial and
ongoing burdens.916 Another
commenter stated that simplifying
covered funds requirements would
eliminate thousands of unnecessary
hours in compliance burdens related to
activities that do not raise the concerns
intended to be addressed by section 13
of the BHC Act.917 One trade
organization indicated that duplicative
examinations drastically increase
burdens on registrants, estimating that
in 2016 members of the organization
spent in aggregate over 50,000 hours
responding to inquiries and
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915 See Data Boiler, citing its own analysis as well
as SIA Partners Briefing Note, July 2015, ‘‘Volcker
Implementation,’’ available at https://en.finance.siapartners.com/sites/default/files/post/sia_partners__briefing_note_volcker_coveredfunds_blog_
version.pdf, last accessed 6/4/2019.
916 See CCMC.
917 See SFIG.
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examinations related to section 13 of the
BHC Act.918
Moreover, the SEC notes that riskaverse market participants are
compensated for bearing greater
systematic 919 risks with higher
expected returns.920 If capital markets
have a high degree of efficiency and
arbitrage opportunities are generally
scarce, greater profitability may simply
be indicative of greater risks taken on by
banking entities. Setting aside the
challenges of causal inference discussed
above, trends in bank profitability may
reflect not only compliance burdens of
the 2013 rule, but also the effects of the
2013 rule on banking entity risk
exposures from permissible activities.
That is, banking entities may have
become more willing to take risk
through engaging in activities permitted
by the 2013 rule. For more discussion of
the existing evidence on the effects of
the 2013 rule on the activities of
banking entities, see the preceding
sections of the economic baseline.
The agencies also received a number
of comments concerning the need to
tailor regulations to banking entities on
the basis of risk profile in order to
balance the intended regulatory goals
with compliance burdens and
competitive effects. Specifically, a
number of commenters supported
tailoring the 2013 rule to more
effectively accomplish the underlying
goals of section 13 of the BHC Act,
reduce unnecessary compliance
burdens, particularly on smaller and
mid-sized banking entities and entities
with small trading books, and more
effectively allocate supervisory
resources to prudential goals.921
The SEC continues to believe that the
compliance regime under the 2013 rule
and related burdens reduce the
profitability of permissible activities by
bank-affiliated dealers and investment
918 See
SIFMA.
term ‘‘systematic risk’’ generally refers to
the variability of returns due to macroeconomic
factors that affect all risky assets and, thus, cannot
be eliminated by diversification. See Frank Reilly
& Keith Brown, Investment Analysis & Portfolio
Management, 1025 (9th ed. 2009). See also Bodie,
supra note 840, at G–12.
920 See supra note 840.
921 See, e.g., IIB; CCMC; CREFC; CCMR;
Covington; Capital One et al. and Credit Suisse.
919 The
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advisers and may be passed along to
customers or clients in the form of
reduced provision of services or higher
service costs.922 Moreover, the SEC
continues to believe that the extensive
compliance program under the 2013
rule detracts resources of some banking
entities and their compliance
departments and supervisors from other
compliance matters, risk management,
and supervision. Finally, the SEC
continues to believe that prescriptive
compliance requirements may not
optimally reflect the organizational
structures, governance mechanisms, or
risk management practices of complex,
innovative, and global banking entities.
In the sections that follow the SEC
discusses rule provisions of the 2013
rule, how each amendment in the final
rule changes the economic effects of the
regulatory requirements, and the
anticipated costs and benefits of the
amendments.
c. Affected Participants
The SEC-regulated entities directly
affected by the final rule include brokerdealers, security-based swap dealers,
and investment advisers.
i. Broker-Dealers 923
Under the 2013 rule, some of the
largest SEC-regulated broker-dealers are
banking entities because they are
affiliated with banks or bank holding
companies. Table 1 reports the number,
total assets, and holdings of brokerdealers by the broker-dealer’s bank
affiliation.
922 See
83 FR at 33550.
estimates differ from the estimates in
the proposal and in the EGRRCPA Conforming
Amendments Adopting Release, as these estimates
rely on more recent data and information about
both U.S. and global trading assets and liabilities of
bank holding companies. This analysis is based on
data from Reporting Form FR Y–9C for domestic
holding companies on a consolidated basis and
Report of Condition and Income for banks regulated
by the Board, FDIC, and OCC for the most recent
available four-quarter average, as well as data from
S&P Market Intelligence LLC on the estimated
amount of global trading activity of U.S. and nonU.S. bank holding companies. Broker-dealer bank
affiliations were obtained from the Federal
Financial Institutions Examination Council’s
(FFIEC) National Information Center (NIC). Brokerdealer assets and holdings were obtained from
FOCUS Report data for Q4 2018.
923 These
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While the 199 bank-affiliated brokerdealers subject to the 2013 rule (affected
broker-dealers) are greatly outnumbered
by the 3,595 broker-dealers that are
either bank broker-dealers exempt under
section 203 of EGRRCPA or nonbank
broker-dealers, the affected brokerdealers dominate other broker-dealers in
62055
terms of total assets (72.7% of total
broker-dealer assets) and aggregate
holdings (66.5% of total broker-dealer
holdings).
TABLE 1—BROKER-DEALER COUNT, ASSETS, AND HOLDINGS BY AFFILIATION
Broker-dealer bank affiliation
Total assets,
$mln 924
Number
Holdings,
$mln 925
Holdings
(altern.),
$mln 926
Bank broker-dealers affected by the final rule 927 ...........................................
All other broker-dealers 928 ..............................................................................
199
3,595
3,142,780
1,179,805
761,532
382,451
567,387
225,675
Total ..........................................................................................................
3,794
4,322,586
1,143,983
793,062
Some of the amendments to the 2013
rule that the agencies are adopting
differentiate banking entities on the
basis of their consolidated trading assets
and liabilities.929 Table 2 reports
affected broker-dealer counts, assets,
and holdings by consolidated trading
assets and liabilities of the (top-level)
parent firm. The SEC estimates that 163
broker-dealer affiliates of firms with less
than $20 billion in consolidated trading
assets and liabilities account for 20.4%
of bank-affiliated broker-dealer assets
and 17.8% of holdings (or 7% using the
alternative measure of holdings).930
TABLE 2—BROKER-DEALER COUNTS, ASSETS, AND HOLDINGS BY CONSOLIDATED TRADING ASSETS AND LIABILITIES OF
THE BANKING ENTITY 931
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Consolidated trading
assets and liabilities 932
Number
Total assets,
$mln
Percent
Holdings,
$mln
Percent
Holdings (altern.),
$mln
Percent
≥50bln ........................................
20bln–50bln ................................
10bln–20bln ................................
5bln–10bln ..................................
1bln–5bln ....................................
≤1bln ..........................................
28
8
9
24
33
97
2,152,225
349,716
198,895
261,622
66,583
113,740
68
11
6
8
2
4
555,787
70,054
49,797
55,316
18,319
12,259
73
9
7
7
2
2
510,325
17,611
13,301
14,295
4,998
6,857
90
3
2
3
1
1
Total ....................................
199
3,142,780
100
761,532
100
567,387
100
ii. Security-Based Swap Dealers
The final rule may also affect bankaffiliated SBSDs. As compliance with
SBSD registration requirements is not
yet required, there are currently no
registered SBSDs. However, the SEC has
previously estimated that as many as 50
entities may potentially register as
security-based swap dealers and that as
many as 16 of these entities may already
be SEC-registered broker-dealers.933
Similarly, the SEC previously estimated
that between 0 and 5 entities may
register as Major Security-Based Swap
Participants (MSBSPs).934 On the basis
of the analysis of TIW transaction and
positions data on single-name creditdefault swaps, the SEC believes that all
entities that may register with the SEC
as SBSDs are bank-affiliated firms,
including those that are SEC-registered
broker-dealers. Therefore, the SEC
estimates that, in addition to the bankaffiliated SBSDs that are already
registered as broker-dealers and
included in the discussion above, as
many as 34 other bank-affiliated SBSDs
may be affected by these amendments.
Similarly, on the basis of the analysis of
TIW data, the SEC estimates that none
of the entities that may register with the
SEC as MSBSPs are affected by the final
rule.
Importantly, compliance with capital
and other substantive requirements for
SBSDs under Title VII of the DoddFrank Act is not yet required.935 The
SEC recognizes that firms may choose to
move security-based swap trading
activity into (or out of) an affiliated bank
or an affiliated broker-dealer instead of
registering as a standalone SBSD, if
bank or broker-dealer capital and other
regulatory requirements are less (or
more) costly than those that may be
imposed on SBSDs under Title VII. As
a result, the above figures may
924 Broker-dealer total assets are based on FOCUS
report data for ‘‘Total Assets.’’
925 Broker-dealer holdings are based on FOCUS
report data for securities and spot commodities
owned at market value, including bankers’
acceptances, certificates of deposit and commercial
paper, state and municipal government obligations,
corporate obligations, stocks and warrants, options,
arbitrage, other securities, U.S. and Canadian
government obligations, and spot commodities.
926 This alternative measure excludes U.S. and
Canadian government obligations and spot
commodities.
927 This category includes all bank-affiliated
broker-dealers except those exempted by section
203 of EGRRCPA.
928 This category includes both bank affiliated
broker-dealers subject to section 203 of EGRRCPA
and broker-dealers that are not affiliated with banks
or holding companies.
929 See, e.g., 2013 rule § ll.20(d)(1).
930 See supra note 926.
931 This analysis excludes SEC-registered brokerdealers subject to section 203 of EGRRCPA.
932 Consolidated trading assets and liabilities are
estimated using information reported in form FR Y–
9C data and from S&P Market Intelligence LLC on
the estimated amount of global trading activity
provided for U.S. and non-U.S. firms. These
estimates exclude from the definition of
consolidated trading assets and liabilities
government, agency, and GSE securities. U.S.
trading assets and liabilities are calculated on the
basis of the most recent four-quarter average, except
for foreign firms without an intermediate holding
company, for which the amount of trading activity
for the nonbank and edge subsidiaries does not
exclude securities of government-sponsored
enterprises. For top-tier bank holding companies,
top-tier independent depositary institutions, and
foreign parents with U.S. activity, Ginnie Mae
securities are included in the calculation of trading
assets and liabilities because of data limitations. (It
is not possible to exclude Ginnie Mae securities
without also excluding Fannie Mae and Freddie
Mac securities.)
933 See Capital, Margin, Segregation Adopting
Release, 84 FR at 43960.
934 Id.
935 Id.
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overestimate or underestimate the
number of SBSDs that are not brokerdealers and that may become SECregistered entities affected by the final
rule. Quantitative cost estimates are
provided separately for affected brokerdealers and potential SBSDs.
iii. Private Funds and Private Fund
Advisers 936
This section focuses on RIAs advising
private funds. Using Form ADV data,
Table 3 reports the number of RIAs
advising private funds by fund types, as
those types are defined in Form ADV.
Table 4 reports the number and gross
assets of private funds advised by RIAs
and separately reports these statistics for
bank-affiliated RIAs. As can be seen
from Table 3, the two largest categories
of private funds advised by RIAs are
hedge funds and private equity funds.
Bank-affiliated RIAs advise a total of
4,316 private funds with approximately
$2 trillion in gross assets. Per Form ADV
data, bank-affiliated RIAs’ gross private
fund assets under management are
concentrated in hedge funds and private
equity funds. On the basis of this data,
bank-affiliated RIAs advise 929 hedge
funds with approximately $668 billion
in gross assets and 1,420 private equity
funds with approximately $395 billion
in assets. While bank-affiliated RIAs are
subject to all of section 13’s restrictions,
because RIAs do not typically engage in
proprietary trading, the SEC continues
to believe that they will not be affected
by the final rule as it relates to
proprietary trading.
TABLE 3—SEC-REGISTERED INVESTMENT ADVISERS ADVISING PRIVATE FUNDS, BY FUND TYPE 937
Fund type
All RIA
Bankaffiliated
RIA
Hedge Funds ...........................................................................................................................................................
Private Equity Funds ...............................................................................................................................................
Real Estate Funds ...................................................................................................................................................
Securitized Asset Funds ..........................................................................................................................................
Liquidity Funds .........................................................................................................................................................
Venture Capital Funds .............................................................................................................................................
Other Private Funds ................................................................................................................................................
2,656
1,644
526
220
46
193
1,066
154
98
52
45
16
8
146
Total Private Fund Advisers .............................................................................................................................
4,756
296
TABLE 4—THE NUMBER AND GROSS ASSETS OF PRIVATE FUNDS ADVISED BY SEC-REGISTERED INVESTMENT
ADVISERS 938
Number of private funds
Fund type
All RIA
All RIA
Bank-affiliated
RIA
Hedge Funds ...................................................................................................
Private Equity Funds .......................................................................................
Real Estate Funds ...........................................................................................
Securitized Asset Funds ..................................................................................
Liquidity Funds .................................................................................................
Venture Capital Funds .....................................................................................
Other Private Funds ........................................................................................
10,431
14,775
3,472
1,814
83
1,201
4,460
929
1,420
320
358
30
43
1,217
7,160
3,446
646
661
297
136
1,396
668
395
100
129
195
3
474
Total Private Funds ..................................................................................
36,230
4,316
13,741
1,964
In addition, for an additional period
of 2 years until July 21, 2021, the
banking agencies will not treat
qualifying foreign excluded funds that
meet the conditions included in the
policy statement discussed above as
banking entities or attribute their
activities and investments to the
banking entity that sponsors the fund or
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Bank-affiliated
RIA
Gross assets, $bln
936 These estimates are calculated from Form
ADV data as of March 31, 2019. An investment
adviser is defined as a ‘‘private fund adviser’’ if it
indicates that it is an adviser to any private fund
on Form ADV Item 7.B. An investment adviser is
defined as a ‘‘bank-affiliated RIA’’ if it indicates on
Form ADV Item 6.A.(7) that it is actively engaged
in business as a bank, or it indicates on Form ADV
Item 7.A.(8) that it has a ‘‘related person’’ that is
a banking or thrift institution. For purposes of Form
ADV, a ‘‘related person’’ is any advisory affiliate
and any person that is under common control with
the adviser. The definition of ‘‘control’’ for
purposes of Form ADV, which is used in
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Jkt 250001
otherwise may control the fund under
the circumstances set forth in the policy
statement.939
iv. Registered Investment Companies
The potential that a registered
investment company (RIC) or a business
development company (BDC) would be
treated as a banking entity where the
identifying related persons on the form, differs from
the definition of ‘‘control’’ under the BHC Act. In
addition, this analysis does not exclude SECregistered investment advisers affiliated with banks
that have consolidated total assets less than or equal
to $10 billion and trading assets and liabilities less
than or equal to 5% of total assets. Thus, these
figures may overestimate or underestimate the
number of bank-affiliated RIAs.
937 This table includes only the advisers that list
private funds on Section 7.B.(1) of Form ADV. The
number of advisers in the ‘‘Any Private Fund’’ row
is not the sum of the rows that follow, since an
PO 00000
Frm 00084
Fmt 4701
Sfmt 4700
fund’s sponsor is a banking entity and
holds 25% or more of the RIC or BDC’s
voting securities after a seeding period
also forms part of the baseline. On the
basis of Commission filings and public
data, the SEC estimates that, as of yearend 2018, there were approximately
adviser may advise multiple types of private funds.
Each listed private fund type (e.g., real estate fund,
liquidity fund) is defined in Form ADV, and those
definitions are the same for purposes of the SEC’s
Form PF.
938 Gross assets include uncalled capital
commitments on Form ADV.
939 See ‘‘Statement regarding Treatment of Certain
Foreign Funds under the Rules Implementing
Section 13 of the Bank Holding Company Act,’’ July
19, 2019, available at https://www.occ.gov/newsissuances/news-releases/2019/nr-ia-2019-79a.pdf,
last accessed July 19, 2019.
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15,700 RICs 940 and 104 BDCs. Although
RICs and BDCs are generally not
banking entities themselves subject to
the 2013 rule, they may be indirectly
affected by the 2013 rule and the final
rule, for example, if their sponsors or
advisers are banking entities. For
instance, bank-affiliated RIAs or their
affiliates may reduce their level of
investment in the funds they advise, or
potentially close those funds, to avoid
those funds becoming banking entities
themselves.
v. Entities Reporting Metrics to the
SEC 941
The regulatory reporting requirements
of the 2013 rule with respect to bankaffiliated broker-dealers, SBSDs, and
RIAs are described in section V.F.2.a
above. As discussed below, the final
rule increases the threshold for entities
subject to metrics reporting from the $10
billion under the 2013 rule to $20
billion in trading assets and liabilities.
Moreover, the final amendments that
link the trading desk definition to the
market risk capital rule have an effect
on the volume of reporting to the SEC
and corresponding burdens.
The agencies have received a number
of comments opposing the proposed
amendments to metrics reporting and
challenging the agencies’ assessment of
the proposed amendments.942 For
example, one commenter indicated that
the SEC’s assessment of the overall
streamlining effects of the amendments
to metrics reporting and recordkeeping
will not be supported by a full-fledged
cost-benefit analysis.943 Another
commenter stated that the proposal
presented no analysis showing that the
benefits of eliminating some metrics
outweigh the costs of imposing new
metrics.944 A number of commenters
indicated that the agencies should not
adopt any of the proposed amendments
to metrics reporting as they would result
in a significant net increase in metrics
data.945 One commenter estimated that
the proposed requirements would
require its member institutions to report
hundreds of thousands of additional
data points each month.946 One
commenter indicated that the extended
reporting timeframe for metrics
submission is insufficient and frequent
resubmissions are likely to persist.947 In
response to these comments and to
enable a quantification of the economic
effects of the metrics amendments on
the volume and timeliness of metrics
reporting, the SEC is updating the
economic baseline with summary
information about the current volume
and resubmission statistics by different
groups of Appendix A filers.
TABLE 5—VOLUME OF METRICS RECORDS SUBMITTED TO THE SEC, BY TRADING ASSETS AND LIABILITIES 948
Number of
reporters
Trading assets & liabilities
Records
submitted
>50bln ......................................................................................................................................................................
20bln–50bln .............................................................................................................................................................
<20bln ......................................................................................................................................................................
8
4
6
40,771,825
7,357,794
10,440,677
Total ..................................................................................................................................................................
18
58,570,296
TABLE 6—TRADING DESKS REPORTING METRICS TO THE SEC, BY TRADING ASSETS AND LIABILITIES
Average
number of
records per
submission
Average
number
of desks
Trading assets & liabilities
>50bln ..........................................................................................................................................
20bln–50bln .................................................................................................................................
<20bln ..........................................................................................................................................
56
43
38
450,921
195,010
216,433
Average
number of
records
per desk
7,588
5,172
7,093
TABLE 7—TIME DELAYS AND RESUBMISSIONS OF METRICS RECORDS SUBMITTED TO THE SEC
Total number
of submitted
records
Trading assets & liabilities
Percent of
records not
resubmitted
Percent of
records
resubmitted
once
Percent of
records
resubmitted
twice
Panel A. Resubmissions of Initial Records
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>50bln ..............................................................................................................
20bln–50bln .....................................................................................................
<20bln ..............................................................................................................
940 This estimate includes open-end companies,
exchange-traded funds, closed-end funds, and noninsurance unit investment trusts and does not
include fund of funds. The inclusion of fund of
funds increases this estimate to approximately
17,200.
941 The estimates in this section are based on
Appendix A information provided by reporters to
the SEC under the 2013 rule at the holding
company level for April 2018 through March 2019,
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18:12 Nov 13, 2019
Jkt 250001
40,785,033
6,908,332
10,441,265
based on the most complete filing for each reporting
period. Appendix A records for a particular trading
desk are reported to the SEC if a trading desk books
activity into the SEC registrant.
942 See, e.g., ABA; Credit Suisse; CCMR; FSF,
Public Citizen and SIFMA.
943 See SIFMA Annex C.
944 See CCMR.
945 See, e.g., CCMC and FSF.
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34
61
96
946 See
56
39
4
10
0
0
FSF.
SIFMA Annex C.
948 For the purposes of this analysis, each record
is one line of the matrix reported to the SEC, with
the value filled out by the reporting entity, on a
monthly basis, for all its related trading desks. The
total number of records also includes the header,
body, and footer. Each submission is the full data
matrix reported by the reporting entity to the SEC
for any specific reporting month.
947 See
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Total records
submitted late
(initial
submission)
Trading assets & liabilities
Percent of
late initial
submissions
Average
delay in initial
submissions
(days, simple
average)
Average
delay in
initial
submissions
(days,
weighted by
record count)
Panel B. Delayed Submission of Initial Records
>50bln ..............................................................................................................
20bln–50bln .....................................................................................................
<20bln ..............................................................................................................
The SEC notes two important caveats
relevant for the interpretation of these
statistics. First, direct attribution of
specific trading activity by a trading
desk to an SEC registrant or group of
registrants is not feasible, since the
trading desk may book transactions into
multiple legal entities, including both
those registered with the SEC as well as
those that are not registered. As a result,
the scope of activity reported in this
section is likely to overestimate the
records and reporting by legal entities
registered with the SEC. Second, the
SEC does not receive reporting from
trading desks that do not transact on
behalf of SEC-registered entities.
Therefore, these estimates may
significantly underestimate the overall
volume of metrics reporting by all
banking entities (including those that
are not registered with the SEC) related
to the 2013 rule.
3. Economic Effects
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a. Treatment of Entities Based on the
Size of Trading Assets and Liabilities
As proposed, the agencies are
adopting a categorization of banking
entities into three groups on the basis of
the size of their trading activity. Under
the final rule, banking entities with
significant trading assets and liabilities
(Group A entities) are required to
comply with a streamlined but
comprehensive version of the 2013
rule’s compliance program
requirements, as discussed below.
Banking entities with moderate trading
assets and liabilities (Group B entities)
are subject to reduced requirements and
an even more tailored approach in light
of their smaller trading activities. The
burdens are further reduced for banking
entities with limited trading assets and
liabilities (Group C entities), for which
the amendments establish a
presumption of compliance, which can
be rebutted by the agencies. The
sections that follow discuss the
economic effects of each of the
amendments on these groups of entities.
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4,771,713
4,020,778
10,437,647
i. Costs and Benefits
First, banking entities with significant
trading assets and liabilities are defined
as those that have, together with
affiliates and subsidiaries, trading assets
and liabilities (excluding trading assets
and liabilities attributable to trading
activities permitted pursuant to
§ ll.6(a)(1) and (2) of subpart B) the
average gross sum of which, over the
previous consecutive four quarters, as
measured as of the last day of each of
the four previous calendar quarters,
equals or exceeds $20 billion.949 This
$20 billion threshold is higher than the
threshold that the agencies proposed in
the proposal. Accordingly, more
banking entities may qualify as Group B
entities rather than Group A entities (as
compared to those that would have
qualified under the proposal’s lower
threshold), which will reduce
compliance burdens for more banking
entities relative to the proposal.950 The
agencies received comments that a
higher than the proposed $10 billion
trading assets and liabilities threshold
would provide Group B banking entities
that are near or approaching $10 billion
threshold with flexibility to have
moderate growth over time and to
manage their business without
triggering the more stringent compliance
requirements imposed on Group A
banking entities.951 In addition, some
commenters stated that potential
fluctuations resulting from customerdriven trades, quarter-end activity, and
market and foreign exchange volatility
may cause banking entities that are near
949 With respect to a banking entity that is a
foreign banking organization or a subsidiary of a
foreign banking organization, this threshold for
having significant trading assets and liabilities
applies according to the trading assets and
liabilities of the combined U.S. operations of the
top-tier foreign banking organization (including all
subsidiaries, affiliates, branches, and agencies of the
foreign banking organization operating, located, or
organized in the United States).
950 The final rule defines banking entities with
moderate trading assets and liabilities as those that
are neither banking entities with significant trading
assets and liabilities nor banking entities with
limited trading assets and liabilities.
951 See, e.g., Capital One et al.; ABA; BPI; and
Custody Banks.
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12
58
99.97
2
32
46
2
32
42
or approaching the $10 billion threshold
to exceed this threshold.952 The SEC
recognizes that fluctuations in customer
demand or market events may cause
these banking entities to exceed the $10
billion threshold temporarily or
permanently, which could trigger a
more enhanced compliance regime and
expose these banking entities to higher
compliance costs.953 Thus, a $20 billion
threshold accounts for such fluctuations
and provides banking entities that are
near or approaching $10 billion in
trading assets and liabilities with more
certainty regarding their compliance
burdens.
Some commenters stated that
changing the threshold from $10 to $20
billion would have minimal effect on
the number of banking entities that
would remain categorized as having
significant trading assets and
liabilities.954 The SEC estimates that
there are 66 broker-dealers with
approximately 16% of all broker-dealer
holdings (or 6% based on the alternative
measure) that would qualify as Group B
entities with the adopted $20 billion
threshold—compared to 57 brokerdealers with between 9% and 4% of all
broker-dealer holdings that would have
qualified under the proposed threshold
value. Thus, relative to the proposal, 15
additional broker-dealers will
experience the cost reduction because of
reduced compliance burdens.
Second, as in the proposal, the
agencies are defining a banking entity
with limited trading assets and
liabilities as a banking entity that has,
together with its affiliates and
subsidiaries on a consolidated basis,
trading assets and liabilities (excluding
trading assets and liabilities attributable
to trading activities permitted pursuant
to § ll.6(a)(1) and (2) of subpart B) the
average gross sum of which, over the
previous consecutive four quarters, as
measured as of the last day of each of
the four previous calendar quarters, is
952 See,
e.g., Custody Banks and BPI.
supra note 123.
954 See, e.g., ABA; Custody Banks; New England
Council; Capital One et al.; SIFMA; State Street and
BPI.
953 See
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less than $1 billion. However, in the
proposal, the agencies proposed this
threshold to be calculated on the
worldwide consolidated basis for both
foreign and domestic registrants. Unlike
in the proposal, with respect to a
banking entity that is a foreign banking
organization or a subsidiary of a foreign
banking organization, this threshold
will be applied on the basis of the
combined U.S. operations of the top-tier
foreign banking organization (including
all subsidiaries, affiliates, branches, and
agencies of the foreign banking
organization operating, located, or
organized in the United States).
The SEC continues to recognize that
the 2013 rule may have resulted in
significant compliance burdens for
banking entities that do not have
significant U.S. operations, even though
such entities may not pose substantial
risks to the U.S. financial system
because of their limited presence in the
U.S. The SEC estimates that the adopted
definition of limited trading assets and
liabilities will allow 97 broker-dealers to
reduce compliance costs related to the
2013 rule as a result of the final rule’s
presumption of compliance. In contrast,
if the final rule adopted the proposed
calculation of limited trading assets and
liabilities, some foreign broker-dealers
would not qualify as those affiliated
with entities with limited trading assets
and liabilities, even though the entities
these broker-dealers are affiliated with
may have very limited activity in the
U.S.
Third, in the final rule the calculation
of thresholds for limited and significant
trading assets and liabilities will
exclude—in addition to the proposed
exclusion of trading assets and
liabilities involving obligations of, or
guaranteed by, the United States, or any
agency of the United States—trading
assets and liabilities involving
obligations, participations, or other
instruments of, or issued or guaranteed
by, government-sponsored enterprises
listed in § ll.6(a)(2). Some
commenters stated that the calculation
of trading assets and liabilities should
exclude financial instruments that are
not regulated under the 2013 rule.955
The SEC recognizes that inclusion of
trading assets and liabilities involving
obligations of, participations by, or
other instruments of, or issued or
guaranteed by, government-sponsored
enterprises in the calculation of trading
assets and liabilities may inadvertently
scope in entities whose trading assets
and liabilities primarily consist of
financial instruments that are excluded
955 See,
from the prohibition on proprietary
trading under the 2013 rule.956
Accordingly, the final rule will better
align the application of the tiered
compliance regime with trading
activities that are subject to the
proprietary trading prohibitions. The
SEC estimates that the exclusion of the
aforementioned trading assets and
liabilities from the calculation of the $1
billion and $20 billion thresholds will
not change the assignment of banking
entities into the tiered compliance
groups.
The SEC continues to believe that the
primary effect of these amendments for
SEC registrants is the reduced
compliance burdens, as discussed in
more detail in later sections. To the
extent that the compliance costs are
currently passed along to customers and
counterparties, some of the cost
reductions for these entities associated
with the final rule may flow through to
counterparties and clients in the form of
reduced transaction costs or a greater
willingness to engage in activity,
including intermediation that facilitates
risk-sharing.
The SEC notes that, from above,
Group B and Group C broker-dealers
currently account for approximately 7%
to 18% of total bank broker-dealer
holdings and that, to the extent that
holdings reflect risk exposure resulting
from trading activity, current trading
activity by Group B and Group C
entities may represent lower risks than
the risks posed by Group A entities’
trading activities addressed in the 2013
rule. In addition, the SEC continues to
recognize that some Group B and Group
C entities that currently exhibit low
levels of trading activity because of the
costs of compliance may respond to the
final rule by increasing their trading
assets and liabilities while still
remaining under the $20 billion or $1
billion threshold, as applicable.
Increases in aggregate risk exposure by
Group B and Group C entities may be
magnified if trading activity becomes
more highly correlated among such
entities, or dampened if trading activity
becomes less correlated among such
entities. Since it is difficult to estimate
the number of Group B and Group C
entities that may increase the riskiness
of their activities and the degree to
which their trading activity would be
correlated, the implications of this effect
for aggregate risk and capital market
activity are unclear.
The shifts in risk exposure may have
two competing effects. On the one hand,
if Group B and Group C entities are able
to bear risk at a lower cost than their
e.g., KeyCorp; BMO and Capital One et
956 See
al.
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Frm 00087
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62059
customers, increased risk exposures
could promote secondary market trading
activity and capital formation in
primary markets and increase access to
capital for issuers, benefitting issuers
and investors. On the other hand, Group
B and Group C firms may be
incentivized to increase their risk
exposures, resulting in more aggregate
risk in the banking sector, greater
market fragility, and exacerbated
conflicts of interest between banking
entities and their customers. This may
ultimately adversely affect issuers and
investors. However, the SEC continues
to recognize that the amendments are
focused on tailoring the compliance
regime based on the amount of trading
activity engaged in by each banking
entity, and all banking entities would
still be subject to the statutory
prohibitions related to such activities.
Thus, the potential risk of increased
market fragility and the severity of
conflicts of interest effects is mitigated.
In response to the final rule, it is
possible that trading activity that was
once consolidated within a small
number of unaffiliated banking entities
may become fragmented among a larger
number of unaffiliated banking entities
that each manage down their trading
books under the $20 billion and $1
billion trading assets and liabilities
thresholds to enjoy reduced hedging
compliance and documentation
requirements and a less costly
compliance and reporting regime
described in sections V.F.3.c, V.F.3.d,
V.F.3.g, and V.F.3.h. The extent to
which banking entities may seek to
manage down their trading books will
depend on a number of factors, such as
the size and complexity of each banking
entity’s trading activities and
organizational structure, along with
those of its affiliated entities, as well as
forms of potential restructuring and the
magnitude of expected compliance
savings from such restructuring relative
to the cost of restructuring. The SEC
anticipates that the incentives to
manage the trading book under the $20
billion or $1 billion threshold, as
applicable, may be strongest for those
holding companies that are near or just
above the thresholds. Such management
of the trading book may reduce the size
of trading activity of some banking
entities and reduce the number of
banking entities subject to more
stringent hedging, compliance, and
reporting requirements. At the same
time, if the amendments incentivize
banking entities to have smaller trading
books, they may mitigate moral hazard
and reduce market impacts from the
failure of a given banking entity.
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ii. Efficiency, Competition, and Capital
Formation
The 2013 rule imposes compliance
burdens that may be particularly
significant for smaller market
participants. Moreover, such
compliance burdens may be passed
along to counterparties and customers
in the form of higher costs, reduced
capital formation, or a reduced
willingness to transact. For example, in
the proposal, the SEC cited one
commenter’s estimate that the funding
cost for an average non-financial firm
may have increased by as much as $30
million after the 2013 rule’s
implementation.957 At the same time,
and as discussed in section V.F.2, the
SEC continues to recognize that the
2013 rule may have yielded important
qualitative benefits, such as reducing
certain types of risks in the financial
system and mitigating potential
incentive conflicts that could be posed
by certain types of proprietary trading
by dealers, as well as enhancing
oversight and supervision.
On one hand, as a result of the
amendments, Group B and Group C
entities might enjoy a competitive
advantage relative to similarly situated
Group A and Group B entities
respectively. As noted, firms that are
near to the $20 billion threshold may
actively manage their trading book to
avoid triggering stricter requirements,
and some firms above the threshold may
seek to manage down the trading
activity to qualify for streamlined
treatment under the amendments. As a
result, the amendments may result in
greater competition between Group B
and Group A entities around the $20
billion threshold, and similarly,
between Group B and Group C entities
around the $1 billion threshold, to the
extent that Group C and Group B
entities will increase their trading
activity without reaching the $1 and $20
billion thresholds respectively. On the
other hand, to the extent that the risk
exposure of Group B and Group C
entities increases as they compete with
Group A and Group B entities,
respectively, investors may demand
additional compensation for bearing
financial risk. A higher required rate of
return and higher cost of capital could
therefore offset potential competitive
advantages for Group B and Group C
entities.
In addition, the adopted methods for
the calculation of limited and
significant trading assets and liabilities
may result in lower compliance costs for
foreign banking entities relative to the
957 See
18:12 Nov 13, 2019
iii. Alternatives
Alternative approaches were
considered. For example, the rule could
have used other values for thresholds
for total consolidated trading assets and
liabilities in the definition of entities
with significant trading assets and
liabilities. As noted in the discussion of
the economic baseline, using different
thresholds would affect the scope of
application of compliance requirements
and requirements described in sections
V.F.3.g and V.F.3.h by changing the
number and size of affected brokerdealers. For instance, using the
proposed $10 billion threshold or a
lower threshold, such as $5 billion, in
the definition of significant trading
assets and liabilities would scope a
larger number of entities into Group A,
as compared to the final rule’s $20
billion threshold, thereby subjecting a
larger share of the dealer and
investment adviser industries to sixpillar compliance obligations. However,
the SEC continues to recognize that
trading activity is heavily concentrated
in the right tail of the distribution and
that using a lower threshold would not
significantly increase the volume of
trading assets and liabilities scoped into
the Group A regime.958 For example,
Table 2 shows that 57 bank-affiliated
broker-dealers that have between $1 and
$10 billion in consolidated trading
958 Some commenters supported this view. See,
e.g., Capital One et al.
83 FR at 33526.
VerDate Sep<11>2014
domestic banking entities, increasing
the competitive advantage of foreign
Group B and C entities.
As in the proposal, the SEC
recognizes that cost savings to Group B
and Group C entities related to the
compliance requirements and
requirements described in sections
V.F.3.g and V.F.3.h may be partially or
fully passed along to clients and
counterparties. To the extent that
hedging documentation and compliance
requirements for Group B and Group C
entities are currently resulting in a
reduced willingness to make markets or
underwrite securities, the amendments
may facilitate trading activity and risksharing, as well as capital formation and
reduced costs of access to capital.
Again, the SEC notes that the
amendments do not eliminate statutory
prohibitions under section 13 of the
BHC but create a simplified compliance
regime for banking entities that do not
have significant trading assets and
liabilities. Thus, the statutory
prohibitions on proprietary trading and
covered funds activities will continue to
apply to all affected entities, including
Group B and Group C entities.
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Frm 00088
Fmt 4701
Sfmt 4700
assets and liabilities and are subject to
section 13 of the BHC Act account for
only approximately 10% of bankaffiliated broker-dealer assets and
between approximately 4% and 9% of
holdings. In addition, 33 broker-dealer
affiliates of firms that have between $1
and $5 billion in consolidated trading
assets and liabilities and are subject to
section 13 of the BHC Act account for
only approximately 2% of bankaffiliated broker-dealer assets and
between approximately 1% and 2% of
holdings.959 At the same time, with a
lower threshold, more banking entities
would face higher compliance burdens
and related costs. Therefore, as
discussed in section IV.A.1.b, the
agencies decided against this
alternative.
A different threshold for the
definition of banking entities with
limited trading assets and liabilities was
also considered. As pointed out by some
commenters, a higher threshold, such as
$5 billion, would allow small and midsize banking entities to have moderate
growth over time without triggering
more costly compliance
requirements.960 As shown in Table 2,
33 more broker-dealers would qualify
for presumed compliance under this
alternative. However, as discussed in
section IV.A.1.b, the agencies continue
to believe that banking entities with $1
billion or less in trading assets and
liabilities differ from banking entities
with between $1 and $5 billion in
trading assets and liabilities in their
business models and risk exposures,
and that a $1 billion threshold
appropriately accounts for the risks
posed by Group B and Group C entities;
therefore, the agencies are not adopting
this alternative.
An alternative of splitting banking
entities into only two groups according
to their trading assets and liabilities—
those with significant trading assets and
liabilities and those without, i.e. joining
the limited and moderate trading assets
and liabilities groups was also
considered.961 This alternative could
have reduced compliance burdens for
Group B entities if the threshold was set
at $20 billion. But, if the threshold for
this alternative would have been set at
$1 billion, the compliance burdens for
Group B entities would have been
959 In addition, one commenter stated that firms
with $20 billion or more in trading assets and
liabilities represented approximately 94.80% of
total reported U.S. trading assets and liabilities and
firms with $5 billion or less in trading assets and
liabilities represented approximately 1.32% of total
reported U.S. trading assets and liabilities. See BPI.
960 See, e.g., ABA.
961 This alternative approach was also suggested
by some commenters. See, e.g., Capital One et al.
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higher than their compliance costs
under the final rule. As shown in Table
2, Group B broker-dealers represent
approximately 16% of total assets of
bank-affiliated broker-dealers and
approximately 16% of their holdings,
while Group C broker-dealers account
for only 4% of total assets of bankaffiliated broker-dealers and 2% of their
holdings. The SEC continues to believe
that Groups B and C differ in their
business models (e.g., level of trading
activity) and the risks posed to the U.S.
financial system. For these reasons, the
agencies decided not to adopt this
alternative.
A percentage-based threshold for
determining whether a banking entity
has significant trading assets and
liabilities was also considered. For
example, the amendment could have
relied exclusively on a threshold where
banking entities are considered to be
entities with significant trading assets
and liabilities if the firm’s total
consolidated trading assets and
liabilities are above a certain percentage
(for example, 10% or 25%) of the firm’s
total consolidated assets. Under this
alternative, a greater number of entities
could have benefited from lower
compliance costs and a streamlined
regime for Group B entities. In addition,
as pointed out by a commenter, this
alternative could address risk for
individual banking entities since it
would base the threshold on the
materiality of trading activity to the
entity’s business.962 However, under
this approach, even firms in the extreme
right tail of the trading asset distribution
could be considered without significant
trading assets and liabilities if they are
also in the extreme right tail of the total
assets distribution. Thus, without
placing an additional limit on total
assets within such regime, entities with
the largest trading books could have
been scoped into the Group B regime if
they also had a sufficiently large amount
of total consolidated assets, while
entities with significantly smaller
trading books could be categorized as
Group A entities if they had fewer assets
overall. Thus, the SEC believes that this
alternative would not have
appropriately accounted for the size of
banking entities’ trading activity.
In addition, a threshold based on total
assets could have been adopted. It is
possible that losses on small trading
portfolios can be amplified through
their effect on non-trading assets held
by a banking entity. To that extent, a
threshold based on total assets may be
useful in potentially capturing both
direct and indirect losses that originate
from trading activity of a holding
company.963 However, such threshold
may not be as meaningful as a threshold
based on trading assets and liabilities
when applied in the context of section
13 of the BHC Act. A threshold based
on total assets would scope in entities
merely on the basis of their balance
sheet size, even though they may have
little or no trading activity of the type
that section 13 of the BHC Act is
intended to address. Therefore, the
agencies decided against this
alternative.
Thresholds based on the level of total
revenues from permitted trading
activities could have been adopted. To
the extent that revenues could be a
proxy for the structure of a banking
entity’s business and the focus of its
operations, this alternative may apply
more stringent compliance requirements
to those entities that focus their
business the most on covered activities.
However, revenues from trading activity
fluctuate over time, rising during
62061
economic booms and deteriorating
during crises and liquidity freezes. As a
result, under the alternative, a banking
entity that is scoped into the regulatory
regime during normal times may be
scoped out during a time of market
stress because of a decrease in the
revenues from permitted activities. That
is, under such alternative, the weakest
compliance regime may be applied to
banking entities with the largest trading
books in times of acute market stress,
when the performance of trading desks
is deteriorating and the underlying
requirements of the 2013 rule may be
the most valuable.
Finally, the agencies could have
excluded from the definition of entities
with significant trading assets and
liabilities those entities that may be
affiliated with a firm with over $20
billion in consolidated trading assets
and liabilities but that are operated
separately and independently and are
not consolidated with the parent
company that have total trading assets
and liabilities (excluding trading assets
and liabilities involving obligations of
or guaranteed by the United States or
any agency of the United States) under
$20 billion. As shown in Table 8 below,
the SEC estimates that there are 17
broker-dealers that have holdings of less
than $20 billion and are affiliated with
bank holding companies that have
trading assets and liabilities in excess of
$20 billion. The SEC does not have data
on how many of these 17 broker-dealers
are operated separately and
independently and are not consolidated
with affiliated entities with significant
trading assets and liabilities. However,
the SEC notes that, at a maximum, this
alternative could decrease the scope of
application of the Group A regime for 17
broker-dealers.
TABLE 8—BROKER-DEALER ASSETS AND HOLDINGS, BY GROSS TRADING ASSETS AND LIABILITIES THRESHOLD OF
AFFILIATED BANKING ENTITIES
khammond on DSKJM1Z7X2PROD with RULES2
Type of broker-dealer
Total assets,
$mln
Number
Holdings,
$mln
Holdings
(altern.),
$mln
Holdings ≥$20bln and affiliated with firms with gross trading assets and liabilities ≥$20bln ............................................................................................
Holdings <$20bln and affiliated with firms with gross trading assets and liabilities ≥$20bln ............................................................................................
Affiliated with firms with gross trading assets and liabilities <$20bln 964 ........
19
2,225,989
594,513
514,360
17
163
275,951
640,840
31,328
135,691
13,576
39,451
Total ..........................................................................................................
199
3,142,780
761,532
567,387
Somecommenters indicated that this
alternative may be beneficial for
banking entities.965 The SEC recognizes
962 See,
e.g., KeyCorp.
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18:12 Nov 13, 2019
that this alternative would increase the
number of entities able to avail
themselves of the reduced compliance,
963 Some commenters supported this view. See,
e.g., Data Boiler.
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documentation, and metrics reporting
requirements, potentially resulting in
cost reductions flowing through to
965 See,
E:\FR\FM\14NOR2.SGM
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khammond on DSKJM1Z7X2PROD with RULES2
customers and counterparties. At the
same time, this alternative would permit
more trading activities by entities
affiliated with firms that have gross
trading assets and liabilities in excess of
$20 billion. In addition, it could
encourage such firms to fragment their
trading activity, for instance, across
multiple dealers, and operate them
separately and independently, thereby
relieving such firms of the requirement
to comply with the hedging,
compliance, and reporting regime of the
2013 rule. This alternative may,
therefore, reduce the regulatory
oversight and compliance benefits of the
full hedging, documentation, reporting,
and compliance requirements for Group
A banking entities. The feasibility and
costs of such fragmentation would
depend, in part, on the organizational
complexity of a firm’s trading activity,
the architecture of trading systems, the
location and skillsets of personnel
across various dealers affiliated with
such entities, and current inter-affiliate
hedging and risk mitigation practices.
Some commenters suggested that
periodic adjustment to thresholds to
account for inflation should be
adopted.966 This alternative would
account for changing market conditions
in the absence of any changes in a
banking entity’s business and level of
trading activities. In an environment
with a moderate level of inflation,
Group B and Group C banking entities
that are situated just below the
thresholds may reduce their level of
activity to avoid triggering a more costly
compliance regime. However, the
agencies do not believe that the
additional complexity associated with
inflation-indexing the thresholds in the
final rule is necessary in light of the
other changes to the thresholds and
calculation methodologies described
above. Therefore, the agencies decided
against this alternative.
b. Proprietary Trading
Under section 13 of the BHC act and
the 2013 rule, proprietary trading is
defined as engaging as principal for the
‘‘trading account’’ of a banking entity.967
Thus, the definition of the trading
account determines the trading activity
that falls within the scope of the
statutory prohibitions and the
compliance regime in the 2013 rule
associated with such activity. The
definition of trading account in the 2013
964 This category excludes SEC-registered brokerdealers affiliated with banks that have consolidated
total assets less than or equal to $10 billion and
trading assets and liabilities less than or equal to
5% of total assets, as well as firms for which bank
trading assets and liabilities data was not available.
966 See, e.g., BPI and Capital One et al.
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rule has three prongs, including the
dealer prong. The final amendments
introduce certain changes to the
definition of trading account; however,
these amendments do not remove or
modify the dealer prong. In addition,
the amendments introduce new
exclusions from the trading account and
a new definition of the trading desk.
i. Trading Account
(1) Costs and Benefits
Under the final rule, the definition of
‘‘trading account’’ continues to include
purchases and sales of financial
instruments by banking entities engaged
in the business of a dealer, swap dealer,
or security-based swap dealer outside of
the United States, to the extent these
instruments are purchased or sold in
connection with the activities of such
business.968 Thus, the SEC expects that
most (if not substantially all) trading
activity by SEC-regulated dealers that
are banking entities will continue to be
captured by the dealer prong of a
banking entity, notwithstanding any of
the changes made to the definition of
the trading account.
Some commenters pointed out that
not all of dealers’ trading activity is
conducted in a dealer capacity.969 The
SEC recognizes the possibility that some
dealers engage in transaction activity
that, by itself, would not trigger a dealer
registration requirement.970 Under the
baseline, such activity may be scoped
into the ‘‘trading account’’ definition by
the short-term prong or the market risk
capital prong. Thus, as discussed below,
the SEC believes that only a small
subset of trading activity by dealers may
be affected by the changes to the
definition of the trading account.
The agencies are adopting three
changes to the definition of the trading
account. First, the applicability of the
short-term prong and the market risk
capital prong is changed under the final
rule. In particular, for dealers that are
subject to the market risk capital prong,
trading activity outside of the dealer
prong will be scoped into the trading
account only if it is a covered position
for the purposes of the market risk
capital rule. That is, if the activity is not
captured by the dealer prong or the
market risk capital prong, it would be
scoped out from the definition of the
2013 rule § ll.3(b)(1)(iii).
e.g., SIFMA and BPI.
970 See 79 FR at 5549 (‘‘The Agencies believe the
scope of the dealer prong is appropriate because, as
noted in the proposal, positions held by a registered
dealer in connection with its dealing activity are
generally held for sale to customers upon request
or otherwise support the firm’s trading activities
(e.g., by hedging its dealing positions), which is
indicative of short term intent.’’).
968 See
969 See,
PO 00000
Frm 00090
Fmt 4701
Sfmt 4700
trading account under the final rule.
This is in contrast to the 2013 rule,
under which, for banking entities that
are subject to the market risk capital
prong, trading activity that is not
captured by the dealer prong or the
market risk capital prong could still be
captured by the short-term prong.971
Thus, under the 2013 rule, bank dealers
that are subject to the market risk capital
prong have to apply three prongs: The
dealer prong, the market risk capital
prong, and the short-term prong. Under
the final rule, these same entities will
apply only two prongs: The dealer
prong and the market-risk capital prong.
To the extent that dealers subject to the
market risk capital prong have trading
activities that are not captured by the
dealer prong currently experience
organizational inefficiencies or
duplicative costs as a result of being
subject to both short-term and market
risk capital prongs, this amendment
may benefit such dealers by decreasing
their compliance costs, as discussed in
section V.F.3.g, and decreasing the
regulatory complexity, consequently
increasing operational efficiency. The
SEC expects that these benefits are
likely to be greater for banking entities
that are not subject to the dealer prong,
although, as noted above, the SEC does
not analyze those potential benefits
here.
In addition, to the extent that the
definition of trading account in the 2013
rule involves position-by-position
analysis of financial instruments which
may be costly, and to the extent that the
costs of such analysis discourage dealers
that are subject to the market risk capital
prong from conducting activities that
could be scoped in by the short-term
intent prong, this amendment may
promote trading activities that would
not be captured by the dealer prong or
the market risk capital prong. On the
one hand, such trading activities may
allow dealers that are subject to the
market risk capital rule to manage their
business more efficiently. On the other
hand, to the extent that, under the final
rule, trading activity that is not captured
by either the dealer prong or the market
risk capital prong would have been
captured by the short-term intent prong,
and to the extent that this activity
exposes dealers to additional risks, this
amendment may increase risk exposure
of dealers that are subject to the market
risk capital rule. The SEC does not have
information about the amount of trading
activity of SEC-registered broker-dealers
971 As noted in section IV.B.1.a.iii, the scope of
activities captured by the short-term intent prong
substantially overlaps with the scope of activities
captured by the market risk capital prong.
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that is not captured by the dealer prong
or the market risk capital prong and
about the prevalence of the current
application of the market risk capital
prong and the short-term prong under
the 2013 rule. As shown in Table 9
below, the SEC estimates that there are
100 broker-dealers that in aggregate hold
between 98% and 99% of holdings by
broker-dealers affected by the final rule
that are subject to the market risk capital
rule and may be affected by this
amendment. The SEC continues to
believe that the largest share of dealers’
62063
trading activity will continue to be
captured by the dealer prong. Thus, the
SEC expects that the effects of this
amendment on SEC-regulated dealers
will be modest.
TABLE 9—MARKET RISK CAPITAL RULE APPLICATION
Number of
broker-dealers
khammond on DSKJM1Z7X2PROD with RULES2
Market risk capital rule application
Total assets,
$mln
Holdings
Holdings
(altern.)
Subject to the market risk capital rule .............................................................
Not subject to the market risk capital rule .......................................................
100
99
3,002,834
139,946
749,867
11,665
562,515
4,872
Total ..........................................................................................................
199
3,142,780
761,532
567,387
The second change to the definition of
trading account affects banking entities
that are not subject to the market risk
capital rule and cannot apply the market
risk capital prong under the 2013 rule.
Under the final rule, these entities will
be able to elect to apply the market risk
capital prong instead of the short-term
prong to determine the scope of the
banking entity’s trading account. This
amendment will affect those dealers that
have trading activity that is not captured
by the dealer prong and instead
captured by the short-term prong. To the
extent that the market risk capital prong
is less costly to comply with, relative to
the short-term prong, this amendment
may benefit dealers that are not subject
to the market risk capital rule and have
trading activity that is not captured by
the dealer prong by providing them with
flexibility to apply the prong that is
more cost-effective. This amendment
may particularly benefit foreign banking
entities that are not subject to the
market risk capital rule but are applying
a different market risk framework, to the
extent that this framework is similar to
the market risk capital rule. To the
extent that foreign dealers with
frameworks similar to the framework of
the market risk capital rule are currently
experiencing inefficiencies because they
cannot apply the market risk capital
prong of the trading account definition,
this amendment may reduce the
compliance costs of these dealers. The
SEC estimates that, at most, 99 brokerdealers that are not subject to the market
risk capital rule may be affected by this
amendment, to the extent that they have
trading activity that is captured by the
short-term prong under the 2013 rule.
However, the SEC continues to believe
that the largest share of dealers’ trading
activity will continue to be captured by
the dealer prong. Thus, the SEC expects
that the effects of this amendment for
dealers will be modest.
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The third amendment to the trading
account definition will eliminate the 60day rebuttable presumption in the shortterm prong and instead establish a new
rebuttable presumption that financial
instruments held for 60 days or more are
not within the short-term prong. Many
commenters supported the proposed
rule’s elimination of the 60-day
rebuttable presumption,972 and some
commenters suggested that the agencies
should presume, for banking entities not
subject to the market risk capital rule,
that financial instruments held for
longer than 60 days, or that have an
original maturity or remaining maturity
upon acquisition, of fewer than 60 days
to their stated maturities, are not for the
banking entity’s trading account.973 As
recognized in section IV.B.1.a.iv, the
agencies have found that the rebuttable
presumption has captured many
activities that should not be included in
the definition of proprietary trading. In
addition, as stated by some commenters,
the presumption may be difficult to
rebut.974 Therefore, the SEC believes
that the reversal of the presumption in
the 2013 rule would reduce the
compliance burdens for dealers that
conduct trading activity that is not
otherwise captured by the dealer prong
or the market risk capital prong. To the
extent that the compliance burdens
related to the rebuttable presumption of
the 2013 rule limit dealers’ ability to
conduct customer-accommodating
transactions or liquidity management
activities, the cost reductions of the
amendment may flow through to
customers and counterparties and
increase operational efficiency of
dealers. The SEC estimates that this
amendment may affect 99 brokerdealers—the broker-dealers that are not
972 See, e.g., State Street; Chatham; BPI; FSF;
CCMR and CFA.
973 See, e.g., ABA; Arvest; BPI; SIFMA and IIB.
974 See, e.g., State Street; Chatham; BPI; FSF;
CCMR and CFA.
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Fmt 4701
Sfmt 4700
subject to the market risk capital rule—
which on aggregate have 1.5% of brokerdealer holdings. However, the SEC
expects that the largest share of dealing
activity subject to SEC oversight will
continue to be captured by the dealer
prong. Thus, the SEC expects that the
effects of this amendment for dealers
will be modest.
(2) Efficiency, Competition, and Capital
Formation
To the extent that the compliance
related to the rebuttable presumption of
the 2013 rule limits dealers’ ability to
conduct customer-accommodating
transactions, or liquidity management or
risk management activities that are
covered by the short-term prong, the
amendments to the definition of trading
account may facilitate such activities,
which could, in turn, promote capital
formation. In addition, to the degree that
the amendments to the trading account
may provide banking entities with more
flexibility to underwrite, market make,
and hedge, and to the extent these
activities facilitate capital formation,
these amendments may improve
allocative efficiency. To the extent that
the amendments to the short-term prong
reduce compliance costs and to the
extent that the short-term prong
primarily applies to smaller dealers (i.e.,
those not covered by the market risk
capital prong), the amendments to the
trading account definition may improve
the competitive position of smaller
dealers. However, the SEC notes that the
largest share of dealing activity subject
to SEC oversight is already captured by
the dealer prong; and, therefore, the
above economic effects of the
amendments to the definition of the
trading account on SEC-regulated
entities, including the effects on
efficiency, competition, and capital
formation, may be de minimis.
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(3) Alternatives
khammond on DSKJM1Z7X2PROD with RULES2
As an alternative to the short-term
prong, the agencies proposed replacing
the short-term prong in the 2013 rule
with an accounting prong that would
have included within the definition of
‘‘trading account’’ any account used by
a banking entity to purchase or sell one
or more financial instruments that are
recorded at fair value on a recurring
basis under applicable accounting
standards.975 As the agencies noted
when they proposed this alternative, the
accounting prong was designed to
provide more certainty and clarity about
which financial instruments should be
included in the trading account due to
the fact that banking entities should
know which positions are recorded at
fair value on their balance sheets.976 In
addition, as pointed out by some
commenters,977 this alternative could
deter noncompliance and facilitate the
agencies’ supervision. However, a large
number of commenters stated that the
proposed accounting prong would
inadvertently scope in activities that are
not principally for the purpose of selling
in the near term or otherwise with the
intent to resell in order to profit from
short-term price movements. For
example, some commenters pointed out
that longer term positions, such as
available-for-sale debt securities,978
certain long-term investments,979 static
hedging of long term investments,980
traditional asset-liability management
activities,981 derivative transactions
entered into for any purpose and
duration,982 long-term holdings of
commercial mortgage-backed
securities; 983 would be scoped in under
this alternative. Although some of these
instruments are held for less than 60
days and may fall under the short-term
prong of the trading account under the
2013 rule, these instruments, in general,
are not held for trading purposes, i.e.,
they are not held principally for the
purpose of selling in the near term;
rather, the majority of the
aforementioned instruments are held for
investment.984 Since this alternative
975 See proposed rule § ll.3(b)(3); 83 FR at
33447–48.
976 See id.
977 See, e.g., Better Markets.
978 See, e.g., BPI and SIFMA.
979 See, e.g., Capital One et al.; BPI; SIFMA; and
CCMR.
980 See, e.g., BPI and ISDA.
981 See, e.g., KeyCorp; BPI; Capital One et al.; FSF
and Goldman Sachs.
982 See e.g., ISDA and BPI.
983 See MBA.
984 See, e.g., FASB defines available-for-sale
securities as investments that are not classified as
trading securities nor as held-to-maturity securities
and states that cash flows from these investments
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would include all instruments reported
at fair value, regardless of the purpose
with which these instruments are
bought or sold and regardless of the
period during which these instruments
are held (short-term or long-term), the
scope of the trading account would be
significantly greater under this
alternative than the scope of the trading
account in the 2013 rule. Given that
many of the instruments that would be
captured by the accounting prong are
not held principally for the purpose of
selling in the near term, the agencies are
not adopting this alternative. The SEC
also notes that if this alternative had
been adopted, the effect on SECregulated dealers would have been
limited because the majority of dealer
trading activity falls under the dealer
prong.
The agencies also proposed, but are
not adopting, including a reservation of
authority allowing for a determination,
on a case-by-case basis, with
appropriate notice and response
procedures, that any purchase or sale of
one or more financial instruments by a
banking entity for which it is the
primary financial regulatory agency
either is or is not for the trading
account. While the SEC continues to
recognize that the use of objective
factors to define proprietary trading is
intended to provide bright lines that
simplify compliance, the SEC also
recognizes that this approach may, in
some circumstances, produce results
that are either underinclusive or
overinclusive with respect to the
definition of proprietary trading. The
SEC continues to believe that the
reservation of authority may add
uncertainty for banking entities about
whether a particular transaction could
be deemed as a proprietary trade by the
regulatory agency, which may affect the
banking entity’s decision to engage in
transactions that are not included in the
definition of the trading account under
the 2013 rule. As discussed in the
proposal, notice and response
procedures related to the reservation of
authority provision would cost as much
as $19,877 for SEC-registered brokerdealers, and $5,006 for entities that may
choose to register with the SEC as
SBSDs.985
The agencies proposed but are not
adopting the revision of the market risk
capital prong to apply to the activities
of FBOs to take into account the
different market risk frameworks FBOs
may have in their home countries.986
This alternative may better align foreign
banking entities’ compliance with the
2013 rule and compliance with market
risk regulations of their home counties,
increasing organizational efficiency and
potentially decreasing compliance costs
for such banking entities. However, as
suggested by some commenters, under
this alternative, positions that are not
held for short-term trading would be
captured in some foreign market risk
capital frameworks.987 Therefore, the
agencies decided against this alternative
and instead are adopting a more flexible
approach, under which foreign banking
entities would be able to apply the
market risk capital prong if they choose
to do so.988
As an alternative, the agencies could
have modified the dealer prong of the
trading account definition to include
only near-term trading, e.g., positions
held for less than 60, 90, or 120 days.
This alternative would likely narrow the
scope of application of the substantive
proprietary trading prohibitions to a
smaller portion of a banking entity’s
activities. Under this alternative, bankaffiliated dealers would be able to amass
large trading positions at the near-term
definition boundary (e.g., for 61, 91, or
121 days) to take advantage of a
directional market view, to profit from
mispricing in an instrument, or to
collect a liquidity premium in a
particular instrument. This may
significantly increase the risk exposure
of bank-affiliated dealers. However, as
this alternative could stimulate an
increase in potentially impermissible
proprietary trading by these dealers, the
volume of trading activity in certain
instruments and liquidity in certain
markets may increase. The SEC also
notes that the temporal thresholds
necessary to implement such a shortterm trading alternative would be
difficult to quantify and may have to
vary by product, asset class, and
aggregate market conditions, among
other factors. For instance, the markets
for large cap equities and investment
grade corporate bonds have different
structures, types of participants, latency
of trading, and liquidity levels.
Therefore, an appropriate horizon for
short-term positions will likely vary
across these markets. Similarly, the
ability to transact quickly differs under
strong macroeconomic conditions and
in times of stress. A meaningful
implementation of this alternative
would likely require calibrating and
should be classified as cash flows from investing
activities. See ‘‘Statement of Financial Accounting
Standards No. 115’’, FASB.
985 See 83 FR 33432.
986 See proposed rule § ll. 3(b)(1)(ii); 83 FR at
33447.
987 See, e.g., IIB.
988 See section IV.B.1.a.v.
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recalibrating complex thresholds to
exempt non-near-term proprietary
trading and so could introduce
additional uncertainty and increase the
compliance burdens on SEC-regulated
banking entities.
As another alternative, the agencies
could have categorically excluded
financial instruments of dealers
purchased in a non-dealing capacity,
such as financial instruments purchased
for long-term investment purposes.
Some commenters pointed out that it is
not always clear whether such
instruments are scoped in the dealer
prong and that banking entities may
engage in costly and time-consuming
position-by-position analysis to confirm
that a long-term investment is captured
in the trading account.989 As discussed
in section IV.B.1.a.vi, the agencies
continue to believe that only the
activities that are done in connection
with activities that would require the
banking entity to be licensed or
registered are covered by the dealer
prong. For example, if a banking entity
purchases or sells a financial instrument
in connection with activities that do not
require registration as a dealer, this
activity would not be covered by the
dealer prong. However, this activity
could still be included in the trading
account under the short-term prong or
the market risk capital prong, as
applicable.990
ii. Exclusions From Proprietary Trading
The agencies are adopting the
proposed expansion of the liquidity
management exclusion, as well as an
exclusion for trading errors and
subsequent correcting transactions,
certain matched derivative transactions,
certain trades related to hedging
mortgage servicing rights or mortgage
servicing assets, and transactions in
instruments not included in the
(1) Costs and Benefits
Exclusion for Liquidity Management
Activities
The agencies are adopting the
proposed expansion of the liquidity
management exclusion substantially as
proposed, but with a modification to
permit the use of non-deliverable crosscurrency swaps. Thus, liquidity
management exclusion would apply not
only to securities, but also to foreign
exchange forwards and foreign exchange
swaps (each as defined in the
Commodity Exchange Act), and to crosscurrency swaps (both physically- and
cash-settled) that are traded for the
purpose of liquidity management in
accordance with a documented liquidity
management plan. On the one hand,
under this amendment, SEC-regulated
banking entities would face lower
burdens and enjoy greater flexibility in
currency-risk management as part of
their overall liquidity management
plans. In the proposal, the SEC
recognized that the liquidity
management exclusion in the 2013 rule
may be narrow and that the trading
account definition may scope in routine
asset-liability management and
commercial-banking related activities.
In their response to the proposal, some
commenters supported that view and
stated that the 2013 rule may be
restricting liquidity-risk management by
banking entities.991 Therefore, the SEC
continues to believe that, to the degree
that these effects constrain activities of
dealers, this amendment could facilitate
more efficient risk management, greater
secondary market activity, and more
capital formation in primary markets.
Some commenters indicated that this
amendment may make it easier to trade
989 See,
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e.g., SIFMA and BPI.
990 See 79 FR 5549.
definition of trading asset or trading
liability under the applicable reporting
form for a banking entity.
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in currency markets for speculative
purposes under the guise of legitimate
liquidity management.992 The SEC
continues to recognize that this
liquidity-management amendment may
lead to currency derivatives exposures,
including potentially very large
exposures, being scoped out of the
trading account definition and the
ensuing substantive prohibitions of the
2013 rule, which may increase the risk
exposures of banking entities and
reduce the effectiveness of regulatory
oversight. However, the SEC continues
to believe that the conditions
maintained in the exemption, including
the requirement to conduct liquidity
management in accordance with a
documented liquidity management
plan, will limit these adverse effects.
Exclusion for Error Trades
The agencies are also adopting an
exclusion for trading errors and
subsequent correcting transactions from
the definition of proprietary trading.
The 2013 rule excludes from the
proprietary trading prohibition certain
excluded clearing activities by banking
entities that are members of clearing
agencies, derivatives clearing
organizations, or designated financial
market utilities. Specifically, such
excluded clearing activities are defined
to include, among others, any purchase
or sale necessary to correct error trades
made by, or on behalf of, customers
with respect to customer transactions
that are cleared, provided the purchase
or sale is conducted in accordance with
certain regulations, rules, or
procedures.993 Accordingly, the
exclusion for error trades under the
2013 rule is applicable only to clearing
members with respect to cleared
customer transactions.994
992 See
993 See
991 See,
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e.g., ISDA; Goldman Sachs and SIFMA.
Frm 00093
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Volcker Alliance and Data Boiler.
2013 rule § ll.3(e)(7).
994 Id.
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This amendment primarily benefits
dealers that are not clearing members
with respect to all customer trades and
dealers that are clearing members with
respect to customer trades that are not
cleared, since under the 2013 rule error
trades of these dealers are not
considered excluded clearing activity.
Table 10 reports information about
broker-dealer count, assets, and
holdings, by affiliation and clearing
type.
TABLE 10—BROKER-DEALER ASSETS AND HOLDINGS, BY CLEARING STATUS 995
Broker-dealers subject to section 13 of the BHC Act
Total assets,
$mln
Holdings,
$mln
Holdings
(altern.),
$mln
Clear or carry (or both) ....................................................................................
Other ................................................................................................................
76
123
3,101,936
40,844
755,975
5,557
562,649
4,738
Total ..........................................................................................................
199
3,142,780
761,532
567,387
Since correcting error trades is not
conducted for the purpose of profiting
from short-term price movements, as
also pointed out by some
commenters,996 this amendment is
likely to facilitate valuable customerfacing activities and promote effective
risk management by dealers. As
discussed in section IV.B.1.b.ii, the
agencies continue to believe that
banking entities generally should
monitor and manage their error trade
account because doing so would help
prevent personnel from using these
accounts for proprietary trading. Some
commenters stated that banking entities
could still make profits while relying on
the error trade exclusion.997 To the
degree that this may happen, banking
entities could become incentivized to
use error trade exclusion to conduct
proprietary trading. However, some
commenters noted that bona fide trade
error activity is separately managed and
classified as an operational loss when
there is a loss event or a near miss when
error activity results in a gain.998 The
SEC agrees with the commenters’ view
and believes that existing requirements
and operational risk management
practices would be sufficient to deter
participants from using the error trade
exclusion to obfuscate impermissible
proprietary trades.
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Number
995 Broker-dealers clearing or carrying customer
accounts (or both) are identified using FOCUS
filings. Broadly, broker-dealers that are clearing or
carrying firms directly carry customer accounts,
maintain custody of the assets, and clear trades.
Other broker-dealers may accept customer orders
but do not maintain custody of assets. This analysis
excludes SEC-registered broker-dealers affiliated
with banks that have consolidated total assets less
than or equal to $10 billion and trading assets and
liabilities less than or equal to 5% of total assets,
as well as firms for which bank trading assets and
liabilities data was not available.
996 See, e.g., BPI; FSF and BB&T.
997 See, e.g., Data Boiler; CAP and Public Citizen.
998 See, e.g., ABA; BB&T; BPI and Capital One et
al.
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Exclusion for Customer-Driven Swaps
and Customer-Driven Security-Based
Swaps
In addition, the agencies are adopting
an exclusion for transactions in which
banking entities contemporaneously
enter into a customer-driven swap or
security-based swap and a matched
swap or security-based swap if (i) the
banking entity retains no more than
minimal price risk; and (ii) the banking
entity is not a registered dealer, swap
dealer, or security-based swap dealer.
The SEC continues to recognize that
loan-related swaps and customer
accommodation back-to-back
derivatives facilitate lending
transactions as a customer service and
are not designed to profit from
speculative price movements.999 Some
commenters indicated that such
customer accommodation loan-related
swaps transactions may reduce the risk
of banking entities and borrowers, and
encourage the extension of credit,
commonly for smaller and medium-size
banking entities that engage in trading
in connection with loans and other
extensions of customer credit. Some
commenters stated that this amendment
increases the scope of permissible
trading activity. The SEC notes that
under the final rule this exclusion is not
available to banking entities that are
subject to the market risk or the dealer
prong, reducing such risks. Therefore,
the SEC believes that the effects of this
amendment discussed above on SECregulated entities would be de minimis.
Exclusion for Hedges of Mortgage
Servicing Rights or Mortgage Servicing
Assets
The agencies are adopting an
exclusion for transactions involving any
purchase or sale of one or more
financial instrument that the banking
entity uses to hedge mortgage servicing
rights or mortgage servicing assets in
999 Commenters
agreed with this view. See, e.g.,
Covington; Credit Suisse; SIFMA; Chatham and
ABA.
PO 00000
Frm 00094
Fmt 4701
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accordance with a documented hedging
strategy. This amendment will provide
more clarity to banking entities that are
subject to the short-term prong that
intangibles, including servicing assets,
are not included in the definition of
proprietary trading. Because under the
market risk capital prong, intangibles,
including servicing assets, are explicitly
excluded from the definition of
‘‘covered position,’’ the exclusion will
provide additional certainty to dealers
that do not apply the market risk capital
prong. To the extent that dealers that do
not apply the market risk capital prong
currently experience uncertainty as to
whether the aforementioned financial
instruments are included in the trading
account and to the extent that this
uncertainty impedes transactions
involving these types of financial
instruments, the amendment may
facilitate permitted trading activity in
these financial instruments. In addition,
to the extent that these exclusions
facilitate more efficient risk
management, dealers that are not subject
to the market risk capital rule may
benefit from this amendment.1000
Exclusion for Financial Instruments
That Are Not Trading Assets or Trading
Liabilities
In addition to the above exclusions,
the agencies are adopting an exclusion
for purchases or sales of financial
instruments that do not meet the
definition of trading assets or trading
liabilities under the applicable reporting
form for a banking entity as of January
1, 2020. Similar to the exclusion for
hedges of mortgage servicing rights or
assets, this exclusion is intended to
clarify the scope of the prohibition on
proprietary trading and to provide
parity between banking entities that
apply the market risk capital prong and
banking entities that apply the short1000 The SEC estimates that there are 99 SECregistered broker-dealers that are not subject to the
market risk capital rule, which on aggregate hold
approximately 1.5% of broker-dealer holdings.
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term intent prong by scoping out of the
rule positions that would not be
captured by the market risk capital
prong. In addition, this amendment will
exclude financial instruments
purchased by a dealer in its dealing
capacity that are not trading assets or
liabilities. Therefore, the SEC believes
that this amendment will benefit
dealers, to the extent that the 2013 rule’s
dealer prong is overinclusive because it
scopes in financial instruments acquired
in dealer capacity, regardless of their
purpose (i.e. both for trading and nontrading purposes). To the extent that
this aspect of the 2013 rule leads to
inefficiencies or increases costs at the
dealer level, the SEC expects that the
final rule will promote dealers’
organizational efficiency by narrowing
the scope of the dealer prong to
financial instruments that are
considered trading assets and liabilities.
To the extent that some financial
instruments that are not trading assets
or liabilities are currently scoped-into
the rule by the short-term prong due to
the fact that they are held for less than
60 days, this amendment may decrease
the scope of the trading account. For
example, some fair value financial
instruments that are not trading assets
or liabilities, such as available-for-sale
securities or derivatives not reported as
trading, may be held for less than 60
days and therefore be presumed to be
for the trading account under the 2013
rule. However, under the 2013 rule,
banking entities could rebut this
presumption by demonstrating that such
instruments are not purchased or sold
principally for the purpose of selling in
the near term.1001 In addition, the SEC
notes that dealers, in general, hold
primarily trading assets and trading
liabilities due to the nature of their
business. The SEC does not have data or
information about what fraction of
dealers’ financial instruments that are
not defined as trading assets or
liabilities under the applicable banking
agency reporting forms is currently
being scoped-into the trading account
by the short-term prong in the 2013 rule.
This is because only non-trading fair
value instruments held for fewer than
60 days are likely to be scoped into the
trading account via the short-term prong
under the 2013 rule, rather than all such
financial instruments, and the data
disaggregated by maturity of non-trading
fair value instruments is not available.
However, the SEC reiterates that only a
1001 As discussed above, the final rule eliminates
the 60-day rebuttable presumption in the short-term
prong and instead establishes a new rebuttable
presumption that financial instruments held for 60
days or more are not within the short-term prong.
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small subset of trading activity by
dealers may be affected by this
exclusion, as majority of financial
instruments purchased or sold by
dealers are trading assets and liabilities.
For this reason and the reasons
discussed above, the SEC expects that
this amendment will not substantially
affect the scope of the trading account
for banking entities that are dealers.
(2) Efficiency, Competition, and Capital
Formation
To the degree that the 2013 rule may
be restricting liquidity-risk management
by banking entities, and to the extent
that this affects their trading activity,
the liquidity management amendment
could facilitate more efficient risk
management, greater secondary market
activity, and more capital formation in
primary markets. Similarly, to the extent
that corrections for bona-fide errors and
exclusions for customer-driven swaps
and customer-driven security-based
swaps and transactions related to
mortgage servicing rights facilitate
customer-driven transactions and
increase banking entities’ willingness to
conduct such transactions, these
exclusions could facilitate more
efficient risk management and promote
capital formation and secondary market
activity. In addition, to the degree that
the exclusions from proprietary trading
may provide banking entities with more
flexibility to manage risks, and to the
extent these activities facilitate capital
formation, these amendments may
improve allocative efficiency.
To the extent that these amendments
may increase the ability of dealers that
are banking entities to hedge risks
related to customer transactions, the
competitive position of dealers that are
banking entities may improve relative to
nonbanking dealers. In addition, to the
extent that these amendments reduce
compliance costs of dealers that are
banking entities and to the extent that
these compliance costs are currently
passed onto customers and
counterparties, the reduction in costs
related to the exclusions from
proprietary trading may result in more
competitive prices set by dealers that
are banking entities, improving their
competitive position further.
(3) Alternatives
The agencies could have taken the
approach of expanding the liquidity
management exclusion to exclude
additional trading activities. For
example, the agencies could exclude
transactions in other derivatives, such
as derivatives related to government
securities, derivatives on foreign
PO 00000
Frm 00095
Fmt 4701
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62067
sovereign debt,1002 instruments that
qualify for certain treatment under the
liquidity coverage ratio or section 165 of
the Dodd-Frank Act, or transactions
executed by SEC-registered dealers on
behalf of their asset management
customers.1003
The 2013 rule exempts all trading in
domestic government obligations and
trading in foreign government
obligations under certain conditions;
however, derivatives referencing such
obligations that are intended to manage
risks—including derivatives portfolios
that can replicate the payoffs and risks
of such government obligations—are not
excluded from the trading account.
Therefore, existing requirements reduce
the flexibility of banking entities to
engage in asset-liability management
and result in a different treatment of two
groups of financial instruments that
have similar risks and payoffs.
Excluding derivatives transactions on
government obligations from the trading
account definition could reduce costs to
market participants and provide greater
flexibility in their asset-liability
management. This alternative could also
result in increased volume of trading in
markets for derivatives on government
obligations, such as Treasury futures.
The SEC recognizes, nonetheless, that
derivatives portfolios that reference an
obligation, including Treasuries, can be
structured to magnify the economic
exposure to fluctuations in the price of
the reference obligation. Moreover,
derivatives transactions involve
counterparty credit risk not present in
transactions in reference obligations
themselves. Since the alternative would
exclude all derivatives transactions on
government obligations, and not just
those that are intended to mitigate risk,
this alternative could permit banking
entities to increase their exposure to
counterparty, interest rate, and liquidity
risk. For the reasons discussed in
section IV.B.1.i, the agencies decided
not to expand the liquidity management
exclusion further.
The agencies also considered
mandating the use of a separatelymanaged trade error account for the
purposes of this amendment. This
alternative could deter banking entities
from using the error trade exclusion to
obfuscate impermissible proprietary
trades. However, as indicated by the
commenters, this approach may result
in duplicative systems and additional
1002 Some commenters indicated that all
derivatives should be excluded in the liquidity
management exclusion. See, e.g., FSF; Capital One
et al.; IIB and JBA.
1003 See, e.g., Capital One et al. and ABA.
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compliance costs.1004 The agencies
agree with these commenters and,
therefore, are not adopting this
alternative.
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iii. Trading Desk Definition
The final rule adopts a multi-factor
definition of the trading desk that is
substantially similar to the definition
included in the request for comment in
the proposal, except that the reference
to incentive compensation has been
removed from the first prong. The
definition of trading desk includes a
new second prong that aligns the
definition with the market risk capital
rule. Specifically, for a banking entity
that is subject to the market risk capital
rule, the trading desk established for
purposes of the market risk capital rule
must be the same unit of organization
that is established as a trading desk for
purposes of the regulations
implementing section 13 of the BHC
Act.
(1) Costs and Benefits
The SEC continues to recognize that
the definition of trading desk is an
important component of the
implementation of the 2013 rule in that
certain requirements, such as those
applicable to the underwriting and
market making exemptions, and the
metrics-reporting requirements, apply at
the trading desk level of organization.
Under the 2013 rule, a trading desk is
defined as the smallest discrete unit of
organization of a banking entity that
purchases or sells financial instruments
for the trading account of the banking
entity or an affiliate thereof. Some
commenters asserted that the smallest
discrete unit language of the 2013 rule
was subjective, ambiguous, or could be
interpreted in different ways.1005 Thus,
the SEC continues to believe that SECregulated banking entities may currently
experience substantial compliance costs
related to the trading desk designation
for the purposes of compliance with
section 13 of the BHC Act. Accordingly,
the SEC believes that the adopted
definition of the trading desk may
provide more certainty to SEC-regulated
banking entities regarding trading desk
designations and will reduce their
compliance burdens, as the multi-factor
definition better aligns with other
operational, management, and
compliance purposes,1006 which
typically depend on the type of trading
activity, asset class, product line
1004 See, e.g., ABA; Credit Suisse; JBA and
SIFMA.
1005 See, e.g., ABA and CCMC.
1006 This was also supported by commenters. See,
e.g., ABA; JBA; FSF; Goldman; ISDA; SIFMA and
CCMC.
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offered, and individual banking entity’s
structure. Among the metrics
submissions from 18 entities received
by the SEC, the SEC estimates that the
average number of desks reported per
entity is approximately 51.1007 To the
extent that the trading desk designations
under the final rule will be less granular
than those under the 2013 rule, and to
the extent that establishing a large
number of desks is more costly, this
amendment will reduce compliance
costs for dealers that are banking
entities.
As seen in Table 9, the SEC estimates
that 100 broker-dealers with between
98% and 99% of holdings are currently
subject to the market risk capital rule
and would be able to align their trading
desks for the purposes of the Volcker
Rule and the market risk capital rule.
The SEC continues to believe that such
alignment will reduce organizational
complexity, consequently reducing
compliance burdens for these banking
entities.1008 The SEC also estimates that
99 broker-dealers are not currently
subject to the market risk capital rule—
these broker-dealers will be able to
establish trading desks on the basis of
the multi-factor definition. To the extent
that the current operational,
management, or compliance structure of
these entities may not perfectly align
with the adopted multi-factor definition
of the trading desk, these entities may
experience one-time setup costs related
to the reorganization of trading activity
in order to satisfy the multi-factor
definition. The SEC does not have
information or data about the costs of
this reorganization. However, the SEC
believes that these reorganization costs
will be offset by a reduction in ongoing
compliance costs, which will be
reduced as a result of the amended
definition of the trading desk for dealers
that are not subject to the market risk
capital rule, to the extent that the
trading desk designations under the
final rule will be less granular than
those under the 2013 rule and will
better align with criteria used to
establish trading desks for operational
and management purposes.
(2) Efficiency, Competition, and Capital
Formation
To the extent that the reduction in
compliance costs stemming from this
amendment facilitates permitted trading
activity by banking entities, capital
formation may increase. To the extent
that the reduced compliance costs
stemming from this amendment flow
through to customers and
section V.0.
1008 See id.
Frm 00096
Fmt 4701
(3) Alternatives
The agencies could have adopted an
amendment that would allow trading
desks to be set completely at the
discretion of banking entities.1009 This
would provide banking entities greater
flexibility in determining their own
optimal organizational structure and
allow banking entities organized with
various degrees of complexity to reflect
their organizational structure in the
trading desk definition. This alternative
could reduce operational costs from
fragmentation of trading activity and
compliance program requirements, as
well as enable more streamlined metrics
reporting. However, under this
alternative, a banking entity may be able
to aggregate impermissible proprietary
trading with permissible activity (e.g.,
underwriting, market making, or
hedging) into the same trading desk and
consequently take speculative positions
under the guise of permitted activities.
To the extent that this alternative would
allow banking entities to use a highly
aggregated definition of a trading desk,
it may increase risk exposures of
banking entities and the conflicts of
interest that the prohibitions of section
13 of the BHC Act aimed to address.1010
The SEC does not have data on
operating and compliance costs that
arise because of the fragmentation of
trading activity by SEC-regulated
banking entities, or data on their
organizational complexity, and the
extent of variation therein. For the
reasons discussed in section IV.B.1.c,
the agencies are not adopting this
definition.
c. Permitted Underwriting and Market
Making
Underwriting and market making are
customer-oriented financial services
that are essential to capital formation
and market liquidity, and the risks and
profit sources related to these activities
are distinct from those related to
impermissible proprietary trading.
Moreover, as discussed above, market
liquidity can be important to investors
1009 This alternative was also suggested by a
commenter. See JBA.
1010 See, e.g., Volcker Alliance.
1007 See
PO 00000
counterparties, bank-affiliated dealers
may become more competitive with
nonbanking dealers. The amendment to
the definition of the trading desk does
not change the information available to
market participants, and the SEC does
not believe that these amendments are
likely to have an effect on informational
efficiency. To the degree that this
amendment facilitates capital formation,
allocative efficiency may improve.
Sfmt 4700
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as it may enable investors to exit (in a
timely manner and at an acceptable
price) from their positions in
instruments, products, and portfolios.
At the same time, excessive risk
exposure by banking entities can, of
course, adversely affect markets and,
therefore, investors.
Under the final rule, banking entities
with covered activities are presumed
compliant with the RENTD
requirements of the exemption for
underwriting and market making-related
activities if the banking entity
establishes and implements, maintains,
and enforces certain internal limits that
are designed not to exceed RENTD,
taking into account the liquidity,
maturity, and depth of the market for
the relevant type of security or financial
instrument. These internal limits are
subject to supervisory review and
oversight on an ongoing basis.
For Group A entities, these limits are
required to be established either within
the entity’s internal compliance
program or under the presumption of
compliance within the exemptions for
permitted underwriting and market
making related activities. Under the
final rule, Group B entities are not
required to establish a separate
compliance program for underwriting
and market making requirements,
including the internal limits for RENTD.
However, in order to be presumed
compliant with the RENTD
requirements under the exemptions for
underwriting and market making-related
activities, banking entities are required
to establish and enforce limits designed
not to exceed RENTD, as well as
authorization procedures for limit
breaches and increases for each trading
desk as described below.
With respect to limit increases and
breaches, banking entities are required
to maintain and make available upon
request records regarding any limit that
is exceeded and any temporary or
permanent increase to any limit. Unlike
the proposal, the final rule does not
include the requirement of prompt
reporting of breaches or limit increases
but requires that banking entities keep
and provide such records to the
agencies upon request. However,
consistent with the requirements under
the 2013 rule, the final rule includes
certain requirements for the continued
availability of the presumption of
compliance in the event of limit
increases or breaches. Specifically, the
presumption of compliance will
continue to remain available in the
event of a breach or limit increase only
if (i) the banking entity takes prompt
action to bring the trading desk into
compliance; and (ii) establishes and
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complies with a set of written
authorization procedures, including
escalation procedures that require
review and approval of any trade that
exceeds a trading desk’s limits,
demonstrable analysis of the basis for
any temporary or permanent increase to
a trading desk’s limits, and independent
review of such demonstrable analysis
and approval.
i. Costs and Benefits
This section discusses the expected
benefits of the final rule and how
regulatory oversight of internal limits
may reduce such benefits; potential
costs related to deterioration of risk
management practices and increased
risk exposures of banking entities,
including with respect to the removal of
the demonstrability requirement;
aspects of the final rule and baseline
that mitigate these costs; and factors
likely to affect the overall balance of
these economic effects.
The primary expected benefits of the
final rule are threefold. First, the
agencies have received comments that
the 2013 rule has created significant
costs and uncertainty about some
banking entities’ ability to rely on the
exemption for underwriting and market
making-related activities,1011 and the
economic baseline discusses existing
research on the baseline effects of the
2013 rule on market quality, trading,
and client facilitation activities. The
SEC believes that the final rule may
provide SEC-regulated banking entities
with beneficial flexibility and certainty
in conducting permissible underwriting
and market making-related activities.
Second, consistent with commenter
views,1012 the SEC recognizes that
banking entities may already routinely
establish and monitor internally set risk
and position limits for purposes of
meeting capital requirements and
internal risk management. Thus, to the
degree that some banking entities
already establish limits that meet the
requirements under the final rule, the
presumption allows the reliance on
internal limits in accordance with a
banking entity’s risk management
function that may already be used to
meet other regulatory requirements.
Therefore, the amendment may prevent
unnecessary duplication of riskmanagement compliance procedures for
the purposes of complying with
multiple regulations and may reduce
compliance costs for SEC-regulated
banking entities. Third, to the extent
that the uncertainty and compliance
burdens related to the RENTD
requirements are currently impeding
otherwise profitable permissible
underwriting and market making by
dealers,1013 the amendments may
increase banking entities’ profits and the
volume of dealer underwriting and
market making activity. The SEC notes
that the returns and risks arising from
banking entity activity may flow
through to investors and that investors
in securities markets may benefit from
market liquidity as it enables exit from
investment positions.
Since the 2013 rule requires oversight
of internal limits and authorization
policies and procedures related to
internal limit increases or breaches, this
aspect of the final rule is unlikely to
result in new compliance burdens for
SEC registrants. In addition, the SEC has
received comment that some banking
entities may already have escalation and
recordkeeping procedures when limits
are breached or changed.1014 The SEC
continues to believe that agency
oversight of internal limits for the
purposes of compliance with the final
rule may help support the benefits and
costs of the substantive prohibitions of
section 13 of the BHC Act. The agencies
have also received comment that the
amendments may allow the agencies to
challenge the limit approval and
exception process but not the nexus
between RENTD and limits.1015 As
discussed above, sections
ll.4(c)(1)(i)–(ii) of the final rule
require that such limits must be
designed not to exceed RENTD.
In the proposal, the SEC noted that
some entities may be able to maintain
positions that are larger than RENTD
and increase risk exposures arising out
of trading activities, thus reducing the
economic effects of section 13 of the
BHC Act and the 2013 rule. The
agencies have received comment that
limits may be designed to exceed
RENTD and banking entities may
frequently exceed limits and that
introducing the presumption may lead
to a deterioration of risk management
practices and increase risk taking by
banking entity dealers.1016 However, as
discussed above, under the final rule
internal limits need to be tied to
RENTD, such that if the banking entity
complies with the limits it will not
maintain positions that are larger than
RENTD. The SEC also notes that
breaches and changes to internal limits
may reflect banking entities’ close
1013 See
section V.F.2.
JBA.
1015 See, e.g., Better Markets.
1016 See, e.g., Volcker Alliance; Better Markets;
NAFCU and Public Citizen.
1014 See
1011 See, e.g., ABA; Credit Suisse; State Street and
BB&T.
1012 See JBA.
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monitoring of market conditions and
tailoring such limits, valuable for both
internal risk management and
supervision and oversight over banking
entities. The agencies have received
comment that some banking entities
may change the way they set internal
limits in response to the final rule, for
instance, by selecting higher initial
limits to avoid breaches or increases for
the purposes of section 13 of the BHC
Act.1017 The SEC recognizes these
possible effects from entities changing
their internal limit setting practices and
notes that this effect may reduce the
value of closely tailored and
dynamically adjusted internal limits for
internal oversight and agency
supervision. Moreover, the SEC notes
that this effect may lead some banking
entities to take on greater trading risks.
Nevertheless, to satisfy the presumption
of compliance, such trading activity
must conducted within risk and
position limits designed not to exceed
RENTD, and thus be consistent with
section 13(d)(1)(B) of the BHC Act. The
SEC also notes that the final rule
contains recordkeeping obligations
concerning any exceeded limits or
temporary or permanent increases to
limits, which may facilitate agency
oversight but impose new burdens on
banking entities. As discussed in section
V.B, this aspect of the final rule may
increase initial burdens 1018 by
$8,870 1019 for SEC-registered banking
entities and ongoing burdens for SECregistered broker-dealers by
approximately $227,278 per year and for
SBSDs by approximately $38,831 per
year.1020
The final rule also eliminates the
requirements of the market making
exemption related to the demonstrable
analysis of historical customer demand,
current inventory of financial
instruments, and market and other
factors concerning financial instruments
1017 See, e.g., Capital One et al.; Better Markets;
and State Street.
1018 For the purposes of the burden estimates in
this release, the SEC is assuming the cost of $423
per hour for an attorney, from SIFMA’s
‘‘Management & Professional Earnings in the
Securities Industry 2013,’’ modified to account for
an 1,800-hour work year, multiplied by 5.35 to
account for bonuses, firm size, employee benefits,
and overhead, and adjusted for inflation as of June
2019.
1019 Initial reporting and recordkeeping burdens:
0.5 hours × 0.18 dealer weight × [199 broker-dealers
+ 34 SBSDs not already registered as broker-dealers]
× Attorney at $423 per hour = $8,870.
1020 Ongoing burdens for broker-dealers: [10
hours recordkeeping + 5 hours reporting] × 0.18
dealer weight × 199 × Attorney at $423 per hour =
$227,278.
Ongoing burdens for SBSDs: [10 hours
recordkeeping + 5 hours reporting] × 0.18 dealer
weight × 34 SBSDs not already registered as brokerdealers × Attorney at $423 per hour = $38,831.
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in which the trading desk makes a
market, including though block trades.
Some commenters indicated that this
aspect of the amendments gives banking
entities greater discretion to establish
higher risk and inventory limits in
excess of RENTD 1021 and that banking
entities should be required to
demonstrate the analysis behind their
RENTD forecasts and compare ex-ante
forecasts with ex-post realizations.1022
However, the agencies also received
comment that RENTD can significantly
deviate from historically observed
levels, particularly in times of severe
market stress, and internal limits
designed to not to exceed RENTD may
be based on current or forward looking
customer inquiries, anticipated
volatility shocks, and other forward
looking information about market
conditions and the evolving risks of a
particular desk.1023 The SEC also notes
that, under the final rule, the
presumption of compliance requires risk
and position limits to be designed not
to exceed RENTD and that the agencies
may rebut the presumption as discussed
above.
Four key aspects of the final rule are
aimed at mitigating these risks and
costs. First, the internal limits,
including any changes to limits, used to
establish the presumption of
compliance are subject to rebuttal
procedures discussed above, and the
final rule requires that the internal
limits are designed not to exceed
RENTD and take into account the
liquidity, maturity, and depth of the
market for the relevant type of security
or financial instrument. Second, the
presumption of compliance is
conditional on the banking entity’s
prompt action to bring the trading desk
into compliance if a limit is exceeded.
Third, banking entities are required to
establish and comply with a robust set
of internal policies and procedures,
requiring review of limits, demonstrable
analysis of a basis for any limit increase,
and independent review of such
analysis and approval. Fourth, the
economic effects of the presumption of
compliance interact with the effects of
the amended trading desk definition,
which the SEC believes will allow the
agencies to better oversee trading
activity across a given banking entity’s
trading desks and across groups of
banking entities to determine whether
the internal limits are appropriately
designed not to exceed RENTD.
The SEC also notes that the final rule
tailors compliance obligations of
1021 See
Volcker Alliance.
Data Boiler.
1023 See, e.g., FSF.
1022 See
PO 00000
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Sfmt 4700
banking entities for purposes of the
exemptions for underwriting and market
making-related activities. The economic
effects of the final amendments related
to compliance are discussed in section
V.F.3.g.
The SEC continues to believe that the
overall economic effect of these
amendments will depend on how
banking entities choose to comply with
the substantive prohibitions in section
13 of the BHC Act and the 2013 rule as
amended. Specifically, banking entities
are likely to weigh the unmet demand
for and profitability of client facilitation
activity against the potential costs of
establishing and maintaining
appropriate internal limits.1024 The SEC
does not have data on the volume of
trading activity that does not occur
because of the costs associated with
complying with the RENTD requirement
or data on the profitability of such
trading activity for SEC-regulated
banking entities. The SEC is not aware
of any such data, and commenters did
not provide data enabling such
quantification.1025
ii. Efficiency, Competition, and Capital
Formation
The SEC believes that the final rule
may reduce the costs of relying on the
exemptions for underwriting and market
making-related activities, which may
facilitate the activities related to these
exemptions. The evolution in market
structure in some asset classes (e.g.,
equities) has transformed the role of
traditional dealers vis-a`-vis other
participants, particularly as it relates to
high-frequency trading and electronic
platforms. However, dealers continue to
play a central role in less liquid
markets, such as corporate bond and
over-the-counter (OTC) derivatives
markets. While it is difficult to establish
causality, corporate bond dealers,
particularly bank-affiliated dealers,
have, on aggregate, significantly reduced
their capital commitment post-crisis.1026
Corporate bond dealers are increasingly
shifting from trading in a principal
capacity to agency trading. To the extent
that this change cannot be explained by
enhanced ability of dealers to manage
corporate bond inventory, electronic
trading, post-crisis changes in dealer
risk tolerance and macro factors (effects
1024 See,
e.g., 83 FR at 33532.
SEC observes that, as shown in Table 1,
broker-dealers affected by the final rule have total
assets of approximately $3.14 trillion and holdings
of approximately $761.53 billion. If the final
amendments increase affected broker-dealer
holdings by even 0.01%, the economic impact of
the final rule may exceed $100 million.
1026 See, e.g., FRB’s ‘‘Staff Q2 2017 Report on
Corporate Bond Market Liquidity.’’ See also section
V.F.2 above.
1025 The
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which themselves need not be fully
independent of the effect of section 13
of the BHC Act and the 2013 rule), such
effects may point to a reduced supply of
liquidity by dealers. Moreover,
corporate bond dealers decrease
liquidity provision in times of stress
after the 2013 rule.1027 In dealer-centric
single-name CDS markets, interdealer
trade activity, trade sizes, quoting
activity, and quoted spreads for illiquid
underliers have deteriorated since 2010,
but dealer-customer activity and various
trading activity metrics have remained
stable.1028
Because of the methodological
challenges described earlier in this
analysis, the SEC cannot quantify
potential effects of the 2013 rule in
general—and the RENTD, underwriting,
and market making provisions of the
2013 rule in particular—on capital
formation and market liquidity. The
SEC also recognizes, as discussed above,
that these provisions may not be
currently affecting all securities
markets, asset classes, and products
uniformly. If, because of uncertainty
and the costs of relying on exemptions
for market making-related activity and
risk-mitigating hedging, dealers
currently limit their market making and
hedging activity in certain products, the
final rule may facilitate market making.
Because secondary market liquidity can
affect the willingness to invest in
primary markets, and access to liquidity
in these markets can enable market
participants to mitigate undesirable risk
exposures, the amendments may
increase trading activity and capital
formation in some segments of the
market.
While section 13 of the BHC Act and
the 2013 rule, as amended, prohibit
banking entities from engaging in
proprietary trading, some trading desks
may attempt to use certain elements of
the final RENTD amendments to
circumvent those restrictions, which
may reduce the economic effects of the
2013 rule outlined in the economic
baseline. However, under the final rule,
internal limits and policies and
procedures regarding breaches and limit
increases and other aspects of banking
entities’ compliance with section 13 of
the BHC Act remain subject to the full
scope of agency oversight and
supervision, and the presumption of
compliance is rebuttable.
The SEC continues to recognize that
proprietary trading by banking entities
may increase the risk exposures of
banking entities, may give rise to
economic inefficiency because of
implicitly subsidized risk exposures of
banking entities, and may increase
market fragility and conflicts of interest
between banking entities and their
customers.1029 However, the SEC also
recognizes the comments and research
discussed above concerning the
unintended effects of the 2013 rule on
valuable underwriting and market
making activities, and the nuanced
effects of section 13 of the BHC Act and
the 2013 rule on the overall volume and
structure of banking entity risk
exposures.
The SEC continues to believe that,
where the final rule increases the scope
of permissible activities or decreases the
risk of detection of proprietary trading,
its effect on informational efficiency
stems from a balance of two effects.1030
On the one hand, where proprietary
trading strategies are based on superior
analysis and prediction models, their
enhanced ability to trade on such
information may make securities
markets more informationally efficient.
While such proprietary trading
strategies can be executed by dealers
that are not affiliated with banking
entities and therefore unaffected by the
prohibitions on proprietary trading,
their ability to do so may be constrained
by their limited access to capital and a
lack of scale needed to profit from such
strategies. On the other hand, if superior
information is obtained by an entity
from its customer-facing activities and
as a result of conflicts of interest, and if
such conflicts are recognized by other
market participants, proprietary trading
may make other market participants less
willing to transact with banks or
participate in securities markets,
potentially reducing informational
efficiency.
iii. Alternatives: Prompt Notice,
Thresholds
The agencies could have adopted a
prompt notice requirement for limit
breaches and limit changes, such as
internal limit increases, for all or a
subgroup of banking entities. Prompt
notification of breaches and changes to
internal limits under the alternative may
provide more immediate information to
agencies about limit breaches and
changes supporting oversight.1031 The
agencies have received comment that
such prompt notice may be especially
beneficial for the oversight of smaller
and mid-size banking entities with less
sophisticated internal controls that may
1027 See
1029 See
1028 For
1030 See
section V.F.2. above.
a literature review and data, see SEC
Report 2017, supra note 774.
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83 FR at 33533.
83 FR at 33534.
1031 See, e.g., Data Boiler.
PO 00000
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62071
be more susceptible to risks from rogue
trading.1032
However, consistent with the views of
a number of commenters,1033 the SEC
believes that the prompt notice
requirement would have imposed
considerable costs on registrants. Such
information may duplicate metrics
reporting for Group A entities and other
information provided to the agencies in
the ordinary course of prudential
supervision.1034 Further, such costs
would likely be most significant for
Group B and Group C entities that do
not engage in significant trading activity
and which may face more difficulties
absorbing reporting costs,1035 as well as
for non-U.S. banking entities with large
non-U.S. operations.1036 In addition,
internal limit increases or breaches may
reflect changes in market conditions and
not changes in a banking entity strategy
or risk tolerance, and smaller and midsize banks may currently be setting
internal limits considerably below
RENTD.1037 Finally, to the degree that
market participants may interpret the
prompt reporting requirement as an
enhanced regulatory focus on the
number of times an entity has breached
RENTD, traders may become less
willing to request limit increases to
accommodate customer demand; 1038
alternatively, entities may set higher
internal limits to avoid breaches or
increases.1039
The final rule balances these
considerations by imposing
recordkeeping requirements that enable
the agencies to access books and records
concerning internal limit increases and
breaches in the course of other
supervision, inspections, and
examinations; require prompt action to
bring the trading desk back in
compliance in the event of a breach; and
impose requirements concerning
policies and procedures for escalation,
for demonstrable analysis of the basis
for internal limit increases, and for
independent review for such analysis
and approval.
The agencies could have also adopted
the internal limit approach, but with
more or less flexibility provided to
banking entities in setting internal
limits. For example, the agencies could
have specified that a desk’s internal
1032 See,
e.g., CFA.
e.g., ABA; Committee on Capital
Markets; Credit Suisse; GFMA; FSF; JBA and BB&T.
1034 See, e.g., FSF; SIFMA; ABA; CREFC; GFMA;
Goldman Sachs; Real Estate Associations and ISDA.
1035 See, e.g., Capital One et al.
1036 See, e.g., JBA and IIB.
1037 See BOK.
1038 See, e.g., CCMC.
1039 See, e.g., Capital One et al.; Better Markets;
MBA and State Street.
1033 See,
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limits can reflect risk appetite, risk
capacity, and business strategy, so long
as that desk holds itself out as a market
maker; the agencies could have also
permitted limits based on absolute value
of profit and loss (in the case of an
underwriting desk).1040 The agencies
could have also adopted an approach
under which the internal limits
necessary for the presumption of
compliance are developed in
collaboration with onsite supervisors or
prudential examiners.1041 The agencies
could have also adopted an approach
under which all or Group B and Group
C banking entities would be able to rely
on the presumption of compliance if
their internal limits were appropriate to
the activities of the desk subject to other
existing bank regulations, supervisory
review, and oversight by the appropriate
agency.1042 Finally, the agencies could
have adopted an approach under which
the presumption of compliance is
available for activity-based internal
limits, such as those based on notional
size and inventory turnover.1043
Alternatives that would provide banking
entities with greater flexibility in setting
internal limits would bolster the ability
of market makers and underwriters to
proactively adjust their risk exposures
to changing market conditions and
potentially accommodate a greater
volume of customer demand. At the
same time, such alternatives may also
allow banking entities to engage in a
greater degree of trading activity while
relying on the presumption of
compliance.
Similarly, one commenter suggested
an approach that more prescriptively
specifies how banking entities should
set and adjust internal limits and what
factors they should consider.1044
Another commenter stated that such a
one-size-fits all approach ignores
differences in the business models of
banking entities and desks.1045 The SEC
believes that, while this alternative may
decrease the trading activity of banking
entities, it would not appropriately
tailor the 2013 rule to the differences in
organization, operation, and risks of
various banking entities and their
trading desks; may hamper client
facilitation activity when market
conditions are in flux; and may have the
unintended effect of banking entities
delegating certain risk management
functions to the agencies. As discussed
above, the final rule specifies that
1040 See
JBA.
e.g., FSF and SIFMA.
1042 See Capital One et al.
1043 See BB&T.
1044 See Better Markets.
1045 See Committee on Capital Markets.
1041 See,
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internal limits must be designed not to
exceed RENTD and that internal limits
of banking entities are subject to
ongoing regulatory oversight by the
agencies.
The agencies could have adopted an
approach under which underwriting
and market making requirements are
tailored to banking entities on the basis
of different thresholds. For example, the
agencies could have instead relied on
the trading assets and liabilities
threshold for market making compliance
(as in the final rule), but applied a
different threshold for underwriting
compliance, such as on the basis of the
volume or profitability of past
underwriting activity. This alternative
would have tailored the compliance
requirements for SEC-regulated banking
entities with respect to underwriting
activities. However, the volume and
profitability of underwriting activity is
highly cyclical and is likely to decline
in weak macroeconomic conditions. As
a result, under the alternative, SECregulated banking entities would face
lower limits with respect to
underwriting activity during times of
economic stress when covered trading
activity related to underwriting may
pose the highest risk of loss. The
alternative may also limit banking
entities in their ability to engage in
underwriting during economic
weakness when economic activity and
capital formation are in decline.
One commenter suggested that the
agencies interpret the underwriting
exemption broadly to accommodate any
activity that assists persons or entities in
accessing the capital markets or raising
capital, as well as any activities done in
connection with a capital raise.1046
Under such an approach, an
underwriter’s hedging of unsold,
contingent, or forward underwriting
allotments would be permissible under
the underwriting exemption. To the
degree that banking entities are unable
to engage in such activities in reliance
on the hedging or other exemptions
under the 2013 rule, this alternative
may increase the ability of some
banking entities to hedge some of the
risks related to underwriting and their
willingness to engage in underwriting
activity. Moreover, a broad underwriting
exemption would eliminate the need to
categorize the underwritten
instruments, which may be difficult to
do in some foreign markets with respect
to loans, repos, securities loans,
financial instruments, or derivatives. At
the same time, the SEC believes that
banking entities may currently be able
to engage in hedging related to
underwriting activity under the rule,
such as in reliance on the hedging
exemption.
d. Permitted Risk-Mitigating Hedging
i. Costs and Benefits
As discussed in the proposal,1047
hedging is an essential tool for risk
mitigation and can enhance a banking
entity’s provision of client-facing
services, such as market making and
underwriting, as well as facilitate
financial stability. In recognition of the
important role that this activity can play
as part of a banking entity’s overall
operations, the agencies are adopting a
number of changes that streamline and
clarify the 2013 rule’s exemption for
risk-mitigating hedging activities to
reduce unnecessary compliance burdens
and uncertainty some banking entities
face concerning their ability to rely on
the hedging exemption.
First, the final rule simplifies the
requirements of the risk-mitigating
hedging exemption for banking entities
that do not have significant trading
assets and liabilities. The amendment
removes the requirement to have a
specific risk-mitigating hedging
compliance program, as well as the
documentation requirements and
certain hedging activity requirements
for such entities. As a result, these
banking entities are subject to the
following requirements: (1) The hedging
activity, at the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks, including
market risk, counterparty or other credit
risk, currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof; and
(2) the hedging activity is subject, as
appropriate, to ongoing recalibration by
the banking entity to ensure that the
hedging activity satisfies these
requirements and is not prohibited
proprietary trading.
As discussed in the proposal,1048
banking entities without significant
trading assets and liabilities may be less
likely to engage in large or complicated
trading activities and hedging strategies.
The agencies have received comment
supporting such reduced compliance
1047 See,
1046 See,
PO 00000
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1048 See,
Sfmt 4700
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e.g., 83 FR at 33536.
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requirements for banking entities that
do not have significant trading assets
and liabilities.1049 One commenter
stated that reduced compliance
requirements for risk-mitigating hedging
by Group B and Group C banking
entities would not affect the safety and
soundness of banking entities or
financial stability and pointed to the
importance of robust monitoring and
banking entity risk management in the
context of risk-mitigating hedging.1050
Another commenter opposed this aspect
of the amendments and stated that,
absent proprietary trading intent,
ensuring that hedging does not increase
banking entities’ risks at inception of
the hedge and that trading personnel are
not compensated for doing so is not
complex.1051
The SEC continues to believe that
compliance with the 2013 rule,
including compliance with the
requirements of § ll.5(b)(2), imposes
disproportionate costs on banking
entities without significant trading
assets and liabilities.1052 The SEC
continues to note that, as quantified in
the economic baseline, Group B and
Group C broker-dealers represent a very
small fraction of total assets and
holdings in the broker-dealer industry.
In addition, fixed compliance costs
represent disproportionately greater
burdens for smaller entities as they may
face greater difficulty absorbing such
costs into revenue. Importantly, the
final rule does not waive the substantive
proprietary trading prohibitions in
section 13 of the BHC Act for any
banking entity, including for any Group
B or Group C banking entity. Instead,
the SEC continues to believe that the
amendment reduces the costs of relying
on the hedging exemption and, thus, the
costs of engaging in hedging activities
for Group B and Group C entities. To the
extent that the removal of these
requirements may reduce the costs of
risk-mitigating hedging activity, Group
B and Group C entities may increase
their intermediation activity while also
growing their trading assets and
liabilities.
Second, the final rule reduces
documentation requirements for Group
A entities. In particular, the final rule
removes the documentation
requirements for some risk-mitigating
hedging activity. More specifically, the
activity is not subject to the
documentation requirement if (1) the
financial instrument used for hedging is
identified on a written list of pre-
approved financial instruments
commonly used by the trading desk for
the specific type of hedging activity; and
(2) at the time the financial instrument
is purchased or sold the hedging activity
(including the purchase or sale of the
financial instrument) complies with
written, pre-approved hedging limits for
the trading desk purchasing or selling
the financial instrument for hedging
activities undertaken for one or more
other trading desks.
The agencies received comment that
this and other final amendments to the
risk-mitigating hedging exemption may
lead banking entities to engage in less
planning, documentation, and testing in
their hedging activities, may reduce the
effectiveness of agency oversight, and
may weaken the proprietary trading
prohibitions of the 2013 rule.1053 Other
commenters supported the revisions,
but stated that enhanced documentation
requirements for the hedging
exemption, as a whole, are unnecessary
given the robust compliance framework
under the 2013 rule and amendments,
and supported the complete elimination
of the documentation requirements for
all banking entities.1054
Consistent with the views of some
commenters,1055 the economic effects
with respect to internal limits for the
purposes of hedging with pre-approved
instruments may be similar to the effects
of internal limits for the purposes the
underwriting and market making
exemptions discussed above. The SEC
recognizes that the economic effects of
this aspect of the final rule depend on
the prevalence of hedging activities in
each registrant, their organizational
structure, business model, and
complexity of risk exposures. However,
the SEC continues to believe that the
flexibility to choose between providing
documentation regarding risk-mitigating
hedging transactions and establishing
hedging limits for pre-approved
instruments may be beneficial for Group
A entities, as it will allow these entities
to tailor their compliance programs to
their specific organizational structure
and existing policies and
procedures.1056 At the same time, the
SEC believes that the remaining
documentation requirements for Group
A entities being adopted will facilitate
effective internal risk management and
agency oversight.
Third, the final rule eliminates the
requirement that the risk-mitigating
hedging activity must demonstrably
1053 See,
1049 See,
e.g., Credit Suisse and BB&T.
1050 See BB&T.
1051 See Better Markets.
1052 See, e.g., 83 FR at 33536.
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e.g., Better Markets; Data Boiler and
Bean.
e.g., ABA; FSF; CREFC; BPI and SIFMA.
e.g., Credit Suisse.
1056 See, e.g., 83 FR at 33536.
1055 See,
PO 00000
Frm 00101
reduce or otherwise significantly
mitigate one or more specific
identifiable risks at the inception of the
hedge. Additionally, the
demonstrability requirement is also
removed from the requirement to
continually review, monitor, and
manage the banking entity’s existing
hedging activity. Banking entities will
continue to be subject to the
requirement that the risk-mitigating
hedging activity be designed to reduce
or otherwise significantly mitigate one
or more specific, identifiable risks, as
well as to the requirement that the
hedging activity be subject to continuing
review, monitoring and management by
the banking entity to confirm that such
activity is designed to reduce or
otherwise significantly mitigate the
specific, identifiable risks that develop
over time from the risk-mitigating
hedging.
Consistent with the views of a number
of commenters,1057 the SEC believes
that the removal of the demonstrability
requirement may benefit banking entity
dealers, as it decreases uncertainty
about the ability to rely on the riskmitigating hedging exemption and may
reduce the compliance costs of engaging
in permitted hedging activities. The SEC
continues to recognize that some SECregulated banking entities may respond
to this aspect of the final rule by
accumulating positions that increase the
banking entity’s risk exposure through
adjustments (or lack thereof) to
otherwise permissible hedging
portfolios.1058 The SEC also recognizes
concerns raised by commenters that
some banking entities may forecast
changes in correlations and construct
hedging portfolios such that they leave
the entity exposed to directional market
movements.1059 The SEC continues to
recognize that this may result in
increased risks from the trading activity
of some banking entities.1060 However,
the final rule’s requirement concerning
ongoing recalibration may mitigate these
adverse effects. In addition, as discussed
in greater detail in the economic
baseline, the SEC recognizes that trading
activity is only one form of activity
conducted by banking entities that can
increase risk exposure, and that market,
credit, and liquidity risks of the banking
book as well as the degree to which
banking book risks are hedged by
tradeable assets all contribute to the
overall risk of a banking entity or group
of banking entities. As a result, the SEC
1057 See,
e.g., ABA; Credit Suisse and SIFMA.
83 FR at 33535. See also, e.g., Better
Markets; Bean; Data Boiler and CFA.
1059 See, e.g., Public Citizen.
1060 See, e.g., 83 FR at 33536.
1058 See
1054 See,
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recognizes that, to the degree that some
banking entities may respond to the
final rule by increasing risk exposures
arising out of trading activity, these
effects may be partly offset by changes
in the risks these banking entities take
in the normal course of their banking
activity or more complete hedging of
their banking and trading risks through
trading portfolios. Moreover, the SEC
believes that this aspect of the final
rules may not only benefit banking
entities by alleviating compliance
burdens related to risk management, but
may also benefit clients and
counterparties by enabling greater
trading activity and liquidity provision
by dealers that are banking entities.
Furthermore, the SEC reiterates that the
returns and risks arising from the
activity of banking entities may flow
through to banking entity’s investors
and that investors in securities markets
may benefit from greater liquidity as it
enables exit from investment positions.
Finally, the final rule removes the
requirement to perform the correlation
analysis. The SEC continues to
recognize that a correlation analysis
based on returns may be prohibitively
complex for some asset classes and that
a correlation coefficient may not always
serve as a meaningful or predictive risk
metric.1061 The agencies received
comment that permitting additional
time to provide correlation analysis
would better address time-related
challenges; 1062 that requiring statistical
tests of randomness to the observed
returns on the hedged positions may
serve to duly constrain hedging; 1063 and
that there should be no regulationrelated delays when hedging if banking
entities rely on documented and stable
risk relationships.1064 The SEC notes
that time costs are only one of the issues
in the correlation requirement and that
banking entities may not be able to rely
on documented and stable risk
relationships in quickly evolving market
conditions. Although in some instances
correlation analysis of past returns may
be helpful in evaluating whether a
hedging transaction was effective in
offsetting the risks intended to be
mitigated, the SEC continues to
recognize that correlation analysis may
not be an effective tool for such
evaluation in other instances. For
example, correlations across assets and
asset classes evolve over time and may
exhibit jumps at times of idiosyncratic
or systematic stress. In such
circumstances, historical correlations
among the returns on assets or asset
classes may not be representative of the
way in which they will affect portfolio
risk going forward. Moreover, the SEC
notes that asset return correlations may
not be informative when financial
instruments are traded infrequently, if
the prices used to construct asset
returns are non-binding indicative
quotes (and not actual execution prices).
Additionally, the hedging activity, even
if properly designed to reduce risk, may
not be practicable if costly delays or
compliance complexities result from a
requirement to undertake a correlation
analysis.1065 These costs and delays
may be most acute in times of market
stress and during spikes in volatility,
during which customers and other
dealers may demand greater liquidity.
The SEC continues to believe that the
removal of the correlation analysis
requirement may provide dealers with
greater flexibility in selecting and
executing risk-mitigating hedging
activities.1066
The SEC received comments that the
elimination of the correlation analysis
may impede supervisory review, enable
some banking entities to disguise
proprietary trades as hedges, or result in
permissible over- or under-hedging due
to changes in asset correlations over
time.1067 Other commenters indicated
that correlation analysis is highly
automated and forces banking entities to
be more purposeful in hedging
activities.1068 The SEC recognizes these
concerns and continues to recognize
that the removal of the correlation
analysis requirement involves the
tensions of the effects discussed
above.1069 The SEC continues to
recognize that, to the extent that some
banking entities may respond to this
aspect of the final rule by engaging in
more trading activities that leave them
exposed to directional market
movements while relying on the riskmitigating hedging exemption, this
aspect of the final rule may increase risk
taking and conflicts of interest between
banking entities and their customers.
However, the SEC believes that the final
rule’s requirement concerning ongoing
recalibration by the banking entity to
ensure that the hedging activity satisfies
the requirements above and is not
prohibited proprietary trading may
mitigate these concerns. In addition,
1065 See,
e.g., SIFMA.
e.g., 83 FR at 33535.
1067 See, e.g., AFR; Bean; NAFCU; Public Citizen;
Volcker Alliance; Better Markets and Systemic Risk
Council.
1068 See, e.g., AFR and Data Boiler.
1069 See 83 FR at 33536.
1066 See,
1061 See 83 FR at 33535. See also, e.g., ABA;
Credit Suisse; JBA; SIFMA and CREFC.
1062 See, e.g., Better Markets.
1063 Id.
1064 Id.
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similar to the discussion above, the SEC
continues to recognize that changes in
the overall risk of banking entities
reflect both changes in the risk of
trading activities and their banking
activities. Importantly, the SEC
continues to believe that the
requirement to engage in correlation
analysis may have slowed the timing of
hedging activities by some banking
entities and may not be beneficial for
prudent risk management or practical
under some circumstances. Moreover,
the SEC continues to believe that
potential increases in permitted riskmitigating hedging may benefit clients,
customers, and counterparties by
increasing trading activity and capital
formation by banking entities,
particularly in times of market stress
and during spikes in volatility. Finally,
under the final rule, banking entities
remain subject to the full scope of
agency oversight over trading activities
in reliance on the hedging exemption.
As discussed above, the SEC estimates
burden reductions, per firm, as a result
of the final rule. The final amendments
to § ll.5(c) may result in ongoing cost
savings for SEC-registered brokerdealers 1070 estimated at $1,295,903.1071
Additionally, the final rule will result in
lower ongoing costs for potential SBSD
registrants relative to the costs that they
would incur under the 2013 rule’s
regime if they were to choose to register
with the SEC—this cost reduction is
estimated to reach up to $51,775.1072
However, the SEC recognizes that
compliance with SBSD registration
1070 The SEC continues to believe that the burden
reduction for SEC-regulated entities will be a
fraction of the burden reduction for the holding
company as a whole. In the proposal, the SEC
attributed 18% of the reductions in holding
company (parent) burdens to the dealer affiliates,
on the basis of the average weight of broker-dealer
assets in holding company assets. The SEC received
no comment on this estimate and continues to rely
on this figure in estimates of compliance burden
reductions for SEC registrants. However, the SEC
recognizes that compliance burdens may be borne
disproportionately by dealer affiliates because of
their role in trading for the holding company. As
a result, some dealers may currently be bearing a
larger fraction of holding company compliance
burdens related to section 13 of the BHC Act. To
this extent, the estimates of compliance burden
savings may underestimate the magnitude of the
benefits enjoyed by SEC registrants under the final
amendments.
1071 Ongoing recordkeeping burden reduction for
broker-dealers: (100 hours per firm × 0.18 weight ×
(Attorney at $423 per hour) × 199 firms)¥(80 hours
per firm × 0.18 weight × (Attorney at $423 per hour)
× 36 firms affiliated with Group A entities) =
$1,515,186¥$219,283 = $1,295,903.
1072 Recordkeeping burden reduction for entities
that may register as SBSDs: (100–80) hours per firm
× 0.18 weight × (Attorney at $423 per hour) × 34
SBSDs not already registered as broker-dealers =
$51,775. This estimate assumes all SBSDs are
Group A entities and will still be subject to these
ongoing recordkeeping obligations.
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requirements is not yet required and
that there are currently no registered
SBSDs.
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ii. Efficiency, Competition, and Capital
Formation
The primary efficiency, competition,
and capital formation effects of the riskmitigating hedging amendments stem
from competition and capital formation.
The final hedging amendments provide
greater relief with respect to the
requirements of the exemption for
hedging activity to Group B and Group
C entities relative to Group A entities.
Since the fixed costs of relying on such
exemptions may be more significant for
entities with smaller trading books, the
final hedging amendments may permit
Group B entities just below the $20
billion threshold to more effectively
compete with Group A entities just
above the threshold.
The final hedging amendments may
also influence the volume of hedging
activity and capital formation. To the
extent that some registrants currently
experience significant compliance costs
related to the hedging exemption, these
costs may constrain the amount of riskmitigating hedging they currently
engage in. The ability to hedge
underlying risks at a low cost can
facilitate the willingness of SECregulated entities to commit capital and
take on underlying risk exposures.
Because the final rule may reduce costs
of relying on the hedging exemption,
these entities may become more
incentivized to engage in risk-mitigating
hedging activity, which may in turn
contribute to greater capital formation.
These amendments to risk-mitigating
hedging do not change the amount or
type of information available to market
participants, and the SEC does not
believe that the final rule is likely to
have an effect on informational
efficiency. To the degree that these
amendments may enable some banking
entities to more easily rely on the
hedging exemption, and to the extent
that hedging supports extension of
credit and other capital formation, these
amendments may somewhat improve
allocative efficiency.
iii. Alternatives
The agencies could have adopted an
approach that would exclude from the
proprietary trading prohibition or allow
all or a subset of banking entities (such
as Group B and Group C entities) to rely
on the presumption of compliance with
respect to hedging activity accounted for
under hedge accounting principles.1073
1073 See, e.g., Capital One et al., JBA, ABA and
KeyCorp.
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The agencies could have also adopted
an approach excluding trading activity
of non-U.S. banking entities accounted
for under hedge accounting rules in
their home jurisdictions.1074 The SEC
believes that such alternatives would
effectively replace the compliance and
documentation obligations for permitted
risk-mitigating hedging in the 2013 rule
as amended in this final rule with the
compliance obligations necessary for an
entity to qualify for hedge accounting
treatment. For example, banking entities
must generally document the hedge
relationship, including hedge objectives,
risks being hedged, hedged item and the
financial instrument used in the hedge,
demonstrate that the hedge is highly
effective, and recognize any
ineffectiveness in profits and losses.1075
As a result, some commenters 1076
indicated that such approaches may
reduce compliance duplication and
further reduce uncertainty regarding the
ability of some banking entities to rely
on the risk-mitigating hedging
exemption with respect to certain
hedging transactions.
However, the SEC also recognizes
commenter concerns that the
compliance and effectiveness testing for
the purposes of hedge accounting are
designed for the purposes of transparent
and informative financial statements
and are not designed to distinguish
between prohibited proprietary trading
and permissible risk-mitigating hedging
for the purposes of section 13 of the
BHC Act.1077 Moreover, international
accounting standards may not involve
the same level of compliance,
documentation, and effectiveness
testing as either the U.S. hedge
accounting standards or the compliance
program for the hedging exemption of
the 2013 rule. As a result, the SEC
continues to believe that the final rule
implements the purposes of section 13
of the BHC Act while reducing
compliance burdens on most affected
registrants.
As another alternative, the agencies
could have adopted an approach, under
which compliance with the riskmitigating hedging exemption is applied
on the basis of analysis of the trading
desk’s activities as a whole and not on
a trade-by-trade basis.1078 In a related
vein, the agencies could have adopted
an approach that allows portfolio
hedging that is not contemporaneous
1074 See
JBA.
FASB, Derivatives and Hedging (Topic
815) (Aug. 2017). See also International Financial
Reporting Standard (‘‘IFRS’’) 9 (Financial
Instruments). See also Capital One et al.
1076 See Capital One et al. and JBA.
1077 See, e.g., Data Boiler.
1078 See, e.g., Credit Suisse and CCMC.
1075 See
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62075
with the inception of the position being
hedged and that does not occur at the
desk to which the risk is booked, so long
as the hedging exposure remains within
permitted internal limits applicable to
each desk and to the banking entity as
a whole.1079 The SEC believes that such
alternatives would have the effect of
enabling firm-wide macro hedges of a
banking entity’s risk exposures by
centralized risk management desks,
which may involve fewer transaction
costs and reduce the burden of
demonstrating compliance with the
hedging exemption for each trade.
However, such an approach may make
it more difficult for the agencies and
banking entities to oversee compliance
with the hedging exemption and
distinguish between transactions
reasonably designed at their inception
to hedge specific risks and
impermissible proprietary trades
intended to profit from asset mispricing
or directional changes in the value of
assets or asset classes.
As discussed above, the agencies
could have also eliminated all enhanced
documentation requirements for Group
A banking entities and all other
conditions of the hedging exemption not
expressly required by the statute.1080
The SEC believes that, relative to the
final rule, such an alternative would
further reduce compliance burdens on
Group A banking entities and
uncertainty regarding their ability to
rely on the hedging exemption and may
increase the volume of risk-mitigating
hedging by Group A banking entities.
However, the elimination of enhanced
documentation requirements as a whole
and other conditions of the exemption
may also reduce the effectiveness of
internal risk management and agency
oversight of Group A entities and may
result in increased trading activity by
Group A entities in reliance on the
hedging exemption. This risk may be
particularly acute given the size and
complexity of trading activity of Group
A entities and their role in the dealer
industry and in the U.S. financial
system as a whole.
The agencies could have adopted an
explicit exclusion from the proprietary
trading prohibition for hedges of
corporate debt issuances. Specifically,
the agencies have received comment
that financial institutions may routinely
hedge debt securities issued for
corporate purposes with interest rate
swaps, which fall into the trading
account under the 60-day rebuttable
1079 Id.
1080 See,
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presumption of the 2013 rule.1081 As
discussed above, the final rule modifies
the short-term prong of the trading
account definition, reducing the
likelihood that such activity would fall
in to the trading account and require the
reliance on the hedging exemption. As
a result, the SEC believes that the final
rule may enable valuable and routine
hedging of corporate debt issued by
banking entities subject to the shortterm prong without the costs of
complying with the risk-mitigating
hedging exemption.
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e. Exemption for Foreign Trading
i. Costs and Benefits
Foreign banking entities seeking to
rely on the exemption for trading
outside of the United States under the
2013 rule face a complex set of
compliance requirements that may
result in significant burdens and
implementation inefficiencies, which
may have reduced cross-border trading
activity and liquidity between U.S. and
non-U.S. entities.1082 In particular,
agencies have received comment from
some market participants that
compliance with the financing prong
may be difficult for some non-U.S.
banking entities because of the
fungibility of some forms of
financing.1083 In addition, the SEC
continues to recognize that satisfying
the U.S counterparty prong is
burdensome for foreign banking entities
and may have led some foreign banking
entities to reduce the range of
counterparties with which they engage
in trading activity.1084 The final rule
removes the financing and counterparty
prongs.
Under the final rule, financing for a
transaction relying on the foreign
trading exemption can be provided by
U.S. branches or affiliates of foreign
banking entities, including U.S.
branches or affiliates that are SECregistered dealers. Foreign banking
entities may benefit from the final rule
because of the greater flexibility
afforded to how they are permitted to
finance their transaction activity in
reliance on the foreign trading
exemption. The agencies have also
received comment supporting the focus
of the exemption on the location of the
principal risk and the location in which
decision making behind the trading
occurs.1085 At the same time, the
1081 See
KeyCorp.
e.g., JBA; HSBC; ABA; ISDA; Credit
Suisse; Committee on Capital Markets and IIB.
1083 See, e.g., EBF (citing 83 FR at 33468–69).
1084 See, e.g., 83 FR at 33537.
1085 See, e.g., ABA; ISDA; Credit Suisse;
Committee on Capital Markets and IIB.
1082 See,
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agencies have received comment that
the proposed amendments to the
exemption may increase the
vulnerability of the U.S. financial
system to proprietary trading losses of
foreign banking entities.1086 However,
for the reasons noted below, the SEC
does not believe that the amendments
will, on balance, increase vulnerability
in the manner described by
commenters. Specifically, the SEC
continues to recognize that some of the
economic exposure and risks of
proprietary trading by foreign banking
entities may flow not just to the foreign
banking entities, but to U.S.-located
entities financing the transactions, e.g.,
through margin loans.1087 However,
potential adverse effects on
vulnerability may be mitigated by two
primary factors. First, the SEC notes that
the final rule retains the condition that
any purchases or sales by a foreign
banking entity, including any hedging
trades, are not accounted for as
principal directly or on a consolidated
basis by any U.S. branch or affiliate of
the foreign banking entity. Thus, under
the final rule, the principal risk of
proprietary trading by non-U.S. banking
entities will remain outside of the
United States. Moreover, U.S. banking
entities providing financing to their
foreign banking entity affiliates are
likely to be separately subject to a full
range of capital, margin, and other
obligations unrelated to section 13 of
the BHC Act, which may reduce risks to
the U.S. branches and affiliates of
foreign banking entities. The SEC
believes that the focus on where the
principal risk and decision making
behind the trading resides tailors the
application of the 2013 rule with respect
to foreign banks’ non-U.S. operations by
reducing compliance burdens and
uncertainties of foreign banking entities
in their trading activity.1088
In addition, the final rule removes the
counterparty prong and its
corresponding clearing and anonymous
exchange and personnel requirements.
As a result, the final rule makes it easier
for foreign banking entities to transact
with or through U.S. counterparties. To
1086 See, e.g., Bean; NAFCU; Better Markets;
Merkley and Data Boiler.
1087 Id.
1088 In addition, the agencies confirmed in this
SUPPLEMENTARY INFORMATION that the foreign trading
exemption does not preclude a foreign banking
entity from engaging a non-affiliated U.S.
investment adviser as long as the actions and
decisions of the banking entity as principal occur
outside of the United States. To the extent that
foreign banking entities were restricting engagement
of non-affiliated U.S. investment advisers due to
uncertainty about the 2013 rule, non-affiliated U.S.
investment advisers may become better able to
compete for the foreign banking entity’s investment
mandates.
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Fmt 4701
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the extent that foreign banking entities
are currently bearing 1089 and passing
along compliance burdens to their U.S.
counterparties, or are unwilling to
intermediate or engage in certain
transactions with or through U.S.
counterparties, the final rule may
reduce transaction costs for U.S.
counterparties and may increase the
volume of trading activity between U.S.
counterparties and foreign banking
entities.1090
The SEC recognizes that this aspect of
the final rule may adversely affect the
current competitive standing of U.S.
banking entities insofar as foreign
banking entities will have greater ability
to engage in proprietary trading
activities with U.S. counterparties.1091
However, the removal of the
counterparty prong in the final rule
maintains a comparable treatment of the
U.S. operations of U.S. and non-U.S.
banking entities with respect to the
transactions that are booked in the U.S.,
as neither U.S. nor non-U.S. banking
entities are able to rely on the foreign
trading exemption for such activity.1092
The agencies have also received
comment that the elimination of
clearing and exchange requirements
may enable U.S. intermediaries to
compete for business in OTC financial
products with foreign banking entity
counterparties, and that the
amendments may foster trading activity
between foreign affiliates and branches
of U.S. banking entities and foreign
banking entities without the constraints
under the counterparty prong on the
involvement of their U.S. personnel.1093
When a foreign banking entity
engages in proprietary trading through a
U.S. dealer, such trades expose the
counterparty to risks related to the
transaction, though such risks born by
U.S. counterparties likely depend on
both the identity of the counterparty
and the nature of the instrument and
terms of trading position. Moreover, the
SEC continues to emphasize that
concerns about moral hazard and the
volume of risk-taking by foreign banking
entities may be less relevant for U.S.
markets for two reasons.1094 First,
foreign banking entities are less likely to
be beneficiaries of U.S. deposit
insurance and implicit bailout
guarantees. Second, foreign banking
entities are likely subject to foreign
1089 See,
e.g., HSBC.
e.g., JBA.
1091 See, e.g., FSF.
1092 See, e.g., IIB.
1093 Id.
1094 See, e.g., 83 FR at 33537. See also JBA.
1090 See,
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securities and prudential regulations
that address these concerns.
In addition, as proposed, the final rule
replaces references to personnel
arranging, negotiating, and executing
trades with references to relevant
personnel. This change is consistent
with the views of some commenters,
who stated that the current arrange,
negotiate, or execute test is burdensome
and may restrain trading activity outside
of the U.S.1095 Specifically, the
availability of the foreign trading
exemption is amended to be
conditioned on the banking entity
engaging as a principal (including
relevant personnel) not being located in
the U.S. or organized under U.S. laws.
As discussed elsewhere in this
SUPPLEMENTARY INFORMATION, the
agencies are modifying the rule such
that relevant personnel for the purposes
of the foreign trading exemption are
limited to personnel engaged in the
banking entity’s decision in the
purchase or sale as principal. The SEC
believes that the location of the
personnel engaged in the banking
entity’s decision in the purchase or sale
is a meaningful trigger for the
application of section 13 of the BHC Act
and implementing rules. Specifically,
the SEC has considered how narrowing
the personnel requirement may increase
risk exposure of banking entities from
trading activity and conflicts of interest
between banking entities and their
clients on the one hand and may
enhance market quality and availability
of trading counterparties on the other
hand. In addition, as part of the baseline
for analysis, the conditions for the
foreign trading exemption in the 2013
rule include both requirements
concerning relevant personnel that
makes the decision to purchase or sell
as principal and requirements
concerning personnel involved in
arranging, negotiating, and executing
trades. As a result, under the 2013 rule
foreign banking entities have to
determine whether a particular
employee meets both the requirements
related to relevant personnel and related
to personnel arranging, negotiating, and
executing purchases and sales. This
aspect of the final rule eliminates the
need for a foreign banking entity to
separately establish that a given
employee meets both sets of
requirements, reducing inefficiencies
associated with foreign banking entities
relying on the foreign trading exemption
from the proprietary trading prohibition.
1095 See,
e.g., EBF; HSBC and IIB.
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ii. Efficiency, Competition, and Capital
Formation
The final rule likely expands the
scope of trading activity by foreign
banking entities that may qualify for the
foreign trading exemption. As a result,
the amendments may reduce the costs,
benefits, and effects on efficiency and
capital formation of the 2013 rule
discussed in the economic baseline, and
may increase competition between U.S.
and foreign banking entities. The final
rule reflects consideration of the
potentially inefficient restructuring of
activities undertaken by foreign banking
entities after the 2013 rule came into
effect and the loss of access of U.S.
market participants to foreign banking
entity counterparties, on the one
hand,1096 and, advancement of the
objectives of section 13 of the BHC Act,
on the other hand.
Allowing foreign banking entities to
be financed by U.S.-dealer affiliates and
to transact with U.S. counterparties on
an OTC basis (i.e., off-exchange) and
without clearing the trades, may reduce
costs of non-U.S. banking entities’
trading activity under the foreign
trading exemption, including with U.S.
counterparties. These costs may
currently represent barriers to entry for
foreign banking entities that
contemplate engaging in trading and
other transaction activity using a U.S.
affiliate’s financing and OTC trading
with U.S. counterparties. To that extent,
the final rule may provide (1) incentives
for foreign banking entities that
currently receive financing from nonU.S. affiliates or other sources to move
financing to U.S. dealer affiliates, and
(2) incentives for foreign banking
entities that currently do not transact
with or through U.S. counterparties (or
transact with or through U.S.
counterparties only in transactions that
are promptly cleared) to transact with or
through U.S. counterparties (or transact
with or through U.S. counterparties
outside of promptly cleared
transactions). As a result, the number of
banking entities engaging in trading
activities in U.S. markets may increase,
which may enhance the incorporation of
new information into prices. However,
the amendments may result in a shift in
securities trading activity away from
U.S. banking entities to foreign banking
entities that are not comparably
regulated.
1096 In the Proposing Release, the SEC noted that,
according to one market participant, at least seven
international banks have terminated or transferred
existing transactions with U.S. counterparties in
order to comply with the foreign trading exemption
and to avoid compliance costs of relying on
alternative exemptions or exclusions. See 83 FR at
33537.
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62077
The final rule may increase market
entry, as it will decrease the need for
foreign banking entities to rely on a
narrower set of unaffiliated market
intermediaries in order to conduct
trading activity under the foreign
trading exemption in compliance with
the 2013 rule. Additionally, the final
rule may increase operational efficiency
of trading activity by foreign banking
entities in the United States, which may
decrease costs to market participants
and may increase the level of market
participation by U.S-dealer affiliates of
foreign banking entities.
Consistent with the views of
commenters,1097 the SEC continues to
recognize that the final rule may also
affect competition among banking
entities.1098 The statute may introduce
competitive disparities between U.S.
and foreign banking entities. Under the
final rule, foreign banking entities may
enjoy a greater degree of flexibility in
financing proprietary trading and
transacting with or through U.S.
counterparties relative to the baseline.
At the same time, U.S. banking entities
are not able to engage in proprietary
trading and are subject to the
substantive prohibitions of section 13 of
the BHC Act. One commenter indicated
that non-U.S. banking entities will
continue to bear operational burdens
because of the legal entity
requirements.1099 To the degree that the
final requirements regarding the
location of the principal risk and
relevant personnel are still burdensome
and constraining foreign banking
entities in their reliance on the foreign
trading exemption, this may partly
dampen the above competitive effect. To
the extent that banking entities at the
holding company level may be able to
reorganize and move their business to a
foreign jurisdiction, some U.S. banking
entity holding companies may exit from
the U.S. regulatory regime. However,
under sections 4(c)(9) and 4(c)(13) of the
Banking Act, U.S. entities would have to
conduct the majority of their business
outside of the United States to become
eligible for the exemption, reducing
potential effects of their activities on
U.S. markets. In addition, certain
changes in control of banks and bank
holding companies require supervisory
approval. Hence, the feasibility and
magnitude of such regulatory arbitrage
remain unclear. The SEC also notes that,
as referenced above, the final rule
preserves equal competitive treatment of
the U.S. operations of both U.S. and
1097 See, e.g., Bean; Data Boiler; FSF and Better
Markets.
1098 See 83 FR at 33538.
1099 See, e.g., JBA.
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non-U.S. banking entities that will
remain unable to rely on the foreign
trading exemption and will remain
subject to section 13 of the BHC Act.1100
To the extent that foreign banking
entities currently engage in cleared
transactions with or through U.S.
counterparties because of the existing
counterparty prong but would have
chosen not to do so otherwise, the final
rule may reduce the amount of cleared
transactions. This may reduce
opportunities for risk-sharing among
market participants and increase
idiosyncratic counterparty risk born by
U.S. and foreign counterparties.
At the same time, the final rule may
increase the availability of liquidity and
reduce transaction costs for market
participants seeking to trade in U.S.
securities markets. To the extent that
non-U.S. banking entities will face
lower costs of transacting with U.S.
counterparties, it may become easier for
U.S. banking entities or customers to
find a transaction counterparty willing
to engage in, for instance, hedging
transactions. To that extent, U.S. market
participants accessing securities markets
to hedge financial and commercial risks
may increase their hedging activity and
assume a more efficient amount of risk.
The potential consequences of
relocation of non-U.S. banking entity
activity to the United States for liquidity
and risk-sharing may be most
concentrated in those asset classes and
market segments where activity is most
constrained by the requirements in the
2013 rule.
iii. Alternatives
The agencies could have amended the
foreign trading exemption to remove all
conditions for the exemption, including
the engaging as principal and decisionmaking requirements, except for the
booking requirement.1101 Relative to the
final rule, the SEC believes that such an
alternative approach would further
lower the compliance burdens of nonU.S. banking entities relying on the
foreign trading exemption and may
foster more trading activity by U.S.
affiliates of non-U.S. banking entities.
For example, the agencies have received
comment that the engaging as principal
and decision-making requirements have
led Japanese firms to downsize their
U.S. affiliates and that the decisionmaking requirement is operationally
difficult for Japanese banks executing
trades in U.S. markets because of time
zone differences. 1102 To the degree that
this alternative encourages more activity
1100 See,
1101 See,
e.g., IIB.
e.g., JBA.
1102 Id.
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of non-U.S. banking entities in the
United States, U.S. counterparties may
benefit from greater availability and
choice of banking entity counterparties.
However, the alternative would place
U.S. banking entities at a greater
competitive disadvantage relative to the
final rule, because it would result in
more flexibility for the U.S. operations
of non-U.S. banking entities to engage in
trading activities relative to the U.S.
operations of U.S. banking entities.
In addition, the agencies have
received comment suggesting an
exclusion of non-U.S. banking entities
with limited U.S. assets and operations
from the scope of section 13 of the BHC
Act.1103 The SEC notes that nothing in
the final rule changes or waives ongoing
statutory obligations of banking entities.
However, to the degree that reliance on
the foreign trading exemption is
burdensome and prevents non-U.S.
entities from trading in the United
States, the final rule may reduce
compliance burdens related to the 2013
rule by introducing the presumption of
compliance for Group C banking
entities. As discussed above, the Group
C threshold of $1 billion applies to the
trading assets and liabilities of the
combined U.S. operations of the top-tier
foreign banking organization (including
all subsidiaries, affiliates, branches, and
agencies of the foreign banking
organization operating, located, or
organized in the United States). As a
result, under the final rule, non-U.S.
banking entities that have limited
trading assets and liabilities in the
United States will be able to avail
themselves of the rebuttable
presumption of compliance and will no
longer be required to bear the fixed costs
and burdens of demonstrating
compliance with section 13 of the BHC
Act and the 2013 rule.
f. Covered Funds
The agencies are adopting
amendments to § ll.11 and § ll.13,
as proposed.
i. Costs and Benefits
First, the final rule removes the
requirement in § ll.11(c)(3) of the
2013 rule that a banking entity include,
for purposes of the aggregate fund limit
and capital deduction, the value of any
ownership interests of a third-party
covered fund (i.e., a covered fund that
the banking entity does not advise or
organize and offer pursuant to § ll.11
of the 2013 rule) acquired or retained in
accordance with the underwriting or
market making exemptions in § ll.4.
In addition, the final rule removes the
1103 See
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IIB.
Frm 00106
Fmt 4701
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guarantee language in § ll.11(c)(2) of
the 2013 rule which requires a banking
entity to include, for purposes of the
aggregate fund limit and capital
deduction, the value of any ownership
interests of a covered fund, the
obligations or performance of which is
directly or indirectly guaranteed,
assumed, or insured by the banking
entity.
The final amendments aim to more
closely align the requirements for
engaging in underwriting or market
making-related activities with respect to
ownership interests in covered funds
with the requirements for engaging in
these activities with respect to other
financial instruments. The SEC agrees
with a number of commenters 1104 and
continues to believe that the 2013 rule
imposed requirements on dealers’
transactions in ownership interests in
covered funds that may limit the ability
of dealers to underwrite and make
markets in ownership interests in
covered funds, even if dealers are able
to underwrite and make markets in the
underlying securities owned by covered
funds or in securities that are otherwise
similar to ownership interests in
covered funds. The SEC continues to
believe that, as also articulated by a
number of commenters,1105 the final
amendments provide banking entities
with greater flexibility in underwriting
and market making ownership interests
in covered funds.
In addition, the SEC continues to
recognize that the 2013 rule’s
restrictions on underwriting and market
making-related activities involving
ownership interests in covered funds
impose costs on banking entities, as also
discussed by a number of
commenters.1106 Under the final rule,
banking entities are able to engage in
potentially profitable market making
and underwriting in ownership interests
in covered funds that they do not advise
or organize or offer without the value of
any ownership interests of the covered
fund acquired or retained in connection
with underwriting or market makingrelated activities becoming subject to
aggregate limits and capital deduction.
Some commenters noted that this
amendment would facilitate capitalraising activities of covered funds,1107
increase liquidity, and generally benefit
the marketplace.1108 The SEC agrees
with these commenters and continues to
believe that SEC-regulated banking
1104 See,
e.g., SIFMA.
e.g., SIFMA and ISDA.
1106 See, e.g., BPI; IIB; SIFMA; ABA and Goldman
Sachs.
1107 See SIFMA.
1108 See ISDA.
1105 See,
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entities will benefit from this
amendment to the extent that they
engage in underwriting and market
making activities involving ownership
interests in covered funds, or to the
extent that they restricted or eliminated
such activities as a result of the
requirements in the 2013 rule. These
benefits may also, at least partially, flow
to funds and investors in those covered
funds. In addition, as some commenters
pointed out,1109 banking entities may
become more willing and able to
underwrite and make markets in
ownership interests in covered funds.
Some commenters indicated that
these amendments would greatly
increase banking entities’ exposure to
interests in covered funds, which would
entail additional risks.1110 For example,
the removal of the guarantee language in
§ ll.11(c)(2) would allow dealers to
have arrangements such as a put option
on the ownership interest in the covered
fund, which could expose the banking
entity to additional risk. The SEC
continues to recognize that ownership
interests in covered funds expose
banking entities to the risks related to
covered funds. The SEC agrees with the
commenters that it is possible that
covered fund ownership interests
acquired or retained by a banking entity
acting as an underwriter or engaged in
market making-related activities may
lead to losses for banking entities.1111
However, the SEC also continues to
recognize that the risks of market
making or underwriting of ownership
interests in covered funds are
substantively similar to the risks of
market making or underwriting of
otherwise comparable financial
instruments, the activity which is
expressly permitted by section 13 of the
BHC Act. Therefore, the same general
tensions discussed in section V.F.3.c of
this SUPPLEMENTARY INFORMATION
between potential benefits for capital
formation and liquidity and potential
costs related to banking entity risk
exposures and market fragility apply to
banking entities’ underwriting and
market making activities involving
ownership interests in covered funds
and other types of securities.
Second, the final rule amends section
§ ll.13(a) of the 2013 rule to expand
the scope of permissible risk-mitigating
hedging activities involving ownership
interests in covered funds, and to
remove the demonstrability requirement
of the risk-mitigating hedging
exemption for covered funds activities,
1109 See,
e.g., BPI.
e.g., Volcker Alliance; AFR and Bean.
1111 See, e.g., AFR and Data Boiler.
1110 See,
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in each case as proposed.1112 Under the
final rule, in addition to being able to
acquire or retain an ownership interest
in a covered fund as a risk-mitigating
hedge with respect to certain employee
compensation agreements as permitted
under the 2013 rule, the banking entity
will be able to acquire or retain an
ownership interest in a covered fund
when acting as intermediary on behalf
of a customer that is not itself a banking
entity to facilitate the exposure by the
customer to the profits and losses of the
covered fund. Some commenters stated
that acquiring or retaining ownership
interests in covered funds as a hedge
when acting as intermediary on behalf
of a customer accommodates client
facilitation and related risk management
activities.1113 The SEC agrees with those
commenters and continues to recognize
that the 2013 rule’s restrictions on riskmitigating hedging activities with
respect to ownership interests in
covered funds limit banking entities’
ability to hedge the risks of fund-linked
derivatives through ownership interests
in the covered funds referenced by those
derivatives. In addition, in the proposal
the SEC recognized that, as a result of
the approach in the 2013 rule, banking
entities may not be able to participate in
offering certain customer facilitating
products related to covered funds.1114
The final rule is likely to benefit
banking entities and their customers, as
well as bank-affiliated advisers of
covered funds, as the final rule
increases the ability of banking entities
to facilitate customer-facing transactions
while hedging banking entities’ own
risk exposure.1115 As a result, this
amendment may increase banking entity
intermediation and provide customers
with more efficient access to the risks
and returns of covered funds. To the
degree that banking entities’ acquisition
or retention of ownership interests in
covered funds to hedge customer-facing
transactions may facilitate banking
entities’ engagement in customer-facing
transactions, customers of banking
entities may benefit from greater
availability of financial instruments
providing exposure to covered funds
and related intermediation. Banking
entities’ ability to hedge customer-facing
transactions through the acquisition or
retention of ownership interests in
covered funds may be particularly
valuable as private capital plays an
1112 The effects of removal of demonstrability
requirement are discussed in section V.F.3.c.
1113 See, e.g., BPI and FSF.
1114 See 83 FR at 33547–33549.
1115 This was also supported by commenters. See,
e.g., BPI; Forum; ISDA and SIFMA.
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62079
increasingly important role in U.S.
capital markets and firm financing.
The SEC recognizes that, under
certain circumstances, an increased
ability of banking entities to acquire or
retain ownership interests in covered
funds in connection with risk-mitigating
hedging activities may result in banking
entities’ exposure to greater risk.1116
Some commenters supported this
view.1117 The SEC continues to
recognize that banking entities’
transactions in fund-linked products
that reference covered funds with
customers can expose a banking entity
to risk in cases where a customer fails
to perform, transforming the banking
entity’s covered fund hedge of the
customer trade into an unhedged, and
potentially illiquid, position in the
covered fund (unless and until the
banking entity takes action to hedge this
exposure and bears the corresponding
costs of hedging). However, the SEC also
continues to recognize that such
counterparty default risk is present in
any principal transaction in illiquid
financial instruments, including when
facilitating customer trades in the
securities in which covered funds
invest, as well as in market making and
underwriting activities. Commenters
also recognized this.1118 The SEC
continues to note that, under the final
rule, risk-mitigating hedging
transactions involving covered funds
must be conducted consistent with the
other requirements of the 2013 rule,
including the requirements with respect
to risk-mitigating hedging transactions.
For example, such transactions must be
made in accordance with the banking
entity’s written policies, procedures,
and internal controls; not give rise, at
the inception of the hedge, to any
significant new or additional risk that is
not itself hedged contemporaneously
with the risk-mitigating hedging
requirements; and be subject to
continuing review, monitoring, and
management by the banking entity.
Therefore, the SEC continues to believe
that hedging and customer facilitation
in ownership interests in covered funds
does not necessarily pose a greater risk
to banking entities than hedging or
customer facilitation in similar financial
instruments that is permissible under
the 2013 rule.
Third, the final rule amends section
§ ll.13(b)(4) of the 2013 rule to
remove the financing prong of the
foreign fund exemption and formally
incorporates existing staff guidance
regarding the marketing of ownership
1116 79
FR at 5737.
e.g., AFR and Volcker Alliance.
1118 See, e.g., SIFMA; Forum and ISDA.
1117 See,
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interests in foreign funds to U.S.
residents into section
§ ll.13(b)(3).1119 Under the final rule,
a foreign banking entity is able to
acquire or retain ownership interests in
and sponsor covered funds with
financing for the banking entity’s
ownership or sponsorship provided,
directly or indirectly, by branches or
affiliates of the banking entity,
including SEC-regulated dealers, that
are located in the United States or
organized under the laws of the United
States or any state. The costs, benefits,
and effects on efficiency, competition,
and capital formation of this
amendment generally parallel those of
the removal of the financing prong with
respect to trading activity outside of the
United States in section V.F.3.e of this
SUPPLEMENTARY INFORMATION.1120
In light of commenters’ responses,1121
the SEC continues to believe that foreign
banking entities may benefit from the
final rule and enjoy greater flexibility in
financing their covered fund activity. In
addition, allowing foreign banking
entities to obtain financing of covered
fund transactions from U.S.-dealer
affiliates may reduce costs to foreign
banking entities as the amendment may
decrease their need to rely on foreign
dealer affiliates solely for the purposes
of avoiding the compliance costs and
prohibitions of the 2013 rule. This may
increase the operational efficiency of
covered fund activity by foreign banking
entities outside the United States.
Other commenters indicated that
elimination of the financing prong could
1119 The SEC understands that, as a practical
matter, market participants have adjusted their
activity in light of the FAQs regarding the
marketing restriction. See supra note 59, FAQ 13.
Hence, the SEC continues to believe that the
economic effects of the amendment to incorporate
existing staff guidance are likely to be de minimis,
and the SEC focuses this discussion on the removal
of the financing prong.
1120 In addition, the agencies confirmed in this
SUPPLEMENTARY INFORMATION that the foreign fund
exemption (1) permits the U.S. personnel and
operations of a foreign banking entity to act as an
investment adviser to a covered fund in certain
circumstances and (2) does not preclude a foreign
banking entity from engaging a non-affiliated U.S.
investment adviser as long as the actions and
decisions of the banking entity as principal occur
outside of the United States. To the extent that
foreign banking entities were restricting (1) hiring
of U.S. personnel to provide investment advice and
recommend investment selections to the manager or
general partner of a covered fund relying on the
foreign fund exemption, or (2) engagement of nonaffiliated U.S. investment advisers due to
uncertainty about the 2013 rule, foreign banking
entities may be more likely to hire U.S. personnel
to provide such services, and non-affiliated U.S.
investment advisers may become better able to
compete for the foreign banking entity’s investment
mandates.
1121 Several commenters supported removing the
financing prong from the foreign fund exemption.
See, e.g., BPI; EBF; IIB; JBA and New England
Council.
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18:12 Nov 13, 2019
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result in a U.S. branch or affiliate that
extends financing to bear some risks.1122
The SEC agrees with the commenters
and continues to recognize that the
economic exposure and risks of foreign
banking entities’ covered funds
activities may be incurred not just by
the foreign banking entities, but by U.S.
entities financing the covered fund
ownership interests, e.g., through
margin loans covering particular
transactions. However, the SEC also
continues to note that the final rule
retains the 2013 rule’s requirement that
the investment or sponsorship,
including any related hedging, is not
accounted for as principal by any U.S.
branch or affiliate.1123 The SEC
continues to believe that concerns about
the size of U.S. banking entity risk
exposures are less relevant when the
covered fund activity is conducted by,
and the risk consolidates to, foreign
banking entities. Moreover, as noted
above, U.S. banking entities providing
financing to their foreign banking entity
affiliates are likely to be separately
subject to a full range of capital, margin,
and other obligations unrelated to
section 13 of the BHC Act, which may
further mitigate risks to the U.S.
branches and affiliates of foreign
banking entities.
ii. Efficiency, Competition, and Capital
Formation
As discussed above, the SEC believes
that the final rule’s amendments to the
covered fund provisions in subpart C
provide banking entities with greater
flexibility in underwriting, market
making, and hedging ownership
interests in covered funds. To the extent
that the 2013 rule’s restrictions on
underwriting and market making with
interests in covered funds limit fund
formation, the final rule may reduce
long-term compliance costs and, as a
result, increase capital formation. In
addition, to the extent that banking
entities experience a reduction in
compliance costs and an increased
ability to accommodate clients and
perform risk management activities, the
willingness of SEC-regulated entities to
commit capital and take on underlying
risk exposures may increase, which may
enhance capital formation.
The final rule may affect competition
between foreign and domestic entities,
as foreign banking entities may benefit
from the final rule and enjoy greater
flexibility in financing their covered
fund activity. To the extent that costs of
compliance with the ‘‘financing prong’’
e.g., Better Markets and CAP.
commenters supported this view. See,
e.g., EBF and BPI.
of the 2013 rule’s foreign fund
exemption may represent barriers to
entry for foreign banking entities’
covered fund activities, the final rule
may increase foreign banking entities’
operational efficiency and promote their
sponsorship and financing of covered
funds.
The final rule’s amendments to
§ ll.11 and § ll.13 do not change
the information available to market
participants, and the SEC does not
believe that these amendments are
likely to have an effect on informational
efficiency. To the degree that these
amendments may provide banking
entities with more flexibility to
underwrite, make markets in, and hedge
ownership interests in covered funds,
and to the extent these activities
facilitate capital formation, these
amendments may improve allocative
efficiency.
iii. Alternatives
The agencies considered alternatives
that would scope out from calculation of
the per-fund limit, aggregate fund limit,
and capital deduction for banking
entities all ownership interests acquired
or retained by banking entities in
connection with other underwriting and
market making. For example, the
agencies considered excluding the value
of ownership interests acquired or
retained in connection with
underwriting or market making-related
activities with respect to covered funds
offered or organized by the banking
entity from the calculation of the perfund and aggregate limits and capital
deductions.1124 If the agencies had
adopted this alternative, this would
have provided dealers a level of
flexibility in underwriting and making
markets in ownership interests in
covered funds that is more similar to the
level of flexibility for dealers in
conducting these activities with respect
to all other types of financial
instruments, including the underlying
financial instruments owned by the
same covered funds.
Compliance with the 2013 rule for
covered funds imposes costs on banking
entities. To the extent that, under the
baseline, such costs prevent banking
entities that are dealers from making
markets in or underwriting certain
financial instruments, this alternative
would enable them to engage in
potentially profitable market making in
and underwriting ownership interests in
covered funds. The benefits of this
alternative may also flow through to
funds, investors, and customers as
1122 See,
1123 Some
PO 00000
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1124 Some commenters supported this alternative.
See, e.g., ISDA.
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banking entities may become more
willing and able to underwrite and
make markets in products linked to
covered funds and to provide customers
with an economic interest in the profits
and losses of covered funds. This may
increase investor access to the returns
and risks of private funds, which may
be particularly valuable when issuers
are increasingly relying on private
capital and delaying public offerings.
Finally, the increased ability of banking
entities to engage in market making and
underwriting activities with respect to
covered funds under this alternative
may have increased market quality for
covered funds that are traded.
The SEC also continues to recognize
that transactions in covered funds—
including transactions with customers,
and holdings of ownership interests in
covered funds related to underwriting
and market making—necessarily involve
the risk of losses. However, the risks of
market making or underwriting by
banking entities of financial instruments
held by the covered fund, or financial
instruments or securities that are
otherwise similar to covered funds, are
substantively similar. Therefore, the
same tensions among the economic
effects discussed in section V.F.3.c of
this SUPPLEMENTARY INFORMATION
between potential benefits to capital
formation and liquidity and potential
costs related to bank risk exposures and
market fragility apply to both banking
entity interests from underwriting and
market making in financial instruments
and underwriting and market making in
covered funds. It is not clear that the
existence of a legal and management
structure of a covered fund per se
changes the economic risk exposure of
banking entities, and, thus, the capital
formation and other tensions of the
economic effects discussed above.
Therefore, the SEC continues to believe
that this alternative would simply
involve a more consistent treatment of
financial instruments and interests in
covered funds as it pertains to
underwriting and market making.
However, as discussed above in section
V.F.1 of this SUPPLEMENTARY
INFORMATION, some of the effects of the
2013 rule’s provisions are difficult to
evaluate outside of economic
downturns, and the SEC is unable to
measure the amount of capital formation
or liquidity in covered funds or
investments of the covered funds that
does not occur because of the existing
treatment of underwriting and market
making activities by banking entities
involving covered funds.
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g. Compliance Program
The SEC continues to recognize that
the scope and breadth of the compliance
obligations under the 2013 rule impose
significant costs on banking entities,
which may be particularly burdensome
for smaller entities. For example, in the
proposal, the SEC cited a market
participants’ estimate that some banking
entities have added as many as 2,500
pages, per institution, of policies,
procedures, mandates, and controls
(which need to be monitored and
updated on an ongoing basis) 1125 for
purposes of compliance with the 2013
rule, and that some banking entities may
spend, on average, more than 10,000
hours on training each year.1126 The
SEC also cited a market participants’
estimate that some banking entities may
have 15 regularly meeting committees
and forums, with as many as 50
participants per institution dedicated to
compliance with the 2013 rule.1127
The compliance regime of the 2013
rule and related burdens may reduce the
profitability of covered activities by
dealers and investment advisers that are
banking entities and may be passed
along to customers or clients in the form
of reduced provision of services or
higher service costs. Moreover, the SEC
recognizes that the extensive
compliance program under the 2013
rule may detract resources of banking
entities and their compliance
departments and supervisors from other
compliance matters, risk management,
and supervision. Finally, prescriptive
compliance requirements may not
optimally reflect the organizational
structures, governance mechanisms, or
risk management practices of complex,
innovative, and global banking entities.
However, the SEC agrees with
commenters 1128 that compliance
programs are important to support the
safety and soundness of the U.S.
financial markets.
i. Costs and Benefits
The final rule is expected to lower
compliance burdens in two ways. First,
the SEC continues to believe that the
amendments would increase flexibility
in complying with the final rule for
banking entities without significant
trading assets and liabilities, reducing
compliance costs for these entities.
Second, the adopted amendments
would streamline the compliance
program for banking entities with
significant trading assets and liabilities.
The SEC continues to believe that, to the
1125 See
83 FR 33432.
1126 Id.
1127 Id.
1128 See,
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62081
extent that the requirements in the 2013
rule are duplicative and that
maintaining compliance systems to
comply with both the general and an
enhanced compliance program
requirements is inefficient, banking
entities with significant trading assets
and liabilities may benefit from the
amendments. The specific final
amendments are discussed below.
For Group C entities, the agencies are
adopting presumed compliance with
proprietary trading and covered fund
prohibitions. Some commenters noted
that the presumed compliance standard
proposed for Group C entities may
benefit entities with very low levels of
trading activity.1129 In light of the
commenters’ responses, the SEC
continues to believe that the
presumption of compliance will provide
Group C entities with additional
compliance flexibility. The SEC
estimates that approximately 97 brokerdealers that hold 3.6% of assets held by
broker-dealers subject to the final rule
would be able to avail themselves of the
rebuttable presumption of compliance
and would not have to apply the final
rule’s compliance program
requirements. Out of these 97 brokerdealers, 28 are subject to the enhanced
requirements under the 2013 rule, 51
are subject to the standard compliance
requirements under the 2013 rule, and
18 qualify for the simplified compliance
regime under the 2013 rule. As
discussed in section V.B, the agencies
estimate recordkeeping or reporting
burden reductions related to presumed
compliance with the final rule are as
high as $1,648,812.1130
Some commenters expressed concern
that Group C entities may experience
uncertainty because of the absence of
specific guidance about what events
would trigger an agency to rebut the
presumption of compliance,1131 and, as
a result, incur compliance costs related
to establishing internal systems and
controls in anticipation of potential
rebuttal of the presumption.1132 To the
extent that some Group C entities
experience this uncertainty and costs,
they may not fully enjoy the benefits of
presumed compliance. One commenter
estimated that smaller banking entities
would likely incur an additional onetime cost of $50,000–$100,000 in
1129 See,
e.g., B&F Capital Markets Inc.
section V.B. Ongoing cost reduction for
broker-dealers: (40 hours per firm × 18 brokerdealers + 265 hours per firm × 79 broker-dealers)
× 0.18 dealer weight × (Attorney at $423 per hour)
= $1,648,812.
1131 See, e.g., Chatham; ABA and SIFMA.
1132 See, e.g., Covington; Chatham; EBF; JBA and
Data Boiler.
1130 See
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consulting or legal advice fees.1133
Using this estimate, the total initial cost
related to consulting or legal advice fees
for Group C broker-dealers may range
between $873,000 and $1,746,000.1134
Some commenters opposed the
presumption of compliance.1135 The
SEC continues to recognize that the
presumption of compliance for Group C
entities may increase the risks of noncompliance with the statute. However,
the SEC also continues to note that the
amendments do not waive the
proprietary trading and covered fund
prohibitions of section 13 of the BHC
Act for such entities.
For Group B entities, the agencies are
adopting the simplified compliance
program as proposed. Some commenters
expressed support for this approach for
Group B entities.1136 In the proposal,
the SEC recognized that existing
compliance program requirements may
burden entities that engage in little
covered trading activity but have larger
total assets.1137 The SEC continues to
recognize that this amendment may
reduce costs for banking entities that
have more than $10 billion in total
assets but do not have significant
trading assets and liabilities, as these
banking entities do not qualify for the
simplified compliance program under
the 2013 rule. As shown in Table 2, the
SEC estimates that 66 broker-dealers
would qualify for the simplified
compliance regime under the final rule.
As discussed in section V.B, the
agencies estimate recordkeeping or
reporting burden reductions related to
the simplified compliance program for
Group B broker-dealers to be $1,130,679
for registered broker-dealers and up to
$582,471 for entities that may choose to
register as SBSDs.1138
The agencies are amending covered
fund recordkeeping requirements to
apply to Group A entities only, rather
than to banking entities with over $10
billion in total assets. The SEC believes
that the covered funds activities of
banking entities without significant
1133 See
Data Boiler.
set-up burden increase for brokerdealers: 97 broker-dealers × 0.18 dealer weight ×
$100,000 = $1,746,000. Using the lower bound: 97
broker-dealers × 0.18 dealer weight × $50,000 =
$873,000.
1135 See, e.g., Occupy the SEC and Data Boiler.
1136 See, e.g., CFA and JBA.
1137 See 83 FR 33432.
1138 Cost reduction for broker-dealers: 225 hours
per firm × 0.18 dealer weight × 66 broker-dealers
× (Attorney at $423 per hour) = $1,130,679.
Cost reductions for entities that may register as
SBSDs may be as high as 225 hours per firm × 0.18
dealer weight × 34 SBSDs × (Attorney at $423 per
hour) = $582,471. The estimate for SBSDs assumes
that 34 SBSDs not already registered as brokerdealers would be Group B entities and so may
overestimate the cost savings.
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1134 Initial
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trading assets and liabilities may
generally be smaller in scale and less
complex than those of banking entities
with significant trading assets and
liabilities. Thus, the value of additional
documentation requirements for
banking entities without significant
trading assets and liabilities may be
lower. The final amendment reflects
these considerations and may reduce
the costs associated with these covered
funds recordkeeping requirements by
reducing the number of banking entities
subject to these requirements.1139 The
SEC continues to note that entities with
moderate trading assets and liabilities
would still be required to comply with
all the covered fund provisions and that
the proposal simply eliminates
recordkeeping for the purposes of
demonstrating compliance. However, in
general, the SEC believes that SEC
oversight of dealers and investment
advisers of covered funds should not be
adversely affected, as the remaining
compliance requirements will be
sufficient to monitor compliance with
the statute. As discussed in section V.B,
the agencies estimate recordkeeping or
reporting burden reductions related to
the covered fund recordkeeping
requirements to be $2,208,060 for
registered broker-dealers and up to
$517,752 for entities that may choose to
register as SBSDs.1140
The agencies are also adopting the
removal of the requirements in
Appendix B of the 2013 rule as
proposed, with an exception for the
CEO attestation. The removal of
Appendix B requirements will affect all
banking entities that have trading assets
and liabilities above $10 billion, as well
as banking entities that have total
consolidated assets of $50 billion or
more. Some commenters expressed
1139 As discussed in section V.F.2.c, RIAs do not
typically engage in proprietary trading, and the SEC
continues to believe that they will not be affected
by the final rule as it relates to proprietary trading.
In addition, the SEC does not have the information
necessary to quantify the compliance program costs
at the RIA level of a BHC. Thus, the SEC does not
allocate cost savings from monetized PRA burdens
to bank-affiliated RIAs from the proposed Appendix
B amendments. To the degree that some bankaffiliated RIAs may be extending compliance
resources and systems independent of the affiliated
holding company and other affiliates and
subsidiaries, this approach may be underestimating
the cost savings from the final rule.
1140 Cost reduction for broker-dealers: 200 hours
per firm × 0.18 dealer weight × 145 broker-dealers
× (Attorney at $423 per hour) = $2,208,060.
Cost reductions for entities that may register as
SBSDs may be as high as 200 hours per firm × 0.18
dealer weight × 34 SBSDs × (Attorney at $423 per
hour) = $517,752. The estimate for SBSDs assumes
that all 34 SBSDs not already registered as brokerdealers would be Group B entities and so may
overestimate the cost savings.
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Frm 00110
Fmt 4701
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general support for this amendment.1141
In addition, some commenters indicated
that compliance with Appendix B
required entities to develop and
administer an enhanced compliance
program that may not be tailored to the
business model or risks of specific
institutions.1142 Further, in the proposal
the SEC cited a market participants’
estimate that some banking entities have
established as many as 500 controls
related to Appendix B obligations, some
of which may be duplicating other
policies and procedures designed as
part of prudential safety and
soundness.1143 In light of these
comments, the SEC continues to believe
that compliance with Appendix B may
impose significant costs on SECregulated banking entities and that
removal of the Appendix B
requirements may significantly reduce
the number and complexity of the
compliance requirements to which such
entities are subject. The SEC estimates
that there are 122 broker-dealers that
may experience reduced compliance
costs as a result of this amendment,
among which 28 are Group C entities,
58 are Group B entities and 36 are
Group A entities. As discussed in
section V.B, the removal of Appendix B
requirements will result in ongoing
annual cost savings estimated as
$10,217,988 for registered brokerdealers and up to $2,847,636 for entities
that may choose to register as
SBSDs.1144
Some commenters opposed the
removal of Appendix B, arguing that,
given the size of affected holding
companies, the 2013 rule’s stringent
compliance regime may help reduce
compliance risks related to the
substantive prohibitions of section 13 of
the BHC Act and the 2013 rule.1145
However, the SEC notes that, under the
final rule, both Group A and Group B
entities will be required to establish and
maintain a compliance program under
§ ll.20.
Finally, the agencies are adopting the
amendment to require CEO attestation
1141 See, e.g., Insurance Coalition; Real Estate
Associations; CREFC; Credit Suisse; JBA; FSF and
ABA.
1142 See, e.g., Credit Suisse; CREFC; SIFMA and
Capital One et al.
1143 See 83 FR at 33551.
1144 Cost reduction for broker-dealers: 1,100 hours
per firm × 0.18 dealer weight × 122 broker-dealers
× (Attorney at $423 per hour) = $10,217,988.
Cost reductions for entities that may register as
SBSDs may be as high as 1,100 hours per firm ×
0.18 dealer weight × 34 SBSDs × (Attorney at $423
per hour) = $ 2,847,636. The estimate for SBSDs
assumes that all 34 SBSDs not already registered as
broker-dealers would be subject to Appendix B
requirements and so may overestimate the cost
savings.
1145 See, e.g., AFR and Bean.
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for Group A entities only.1146 In the
proposal, the SEC recognized that the
CEO attestation process is costly and
cited market participants’ estimates that
some banking entities may spend more
than 1,700 hours on the CEO attestation
process and that the elimination of this
requirement may reduce time dedicated
towards the compliance program by as
much as 10%.1147 In addition, as
indicated by some commenters, the CEO
attestation requirement requires banking
entities to undertake costly internal
compliance efforts that are not
consistent with the activities or risks of
such firms.1148 Therefore, the SEC
believes that the amendments to the
application of the CEO attestation
requirement will benefit SEC-regulated
banking entities and their holding
companies that do not have significant
trading assets and liabilities but are
subject to the CEO requirement under
the 2013 rule.
The SEC continues to note that, under
the 2013 rule, SEC-regulated banking
entities have flexibility to comply with
the attestation requirement either at the
SEC-registrant or at the holdingcompany level. In 2019, the SEC
received a total of 55 attestations that
cover compliance for 2018, including 14
attestations directly from SEC
registrants, none of which are Group A
entities. Therefore, the SEC expects that,
under the final rule, these registrants
would no longer be providing CEO
attestations. The SEC estimates that
there are 122 broker-dealers that are
subsidiaries or affiliates of bank holding
companies that are required to comply
with the CEO attestation requirement
under the 2013 rule. The SEC estimates
that under the final rule this number
will decrease to 36 Group A brokerdealers. Therefore, the amendment may
result in annual cost savings from
$654,804 to $774,000 for broker-dealers
and up to between $258,876 and
$306,000 for entities that may choose to
register as SBSDs.1149
1146 As a baseline matter, under the 2013 rule, the
CEO is required to annually attest that the banking
entity has in place processes to establish, maintain,
enforce, review, test, and modify the compliance
program established pursuant to Appendix B in a
manner reasonably designed to achieve compliance
with section 13 of the BHC Act and the 2013 rule.
1147 See 83 FR at 33551.
1148 See, e.g., Capital One, et al.
1149 Cost reduction for broker-dealers: 100 hours
per firm × 0.18 dealer weight × 86 broker-dealers
× (Attorney at $423 per hour) = $654,804.
Alternatively, using the CEO hourly rate, cost
reduction for broker-dealers is: 100 hours per firm
× 78 broker-dealers × 0.18 dealer weight × (CEO at
$500 per hour) = $774,000.
Cost reduction for entities that may register as
SBSDs may be as high as: 100 hours per firm × 0.18
dealer weight × 34 SBSDs × (Attorney at $423 per
hour) = $258,876. Alternatively, using the CEO
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The agencies are also adopting notice
and response procedures related to
sections ll.3(b)(4), ll.4(c)(4),
ll.20(g)(2), and ll.20(h) of the final
rule. As a result, all broker-dealers and
entities that may potentially register as
SBSDs may experience increases in
initial reporting set-up costs. As
discussed in section V.B, the agencies
estimate the initial set-up reporting
burden increase related to the notice
and response procedures to be $303,037
for registered broker-dealers and up to
$51,775 for entities that may choose to
register as SBSDs.1150 In addition, as
discussed in section V.B, the agencies
may exercise a reservation of authority
and seek to rebut the presumption in
section ll.3(b)(4) in accordance with
the notice and response procedures in
section ll.20(i) of the final rule,
involving a burden of up to 20 hours per
entity per response. In such cases, an
SEC-regulated banking entity may incur
a cost of up to $1,523 (=20 hours per
response × 0.18 dealer weight ×
Attorney at $423 per hour) per response.
The SEC is unable to estimate how
many entities may bear such costs since
this figure will depend on how SECregulated banking entities may choose
to comply with the final rule.
ii. Efficiency, Competition, and Capital
Formation
Under the final amendments, both
Group A and Group B entities will
benefit from reduced compliance
program requirements and Group C
entities will be presumed compliant
with prohibitions of subparts B and C of
the final rule. To the extent that
compliance program requirements for
Group B entities are less costly, Group
A entities close to the $20 billion
threshold may choose to manage down
their trading book such that they would
qualify for the simplified compliance
program, resulting in more competition
among entities that are close to the
threshold. Similarly, the final rule may
incentivize Group B entities close to the
$1 billion threshold to rebalance their
trading book in order to qualify for the
presumed compliance treatment of
hourly rate, cost reduction for broker-dealers is: 100
hours per firm × 34 SBSDs × 0.18 dealer weight ×
(CEO at $500 per hour) = $306,000. The SEC
assumes that all entities that may register as SBSDs
would be subject to the CEO attestation
requirement, and so may overestimate the cost
savings.
1150 Initial set-up reporting burden increase for
broker-dealers: 20 hours per firm × 0.18 dealer
weight × 199 broker-dealers × (Attorney at $423 per
hour) = $303,037.
Initial set-up reporting burden increase for
entities that may register as SBSDs may be as high
as: 20 hours per firm × 0.18 dealer weight × 34
SBSDs × (Attorney at $423 per hour) = $51,775.
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62083
Group C entities. Such management of
the trading book may reduce the risk of
each individual banking entity and may
decrease the risks to the financial
system. The SEC notes that entities are
likely to weigh potential cost savings
related to lighter compliance
requirements for Group B and Group C
entities against the costs of reducing
trading activity below the $20 billion
and $1 billion thresholds. Therefore,
this competition effect may be
particularly significant for Group A
entities that are close to the $20 billion
threshold and for Group B entities that
are close to the $1 billion threshold.
Since the compliance requirements do
not affect the scope of information
available to investors, the SEC does not
anticipate effects on informational
efficiency to be significant. To the
extent that some dealers are
experiencing large compliance costs and
partially or fully passing them along to
customers in the form of reduced access
to capital or higher cost of capital, the
amendment may reduce costs of and
increase access to capital.
iii. Alternatives
As an alternative, the agencies could
have applied the CEO attestation
requirement to both Group A and Group
B entities. Under this alternative, some
banking entities would have become
subject to the CEO attestation
requirement for the first time, as noted
by some commenters.1151 As discussed
above and noted by commenters,1152 the
SEC continues to recognize that Group
B entities pose lower risks to the
financial system that may not
necessarily justify a costly and stringent
compliance regime that requires CEO
attestation.
As other alternatives, the agencies
could have required CEO attestations for
Group A entities only if they have over
$50 billion in total assets; removed the
CEO attestation requirement; or allowed
other senior officers, such as the chief
compliance officer (CCO), to provide the
requisite attestation for some or all
affected banking entities. As discussed
above, the SEC recognized in the
proposal that the CEO attestation
process is costly and that some market
participants estimated that some
banking entities may spend more than
1,700 hours on the CEO attestation
process and that eliminating this
requirement may reduce time dedicated
toward the compliance program by as
1151 See,
e.g., IIB.
e.g., Capital One et al.; BB&T; ABA;
Arvest; State Street and IIB.
1152 See,
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much as 10%.1153 Under the
aforementioned alternatives, more SECregulated banking entities would
generally experience larger cost
reductions. However, as discussed in
section IV.D.1, the agencies continue to
believe that incorporating the CEO
attestation requirement into § ll.20(c)
for Group A banking entities will help
to ensure that the compliance program
established pursuant to that section is
reasonably designed to achieve
compliance with section 13 of the BHC
Act and the final rule.
As an alternative, the agencies could
have included a knowledge qualifier for
CEO attestation. Since CEOs of banking
entities do not necessarily know every
single policy, procedure, process, and
control, as pointed out by some
commenters,1154 they may rely on
multiple layers of sub-attestations
within a banking entity. If CEOs of
banking entities are risk averse, they
may require additional liability
insurance, higher compensation, or
lower incentive pay as a fraction of
overall compensation. Under this
alternative, such effects stemming from
risk aversion would be mitigated.
However, the attestation may also serve
as a disciplining mechanism and
incentivize compliance. In addition, as
one commenter stated, CEOs of
publically traded banking entities
regularly attest that their company’s
annual and quarterly reports are
accurate and complete and that internal
controls have been established and
maintained.1155 The SEC also notes that
the covered activities of larger and more
complex banking entities with higher
volumes of trading activity may involve
risk exposures with a larger potential for
systemic risk and conflicts of interest.
The agencies also recognize that CEO
attestation may be costly for banking
entities affiliated with foreign banking
organizations. For example, the SEC
noted in the proposal that one foreign
firm reported that it organized and
managed a global controls subcertification process that takes 6 months
to complete and involves over 400 staff
(including over 260 outside of the
United States) in order for the CEO to
sign and deliver the annual
attestation.1156 As an alternative, the
agencies could have proposed
exempting banking entities affiliated
with a foreign banking organization
from the CEO attestation requirement.
Under the 2013 rule, the requirement
covers only the U.S. operations of a
1153 See
83 FR at 33551.
e.g., FSF; BPI and SIFMA.
1155 See, e.g., BOK.
1156 See 83 FR at 33552.
1154 See,
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foreign banking entity and not its
foreign operations. Similar to the
analysis of the final amendment to
trading outside of the United States, this
alternative may decrease compliance
costs and increase trading activity by
foreign banking entities in the United
States but result in losses in market
share and profitability for U.S. banking
entities that would remain subject to the
attestation requirement and would be
placed at a competitive disadvantage as
a result.
h. Metrics
i. Costs and Benefits
In the proposal, the SEC discussed the
compliance burdens related to the
metrics reporting and recordkeeping
requirements under the 2013 rule. For
example, the SEC reported that a market
participant estimated that the average
cost of collecting and filing metrics
subject to the reporting requirements
may be as high as $2 million per year
per participant, and that market
participants may submit an average of
over 5 million data points in each
filing.1157 The SEC also reported an
estimate from a market participant
incurring approximately $3 million in
costs associated with the buildout of
new IT infrastructure and system
enhancements and estimated that this IT
infrastructure will require at least
$250,000 in maintenance and operating
costs year-to-year.1158 In addition, the
SEC noted that the same firm estimated
costs related to compliance consultants
assisting with the construction of the
2013 rule compliance regime at $3
million.1159
The SEC continues to believe that the
metrics reporting and recordkeeping
requirements of the 2013 rule may
involve large compliance costs.1160 The
agencies have received comment that
the proposed amendments do not
streamline metrics reporting and
recordkeeping requirements but impose
costly new requirements.1161 Moreover,
the agencies received comment that the
new qualitative information
requirements, such as the trading desk
information, are unlikely to enhance
review by regulators.1162 In addition,
the agencies received comment that
1157 See
83 FR at 33539.
1158 Id.
1159 To the extent that costs related to compliance
consulting include both costs of metrics reporting
and related systems, as well as costs related to other
compliance requirements under the 2013 rule, the
SEC cannot estimate the firm’s all-in metrics
reporting costs.
1160 See, e.g., 83 FR at 33538.
1161 See, e.g., CCMC; JBA; Committee on Capital
Markets; SIFMA Annex C and IIB.
1162 See SIFMA.
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even where underlying data is already
collected by reporters in the regular
course of business and for regulatory
compliance, reporters will still incur
costs of determining how best to
compile and standardize the
information.1163
As discussed below, the SEC
continues to recognize that some aspects
of the final rule may impose new
requirements on reporters. Moreover,
the SEC continues to emphasize that
quantitative metrics do not clearly
identify impermissible proprietary
trading, but, rather, inform general
agency oversight and supervision. As
discussed further below, in response to
the comments received, the SEC has
revised its estimates of the compliance
costs of various amendments and
burden savings from metrics
amendments as a whole. Importantly,
the final metrics amendments include
changes from the proposed approach—
changes that both reduce the scope of
new requirements and eliminate other
existing quantitative metrics, such as
risk factor sensitivities. For example, as
discussed in section IV.E, the agencies
estimate that the final rule may
significantly reduce both the number of
reported data items (by approximately
67%) and the overall volume of
submissions (by approximately 94%)
relative to baseline.
Overall, the SEC believes that the
final rule reduces the costs of metrics
requirements for reporters, eliminating
certain metrics on the basis of regulatory
experience with the data and provides
some entities with additional reporting
time. Broadly, metrics reporting
provides information for regulatory
oversight and supervision but presents
compliance burdens for registrants. The
balance of these effects turns on the
value of different metrics in evaluating
covered trading activity for compliance
with the rule, as well as their usefulness
for risk assessment and general
supervision. These effects are discussed
with respect to each final amendment in
the sections that follow.
The SEC considered how to assess the
costs of the final rule for SEC-regulated
banking entities. The metrics costs are
generally estimated at the holding
company level for each reporter.1164 The
SEC allocates these costs to the affiliated
1163 Id.
1164 The SEC currently receives metrics from 18
entities, including 2 reporters that are below $10
billion in trading assets and liabilities. Since
voluntary reporters are not constrained by the
requirements of the amendment, they are not
reflected in the SEC’s cost estimates. In addition,
the SEC believes that the additional systems costs
estimated here will be incurred at the holding
company level and scope in the trading activity of
all SEC-registered banking entity affiliates.
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SEC-regulated banking entity.1165 The
SEC believes that estimating the cost
savings of the final rule at the
individual registrant level would be
inconsistent with the SEC’s
understanding of how these entities are
complying with the metrics reporting
requirements of the 2013 rule. The SEC
continues to believe that SEC-regulated
banking entities within the same
corporate group will collaborate with
one another to comply with the final
rule, to take advantage of efficiencies of
scale. Further, the SEC continues to note
that individual SEC-regulated banking
entities may vary in the scope and type
of activity they conduct and that not all
entities within an organization subject
to Appendix A engage in the types of
covered trading activity for which
metrics must be reported. Thus, to the
extent that metrics compliance occurs at
the holding company level, estimating
costs at the registrant level may
overstate the magnitude of the costs and
cost savings for SEC-regulated entities
as a result of the final rule.
The discussion that follows addresses
the effects of the final rule on the
reporting and recordkeeping burdens
and other compliance costs for banking
entities, the effects of the elimination
and streamlining of certain metrics, the
effects of extended time to report, and
amendments related to the XML format.
(1) Reporting and Recordkeeping
Burden for SEC-Regulated Banking
Entities
The changes in reporting and
recordkeeping burdens as a result of the
final rule stem from four key groups of
changes to the metrics reporting regime.
First, the final rule requires metrics
reporting for Group A entities only.
Under the 2013 rule, banking entities
with consolidated trading assets and
liabilities above $10 billion are required
to record and report certain quantitative
measurements for each trading desk
engaged in covered trading.1166 Under
the amended rules, entities with $20
billion or more in trading assets and
liabilities would be required to furnish
metrics. The SEC estimates that three
metrics reporters that have affiliated
broker-dealers required to submit
metrics to the SEC under the 2013 rule
will no longer be required to report
metrics under the final rule.
Second, as discussed above, the
agencies are narrowing the scope of
many of the 2013 rule’s metrics
requirements or eliminating them as a
whole. For example, the agencies are
eliminating the Inventory Aging metric,
supra note 1070.
1166 See 2013 rule § ll.20(d) and Appendix A.
the Stress Value-at-Risk (VaR) metric,
and the Risk Factor Sensitivities metric.
As discussed above, the agencies
estimate that the final rule eliminates
approximately 67% of data items by
number and 94% of data by volume.
The reduction in the volume of data
required to be compiled, reviewed, and
transmitted to the agencies is expected
to decrease the volume of data that
needs to be produced, manipulated, and
submitted to the agencies for purposes
of compliance with the 2013 rule.
Third, the amendment to the trading
account definition may change the
scope of desks required to report
metrics. Specifically, some trading
desks, such as some asset and liability
management desks, under the 2013 rule,
may be required to report metrics solely
due to activity that falls within the 60day rebuttable presumption. Because of
the nature of their activity, such trading
desks may face greater burdens of
producing metrics that are routine for
other trading desks. The elimination of
the 60-day rebuttable presumption may
eliminate the need for such desks to
report metrics, removing related
burdens.
Fourth, the agencies are adopting an
amendment to require metrics reporting
by all reporters on a quarterly basis
within 30 days of the end of each
calendar quarter. Under the 2013 rule,
banking entities that report metrics and
have less than $50 billion in
consolidated trading assets and
liabilities are required to report metrics
for each quarter within 30 days of the
end of that quarter. In contrast, under
the 2013 rule, banking entities with total
trading assets and liabilities equal to or
above $50 billion are required to report
metrics more frequently—each month
within 10 days of the end of that
month.1167 As discussed further below,
because processes enabling reporting
under tight deadlines may generally be
costlier, the SEC anticipates that the
amended reporting requirements may
reduce compliance costs for entities that
are subject to the 2013 rule’s metrics
requirements and have more than $50
billion in trading assets and liabilities
and may result in fewer resubmissions
by such filers.
In the proposal, the SEC stated that
reporters may incur systems-related
costs of approximately $120,000 to
$130,000, estimated at the level of the
reporter. The agencies have received
comment that the SEC’s estimates of the
costs of the metrics amendments are a
significant underestimate, since
reporters will need to revise all of their
metrics reporting systems and embark
1165 See
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on a new round of systems integration
with multiple agencies
independently.1168 The commenter
indicated that the exercise is not
dissimilar from the initial
implementation of the 2013 rule’s
metrics.1169 Another commenter
supported retaining requirements of the
2013 rule, since any metrics
amendments would require
modifications to measurement tools,
involving burdens, testing time, and
outsourcing costs of development
staff.1170
The SEC agrees that compliance with
the final rule will involve one-time costs
to transition systems and compliance
architecture to the metrics amendments
for Group A entities, including the new
requirements related to granular
Transaction Volumes and Positions
metrics, Comprehensive Profit and Loss
Attribution, Trading Desk and
Quantitative Measurements Identifying
Information, and the elimination of
reporting of other metrics (such as
Inventory Turnover, Customer-Facing
Trade Ratio, Risk Factor Sensitivities,
and Stress VaR). The SEC notes that its
analysis is specific to SEC registrants,
and the estimates represent only a
fraction of the compliance costs of
holding companies allocated to
affiliated SEC-regulated banking
entities. Moreover, the SEC anticipates
considerable variation in one-time
system transition costs among reporters,
depending on the size and complexity
of their existing trading activity, the
number of trading desks per reporter for
the purposes of metrics reporting, the
way in which reporters may organize
reporting and compliance obligations
for the purposes of, for instance, the
market risk capital rule, and the
complexity of their current systems.
However, if transitioning reporting
systems to meet the requirements of the
final rule impose one-time costs and IT
burdens comparable with those of the
metrics requirements of the 2013
rule,1171 the compliance costs related to
the 2013 rule can be used to estimate
potential one-time switching costs for
some banking entities. In the proposal,
the SEC reported an estimate from a
market participant incurring
approximately $3 million in costs
associated with the buildout of new IT
infrastructure and system
enhancements.1172 Using this estimate,
the one-time costs related to
transitioning metrics reporting to
1168 See
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1169 Id.
1170 See,
1171 See
1167 See
62085
e.g., JBA.
SIFMA.
1172 Id.
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comply with the requirements of the
final rule may be as high as
$540,000 1173 for SEC-regulated dealers
affiliated with a single Group A metrics
reporter and as high as $6,480,000 1174
for all SEC-regulated entities affiliated
with all reporters.
However, as discussed earlier in this
section, the SEC believes that the final
metrics amendments may reduce
reporting and recordkeeping
burdens.1175 The SEC estimates that the
amendments may decrease ongoing
annual reporting and recordkeeping cost
by $463,921.1176 These figures reflect
the estimated burden reductions net of
any new systems costs imposed by the
final rule.
(2) Elimination, Replacement, and
Streamlining of Certain Metrics
As discussed above, the final rule
includes a number of amendments
eliminating, replacing, and streamlining
metrics reporting. For example, the final
rule eliminates the Inventory Aging,
Stress VaR, and Risk Factor Sensitivities
metrics, as well as replaces the
Inventory Turnover with the Positions
metric and the Customer Facing Trade
Ratio with the Transaction Volumes
metric. As discussed above, both the
Transaction Volumes metric and the
Positions metric will be required only
by desks involved in underwriting or
market making-related activity. The SEC
continues to believe that the key
balancing of economic effects from
metrics reporting is between compliance
million × 0.18 × 1 reporter = $540,000.
× 12 reporters = $6,480,000.
1175 In the proposal, the SEC estimated the effect
on SEC-registered broker-dealers and entities that
may register as SBS dealers by scaling per-reporter
estimates by 0.18 and multiplying by the number
of broker-dealers or SBSDs affiliated with reporters
in an affected category. This approach assumes that
reporters with multiple dealers may allocate metrics
compliance costs savings to each dealer. The SEC
now more conservatively allocates compliance cost
savings to multiple dealers affiliated with a reporter
as one dealer entity. This approach also avoids
assuming that entities that may register as SBSDs
that are not broker-dealers are affiliated with
reporters with over $50 billion in trading assets and
liabilities (TAL) and is consistent with how the SEC
allocates systems costs related to metrics
amendments.
1176 Ongoing reporting cost reduction for SEC
entities: [(55 hours per report × 12 reports per year
× 9 reporters with over $50 billion) + (55 hours per
report × 4 reports per year × 9 reporters with under
$50 billion)¥(41 hours per report × 4 reports per
year × 12 reporters with TAL above $20 billion)] ×
0.18 dealer weight × (Attorney at $423 per hour) =
$453,185.
Ongoing recordkeeping cost reduction for SEC
entities: [(16 hours per firm × 9 reporters with over
$50 billion + 13 hours per firm × 9 reporters with
<$50 billion)¥(10 hours per firm × 12 reporters
with >$20 billion TAL)] × 0.18 × (Attorney at $423
per hour) = $10,736.
Total ongoing cost reduction: $453,185 reporting
+ $10,736 recordkeeping = $463,921.
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burdens (which may be particularly
significant for smaller entities) and the
amount and usefulness of information
provided for regulatory oversight of the
2013 rule, as well as for general
supervision and oversight. As estimated
above, the limitation of certain metrics
to desks engaged in covered trading
activities, elimination of the above
metrics, and removal of the Stress VaR
limit requirements is expected to reduce
burdens related to reporting and
recordkeeping for Group A entities.
Although metrics do not allow the SEC
to clearly identify proprietary trading
from permitted market making, riskmitigating hedging, or underwriting
activity, certain metrics may provide
additional information that is useful for
regulatory oversight.
Replacement of Inventory Turnover
With Positions and Customer-Facing
Trade Ratio With Transaction Volumes
The final rule replaces the Inventory
Turnover metric with the Market Value
of Positions quantitative measurement
and replaces the Customer-Facing Trade
Ratio metric with the Transaction
Volumes quantitative measurement. The
Inventory Turnover and CustomerFacing Trade Ratio metrics are ratios
that measure the turnover of a trading
desk’s inventory and compare the
transactions involving customers and
non-customers of the trading desk,
respectively.
The Positions and Transaction
Volumes metrics are expected to
provide information about risk exposure
and trading activity at a more granular
level. Specifically, the final rule
requires that banking entities provide
the relevant agency with the underlying
data used to calculate the ratios for each
trading day, rather than providing more
aggregated data over 30-, 60-, and 90day calculation periods. By providing
more granular data, the Positions metric,
in conjunction with the Transaction
Volumes metric, is expected to provide
the SEC with the flexibility to calculate
inventory turnover ratios and customerfacing trade ratios over any period of
time, including a single trading day,
allowing the use of the calculation
method the SEC finds most effective for
purposes of regulatory oversight.
Moreover, the new Positions and
Transaction Volumes metrics will
distinguish between securities and
derivatives positions, unlike the
Inventory Turnover and CustomerFacing Trade Ratio metrics. These
metrics would require a banking entity
to separately report the value of
securities positions and the value of
derivatives positions. While the
Inventory Turnover and Customer-
PO 00000
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Facing Trade Ratio metrics require
banking entities to use different
methodologies for valuing securities
positions and derivatives positions
because of differences between these
asset classes, these metrics currently
require banking entities to aggregate
such values for reporting purposes. By
combining separate and distinct
valuation types (e.g., market value and
notional value), the Inventory Turnover
and Customer-Facing Trade Ratio
metrics are providing less meaningful
information than was intended by the
2013 rule. Therefore, requiring banking
entities to disaggregate the value of
securities positions and the value of
derivatives positions for reporting
purposes may enhance the usability of
this information.
In addition to requiring separate
reporting of the value of securities
positions and the value of derivatives
positions, the final rule would also
streamline valuation method
requirements for different product
types. The removal of the notional value
of derivative positions in the Positions
metric avoids complexities related to
mixing various calculation methods for
notional value for different derivatives.
For example, using delta-adjusted
notional for options, bond equivalents
for interest rate derivatives, commodity
price adjusted values for commodity
derivatives, and gross notional for other
derivatives increases complexity and
reduces comparability. Moreover,
certain valuation methodologies
required by the 2013 rule’s Inventory
Turnover and the Customer-Facing
Trade Ratio metrics may not be
otherwise used by banking entities (e.g.,
for internal monitoring or external
reporting purposes). Furthermore, the
2013 rule’s requirements result in
information being aggregated and
furnished to the SEC in non-comparable
units. At the same time, the final rule
retains gross notional value of
derivatives as part of the Transactions
Volumes Metric. The SEC believes that
changing market values of positions as
well as the volume of derivative
contracts in terms of notional are
important measures of risk useful for
ongoing agency oversight. Therefore,
this aspect of the final rule may further
enhance the usability of the information
provided in the Positions metric.
Moreover, the valuation methods
required under the final rule are
intended to be more consistent with the
agencies’ understanding of how banking
entities value securities and derivatives
positions in other contexts, such as
internal monitoring or external
reporting purposes, which may allow
them to leverage existing systems and
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reduce ongoing costs relative to the
costs of reporting requirements under
the 2013 rule. While a banking entity
may incur one-time costs in modifying
how it values certain positions for
purposes of metrics reporting, the SEC
does not expect such systems costs to be
significant, particularly if the banking
entity is able to use the systems it
currently has in place for purposes of
metrics reporting to value positions
consistent with the final rule. However,
the SEC recognizes that some metrics
reporters may incur such costs, and they
are reflected in the estimate of the onetime metrics switching costs of up to
$540,000 for SEC-registered dealers
affiliated with a single Group A metrics
reporter in section V.F.3.h.i above.
The agencies have received a number
of comments on the proposed
replacement of the Inventory Turnover
metric with the Positions metric and of
the Customer-Facing Trade Ratio metric
with the Transaction Volumes metrics.
With respect to the replacement of
Inventory Turnover with Positions,
commenters indicated that the Positions
metric will involve costly modifications
to existing infrastructure and re-scoping
of products.1177 In addition,
commenters indicated that Positions
metric will provide few valuable
insights regarding each desk’s overall
risk profile and that the granularity will
result in false positives.1178 Commenters
also opposed the replacement of the
Customer-Facing Trade Ratio with the
Transactions Volume metric, arguing
that it would create a new metric,
require firms to classify inter-affiliate
transactions, increase transition and
system update costs, and fail to provide
the agencies with valuable information
enhancing oversight for the purposes of
section 13 of the BHC Act.1179
The SEC continues to believe that
requiring banking entities to provide
more granular data in the Positions and
Transaction Volumes metrics will not
significantly alter the costs associated
with the 2013 rule’s Inventory Turnover
and Customer-Facing Trade Ratio
metrics.1180 The Positions and
Transaction Volumes metrics are based
on the same underlying data regarding
the trading activity of a trading desk as
the Inventory Turnover and CustomerFacing Trade Ratio metrics. The SEC
expects that banking entities already
keep records of these data and have
systems in place that collect these data.
Moreover, in response to commenter
concerns regarding the extra
1177 See,
e.g., SIFMA and GFMA.
1178 Id.
1179 See
IIB; SIFMA and JBA.
e.g., 83 FR at 33541.
1180 See,
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recordkeeping costs related to
distinguishing trades across affiliated
banking entities from trades within a
single banking entity, the final rule adds
a category of counterparty for internal
transactions that consolidates the two
proposed categories (transactions across
affiliated banking entities from trades
within a single banking entity) into one
category (transactions with trading
desks and other organizational units).
This additional category of information
may facilitate better classification of
internal transactions, which may assist
the SEC in evaluating whether the
trading desk’s activities are consistent
with the requirements of the exemptions
for underwriting or market makingrelated activity.
The SEC remains cognizant of the
costs of the amendments on reporters. In
the proposal the SEC anticipated that
reporting more granular information in
the Positions and Transaction Volumes
metrics may result in costs of
$24,480.1181 The SEC revises the
estimate to $17,280 to reflect updated
information about the number of
reporters with affiliated SEC-registered
dealers affected by the metrics
amendments.1182 In addition, in the
proposal, the SEC estimated that
modifying the 2013 rule’s requirements
of the Customer-Facing Trade Ratio to
require SEC-regulated banking entities
to further categorize trading desk
transactions may impose additional
systems costs related to tagging internal
transactions and maintaining associated
records valued at $21,420 for all
reporters.1183 The SEC now revises this
estimate to $15,120 to reflect updated
information about the number of
reporters with affiliated SEC-registered
dealers affected by the metrics
amendments.1184
Importantly, the Positions and
Transaction Volumes metrics
requirements as amended may reduce
costs compared to the reporting
requirements under the 2013 rule by
limiting the scope of trading desks that
must provide the position- and tradebased data that is currently required by
1181 In the Proposing Release, the SEC anticipated
that costs associated with the more granular
reporting in the Positions and Transaction Volumes
metrics will be $8,000 per affiliated group of SECregulated banking entities. ($8,000 × 17 reporters ×
0.18 SEC-registered banking entity weight) =
$24,480.
1182 $8,000 × 12 reporters × 0.18 SEC-registered
banking entity weight = $17,280.
1183 In that Release, the SEC estimated that the
additional costs associated with categorizing
transactions under the Transaction Volumes metric
will be $7,000 per reporter. ($7,000 × 17 reporters
× 0.18 SEC-registered banking entity weight) =
$21,420.
1184 $7,000 × 12 reporters × 0.18 SEC-registered
banking entity weight = $15,120.
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62087
the Inventory Turnover and CustomerFacing Trade Ratio metrics. Under the
2013 rule, banking entities are required
to calculate and report the Inventory
Turnover and the Customer-Facing
Trade Ratio metrics for all trading desks
engaged in covered trading activity. The
final rule would limit the scope of
trading desks for which a banking entity
would be required to calculate and
report the Positions and Transaction
Volumes metrics to only those trading
desks engaged in market making-related
activity or underwriting activity. These
burden reductions are captured in the
estimates of reporting and
recordkeeping burden reductions in
section V.F.3.h.i.
Risk Factor Sensitivities, Inventory
Aging, and Stress VaR
The final rule eliminates the Risk
Factor Sensitivities, Inventory Aging,
and Stress VaR metrics of the 2013 rule.
As estimated in section V.F.3.h.i, the
SEC expects that the metrics
amendments, including the elimination
of these quantitative metrics
requirements, will reduce burdens
related to reporting and recordkeeping
for Group A entities without adversely
affecting the SEC’s ability to oversee
banking entities for purposes of section
13 of the BHC Act.
The final rule removes the
requirement to report Risk Factor
Sensitivities metrics, which is expected
to reduce burdens related to data
manipulation. The SEC understands
that reporters may routinely calculate
Risk Factor Sensitivities as part of their
risk systems. However, the SEC
understands that reporters have to
routinely summarize large volumes of
highly disaggregated Risk Factor
Sensitivities from the risk systems for
purposes of compliance with the 2013
rule. As discussed in section IV.E.5, the
agencies estimate that the removal of
Risk Factor Sensitivities may reduce the
total volume of data submitted by
reporters by more than half.
In addition, the SEC recognizes that
one size may not fit all with respect to
risk factors. Specifically, different risk
factors at various levels of granularity
may be relevant for different banking
entities, and the Risk Factor
Sensitivities may not adequately capture
structural differences among the types
of risk managed by trading desks in
some banking entities.1185 The SEC also
notes that banking entities may already
provide information about risk factor
sensitivities as part of market risk
1185 See
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reporting.1186 As discussed in section
IV.E.9.a.i above, the final rule may
reduce redundancy in metrics reporting
since banking entities would be
required to submit one consolidated
Internal Limits Information Schedule for
the covered trading activity of the entire
entity.
The elimination of the Inventory
Aging metric in the final rule recognizes
the limitations of this metric for SEC’s
oversight for purposes of section 13 of
the BHC Act, the information in the
newly required Positions metric, as well
as the fact that the notions of inventory
and inventory aging are not meaningful
indicators of the scale and risk of
derivative positions.1187 The SEC
continues to believe that this
amendment does not reduce the benefits
of metrics reporting, as inventory aging
does not enable a clear identification of
prohibited proprietary trading or
exempt market making, risk-mitigating
hedging, or underwriting activities.
The elimination of the Stress VaR
metric is expected to reduce burdens
related to reporting and recordkeeping
for Group A entities, contributing to the
estimates of burden reductions in
section V.F.3.h.i. The SEC recognizes
one commenter’s concerns that banking
entities may currently face
computational challenges, including
those related to the determination of the
stressed period and dynamic
recalibration and that multinational
holding companies may use different
stress periods for subsidiaries in
different jurisdictions.1188 As discussed
above, under the final rule, banking
entities would still be required to
submit one consolidated Internal Limits
Information Schedule for the covered
trading activity of the entire entity. The
SEC understands that many banking
entities do not routinely set Stress VaR
limits at the trading desk level but
compute Stress VaR at the entity level.
Thus, as discussed above, the final rule
may alleviate the need for redundant
computations and submissions of Stress
VaR at the desk level and may reduce
the size of electronic submissions.
Importantly, the SEC continues to note
that eliminating the Stress VaR metric is
unlikely to reduce the benefits of
metrics reporting, as Stress VaR does
not enable the SEC to distinguish
between prohibited proprietary trading
and permissible market making, risk1186 Id.
1187 For example, the value of derivatives
fluctuates with the price of an underlying asset and
the notional amount of the contract, and derivative
contracts are routinely amended and terminated
prior to expiry. See also, e.g., GFMA, State Street,
Data Boiler.
1188 See, e.g., Data Boiler.
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mitigating hedging, or underwriting
activities of a trading desk.1189
Comprehensive Profit and Loss
Attribution
The final rule makes two main
changes to the Source-of-Revenue
Measurements. First, the final rule
eliminates the requirement that banking
entities calculate and report the
volatility of comprehensive profit and
loss. Since the volatility of profit and
loss can be calculated from other items
being reported by the banking entities,
the SEC does not believe that this aspect
of the final rule would adversely affect
the information available for the
oversight of entities for the purposes of
section 13 of the BHC Act.
Second, the final rule requires
banking entities to provide a complete
attribution of their profit and loss and,
for one or more factors that explain the
preponderance of the profit or loss
changes due to risk factor changes,
banking entities are required to report a
unique identification label for the factor
and the profit or loss due to the factor
change. The SEC recognizes that the
Risk Factor Attribution Information
Schedule and the new unique
identification label reporting
requirement may impose additional
burdens on reporters. As discussed in
section IV.E, the agencies generally
expect that the final rule may enable
banking entities to leverage compliance
with market risk capital programs to
meet the final metrics requirements,
which may reduce complexity and cost
for banking entities and improve the
effectiveness of the final rule. The SEC
also notes that the final rule also
includes an amendment to the trading
desk definition, allowing reporters to
use the same trading desk and risk
factor attribution and risk factor
sensitivity hierarchies. At the same
time, profit and loss attribution and the
identification label may enhance the
ability of regulators to connect risk
factors that explain a preponderance of
the profit or loss changes due to risk
factors with a separate Risk Factor
Attribution Information Schedule. Thus,
these amendments may help enhance
the agencies’ understanding of the
structure of reporters’ activity and the
nature of their revenue sources.
(3) Trading Desk Information,
Quantitative Measurements Identifying
Information, and Narrative Statement
As recognized in Appendix A of the
2013 rule, the effectiveness of particular
quantitative measurements may differ
depending on the profile of a particular
trading desk, including the types of
instruments traded and trading
activities and strategies.1190 Thus, the
additional qualitative information the
agencies would collect in the Trading
Desk Information and Quantitative
Measurements Identifying Information
provision may facilitate SEC review and
analysis of covered trading activities
and reported metrics. For instance, the
trading desk description may help the
SEC assess the risks associated with a
given activity and establish the
appropriate frequency and scope of
examination of such activity. Having
access to such information may allow
the agencies to consider the specifics of
each trading desk’s activities during the
reporting period, which may facilitate
regulatory oversight.
In addition, under the final rule,
banking entities may choose to provide
a Narrative Statement that describes any
changes in calculation methods used, a
description of and reasons for changes
in the trading desk structure or trading
desk strategies, and when any such
change occurred. The Narrative
Statement may include any information
the banking entity views as relevant for
assessing the information reported, such
as further description of calculation
methods used. The Narrative Statement
may provide banking entities with an
opportunity to describe and explain
unusual aspects of the data or
modifications that may have occurred
since the last submission, which may
facilitate better evaluation of the
reported data.
The SEC has received comments
opposing the inclusion of additional
descriptive information about metrics,
including the Trading Desk Information,
Narrative Statement, and Quantitative
Measurements Identifying Information,
as part of amended metrics reporting
requirements.1191 Specifically, a number
of commenters indicated that there are
few benefits of such qualitative
information for the agencies’ ability to
oversee registrants for purposes of
section 13 of the BHC Act.1192 In
addition, some commenters stated that
the requirements are costly and
burdensome as they vastly expand the
scope of information requested.1193
With respect to the Narrative Statement,
one commenter recognized that banking
entities currently provide such
additional information voluntarily but
indicated that the requirement would
impose costs on banking entities that are
1190 See
79 FR 5798.
e.g., Credit Suisse; JBA and SIFMA.
1192 See ABA; CCMR; SIFMA and Credit Suisse.
1193 See, e.g., Credit Suisse and CCMR.
1191 See,
1189 See, e.g., Goldman Sachs; FSF and Data
Boiler.
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unnecessary given that the agencies may
be able to obtain this information
through other supervision.1194 Another
commenter indicated that the proposed
amendments significantly expanded the
scope of the Narrative Statement
requirement relative to current
voluntary submissions, and that the
Narrative Statement may provide little
value to the agencies when assessing
data submissions for purposes of
compliance with the 2013 rule.1195
As discussed above, the SEC
continues to believe that the Trading
Desk Information and Quantitative
Measurements Identifying Information
may enhance the efficiency of data
review by regulators. Three aspects of
the final rule address the cost concerns
of commenters regarding the proposed
Trading Desk, Narrative Statement, and
Quantitative Measurements Identifying
Information amendments discussed
above. First, the final rule would not
require reporters to identify the legal
entity used as a booking entity by the
trading desk, but instead would require
the reporting of a list of agencies
receiving the submission of the trading
desk and the exemptions or exclusions
under which the desk conducts trading
activity. Second, the final rule would
not require reporters to identify
products traded by the desk. Third,
under the final rule, the submission of
the Narrative Statement would be
optional for reporters. The SEC believes
that these aspects of the qualitative
information amendments would
mitigate any new burdens related to
these requirements while facilitating
oversight by the agencies.
However, the SEC recognizes that
several proposed schedules in
quantitative measurements identifying
information may create reporting
burdens. As discussed in section IV.E,
the final rule does not require reporting
of the risk factor sensitivities
information schedule, the limit/
sensitivity cross-reference schedule, and
the risk-factor sensitivity/attribution
cross-reference schedule. However, the
final rules would require reporting of
Risk Factor Attribution Information
Schedules and Internal Limits
Information Schedules that includes
identification of the corresponding risk
factor attribution for certain limits,
imposing two new schedule
requirements relative to the regulatory
baseline under the 2013 rule. However,
as discussed above, some reporters may
currently use the same limits and risk
factors for multiple desks, resulting in
duplicative reporting of daily limits by
1194 See
1195 See
SIFMA.
Credit Suisse.
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multiple desks for a given reporter. To
the extent that these reporters may
choose to use the two new schedules to
submit a comprehensive list of risk and
position limits and risk-factor
sensitivities, these schedules may
reduce duplicative reporting burdens.
The agencies have also received
comment that the agencies have
alternative tools for monitoring banking
entity risk (such as the CCAR process)
and that the risk factor attribution
schedule does not adequately capture
differences between risks managed by
different trading desks of a banking
entity.1196 The SEC believes that the
descriptions of the Internal Limits
Information Schedule and Risk Factor
Attribution Information Schedule for
certain limits may inform oversight of
SEC-regulated banking entities affiliated
with reporters with respect to their
compliance with the requirements of the
final rule.
Moreover, the SEC continues to note
that all the SEC-regulated entities that
currently report metrics are also
currently providing certain elements of
the Trading Desk Information to the
SEC. The SEC continues to believe that
the costs associated with preparing the
Narrative Statement will depend on the
extent to which a banking entity
modifies its calculation methods, makes
changes to a trading desk’s structure or
trading strategies, or otherwise has
additional information that it views as
relevant for assessing the information
reported. Preparation of a Narrative
Statement is expected to be more of a
manual process involving a written
description of pertinent issues.
However, all but one SEC reporter
already provides a narrative with every
submission.
In the proposal, the SEC estimated
that the proposed Narrative Statement
requirement is expected to result in
ongoing personnel and monitoring costs
of only $1,980.1197 The agencies have
received comment that this estimate of
ongoing costs is a significant
underestimate, since reporters will need
to revise all of their metrics reporting
systems and embark on a new round of
systems integration with multiple
agencies independently.1198 The
commenter indicated that the exercise is
not dissimilar from the initial
implementation of the 2013 rule’s
metrics.1199 Another commenter
supported retaining requirements of the
1196 See,
e.g., SIFMA.
SEC estimates that costs associated with
the proposed Narrative Statement will be $11,000
per affiliated group of SEC-regulated banking
entities. ($11,000 × 1 reporter × 0.18) = $1,980.
1198 See SIFMA.
1199 Id.
1197 The
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2013 rule since any metrics
amendments would require
modifications to measurement tools,
involving burdens, testing time, and
outsourcing costs of development
staff.1200
The SEC agrees that the final rule will
involve one-time costs to transition their
systems and transition their compliance
architecture to the amended metrics
requirements for Group A entities,
which are incorporated in the agencies’
estimates in section V.B and in the
SEC’s analysis in section V.F.3.h.i. The
SEC notes that its analysis is specific to
SEC regulated banking entities and the
estimates only represent a fraction of the
compliance costs of holding companies
allocated to affiliated SEC-regulated
banking entities. The SEC also notes
that the $1,980 estimate in the proposal
was specific to the Narrative Statement
requirement for one reporter, rather than
the totality of the burdens imposed on
registrants from new metrics
requirements; and, under the final rule,
the submission of the Narrative
Statement is optional. Moreover, the
SEC anticipates considerable variation
in one-time system transition costs
among reporters, depending on the size
and complexity of their existing trading
activity, the number of trading desks per
reporter for the purposes of metrics
reporting, the way in which reporters
may organize reporting and compliance
obligations for the purposes of, for
instance, the market risk capital rule,
and the complexity of their current
systems.
However, recognizing the above
comments concerning systems changes
that all reporters may have to make for
the purposes of reporting of qualitative
information, the SEC now estimates that
the combined one-time systems costs
related to the submission of new
qualitative information (including
Trading Desk Information, Quantitative
Measurements Identifying Information,
and the optional Narrative Statement)
may be as high as $22,500 for SECregistered entities affiliated with a
single Group A metrics reporter 1201 and
1200 See,
e.g., JBA.
Regulation Crowdfunding, the SEC
estimated that intermediaries (whether brokerdealers or funding portals) that already have in
place platforms and related systems that will need
to tailor their existing platform and systems to
comply with the requirements of Regulation
Crowdfunding may incur an initial average cost of
$250,000. See 80 FR 71509. Since the qualitative
information requirements in the final rule are
considerably more limited than the requirements in
Regulation Crowdfunding, the SEC estimates that
tailoring existing platforms and systems with
respect to the qualitative information requirements
for metrics reporters may be half as costly as the
1201 In
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$270,000 for all SEC-registered entities
affiliated with all reporters.1202 If
transitioning reporting systems to meet
the requirements of the final rule
impose one-time costs and IT burdens
comparable with those of the metrics
requirements of the 2013 rule,1203 the
compliance costs related to the 2013
rule can be used to estimate potential
one-time switching costs for some
banking entities. In the proposal, the
SEC reported an estimate from a market
participant incurring approximately $3
million in costs associated with the
buildout of new IT infrastructure and
system enhancements.1204 Using this
estimate, the one-time costs related to
transitioning metrics reporting to
comply with the requirements of the
final rule may be as high as
$540,000 1205 for SEC-registered dealers
affiliated with a single Group A metrics
reporter and as high as $6,480,000 1206
for all SEC-registered entities affiliated
with all reporters.
trading assets and liabilities. In addition
to reductions in compliance burdens,
the final rule may also involve greater
improvements in the number of banking
entities reporting on time and in the
quality of submissions. As estimated in
Panel A of Table 7, approximately 66%
of all records submitted by reporters
with over $50 billion in trading assets
and liabilities are resubmitted to the
SEC at least once. In addition, from
Panel B of Table 7, the average delay in
initial submissions is approximately 2
days. The SEC notes that in addition to
resulting in potentially higher quality
submissions with fewer resubmissions,
under the final rule the agencies may
not receive the information as promptly.
However, the SEC will continue to have
access to quantitative metrics and
related information through the
standard examination and review
process and existing recordkeeping
requirements.
(4) Time to Report
The agencies are amending the time
frame for metrics reporting by requiring
quarterly reporting for all reporters and
extending the timeline for metrics
submissions to 30 days following the
end of each calendar quarter. The SEC
has received comments supporting a
move to quarterly reporting 1207 and an
extended reporting timeframe for
reporters with more than $50 billion in
trading assets and liabilities 1208 and
stating that such timeframes account for
the scale and complexity of profit and
loss reconciliations as well as the
internal compliance and governance
processes of such banking entities. The
SEC also notes that, to the extent that
the shorter timeframe for submission
may result in later resubmissions to
correct errors, the increase in time for
some reporters may decrease
compliance burdens and make the
information collection process more
efficient.
As estimated in Table 5 of the
economic baseline, this amendment
would not affect the reporting schedule
of four reporters with between $20
billion and $50 billion in trading assets
and liabilities and would provide
additional flexibility and time to eight
reporters with over $50 billion in
(5) XML Format
cost estimate in Regulation Crowdfunding.
$250,000 × 0.5 × 0.18 = $22,500.
1202 $22,500 × 12 reporters = $270,000.
1203 See SIFMA.
1204 Id.
1205 $3 million × 0.18 × 1 reporter = $540,000.
1206 $540,000 × 12 reporters = $6,480,000.
1207 See, e.g., SIFMA.
1208 See, e.g., Goldman Sachs; Credit Suisse and
FSF.
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The agencies are requiring banking
entities to submit the Trading Desk
Information, the Quantitative
Measurements Identifying Information,
and each applicable quantitative
measurement in accordance with the
XML Schema specified and published
on the relevant agency’s website.1209
Under the 2013 rule, the metrics are not
required to be reported in a structured
format, and banking entities are
currently reporting quantitative
measurement data electronically. In the
proposal, the SEC noted that, on the
basis of discussions with metrics
reporters, most of these entities
indicated a familiarity with XML, and
further, several indicated that they use
XML internally for other reporting
purposes. In addition, banks currently
submit quarterly Reports of Condition
and Income (‘‘Call Reports’’) to the
Federal Financial Institutions
Examination Council (‘‘FFIEC’’) Central
Data Repository in eXtensible Business
Reporting Language (‘‘XBRL’’) format,
an XML-based reporting language, so
they are generally familiar with the
processes and technology for submitting
regulatory reports in a structured data
format. The SEC believes that familiarity
with these practices at the bank level
will facilitate the implementation of
these practices for SEC registrants.
Furthermore, FINRA requires its
member broker-dealers to file their
FOCUS Reports in a structured format
1209 XML is an open standard, meaning that it is
a technological standard that is widely available to
the public at no cost. XML is also widely used
across the industry.
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through its eFOCUS system.1210 The
eFOCUS system permits broker-dealers
to import the FOCUS Report data into
a filing using an Excel, XML, or text file.
Therefore, the SEC continues to believe
that SEC-regulated dealers covered by
the metrics reporting and recordkeeping
requirements may have experience
applying the XML format to their data.
Reporting metrics and other
information in XML allows data to be
tagged, which in turn identifies the
content of the underlying information.
The data then becomes instantly
machine readable through the use of
standard software. Requiring banking
entities to submit the metrics in
accordance with the XML Schema
would enhance the agencies’ ability to
process and analyze the data. Once the
data is in a structured format, it can be
easily organized for viewing,
manipulation, and analysis through the
use of commonly used software tools
and applications. Structured data can
allow the agencies to discern patterns
from large quantities of information
much more easily than unstructured
data. The SEC continues to believe that
structured data also facilitates the
ability to dynamically search, aggregate,
and compare information across
submissions, whether within a banking
entity, across multiple banking entities,
or across multiple date ranges. The data
supplied in a structured format could
help the SEC identify outliers or trends
that could warrant further investigation.
Specifying the format in which
banking entities must report information
may help ensure that the agencies
receive consistently comparable
information in an efficient manner
across banking entities. The costs
associated with providing XML data lie
in the specialized software or services
required to make the submission and
the time required to map the required
data elements to the requisite taxonomy.
In addition to enhanced viewing,
manipulation, and analysis, the benefits
associated with providing XML data lie
in the enhanced validation tools that
minimize the likelihood that data are
reported with errors. Therefore,
subsequent reporting periods may
require fewer resources, relative to both
initial reporting periods under the final
rule and the current reporting process.
In the proposal, the SEC recognized
that, as a result of the proposed
amendments, banking entities will be
1210 For example, FINRA members commonly use
FINRA’s Web EFT system, which requires that all
data be submitted in XML. See https://
www.finra.org/industry/web-crd/web-eft-schemadocumentation-and-schema-files. Also see 81 FR
49499. Information about FINRA’s eFOCUS system
is available at https://www.finra.org/industry/focus.
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required to establish and implement
systems in accordance with the XML
Schema that will result in one-time
costs and estimated such costs at an
average of $75,000 1211 per reporter, for
an expected aggregate one-time cost of
approximately $229,500 for all SEC
registrants.1212
The agencies received several
comments regarding the costs of
transitioning to metrics reporting in an
XML format. Some commenters
indicated that they did not support the
amendment as it would increase costs
related to switching formats of reporting
software and systems and supported the
retention of existing (.DAT) format used
for submissions but did not provide any
quantification for the costs of switching
to the .XML format.1213 Other
commenters generally supported
metrics reporting in a standardized data
format and the proposed transition to
XML reporting.1214 One commenter
indicated that the transition to XML
reporting of metrics will require
1211 These cost estimates were based in part on
the SEC’s recent estimates of the one-time systems
costs associated with the proposed requirement that
security-based swap data repositories (SDRs) make
transaction-level security-based swap data available
to the SEC in Financial products Markup Language
(FpML) and Financial Information eXchange
Markup Language (FIXML). See Establishing the
Form and Manner with which Security-Based Swap
Data Repositories Must Make Security-Based Swap
Data Available to the Commission, Exchange Act
Release No. 76624 (Dec. 11, 2015), 80 FR 79757
(Dec. 23, 2015) (SBS Taxonomy rule proposing
release). The SBS Taxonomy rule proposing release
estimates a one-time cost per SDR of $127,000.
Although the substance of reporting associated with
the metrics is different from the information
collected and made available by SDRs, in the
Proposing Release, the SEC stated that similar costs
may apply to the implementation of XML for the
reporting metrics. In particular, on the basis of its
experience with similar structured data reporting
requirements in other contexts (e.g., the SBS
Taxonomy rule), the SEC expected that systems
engineering fixed costs will represent the bulk of
the costs related to the XML requirement. Among
other things, the proposed SBS Taxonomy rule
would require SDRs to make available to the SEC
in a specific format (in this case, FpML or FIXML)
transaction-level data that they are already required
to provide. Similarly, in the Proposing Release, the
SEC noted that the proposed metrics amendments
would require banking entities to produce in XML
metrics reports that they are already required (or
will be required) to provide. However, the SEC’s
estimate was reduced to account for the fact that
registered broker-dealers already provide eFOCUS
reports to FINRA in XML and, therefore, must have
the requisite systems in place. The SEC’s cost
estimates at proposal included responsibilities for
modifications of information technology systems to
an attorney, a compliance Manager, a programmer
analyst, and a senior business analyst and
responsibilities for policies and procedures to an
attorney, a compliance Manager, a senior systems
analyst, and an operations specialist.
1212 In the Proposing Release, the SEC computed
total costs as follows: $75,000 × 17 reporters × 0.18
entity weight = $229,500.
1213 See, e.g., JBA and Credit Suisse.
1214 See, e.g., Goldman Sachs and Data Boiler.
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significant switching costs and that
there will also be ongoing costs because
of potential changes to the XML schema
or the underlying information to which
the XML schema relates over time.1215
Another commenter supported the XML
reporting format and estimated that
reporters would incur a one-time
switching cost related to equipment,
systems, training, and staffing or
maintenance of $40,000 per banking
entity.1216
The SEC continues to estimate that
each reporter may incur a one-time
switching cost of up to $75,000 but is
adjusting the total aggregate reporting
costs to reflect an updated count of
metrics reporters with affiliated SECregistered banking entities. As discussed
in the economic baseline, using data
from March 2018 through March 2019,
the SEC estimates that 12 reporters with
trading assets and liabilities in excess of
$20 billion may be subject to the final
metrics reporting amendments, resulting
in an aggregate estimate of a one-time
switching cost of $162,000 for all SEC
registrants.1217 Moreover, since the final
rule involves a single one-time change
to the reporting format, the SEC
continues to believe that SEC-regulated
banking entities will not incur
significant ongoing costs from this
aspect of the final rule. Moreover, the
SEC continues to believe that XML
reporting will result in a more efficient
submission process, including
validation of submissions, and
anticipates that some of the
implementation costs may be offset over
time by these greater efficiencies.
ii. Competition, Efficiency, and Capital
Formation
Under the amendments, entities that
have between $10 and $20 billion in
trading assets and liabilities would
incur lower costs of compliance as they
would no longer be subject to metrics
requirements. To the extent that these
compliance burdens may be significant
for some entities, and since Group B
entities are not subject to any metrics
requirements, Group A entities close to
the threshold may become more
competitive with Group B entities. To
the extent that some entities are
currently experiencing significant
metrics-reporting costs and partially or
fully passing them along to customers in
the form of reduced willingness to
transact or higher costs, the final rule
may reduce costs of and increase access
to capital. However, estimated reporting
1215 See
SIFMA.
Data Boiler.
1217 $75,000 × 12 reporters × 0.18 entity weight
= $162,000.
1216 See
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62091
and recordkeeping burden savings
resulting from the final rule are
relatively modest, and the SEC does not
anticipate a substantial increase in
access to capital as a result of the final
rule to metrics reporting requirements.
iii. Alternatives
The agencies could have taken several
alternative approaches. First, the
agencies could have kept the metrics
being reported unchanged, but
increased or decreased the trading
activity thresholds used to determine
metrics recordkeeping and reporting by
filers and the frequency of such
reporting. For instance, the agencies
could have used the $10 billion trading
activity threshold as proposed. As
shown in Table 2, the SEC estimates
that this alternative would affect nine
bank-affiliated SEC-registered brokerdealers. The alternative would increase
the amount and frequency of
quantitative data available for regulatory
oversight of banking entities. However,
under the alternative, these dealers
would be required to keep or report
metrics, experiencing higher
compliance burdens. Similarly,
increasing the recordkeeping and
reporting thresholds would reduce the
scope of application of the metrics
reporting requirement, lowering
accompanying recordkeeping and
reporting obligations as well as potential
oversight and supervision benefits. The
SEC continues to recognize that while
metrics may be used to flag risks and
enhance general supervision, as well as
demonstrate prudent risk management,
metrics being reported under the 2013
rule do not clearly distinguish
proprietary trading from market making
or hedging activities.
In addition, the agencies could have
eliminated the VaR requirement 1218 or
replaced VaR with Expected
Shortfall 1219 as a potentially better
measure of tail risk of a trading desk or
banking entity.1220 The SEC recognizes
that VaR and Expected Shortfall are
normally based on firm-wide activity,
and some entities may not be routinely
using such measures to manage and
control risk at the trading desk level. As
a result, VaR, or Expected Shortfall
limits may not be meaningful at the
trading desk level. These alternatives
1218 See,
e.g., Goldman Sachs.
Shortfall is an estimate of the
expected value of losses beyond a given confidence
level and is generally calculated as the area under
the probability distribution of asset or portfolio
returns in the left tail. For an expected shortfall at
the 99 percent confidence level, the measure would
capture the area under the probability distribution
from the 99th percentile to the 100th percentile. See
Saunders and Cornett (2014), pp. 458–461.
1220 See, e.g., Data Boiler.
1219 Expected
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may reduce the burden of reporting and
compliance costs relative to the
approach being adopted without
necessarily reducing the effectiveness of
regulatory oversight by the SEC. In
addition, VaR and Expected Shortfall
may not be informative about banking
entity compliance with section 13 of the
BHC Act but may help agencies
understand the tail risk of supervised
entities as a part of ongoing oversight
and supervision.
The agencies could have required all
Group A banking entities to report
metrics on a monthly basis within 20
days of the end of the calendar month.
The SEC believes that this alternative
would have two partly offsetting effects
relative to the baseline. First, the
reporters with more than $50 billion in
trading assets and liabilities, which are
required to report metrics monthly and
within 10 days of the end of each
calendar month under the 2013 rule,
would, under the alternative, have 20
days after the end of each calendar
month to report metrics. As estimated in
Table 5 of the economic baseline, this
aspect of the alternative would affect
eight reporters with SEC-registered
affiliated banking entities. Second,
reporters with more than $20 billion but
less than $50 billion in trading assets
and liabilities are required to report
metrics on a quarterly basis and have 30
days after the end of reach calendar
month to do so under the 2013 rule.
Under the alternative, these reporters
would be required to report on a
monthly basis and would have 10 fewer
days to do so, relative to the baseline.
As estimated in Table 5, this aspect of
the alternative would affect four
reporters with SEC-registered affiliated
banking entities. Thus, the effects of the
alternative on the compliance costs and
resubmissions of data, as well on
changes to the timeliness of data
available to the SEC, would likely to be
partly offsetting for these two groups of
reporters.
The SEC recognizes that the
alternative would increase how
promptly the SEC receives data from
some SEC-registered banking entities
relative to the baseline and the final
rule. However, more frequent reporting
may also decrease the quality of
submissions and the need for
resubmissions by some SEC-registered
banking entities. In addition, because
processes enabling more frequent
reporting under tight deadlines may
generally be costlier, the alternative
would result in even smaller reductions
in compliance costs for reporters.
The agencies could have eliminated
all quantitative metrics recordkeeping
and reporting requirements under
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Appendix A of the 2013 rule.1221
Alternatively, the agencies could have
eliminated all quantitative metrics
except for Risk Management and Source
of Revenue Metrics.1222 The SEC
recognizes that these alternatives would
reduce the amount of data produced and
transmitted to the agencies. Metrics
reporting enables regulators to have a
more complete picture of risk exposures
from trading and profit and loss
attribution for supervised entities.
However, the metrics reporting regime
is costly, and banking entities subject to
the 2013 rule and SEC oversight are also
subject to other compliance and
reporting requirements unrelated to the
2013 rule, as well as the standard
examination and review process. It is
not clear that metrics are superior to
internal quantitative risk measurements
or other data (such as metrics in the
FOCUS reports) reported by SECregistered broker-dealers in illustrating
risk exposures and profitability of
various activities by SEC registrants. As
previously noted, metrics—such as VaR,
dealer inventory, transaction volume,
and profit and loss attribution—do not
delineate a prohibited proprietary trade
and a permitted market making,
underwriting or hedging trade. In
addition, reporting at the trading desk
level may obscure potential prohibited
proprietary trades since a banking entity
could attempt to accumulate large
proprietary trading exposures by
allocating them to a large number of
trading desks and comingling these
proprietary positions with customer
facilitation positions for reporting
purposes. For example, as can be seen
from Table 6 of the economic baseline,
reporters across various trading assets
and liabilities thresholds currently
report metrics for an average or 38 to 56
trading desks. Moreover, reporters’
flexibility in defining the metrics may
reduce their comparability. The SEC
continues to recognize that metrics do
not delineate a prohibited proprietary
trade and a permitted market making,
underwriting or hedging trade, but they
may be used to enhance regulatory
oversight. The SEC notes that reporters
are already currently subject to a large
number of reporting obligations
unrelated to section 13 of the BHC Act,
such as those under the Market Risk
Capital rule and Form FOCUS reporting
requirements, providing large volumes
of distinct data that can be used to flag
risks and enhance general supervision.
However, as discussed above, the SEC
recognizes that metrics may have value
1221 See
New England Council.
e.g., New England Council and State
1222 See,
Street.
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for ongoing oversight, and the final rule
tailors and streamlines metrics reporting
requirements rather than eliminating all
metrics as a whole.
As discussed elsewhere in this
supplementary information, the final
rule has a compliance date of January 1,
2021, while enabling early voluntary
compliance with the final rule (subject
to the agencies’ completion of necessary
technological changes). This approach
recognizes the heterogeneity in the
existing compliance burdens related to
the 2013 rule and in the one-time
burdens and time costs that different
banking entities may incur as a result of
transitioning their compliance
programs, while preserving continuity
of metrics reporting and agency
oversight. The SEC has considered
alternative approaches adopting more
(or less) delayed compliance dates and
disallowing voluntary early compliance
with some aspects of the final rule. Such
alternatives would provide more (or
less) time to transition their compliance
programs and adapt reporting systems to
the requirements of the final rule.
Moreover, as discussed elsewhere in
this economic analysis, the SEC
continues to believe that the final rule
may result in significant burden
reductions for some banking entities.
Alternatives disallowing early voluntary
compliance would delay the benefits of
such burden reductions for the most
affected banking entities.
G. Congressional Review Act
For the SEC, the Office of Information
and Regulatory Affairs, pursuant to the
Congressional Review Act (CRA), has
designated this rule as a ‘‘major rule’’ as
defined by 5 U.S.C. 804(2). For the FDIC
and OCC, the Office of Information and
Regulatory Affairs, pursuant to the CRA,
has designated this rule as not a ‘‘major
rule.’’
List of Subjects
12 CFR Part 44
Banks, Banking, Compensation,
Credit, Derivatives, Government
securities, Insurance, Investments,
National banks, Penalties, Reporting and
recordkeeping requirements, Risk, Risk
retention, Securities, Trusts and
trustees.
12 CFR Part 248
Administrative practice and
procedure, Banks, Banking, Conflict of
interests, Credit, Foreign banking,
Government securities, Holding
companies, Insurance, Insurance
companies, Investments, Penalties,
Reporting and recordkeeping
requirements, Securities, State
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nonmember banks, State savings
associations, Trusts and trustees.
12 CFR Part 351
Banks, Banking, Conflicts of interest,
Credit, Government securities,
Insurance, Insurance companies,
Investments, Penalties, Reporting and
recordkeeping requirements, Securities,
Trusts and trustees.
17 CFR Part 75
Banks, Banking, Compensation,
Credit, Derivatives, Federal branches
and agencies, Federal savings
associations, Government securities,
Hedge funds, Insurance, Investments,
National banks, Penalties, Proprietary
trading, Reporting and recordkeeping
requirements, Risk, Risk retention,
Securities, Swap dealers, Trusts and
trustees, Volcker rule.
17 CFR Part 255
Banks, Brokers, Dealers, Investment
advisers, Recordkeeping, Reporting,
Securities.
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
12 CFR Chapter I
Authority and Issuance
For the reasons stated in the Common
Preamble, the Office of the Comptroller
of the Currency amends chapter I of
Title 12, Code of Federal Regulations as
follows:
PART 44—PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS
1. The authority citation for part 44
continues to read as follows:
■
Authority: 7 U.S.C. 27 et seq., 12 U.S.C.
1, 24, 92a, 93a, 161, 1461, 1462a, 1463, 1464,
1467a, 1813(q), 1818, 1851, 3101 3102, 3108,
5412.
Subpart A—Authority and Definitions
2. Section 44.2 is revised to read as
follows:
■
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§ 44.2
Definitions.
Unless otherwise specified, for
purposes of this part:
(a) Affiliate has the same meaning as
in section 2(k) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(k)).
(b) Bank holding company has the
same meaning as in section 2 of the
Bank Holding Company Act of 1956 (12
U.S.C. 1841).
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(c) Banking entity. (1) Except as
provided in paragraph (c)(2) of this
section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an
insured depository institution;
(iii) Any company that is treated as a
bank holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any
entity described in paragraph (c)(1)(i),
(ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a
banking entity under paragraph (c)(1)(i),
(ii), or (iii) of this section;
(ii) A portfolio company held under
the authority contained in section
4(k)(4)(H) or (I) of the BHC Act (12
U.S.C. 1843(k)(4)(H), (I)), or any
portfolio concern, as defined under 13
CFR 107.50, that is controlled by a small
business investment company, as
defined in section 103(3) of the Small
Business Investment Act of 1958 (15
U.S.C. 662), so long as the portfolio
company or portfolio concern is not
itself a banking entity under paragraph
(c)(1)(i), (ii), or (iii) of this section; or
(iii) The FDIC acting in its corporate
capacity or as conservator or receiver
under the Federal Deposit Insurance Act
or Title II of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
(d) Board means the Board of
Governors of the Federal Reserve
System.
(e) CFTC means the Commodity
Futures Trading Commission.
(f) Dealer has the same meaning as in
section 3(a)(5) of the Exchange Act (15
U.S.C. 78c(a)(5)).
(g) Depository institution has the same
meaning as in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)).
(h) Derivative. (1) Except as provided
in paragraph (h)(2) of this section,
derivative means:
(i) Any swap, as that term is defined
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)), or
security-based swap, as that term is
defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68));
(ii) Any purchase or sale of a
commodity, that is not an excluded
commodity, for deferred shipment or
delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as
that term is defined in section 1a(24) of
the Commodity Exchange Act (7 U.S.C.
1a(24)) or foreign exchange swap (as
that term is defined in section 1a(25) of
the Commodity Exchange Act (7 U.S.C.
1a(25));
(iv) Any agreement, contract, or
transaction in foreign currency
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62093
described in section 2(c)(2)(C)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(C)(i));
(v) Any agreement, contract, or
transaction in a commodity other than
foreign currency described in section
2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under
section 19 of the Commodity Exchange
Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or
other agreement, contract, or transaction
that the CFTC and SEC have further
defined by joint regulation,
interpretation, or other action as not
within the definition of swap, as that
term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C.
1a(47)), or security-based swap, as that
term is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)); or
(ii) Any identified banking product, as
defined in section 402(b) of the Legal
Certainty for Bank Products Act of 2000
(7 U.S.C. 27(b)), that is subject to section
403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the
immediate family of the employee.
(j) Exchange Act means the Securities
Exchange Act of 1934 (15 U.S.C. 78a et
seq.).
(k) Excluded commodity has the same
meaning as in section 1a(19) of the
Commodity Exchange Act (7 U.S.C.
1a(19)).
(l) FDIC means the Federal Deposit
Insurance Corporation.
(m) Federal banking agencies means
the Board, the Office of the Comptroller
of the Currency, and the FDIC.
(n) Foreign banking organization has
the same meaning as in § 211.21(o) of
the Board’s Regulation K (12 CFR
211.21(o)), but does not include a
foreign bank, as defined in section
1(b)(7) of the International Banking Act
of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the
Commonwealth of Puerto Rico, Guam,
American Samoa, the United States
Virgin Islands, or the Commonwealth of
the Northern Mariana Islands.
(o) Foreign insurance regulator means
the insurance commissioner, or a
similar official or agency, of any country
other than the United States that is
engaged in the supervision of insurance
companies under foreign insurance law.
(p) General account means all of the
assets of an insurance company except
those allocated to one or more separate
accounts.
(q) Insurance company means a
company that is organized as an
insurance company, primarily and
predominantly engaged in writing
insurance or reinsuring risks
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underwritten by insurance companies,
subject to supervision as such by a state
insurance regulator or a foreign
insurance regulator, and not operated
for the purpose of evading the
provisions of section 13 of the BHC Act
(12 U.S.C. 1851).
(r) Insured depository institution has
the same meaning as in section 3(c) of
the Federal Deposit Insurance Act (12
U.S.C. 1813(c)), but does not include:
(1) An insured depository institution
that is described in section 2(c)(2)(D) of
the BHC Act (12 U.S.C. 1841(c)(2)(D));
or
(2) An insured depository institution
if it has, and if every company that
controls it has, total consolidated assets
of $10 billion or less and total trading
assets and trading liabilities, on a
consolidated basis, that are 5 percent or
less of total consolidated assets.
(s) Limited trading assets and
liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together
with its affiliates and subsidiaries,
trading assets and liabilities (excluding
trading assets and liabilities attributable
to trading activities permitted pursuant
to § 44.6(a)(1) and (2) of subpart B) the
average gross sum of which over the
previous consecutive four quarters, as
measured as of the last day of each of
the four previous calendar quarters, is
less than $1 billion; and
(ii) The OCC has not determined
pursuant to § 44.20(g) or (h) of this part
that the banking entity should not be
treated as having limited trading assets
and liabilities.
(2) With respect to a banking entity
other than a banking entity described in
paragraph (s)(3) of this section, trading
assets and liabilities for purposes of this
paragraph (s) means trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 44.6(a)(1) and (2) of subpart B) on a
worldwide consolidated basis.
(3)(i) With respect to a banking entity
that is a foreign banking organization or
a subsidiary of a foreign banking
organization, trading assets and
liabilities for purposes of this paragraph
(s) means the trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 44.6(a)(1) and (2) of subpart B) of the
combined U.S. operations of the top-tier
foreign banking organization (including
all subsidiaries, affiliates, branches, and
agencies of the foreign banking
organization operating, located, or
organized in the United States).
(ii) For purposes of paragraph (s)(3)(i)
of this section, a U.S. branch, agency, or
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subsidiary of a banking entity is located
in the United States; however, the
foreign bank that operates or controls
that branch, agency, or subsidiary is not
considered to be located in the United
States solely by virtue of operating or
controlling the U.S. branch, agency, or
subsidiary. For purposes of paragraph
(s)(3)(i) of this section, all foreign
operations of a U.S. agency, branch, or
subsidiary of a foreign banking
organization are considered to be
located in the United States, including
branches outside the United States that
are managed or controlled by a U.S.
branch or agency of the foreign banking
organization, for purposes of calculating
the banking entity’s U.S. trading assets
and liabilities.
(t) Loan means any loan, lease,
extension of credit, or secured or
unsecured receivable that is not a
security or derivative.
(u) Moderate trading assets and
liabilities means, with respect to a
banking entity, that the banking entity
does not have significant trading assets
and liabilities or limited trading assets
and liabilities.
(v) Primary financial regulatory
agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act (12 U.S.C. 5301(12)).
(w) Purchase includes any contract to
buy, purchase, or otherwise acquire. For
security futures products, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a commodity future, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a derivative, purchase
includes the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(x) Qualifying foreign banking
organization means a foreign banking
organization that qualifies as such under
§ 211.23(a), (c), or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c), or
(e)).
(y) SEC means the Securities and
Exchange Commission.
(z) Sale and sell each include any
contract to sell or otherwise dispose of.
For security futures products, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a commodity future, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a derivative, such terms
include the execution, termination
(prior to its scheduled maturity date),
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assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(aa) Security has the meaning
specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(bb) Security-based swap dealer has
the same meaning as in section 3(a)(71)
of the Exchange Act (15 U.S.C.
78c(a)(71)).
(cc) Security future has the meaning
specified in section 3(a)(55) of the
Exchange Act (15 U.S.C. 78c(a)(55)).
(dd) Separate account means an
account established and maintained by
an insurance company in connection
with one or more insurance contracts to
hold assets that are legally segregated
from the insurance company’s other
assets, under which income, gains, and
losses, whether or not realized, from
assets allocated to such account, are, in
accordance with the applicable contract,
credited to or charged against such
account without regard to other income,
gains, or losses of the insurance
company.
(ee) Significant trading assets and
liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together
with its affiliates and subsidiaries,
trading assets and liabilities the average
gross sum of which over the previous
consecutive four quarters, as measured
as of the last day of each of the four
previous calendar quarters, equals or
exceeds $20 billion; or
(ii) The OCC has determined pursuant
to § 44.20(h) of this part that the banking
entity should be treated as having
significant trading assets and liabilities.
(2) With respect to a banking entity,
other than a banking entity described in
paragraph (ee)(3) of this section, trading
assets and liabilities for purposes of this
paragraph (ee) means trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 44.6(a)(1) and (2) of subpart B) on a
worldwide consolidated basis.
(3)(i) With respect to a banking entity
that is a foreign banking organization or
a subsidiary of a foreign banking
organization, trading assets and
liabilities for purposes of this paragraph
(ee) means the trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 44.6(a)(1) and (2) of subpart B) of the
combined U.S. operations of the top-tier
foreign banking organization (including
all subsidiaries, affiliates, branches, and
agencies of the foreign banking
organization operating, located, or
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organized in the United States as well
as branches outside the United States
that are managed or controlled by a
branch or agency of the foreign banking
entity operating, located or organized in
the United States).
(ii) For purposes of paragraph
(ee)(3)(i) of this section, a U.S. branch,
agency, or subsidiary of a banking entity
is located in the United States; however,
the foreign bank that operates or
controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary. For
purposes of paragraph (ee)(3)(i) of this
section, all foreign operations of a U.S.
agency, branch, or subsidiary of a
foreign banking organization are
considered to be located in the United
States for purposes of calculating the
banking entity’s U.S. trading assets and
liabilities.
(ff) State means any State, the District
of Columbia, the Commonwealth of
Puerto Rico, Guam, American Samoa,
the United States Virgin Islands, and the
Commonwealth of the Northern Mariana
Islands.
(gg) Subsidiary has the same meaning
as in section 2(d) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(d)).
(hh) State insurance regulator means
the insurance commissioner, or a
similar official or agency, of a State that
is engaged in the supervision of
insurance companies under State
insurance law.
(ii) Swap dealer has the same meaning
as in section 1(a)(49) of the Commodity
Exchange Act (7 U.S.C. 1a(49)).
Subpart B—Proprietary Trading
3. Section 44.3 is amended by:
a. Revising paragraphs (b), (d)(3), and
(d)(8) and (9);
■ b. Adding paragraphs (d)(10) through
(13);
■ c. Redesignating paragraphs (e)(5)
through (13) as paragraphs (e)(6)
through (14);
■ d. Adding new paragraph (e)(5); and
■ e. Revising newly redesignated
paragraphs (e)(11), (12), and (14).
The revisions and additions read as
follows:
■
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§ 44.3
Prohibition on proprietary trading.
*
*
*
*
*
(b) Definition of trading account. (1)
Trading account. Trading account
means:
(i) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments principally
for the purpose of short-term resale,
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benefitting from actual or expected
short-term price movements, realizing
short-term arbitrage profits, or hedging
one or more of the positions resulting
from the purchases or sales of financial
instruments described in this paragraph;
(ii) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments that are both
market risk capital rule covered
positions and trading positions (or
hedges of other market risk capital rule
covered positions), if the banking entity,
or any affiliate with which the banking
entity is consolidated for regulatory
reporting purposes, calculates riskbased capital ratios under the market
risk capital rule; or
(iii) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments, if the
banking entity:
(A) Is licensed or registered, or is
required to be licensed or registered, to
engage in the business of a dealer, swap
dealer, or security-based swap dealer, to
the extent the instrument is purchased
or sold in connection with the activities
that require the banking entity to be
licensed or registered as such; or
(B) Is engaged in the business of a
dealer, swap dealer, or security-based
swap dealer outside of the United
States, to the extent the instrument is
purchased or sold in connection with
the activities of such business.
(2) Trading account application for
certain banking entities. (i) A banking
entity that is subject to paragraph
(b)(1)(ii) of this section in determining
the scope of its trading account is not
subject to paragraph (b)(1)(i) of this
section.
(ii) A banking entity that does not
calculate risk-based capital ratios under
the market risk capital rule and is not
a consolidated affiliate for regulatory
reporting purposes of a banking entity
that calculates risk based capital ratios
under the market risk capital rule may
elect to apply paragraph (b)(1)(ii) of this
section in determining the scope of its
trading account as if it were subject to
that paragraph. A banking entity that
elects under this section to apply
paragraph (b)(1)(ii) of this section in
determining the scope of its trading
account as if it were subject to that
paragraph is not required to apply
paragraph (b)(1)(i) of this section.
(3) Consistency of account election for
certain banking entities. (i) Any election
or change to an election under
paragraph (b)(2)(ii) of this section must
apply to the electing banking entity and
all of its wholly owned subsidiaries.
The primary financial regulatory agency
of a banking entity that is affiliated with
but is not a wholly owned subsidiary of
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such electing banking entity may
require that the banking entity be
subject to this uniform application
requirement if the primary financial
regulatory agency determines that it is
necessary to prevent evasion of the
requirements of this part after notice
and opportunity for response as
provided in subpart D of this part.
(ii) A banking entity that does not
elect under paragraph (b)(2)(ii) of this
section to be subject to the trading
account definition in (b)(1)(ii) of this
section may continue to apply the
trading account definition in paragraph
(b)(1)(i) of this section for one year from
the date on which it becomes, or
becomes a consolidated affiliate for
regulatory reporting purposes with, a
banking entity that calculates risk-based
capital ratios under the market risk
capital rule.
(4) Rebuttable presumption for certain
purchases and sales. The purchase (or
sale) of a financial instrument by a
banking entity shall be presumed not to
be for the trading account of the banking
entity under paragraph (b)(1)(i) of this
section if the banking entity holds the
financial instrument for sixty days or
longer and does not transfer
substantially all of the risk of the
financial instrument within sixty days
of the purchase (or sale).
*
*
*
*
*
(d) * * *
(3) Any purchase or sale of a security,
foreign exchange forward (as that term
is defined in section 1a(24) of the
Commodity Exchange Act (7 U.S.C.
1a(24)), foreign exchange swap (as that
term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C.
1a(25)), or cross-currency swap by a
banking entity for the purpose of
liquidity management in accordance
with a documented liquidity
management plan of the banking entity
that:
(i) Specifically contemplates and
authorizes the particular financial
instruments to be used for liquidity
management purposes, the amount,
types, and risks of these financial
instruments that are consistent with
liquidity management, and the liquidity
circumstances in which the particular
financial instruments may or must be
used;
(ii) Requires that any purchase or sale
of financial instruments contemplated
and authorized by the plan be
principally for the purpose of managing
the liquidity of the banking entity, and
not for the purpose of short-term resale,
benefitting from actual or expected
short-term price movements, realizing
short-term arbitrage profits, or hedging a
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position taken for such short-term
purposes;
(iii) Requires that any financial
instruments purchased or sold for
liquidity management purposes be
highly liquid and limited to financial
instruments the market, credit, and
other risks of which the banking entity
does not reasonably expect to give rise
to appreciable profits or losses as a
result of short-term price movements;
(iv) Limits any financial instruments
purchased or sold for liquidity
management purposes, together with
any other financial instruments
purchased or sold for such purposes, to
an amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan;
(v) Includes written policies and
procedures, internal controls, analysis,
and independent testing to ensure that
the purchase and sale of financial
instruments that are not permitted
under § 44.6(a) or (b) of this subpart are
for the purpose of liquidity management
and in accordance with the liquidity
management plan described in this
paragraph (d)(3); and
(vi) Is consistent with the OCC’s
regulatory requirements regarding
liquidity management;
*
*
*
*
*
(8) Any purchase or sale of one or
more financial instruments by a banking
entity through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity that is
established and administered in
accordance with the law of the United
States or a foreign sovereign, if the
purchase or sale is made directly or
indirectly by the banking entity as
trustee for the benefit of persons who
are or were employees of the banking
entity;
(9) Any purchase or sale of one or
more financial instruments by a banking
entity in the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the financial instrument
as soon as practicable, and in no event
may the banking entity retain such
instrument for longer than such period
permitted by the OCC;
(10) Any purchase or sale of one or
more financial instruments that was
made in error by a banking entity in the
course of conducting a permitted or
excluded activity or is a subsequent
transaction to correct such an error;
(11) Contemporaneously entering into
a customer-driven swap or customer-
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driven security-based swap and a
matched swap or security-based swap if:
(i) The banking entity retains no more
than minimal price risk; and
(ii) The banking entity is not a
registered dealer, swap dealer, or
security-based swap dealer;
(12) Any purchase or sale of one or
more financial instruments that the
banking entity uses to hedge mortgage
servicing rights or mortgage servicing
assets in accordance with a documented
hedging strategy; or
(13) Any purchase or sale of a
financial instrument that does not meet
the definition of trading asset or trading
liability under the applicable reporting
form for a banking entity as of January
1, 2020.
(e) * * *
(5) Cross-currency swap means a swap
in which one party exchanges with
another party principal and interest rate
payments in one currency for principal
and interest rate payments in another
currency, and the exchange of principal
occurs on the date the swap is entered
into, with a reversal of the exchange of
principal at a later date that is agreed
upon when the swap is entered into.
*
*
*
*
*
(11) Market risk capital rule covered
position and trading position means a
financial instrument that meets the
criteria to be a covered position and a
trading position, as those terms are
respectively defined, without regard to
whether the financial instrument is
reported as a covered position or trading
position on any applicable regulatory
reporting forms:
(i) In the case of a banking entity that
is a bank holding company, savings and
loan holding company, or insured
depository institution, under the market
risk capital rule that is applicable to the
banking entity; and
(ii) In the case of a banking entity that
is affiliated with a bank holding
company or savings and loan holding
company, other than a banking entity to
which a market risk capital rule is
applicable, under the market risk capital
rule that is applicable to the affiliated
bank holding company or savings and
loan holding company.
(12) Market risk capital rule means
the market risk capital rule that is
contained in 12 CFR part 3, subpart F,
with respect to a banking entity for
which the OCC is the primary financial
regulatory agency, 12 CFR part 217 with
respect to a banking entity for which the
Board is the primary financial
regulatory agency, or 12 CFR part 324
with respect to a banking entity for
which the FDIC is the primary financial
regulatory agency.
*
*
*
*
*
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(14) Trading desk means a unit of
organization of a banking entity that
purchases or sells financial instruments
for the trading account of the banking
entity or an affiliate thereof that is:
(i)(A) Structured by the banking entity
to implement a well-defined business
strategy;
(B) Organized to ensure appropriate
setting, monitoring, and management
review of the desk’s trading and hedging
limits, current and potential future loss
exposures, and strategies; and
(C) Characterized by a clearly defined
unit that:
(1) Engages in coordinated trading
activity with a unified approach to its
key elements;
(2) Operates subject to a common and
calibrated set of risk metrics, risk levels,
and joint trading limits;
(3) Submits compliance reports and
other information as a unit for
monitoring by management; and
(4) Books its trades together; or
(ii) For a banking entity that
calculates risk-based capital ratios
under the market risk capital rule, or a
consolidated affiliate for regulatory
reporting purposes of a banking entity
that calculates risk-based capital ratios
under the market risk capital rule,
established by the banking entity or its
affiliate for purposes of market risk
capital calculations under the market
risk capital rule.
■ 4. Section 44.4 is revised to read as
follows:
§ 44.4 Permitted underwriting and market
making-related activities.
(a) Underwriting activities—(1)
Permitted underwriting activities. The
prohibition contained in § 44.3(a) does
not apply to a banking entity’s
underwriting activities conducted in
accordance with this paragraph (a).
(2) Requirements. The underwriting
activities of a banking entity are
permitted under paragraph (a)(1) of this
section only if:
(i) The banking entity is acting as an
underwriter for a distribution of
securities and the trading desk’s
underwriting position is related to such
distribution;
(ii)(A) The amount and type of the
securities in the trading desk’s
underwriting position are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, taking into account the
liquidity, maturity, and depth of the
market for the relevant types of
securities; and
(B) Reasonable efforts are made to sell
or otherwise reduce the underwriting
position within a reasonable period,
taking into account the liquidity,
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maturity, and depth of the market for
the relevant types of securities;
(iii) In the case of a banking entity
with significant trading assets and
liabilities, the banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (a)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The products, instruments or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
(B) Limits for each trading desk, in
accordance with paragraph (a)(2)(ii)(A)
of this section;
(C) Written authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
and
(D) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits.
(iv) A banking entity with significant
trading assets and liabilities may satisfy
the requirements in paragraphs
(a)(2)(iii)(B) and (C) of this section by
complying with the requirements set
forth in paragraph (c) of this section;
(v) The compensation arrangements of
persons performing the activities
described in this paragraph (a) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in the activity
described in this paragraph (a) in
accordance with applicable law.
(3) Definition of distribution. For
purposes of this paragraph (a), a
distribution of securities means:
(i) An offering of securities, whether
or not subject to registration under the
Securities Act of 1933, that is
distinguished from ordinary trading
transactions by the presence of special
selling efforts and selling methods; or
(ii) An offering of securities made
pursuant to an effective registration
statement under the Securities Act of
1933.
(4) Definition of underwriter. For
purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an
issuer or selling security holder to:
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(A) Purchase securities from the
issuer or selling security holder for
distribution;
(B) Engage in a distribution of
securities for or on behalf of the issuer
or selling security holder; or
(C) Manage a distribution of securities
for or on behalf of the issuer or selling
security holder; or
(ii) A person who has agreed to
participate or is participating in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.
(5) Definition of selling security
holder. For purposes of this paragraph
(a), selling security holder means any
person, other than an issuer, on whose
behalf a distribution is made.
(6) Definition of underwriting
position. For purposes of this section,
underwriting position means the long or
short positions in one or more securities
held by a banking entity or its affiliate,
and managed by a particular trading
desk, in connection with a particular
distribution of securities for which such
banking entity or affiliate is acting as an
underwriter.
(7) Definition of client, customer, and
counterparty. For purposes of this
paragraph (a), the terms client,
customer, and counterparty, on a
collective or individual basis, refer to
market participants that may transact
with the banking entity in connection
with a particular distribution for which
the banking entity is acting as
underwriter.
(b) Market making-related activities—
(1) Permitted market making-related
activities. The prohibition contained in
§ 44.3(a) does not apply to a banking
entity’s market making-related activities
conducted in accordance with this
paragraph (b).
(2) Requirements. The market makingrelated activities of a banking entity are
permitted under paragraph (b)(1) of this
section only if:
(i) The trading desk that establishes
and manages the financial exposure,
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure, and is willing and available to
quote, purchase and sell, or otherwise
enter into long and short positions in
those types of financial instruments for
its own account, in commercially
reasonable amounts and throughout
market cycles on a basis appropriate for
the liquidity, maturity, and depth of the
market for the relevant types of financial
instruments;
(ii) The trading desk’s market-making
related activities are designed not to
exceed, on an ongoing basis, the
reasonably expected near term demands
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of clients, customers, or counterparties,
taking into account the liquidity,
maturity, and depth of the market for
the relevant types of financial
instruments;
(iii) In the case of a banking entity
with significant trading assets and
liabilities, the banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of this paragraph
(b), including reasonably designed
written policies and procedures,
internal controls, analysis and
independent testing identifying and
addressing:
(A) The financial instruments each
trading desk stands ready to purchase
and sell in accordance with paragraph
(b)(2)(i) of this section;
(B) The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the limits
required under paragraph (b)(2)(iii)(C) of
this section; the products, instruments,
and exposures each trading desk may
use for risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and
positions; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
desk to mitigate these risks are and
continue to be effective;
(C) Limits for each trading desk, in
accordance with paragraph (b)(2)(ii) of
this section;
(D) Written authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
and
(E) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits.
(iv) A banking entity with significant
trading assets and liabilities may satisfy
the requirements in paragraphs
(b)(2)(iii)(C) and (D) by complying with
the requirements set forth in paragraph
(c) of this section;
(v) The compensation arrangements of
persons performing the activities
described in this paragraph (b) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in activity
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described in this paragraph (b) in
accordance with applicable law.
(3) Definition of client, customer, and
counterparty. For purposes of this
paragraph (b), the terms client,
customer, and counterparty, on a
collective or individual basis refer to
market participants that make use of the
banking entity’s market making-related
services by obtaining such services,
responding to quotations, or entering
into a continuing relationship with
respect to such services, provided that:
(i) A trading desk or other
organizational unit of another banking
entity is not a client, customer, or
counterparty of the trading desk if that
other entity has trading assets and
liabilities of $50 billion or more as
measured in accordance with the
methodology described in § 44.2(ee) of
this part, unless:
(A) The trading desk documents how
and why a particular trading desk or
other organizational unit of the entity
should be treated as a client, customer,
or counterparty of the trading desk for
purposes of paragraph (b)(2) of this
section; or
(B) The purchase or sale by the
trading desk is conducted anonymously
on an exchange or similar trading
facility that permits trading on behalf of
a broad range of market participants.
(ii) [Reserved]
(4) Definition of financial exposure.
For purposes of this section, financial
exposure means the aggregate risks of
one or more financial instruments and
any associated loans, commodities, or
foreign exchange or currency, held by a
banking entity or its affiliate and
managed by a particular trading desk as
part of the trading desk’s market
making-related activities.
(5) Definition of market-maker
positions. For the purposes of this
section, market-maker positions means
all of the positions in the financial
instruments for which the trading desk
stands ready to make a market in
accordance with paragraph (b)(2)(i) of
this section, that are managed by the
trading desk, including the trading
desk’s open positions or exposures
arising from open transactions.
(c) Rebuttable presumption of
compliance—(1) Internal limits. (i) A
banking entity shall be presumed to
meet the requirement in paragraph
(a)(2)(ii)(A) or (b)(2)(ii) of this section
with respect to the purchase or sale of
a financial instrument if the banking
entity has established and implements,
maintains, and enforces the internal
limits for the relevant trading desk as
described in paragraph (c)(1)(ii) of this
section.
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(ii)(A) With respect to underwriting
activities conducted pursuant to
paragraph (a) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall be available
to each trading desk that establishes,
implements, maintains, and enforces
internal limits that should take into
account the liquidity, maturity, and
depth of the market for the relevant
types of securities and are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, based on the nature and
amount of the trading desk’s
underwriting activities, on the:
(1) Amount, types, and risk of its
underwriting position;
(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held.
(B) With respect to market makingrelated activities conducted pursuant to
paragraph (b) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall be available
to each trading desk that establishes,
implements, maintains, and enforces
internal limits that should take into
account the liquidity, maturity, and
depth of the market for the relevant
types of financial instruments and are
designed not to exceed the reasonably
expected near term demands of clients,
customers, or counterparties, based on
the nature and amount of the trading
desk’s market-making related activities,
that address the:
(1) Amount, types, and risks of its
market-maker positions;
(2) Amount, types, and risks of the
products, instruments, and exposures
the trading desk may use for risk
management purposes;
(3) Level of exposures to relevant risk
factors arising from its financial
exposure; and
(4) Period of time a financial
instrument may be held.
(2) Supervisory review and oversight.
The limits described in paragraph (c)(1)
of this section shall be subject to
supervisory review and oversight by the
OCC on an ongoing basis.
(3) Limit breaches and increases. (i)
With respect to any limit set pursuant
to paragraph (c)(1)(ii)(A) or (B) of this
section, a banking entity shall maintain
and make available to the OCC upon
request records regarding:
(A) Any limit that is exceeded; and
(B) Any temporary or permanent
increase to any limit(s), in each case in
the form and manner as directed by the
OCC.
(ii) In the event of a breach or increase
of any limit set pursuant to paragraph
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(c)(1)(ii)(A) or (B) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall continue to
be available only if the banking entity:
(A) Takes action as promptly as
possible after a breach to bring the
trading desk into compliance; and
(B) Follows established written
authorization procedures, including
escalation procedures that require
review and approval of any trade that
exceeds a trading desk’s limit(s),
demonstrable analysis of the basis for
any temporary or permanent increase to
a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval.
(4) Rebutting the presumption. The
presumption in paragraph (c)(1)(i) of
this section may be rebutted by the OCC
if the OCC determines, taking into
account the liquidity, maturity, and
depth of the market for the relevant
types of financial instruments and based
on all relevant facts and circumstances,
that a trading desk is engaging in
activity that is not based on the
reasonably expected near term demands
of clients, customers, or counterparties.
The OCC’s rebuttal of the presumption
in paragraph (c)(1)(i) must be made in
accordance with the notice and
response procedures in subpart D of this
part.
■ 5. Section 44.5 is amended by revising
paragraphs (b) and (c)(1) introductory
text and adding paragraph (c)(4) to read
as follows:
§ 44.5 Permitted risk-mitigating hedging
activities.
*
*
*
*
*
(b) Requirements. (1) The riskmitigating hedging activities of a
banking entity that has significant
trading assets and liabilities are
permitted under paragraph (a) of this
section only if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures regarding the
positions, techniques and strategies that
may be used for hedging, including
documentation indicating what
positions, contracts or other holdings a
particular trading desk may use in its
risk-mitigating hedging activities, as
well as position and aging limits with
respect to such positions, contracts or
other holdings;
(B) Internal controls and ongoing
monitoring, management, and
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authorization procedures, including
relevant escalation procedures; and
(C) The conduct of analysis and
independent testing designed to ensure
that the positions, techniques and
strategies that may be used for hedging
may reasonably be expected to reduce or
otherwise significantly mitigate the
specific, identifiable risk(s) being
hedged;
(ii) The risk-mitigating hedging
activity:
(A) Is conducted in accordance with
the written policies, procedures, and
internal controls required under this
section;
(B) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks, including
market risk, counterparty or other credit
risk, currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section;
(D) Is subject to continuing review,
monitoring and management by the
banking entity that:
(1) Is consistent with the written
hedging policies and procedures
required under paragraph (b)(1)(i) of this
section;
(2) Is designed to reduce or otherwise
significantly mitigate the specific,
identifiable risks that develop over time
from the risk-mitigating hedging
activities undertaken under this section
and the underlying positions, contracts,
and other holdings of the banking
entity, based upon the facts and
circumstances of the underlying and
hedging positions, contracts and other
holdings of the banking entity and the
risks and liquidity thereof; and
(3) Requires ongoing recalibration of
the hedging activity by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(1)(ii) of this section and is
not prohibited proprietary trading; and
(iii) The compensation arrangements
of persons performing risk-mitigating
hedging activities are designed not to
reward or incentivize prohibited
proprietary trading.
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(2) The risk-mitigating hedging
activities of a banking entity that does
not have significant trading assets and
liabilities are permitted under paragraph
(a) of this section only if the riskmitigating hedging activity:
(i) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks, including
market risk, counterparty or other credit
risk, currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to
ongoing recalibration by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(2) of this section and is
not prohibited proprietary trading.
(c) * * *
(1) A banking entity that has
significant trading assets and liabilities
must comply with the requirements of
paragraphs (c)(2) and (3) of this section,
unless the requirements of paragraph
(c)(4) of this section are met, with
respect to any purchase or sale of
financial instruments made in reliance
on this section for risk-mitigating
hedging purposes that is:
*
*
*
*
*
(4) The requirements of paragraphs
(c)(2) and (3) of this section do not
apply to the purchase or sale of a
financial instrument described in
paragraph (c)(1) of this section if:
(i) The financial instrument
purchased or sold is identified on a
written list of pre-approved financial
instruments that are commonly used by
the trading desk for the specific type of
hedging activity for which the financial
instrument is being purchased or sold;
and
(ii) At the time the financial
instrument is purchased or sold, the
hedging activity (including the purchase
or sale of the financial instrument)
complies with written, pre-approved
limits for the trading desk purchasing or
selling the financial instrument for
hedging activities undertaken for one or
more other trading desks. The limits
shall be appropriate for the:
(A) Size, types, and risks of the
hedging activities commonly
undertaken by the trading desk;
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62099
(B) Financial instruments purchased
and sold for hedging activities by the
trading desk; and
(C) Levels and duration of the risk
exposures being hedged.
■ 6. Section 44.6 is amended by revising
paragraph (e)(3), removing paragraphs
(e)(4) and (6), and redesignating
paragraph (e)(5) as paragraph (e)(4).
The revision reads as follows:
§ 44.6 Other permitted proprietary trading
activities.
*
*
*
*
*
(e) * * *
(3) A purchase or sale by a banking
entity is permitted for purposes of this
paragraph (e) if:
(i) The banking entity engaging as
principal in the purchase or sale
(including relevant personnel) is not
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State; and
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State.
*
*
*
*
*
Subpart C—Covered Funds Activities
and Investments
7. Section 44.10 is amended by
revising paragraphs (c)(7)(ii) and
(c)(8)(i)(A) to read as follows:
■
§ 44.10 Prohibition on Acquiring or
Retaining an Ownership Interest in and
Having Certain Relationships with a
Covered Fund.
*
*
*
*
*
(c) * * *
(7) * * *
(ii) Participates in the profits and
losses of the separate account other than
in compliance with applicable
requirements regarding bank owned life
insurance.
(8) * * *
(i) * * *
(A) Loans as defined in § 44.2(t) of
subpart A;
*
*
*
*
*
■ 8. Section 44.11 is amended by
revising paragraph (c) to read as follows:
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§ 44.11 Permitted organizing and offering,
underwriting, and market making with
respect to a covered fund.
*
*
*
*
*
(c) Underwriting and market making
in ownership interests of a covered
fund. The prohibition contained in
§ 44.10(a) of this subpart does not apply
to a banking entity’s underwriting
activities or market making-related
activities involving a covered fund so
long as:
(1) Those activities are conducted in
accordance with the requirements of
§ 44.4(a) or (b) of subpart B,
respectively; and
(2) With respect to any banking entity
(or any affiliate thereof) that: Acts as a
sponsor, investment adviser or
commodity trading advisor to a
particular covered fund or otherwise
acquires and retains an ownership
interest in such covered fund in reliance
on paragraph (a) of this section; or
acquires and retains an ownership
interest in such covered fund and is
either a securitizer, as that term is used
in section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)), or is acquiring
and retaining an ownership interest in
such covered fund in compliance with
section 15G of that Act (15 U.S.C. 78o–
11) and the implementing regulations
issued thereunder each as permitted by
paragraph (b) of this section, then in
each such case any ownership interests
acquired or retained by the banking
entity and its affiliates in connection
with underwriting and market making
related activities for that particular
covered fund are included in the
calculation of ownership interests
permitted to be held by the banking
entity and its affiliates under the
limitations of § 44.12(a)(2)(ii) and (iii)
and (d).
§ 44.12
[Amended]
9. Section 44.12 is amended by
redesignating the second instance of
paragraph (e)(2)(vi) as paragraph
(e)(2)(vii).
■ 10. Section 44.13 is amended by
revising paragraphs (a), (b)(3) and (4),
and (c) to read as follows:
■
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§ 44.13 Other permitted covered fund
activities and investments.
(a) Permitted risk-mitigating hedging
activities. (1) The prohibition contained
in § 44.10(a) of this subpart does not
apply with respect to an ownership
interest in a covered fund acquired or
retained by a banking entity that is
designed to reduce or otherwise
significantly mitigate the specific,
identifiable risks to the banking entity
in connection with:
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(i) A compensation arrangement with
an employee of the banking entity or an
affiliate thereof that directly provides
investment advisory, commodity trading
advisory or other services to the covered
fund; or
(ii) A position taken by the banking
entity when acting as intermediary on
behalf of a customer that is not itself a
banking entity to facilitate the exposure
by the customer to the profits and losses
of the covered fund.
(2) The risk-mitigating hedging
activities of a banking entity are
permitted under this paragraph (a) only
if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program in
accordance with subpart D of this part
that is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures; and
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(ii) The acquisition or retention of the
ownership interest:
(A) Is made in accordance with the
written policies, procedures, and
internal controls required under this
section;
(B) At the inception of the hedge, is
designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks arising:
(1) Out of a transaction conducted
solely to accommodate a specific
customer request with respect to the
covered fund; or
(2) In connection with the
compensation arrangement with the
employee that directly provides
investment advisory, commodity trading
advisory, or other services to the
covered fund;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section; and
(D) Is subject to continuing review,
monitoring and management by the
banking entity.
(iii) With respect to risk-mitigating
hedging activity conducted pursuant to
paragraph (a)(1)(i) of this section, the
compensation arrangement relates
solely to the covered fund in which the
banking entity or any affiliate has
acquired an ownership interest pursuant
to paragraph (a)(1)(i) and such
compensation arrangement provides
that any losses incurred by the banking
entity on such ownership interest will
be offset by corresponding decreases in
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amounts payable under such
compensation arrangement.
(b) * * *
(3) An ownership interest in a covered
fund is not offered for sale or sold to a
resident of the United States for
purposes of paragraph (b)(1)(iii) of this
section only if it is not sold and has not
been sold pursuant to an offering that
targets residents of the United States in
which the banking entity or any affiliate
of the banking entity participates. If the
banking entity or an affiliate sponsors or
serves, directly or indirectly, as the
investment manager, investment
adviser, commodity pool operator or
commodity trading advisor to a covered
fund, then the banking entity or affiliate
will be deemed for purposes of this
paragraph (b)(3) to participate in any
offer or sale by the covered fund of
ownership interests in the covered fund.
(4) An activity or investment occurs
solely outside of the United States for
purposes of paragraph (b)(1)(iv) of this
section only if:
(i) The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
and is not controlled directly or
indirectly by, a banking entity that is
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
laws of the United States or of any State;
and
(iii) The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
as principal directly or indirectly on a
consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State.
*
*
*
*
*
(c) Permitted covered fund interests
and activities by a regulated insurance
company. The prohibition contained in
§ 44.10(a) of this subpart does not apply
to the acquisition or retention by an
insurance company, or an affiliate
thereof, of any ownership interest in, or
the sponsorship of, a covered fund only
if:
(1) The insurance company or its
affiliate acquires and retains the
ownership interest solely for the general
account of the insurance company or for
one or more separate accounts
established by the insurance company;
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(2) The acquisition and retention of
the ownership interest is conducted in
compliance with, and subject to, the
insurance company investment laws
and regulations of the State or
jurisdiction in which such insurance
company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law or
regulation described in paragraph (c)(2)
of this section is insufficient to protect
the safety and soundness of the banking
entity, or the financial stability of the
United States.
■ 11. Section 44.14 is amended by
revising paragraph (a)(2)(ii)(B) to read as
follows:
§ 44.14 Limitations on relationships with a
covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or
equivalent officer) of the banking entity
certifies in writing annually no later
than March 31 to the OCC (with a duty
to update the certification if the
information in the certification
materially changes) that the banking
entity does not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests; and
*
*
*
*
*
Subpart D—Compliance Program
Requirement; Violations
12. Section 44.20 is amended by
revising paragraphs (a), (b) introductory
text, (c), (d), (e) introductory text, and
(f)(2) and adding paragraphs (g), (h), and
(i) to read as follows:
■
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§ 44.20
Program for compliance; reporting.
(a) Program requirement. Each
banking entity (other than a banking
entity with limited trading assets and
liabilities) shall develop and provide for
the continued administration of a
compliance program reasonably
designed to ensure and monitor
compliance with the prohibitions and
restrictions on proprietary trading and
covered fund activities and investments
set forth in section 13 of the BHC Act
and this part. The terms, scope, and
detail of the compliance program shall
be appropriate for the types, size, scope,
and complexity of activities and
business structure of the banking entity.
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(b) Banking entities with significant
trading assets and liabilities. With
respect to a banking entity with
significant trading assets and liabilities,
the compliance program required by
paragraph (a) of this section, at a
minimum, shall include:
*
*
*
*
*
(c) CEO attestation. The CEO of a
banking entity that has significant
trading assets and liabilities must, based
on a review by the CEO of the banking
entity, attest in writing to the OCC, each
year no later than March 31, that the
banking entity has in place processes to
establish, maintain, enforce, review, test
and modify the compliance program
required by paragraph (b) of this section
in a manner reasonably designed to
achieve compliance with section 13 of
the BHC Act and this part. In the case
of a U.S. branch or agency of a foreign
banking entity, the attestation may be
provided for the entire U.S. operations
of the foreign banking entity by the
senior management officer of the U.S.
operations of the foreign banking entity
who is located in the United States.
(d) Reporting requirements under
appendix A to this part. (1) A banking
entity engaged in proprietary trading
activity permitted under subpart B of
this part shall comply with the reporting
requirements described in appendix A
to this part, if:
(i) The banking entity has significant
trading assets and liabilities; or
(ii) The OCC notifies the banking
entity in writing that it must satisfy the
reporting requirements contained in
appendix A to this part.
(2) Frequency of reporting: Unless the
OCC notifies the banking entity in
writing that it must report on a different
basis, a banking entity subject to the
Appendix shall report the information
required by appendix A to this part for
each quarter within 30 days of the end
of the quarter.
(e) Additional documentation for
covered funds. A banking entity with
significant trading assets and liabilities
shall maintain records that include:
*
*
*
*
*
(f) * * *
(2) Banking entities with moderate
trading assets and liabilities. A banking
entity with moderate trading assets and
liabilities may satisfy the requirements
of this section by including in its
existing compliance policies and
procedures appropriate references to the
requirements of section 13 of the BHC
Act and this part and adjustments as
appropriate given the activities, size,
scope, and complexity of the banking
entity.
(g) Rebuttable presumption of
compliance for banking entities with
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limited trading assets and liabilities—
(1) Rebuttable presumption. Except as
otherwise provided in this paragraph, a
banking entity with limited trading
assets and liabilities shall be presumed
to be compliant with subpart B and
subpart C of this part and shall have no
obligation to demonstrate compliance
with this part on an ongoing basis.
(2) Rebuttal of presumption. If upon
examination or audit, the OCC
determines that the banking entity has
engaged in proprietary trading or
covered fund activities that are
otherwise prohibited under subpart B or
subpart C of this part, the OCC may
require the banking entity to be treated
under this part as if it did not have
limited trading assets and liabilities.
The OCC’s rebuttal of the presumption
in this paragraph must be made in
accordance with the notice and
response procedures in paragraph (i) of
this section.
(h) Reservation of authority.
Notwithstanding any other provision of
this part, the OCC retains its authority
to require a banking entity without
significant trading assets and liabilities
to apply any requirements of this part
that would otherwise apply if the
banking entity had significant or
moderate trading assets and liabilities if
the OCC determines that the size or
complexity of the banking entity’s
trading or investment activities, or the
risk of evasion of subpart B or subpart
C of this part, does not warrant a
presumption of compliance under
paragraph (g) of this section or treatment
as a banking entity with moderate
trading assets and liabilities, as
applicable. The OCC’s exercise of this
reservation of authority must be made in
accordance with the notice and
response procedures in paragraph (i) of
this section.
(i) Notice and response procedures—
(1) Notice. The OCC will notify the
banking entity in writing of any
determination requiring notice under
this part and will provide an
explanation of the determination.
(2) Response. The banking entity may
respond to any or all items in the notice
described in paragraph (i)(1) of this
section. The response should include
any matters that the banking entity
would have the OCC consider in
deciding whether to make the
determination. The response must be in
writing and delivered to the designated
OCC official within 30 days after the
date on which the banking entity
received the notice. The OCC may
shorten the time period when, in the
opinion of the OCC, the activities or
condition of the banking entity so
requires, provided that the banking
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entity is informed of the time period at
the time of notice, or with the consent
of the banking entity. In its discretion,
the OCC may extend the time period for
good cause.
(3) Waiver. Failure to respond within
30 days or such other time period as
may be specified by the OCC shall
constitute a waiver of any objections to
the OCC’s determination.
(4) Decision. The OCC will notify the
banking entity of the decision in
writing. The notice will include an
explanation of the decision.
■ 13. Revise appendix A to part 44 to
read as follows:
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Appendix A to Part 44—Reporting and
Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and
recordkeeping requirements that certain
banking entities must satisfy in connection
with the restrictions on proprietary trading
set forth in subpart B (‘‘proprietary trading
restrictions’’). Pursuant to § 44.20(d), this
appendix applies to a banking entity that,
together with its affiliates and subsidiaries,
has significant trading assets and liabilities.
These entities are required to (i) furnish
periodic reports to the OCC regarding a
variety of quantitative measurements of their
covered trading activities, which vary
depending on the scope and size of covered
trading activities, and (ii) create and maintain
records documenting the preparation and
content of these reports. The requirements of
this appendix must be incorporated into the
banking entity’s internal compliance program
under § 44.20.
b. The purpose of this appendix is to assist
banking entities and the OCC in:
(1) Better understanding and evaluating the
scope, type, and profile of the banking
entity’s covered trading activities;
(2) Monitoring the banking entity’s covered
trading activities;
(3) Identifying covered trading activities
that warrant further review or examination
by the banking entity to verify compliance
with the proprietary trading restrictions;
(4) Evaluating whether the covered trading
activities of trading desks engaged in market
making-related activities subject to § 44.4(b)
are consistent with the requirements
governing permitted market making-related
activities;
(5) Evaluating whether the covered trading
activities of trading desks that are engaged in
permitted trading activity subject to § 44.4,
§ 44.5, or § 44.6(a) and (b) (i.e., underwriting
and market making-related activity, riskmitigating hedging, or trading in certain
government obligations) are consistent with
the requirement that such activity not result,
directly or indirectly, in a material exposure
to high-risk assets or high-risk trading
strategies;
(6) Identifying the profile of particular
covered trading activities of the banking
entity, and the individual trading desks of
the banking entity, to help establish the
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appropriate frequency and scope of
examination by the OCC of such activities;
and
(7) Assessing and addressing the risks
associated with the banking entity’s covered
trading activities.
c. Information that must be furnished
pursuant to this appendix is not intended to
serve as a dispositive tool for the
identification of permissible or
impermissible activities.
d. In addition to the quantitative
measurements required in this appendix, a
banking entity may need to develop and
implement other quantitative measurements
in order to effectively monitor its covered
trading activities for compliance with section
13 of the BHC Act and this part and to have
an effective compliance program, as required
by § 44.20. The effectiveness of particular
quantitative measurements may differ based
on the profile of the banking entity’s
businesses in general and, more specifically,
of the particular trading desk, including
types of instruments traded, trading activities
and strategies, and history and experience
(e.g., whether the trading desk is an
established, successful market maker or a
new entrant to a competitive market). In all
cases, banking entities must ensure that they
have robust measures in place to identify and
monitor the risks taken in their trading
activities, to ensure that the activities are
within risk tolerances established by the
banking entity, and to monitor and examine
for compliance with the proprietary trading
restrictions in this part.
e. On an ongoing basis, banking entities
must carefully monitor, review, and evaluate
all furnished quantitative measurements, as
well as any others that they choose to utilize
in order to maintain compliance with section
13 of the BHC Act and this part. All
measurement results that indicate a
heightened risk of impermissible proprietary
trading, including with respect to otherwisepermitted activities under §§ 44.4 through
44.6(a) and (b), or that result in a material
exposure to high-risk assets or high-risk
trading strategies, must be escalated within
the banking entity for review, further
analysis, explanation to the OCC, and
remediation, where appropriate. The
quantitative measurements discussed in this
appendix should be helpful to banking
entities in identifying and managing the risks
related to their covered trading activities.
increase or decrease in the market value of
a trading desk’s holdings, dividend income,
and interest income and expense.
Covered trading activity means trading
conducted by a trading desk under § 44.4,
§ 44.5, § 44.6(a), or § 44.6(b). A banking entity
may include in its covered trading activity
trading conducted under § 44.3(d), § 44.6(c),
§ 44.6(d), or § 44.6(e).
Measurement frequency means the
frequency with which a particular
quantitative metric must be calculated and
recorded.
Trading day means a calendar day on
which a trading desk is open for trading.
II. Definitions
The terms used in this appendix have the
same meanings as set forth in §§ 44.2 and
44.3. In addition, for purposes of this
appendix, the following definitions apply:
Applicability identifies the trading desks
for which a banking entity is required to
calculate and report a particular quantitative
measurement based on the type of covered
trading activity conducted by the trading
desk.
Calculation period means the period of
time for which a particular quantitative
measurement must be calculated.
Comprehensive profit and loss means the
net profit or loss of a trading desk’s material
sources of trading revenue over a specific
period of time, including, for example, any
b. Trading Desk Information
1. Each banking entity must provide
descriptive information regarding each
trading desk engaged in covered trading
activities, including:
i. Name of the trading desk used internally
by the banking entity and a unique
identification label for the trading desk;
ii. Identification of each type of covered
trading activity in which the trading desk is
engaged;
iii. Brief description of the general strategy
of the trading desk;
v. A list identifying each Agency receiving
the submission of the trading desk;
2. Indication of whether each calendar date
is a trading day or not a trading day for the
trading desk; and
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III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each
banking entity made subject to this appendix
by § 44.20 must furnish the following
quantitative measurements, as applicable, for
each trading desk of the banking entity
engaged in covered trading activities and
calculate these quantitative measurements in
accordance with this appendix:
i. Internal Limits and Usage;
ii. Value-at-Risk;
iii. Comprehensive Profit and Loss
Attribution;
iv. Positions; and
v. Transaction Volumes.
2. Trading desk information. Each banking
entity made subject to this appendix by
§ 44.20 must provide certain descriptive
information, as further described in this
appendix, regarding each trading desk
engaged in covered trading activities.
3. Quantitative measurements identifying
information. Each banking entity made
subject to this appendix by § 44.20 must
provide certain identifying and descriptive
information, as further described in this
appendix, regarding its quantitative
measurements.
4. Narrative statement. Each banking entity
made subject to this appendix by § 44.20 may
provide an optional narrative statement, as
further described in this appendix.
5. File identifying information. Each
banking entity made subject to this appendix
by § 44.20 must provide file identifying
information in each submission to the OCC
pursuant to this appendix, including the
name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the
Board, and identification of the reporting
period and creation date and time.
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3. Currency reported and daily currency
conversion rate.
c. Quantitative Measurements Identifying
Information
Each banking entity must provide the
following information regarding the
quantitative measurements:
1. An Internal Limits Information Schedule
that provides identifying and descriptive
information for each limit reported pursuant
to the Internal Limits and Usage quantitative
measurement, including the name of the
limit, a unique identification label for the
limit, a description of the limit, the unit of
measurement for the limit, the type of limit,
and identification of the corresponding risk
factor attribution in the particular case that
the limit type is a limit on a risk factor
sensitivity and profit and loss attribution to
the same risk factor is reported; and
2. A Risk Factor Attribution Information
Schedule that provides identifying and
descriptive information for each risk factor
attribution reported pursuant to the
Comprehensive Profit and Loss Attribution
quantitative measurement, including the
name of the risk factor or other factor, a
unique identification label for the risk factor
or other factor, a description of the risk factor
or other factor, and the risk factor or other
factor’s change unit.
d. Narrative Statement
Each banking entity made subject to this
appendix by § 44.20 may submit in a separate
electronic document a Narrative Statement to
the OCC with any information the banking
entity views as relevant for assessing the
information reported. The Narrative
Statement may include further description of
or changes to calculation methods,
identification of material events, description
of and reasons for changes in the banking
entity’s trading desk structure or trading desk
strategies, and when any such changes
occurred.
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e. Frequency and Method of Required
Calculation and Reporting
A banking entity must calculate any
applicable quantitative measurement for each
trading day. A banking entity must report the
Trading Desk Information, the Quantitative
Measurements Identifying Information, and
each applicable quantitative measurement
electronically to the OCC on the reporting
schedule established in § 44.20 unless
otherwise requested by the OCC. A banking
entity must report the Trading Desk
Information, the Quantitative Measurements
Identifying Information, and each applicable
quantitative measurement to the OCC in
accordance with the XML Schema specified
and published on the OCC’s website.
f. Recordkeeping
A banking entity must, for any quantitative
measurement furnished to the OCC pursuant
to this appendix and § 44.20(d), create and
maintain records documenting the
preparation and content of these reports, as
well as such information as is necessary to
permit the OCC to verify the accuracy of such
reports, for a period of five years from the
end of the calendar year for which the
measurement was taken. A banking entity
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must retain the Narrative Statement, the
Trading Desk Information, and the
Quantitative Measurements Identifying
Information for a period of five years from
the end of the calendar year for which the
information was reported to the OCC.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Internal Limits and Usage
i. Description: For purposes of this
appendix, Internal Limits are the constraints
that define the amount of risk and the
positions that a trading desk is permitted to
take at a point in time, as defined by the
banking entity for a specific trading desk.
Usage represents the value of the trading
desk’s risk or positions that are accounted for
by the current activity of the desk. Internal
limits and their usage are key compliance
and risk management tools used to control
and monitor risk taking and include, but are
not limited to, the limits set out in §§ 44.4
and 44.5. A trading desk’s risk limits,
commonly including a limit on ‘‘Value-atRisk,’’ are useful in the broader context of the
trading desk’s overall activities, particularly
for the market making activities under
§ 44.4(b) and hedging activity under § 44.5.
Accordingly, the limits required under
§§ 44.4(b)(2)(iii)(C) and 44.5(b)(1)(i)(A) must
meet the applicable requirements under
§§ 44.4(b)(2)(iii)(C) and 44.5(b)(1)(i)(A) and
also must include appropriate metrics for the
trading desk limits including, at a minimum,
‘‘Value-at-Risk’’ except to the extent the
‘‘Value-at-Risk’’ metric is demonstrably
ineffective for measuring and monitoring the
risks of a trading desk based on the types of
positions traded by, and risk exposures of,
that desk.
A. A banking entity must provide the
following information for each limit reported
pursuant to this quantitative measurement:
The unique identification label for the limit
reported in the Internal Limits Information
Schedule, the limit size (distinguishing
between an upper and a lower limit), and the
value of usage of the limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
2. Value-at-Risk
i. Description: For purposes of this
appendix, Value-at-Risk (‘‘VaR’’) is the
measurement of the risk of future financial
loss in the value of a trading desk’s
aggregated positions at the ninety-nine
percent confidence level over a one-day
period, based on current market conditions.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this
appendix, Comprehensive Profit and Loss
Attribution is an analysis that attributes the
daily fluctuation in the value of a trading
desk’s positions to various sources. First, the
daily profit and loss of the aggregated
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62103
positions is divided into two categories: (i)
Profit and loss attributable to a trading desk’s
existing positions that were also positions
held by the trading desk as of the end of the
prior day (‘‘existing positions’’); and (ii)
profit and loss attributable to new positions
resulting from the current day’s trading
activity (‘‘new positions’’).
A. The comprehensive profit and loss
associated with existing positions must
reflect changes in the value of these positions
on the applicable day. The comprehensive
profit and loss from existing positions must
be further attributed, as applicable, to (i)
changes in the specific risk factors and other
factors that are monitored and managed as
part of the trading desk’s overall risk
management policies and procedures; and (ii)
any other applicable elements, such as cash
flows, carry, changes in reserves, and the
correction, cancellation, or exercise of a
trade.
B. For the attribution of comprehensive
profit and loss from existing positions to
specific risk factors and other factors, a
banking entity must provide the following
information for the factors that explain the
preponderance of the profit or loss changes
due to risk factor changes: The unique
identification label for the risk factor or other
factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss
due to the risk factor or other factor change.
C. The comprehensive profit and loss
attributed to new positions must reflect
commissions and fee income or expense and
market gains or losses associated with
transactions executed on the applicable day.
New positions include purchases and sales of
financial instruments and other assets/
liabilities and negotiated amendments to
existing positions. The comprehensive profit
and loss from new positions may be reported
in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and
loss from existing positions that is not
attributed to changes in specific risk factors
and other factors must be allocated to a
residual category. Significant unexplained
profit and loss must be escalated for further
investigation and analysis.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
c. Positions and Transaction Volumes
Measurements
1. Positions
i. Description: For purposes of this
appendix, Positions is the value of securities
and derivatives positions managed by the
trading desk. For purposes of the Positions
quantitative measurement, do not include in
the Positions calculation for ‘‘securities’’
those securities that are also ‘‘derivatives,’’ as
those terms are defined under subpart A;
instead, report those securities that are also
derivatives as ‘‘derivatives.’’ 1223 A banking
1223 See § 44.2(h), (aa). For example, under this
part, a security-based swap is both a ‘‘security’’ and
a ‘‘derivative.’’ For purposes of the Positions
quantitative measurement, security-based swaps are
reported as derivatives rather than securities.
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entity must separately report the trading
desk’s market value of long securities
positions, short securities positions,
derivatives receivables, and derivatives
payables.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely
on § 44.4(a) or (b) to conduct underwriting
activity or market-making-related activity,
respectively.
2. Transaction Volumes
i. Description: For purposes of this
appendix, Transaction Volumes measures
three exclusive categories of covered trading
activity conducted by a trading desk. A
banking entity is required to report the value
and number of security and derivative
transactions conducted by the trading desk
with: (i) Customers, excluding internal
transactions; (ii) non-customers, excluding
internal transactions; and (iii) trading desks
and other organizational units where the
transaction is booked into either the same
banking entity or an affiliated banking entity.
For securities, value means gross market
value. For derivatives, value means gross
notional value. For purposes of calculating
the Transaction Volumes quantitative
measurement, do not include in the
Transaction Volumes calculation for
‘‘securities’’ those securities that are also
‘‘derivatives,’’ as those terms are defined
under subpart A; instead, report those
securities that are also derivatives as
‘‘derivatives.’’ 1224 Further, for purposes of
the Transaction Volumes quantitative
measurement, a customer of a trading desk
that relies on § 44.4(a) to conduct
underwriting activity is a market participant
identified in § 44.4(a)(7), and a customer of
a trading desk that relies on § 44.4(b) to
conduct market making-related activity is a
market participant identified in § 44.4(b)(3).
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely
on § 44.4(a) or (b) to conduct underwriting
activity or market-making-related activity,
respectively.
Appendix B to Part 44—[Removed]
14. Appendix B to part 44 is removed.
15. Effective January 1. 2020 until
December 31, 2020, appendix Z to part
44 is added to read as follows:
■
■
Appendix Z to Part 44—Proprietary
Trading and Certain Interests in and
Relationships With Covered Funds
(Alternative Compliance)
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Note: The content of this appendix
reproduces the regulation implementing
Section 13 of the Bank Holding Company Act
as of November 13, 2019.
Subpart A—Authority and Definitions
§ 44.1 Authority, purpose, scope, and
relationship to other authorities.
(a) Authority. This part is issued by
the OCC under section 13 of the Bank
1224 See
§ 44.2(h), (aa).
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Holding Company Act of 1956, as
amended (12 U.S.C. 1851).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes
prohibitions and restrictions on
proprietary trading and on investments
in or relationships with covered funds
by certain banking entities, including
national banks, Federal branches and
agencies of foreign banks, Federal
savings associations, and certain
subsidiaries thereof. This part
implements section 13 of the Bank
Holding Company Act by defining terms
used in the statute and related terms,
establishing prohibitions and
restrictions on proprietary trading and
on investments in or relationships with
covered funds, and explaining the
statute’s requirements.
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to banking
entities for which the OCC is authorized
to issue regulations under section
13(b)(2) of the Bank Holding Company
Act (12 U.S.C. 1851(b)(2)) and take
actions under section 13(e) of that Act
(12 U.S.C. 1851(e)). These include
national banks, Federal branches and
Federal agencies of foreign banks,
Federal savings associations, Federal
savings banks, and any of their
respective subsidiaries (except a
subsidiary for which there is a different
primary financial regulatory agency, as
that term is defined in this part), but do
not include such entities to the extent
they are not within the definition of
banking entity in § 44.2(c).
(d) Relationship to other authorities.
Except as otherwise provided under
section 13 of the Bank Holding
Company Act or this part, and
notwithstanding any other provision of
law, the prohibitions and restrictions
under section 13 of the Bank Holding
Company Act and this part shall apply
to the activities and investments of a
banking entity identified in paragraph
(c) of this section, even if such activities
and investments are authorized for the
banking entity under other applicable
provisions of law.
(e) Preservation of authority. Nothing
in this part limits in any way the
authority of the OCC to impose on a
banking entity identified in paragraph
(c) of this section additional
requirements or restrictions with respect
to any activity, investment, or
relationship covered under section 13 of
the Bank Holding Company Act or this
part, or additional penalties for
violation of this part provided under
any other applicable provision of law
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§ 44.2
Definitions.
Unless otherwise specified, for
purposes of this part:
(a) Affiliate has the same meaning as
in section 2(k) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(k)).
(b) Bank holding company has the
same meaning as in section 2 of the
Bank Holding Company Act of 1956 (12
U.S.C. 1841).
(c) Banking entity. (1) Except as
provided in paragraph (c)(2) of this
section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an
insured depository institution;
(iii) Any company that is treated as a
bank holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any
entity described in paragraphs (c)(1)(i),
(ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a
banking entity under paragraphs
(c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under
the authority contained in section
4(k)(4)(H) or (I) of the BHC Act (12
U.S.C. 1843(k)(4)(H), (I)), or any
portfolio concern, as defined under 13
CFR 107.50, that is controlled by a small
business investment company, as
defined in section 103(3) of the Small
Business Investment Act of 1958 (15
U.S.C. 662), so long as the portfolio
company or portfolio concern is not
itself a banking entity under paragraphs
(c)(1)(i), (ii), or (iii) of this section; or
(iii) The FDIC acting in its corporate
capacity or as conservator or receiver
under the Federal Deposit Insurance Act
or Title II of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
(d) Board means the Board of
Governors of the Federal Reserve
System.
(e) CFTC means the Commodity
Futures Trading Commission.
(f) Dealer has the same meaning as in
section 3(a)(5) of the Exchange Act (15
U.S.C. 78c(a)(5)).
(g) Depository institution has the same
meaning as in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)).
(h) Derivative. (1) Except as provided
in paragraph (h)(2) of this section,
derivative means:
(i) Any swap, as that term is defined
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)), or
security-based swap, as that term is
defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68));
(ii) Any purchase or sale of a
commodity, that is not an excluded
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commodity, for deferred shipment or
delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as
that term is defined in section 1a(24) of
the Commodity Exchange Act (7 U.S.C.
1a(24)) or foreign exchange swap (as
that term is defined in section 1a(25) of
the Commodity Exchange Act (7 U.S.C.
1a(25));
(iv) Any agreement, contract, or
transaction in foreign currency
described in section 2(c)(2)(C)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(C)(i));
(v) Any agreement, contract, or
transaction in a commodity other than
foreign currency described in section
2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under
section 19 of the Commodity Exchange
Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or
other agreement, contract, or transaction
that the CFTC and SEC have further
defined by joint regulation,
interpretation, guidance, or other action
as not within the definition of swap, as
that term is defined in section 1a(47) of
the Commodity Exchange Act (7 U.S.C.
1a(47)), or security-based swap, as that
term is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)); or
(ii) Any identified banking product, as
defined in section 402(b) of the Legal
Certainty for Bank Products Act of 2000
(7 U.S.C. 27(b)), that is subject to section
403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the
immediate family of the employee.
(j) Exchange Act means the Securities
Exchange Act of 1934 (15 U.S.C. 78a et
seq.).
(k) Excluded commodity has the same
meaning as in section 1a(19) of the
Commodity Exchange Act (7 U.S.C.
1a(19)).
(l) FDIC means the Federal Deposit
Insurance Corporation.
(m) Federal banking agencies means
the Board, the Office of the Comptroller
of the Currency, and the FDIC.
(n) Foreign banking organization has
the same meaning as in section
211.21(o) of the Board’s Regulation K
(12 CFR 211.21(o)), but does not include
a foreign bank, as defined in section
1(b)(7) of the International Banking Act
of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the
Commonwealth of Puerto Rico, Guam,
American Samoa, the United States
Virgin Islands, or the Commonwealth of
the Northern Mariana Islands.
(o) Foreign insurance regulator means
the insurance commissioner, or a
similar official or agency, of any country
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other than the United States that is
engaged in the supervision of insurance
companies under foreign insurance law.
(p) General account means all of the
assets of an insurance company except
those allocated to one or more separate
accounts.
(q) Insurance company means a
company that is organized as an
insurance company, primarily and
predominantly engaged in writing
insurance or reinsuring risks
underwritten by insurance companies,
subject to supervision as such by a state
insurance regulator or a foreign
insurance regulator, and not operated
for the purpose of evading the
provisions of section 13 of the BHC Act
(12 U.S.C. 1851).
(r) Insured depository institution,
unless otherwise indicated, has the
same meaning as in section 3(c) of the
Federal Deposit Insurance Act (12
U.S.C. 1813(c)), but does not include:
(1) An insured depository institution
that is described in section 2(c)(2)(D) of
the BHC Act (12 U.S.C. 1841(c)(2)(D));
or
(2) An insured depository institution
if it has, and if every company that
controls it has, total consolidated assets
of $10 billion or less and total trading
assets and trading liabilities, on a
consolidated basis, that are 5 percent or
less of total consolidated assets.
(s) Loan means any loan, lease,
extension of credit, or secured or
unsecured receivable that is not a
security or derivative.
(t) Primary financial regulatory
agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act (12 U.S.C. 5301(12)).
(u) Purchase includes any contract to
buy, purchase, or otherwise acquire. For
security futures products, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a commodity future, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a derivative, purchase
includes the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(v) Qualifying foreign banking
organization means a foreign banking
organization that qualifies as such under
section 211.23(a), (c) or (e) of the
Board’s Regulation K (12 CFR 211.23(a),
(c), or (e)).
(w) SEC means the Securities and
Exchange Commission.
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62105
(x) Sale and sell each include any
contract to sell or otherwise dispose of.
For security futures products, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a commodity future, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a derivative, such terms
include the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(y) Security has the meaning specified
in section 3(a)(10) of the Exchange Act
(15 U.S.C. 78c(a)(10)).
(z) Security-based swap dealer has the
same meaning as in section 3(a)(71) of
the Exchange Act (15 U.S.C. 78c(a)(71)).
(aa) Security future has the meaning
specified in section 3(a)(55) of the
Exchange Act (15 U.S.C. 78c(a)(55)).
(bb) Separate account means an
account established and maintained by
an insurance company in connection
with one or more insurance contracts to
hold assets that are legally segregated
from the insurance company’s other
assets, under which income, gains, and
losses, whether or not realized, from
assets allocated to such account, are, in
accordance with the applicable contract,
credited to or charged against such
account without regard to other income,
gains, or losses of the insurance
company.
(cc) State means any State, the District
of Columbia, the Commonwealth of
Puerto Rico, Guam, American Samoa,
the United States Virgin Islands, and the
Commonwealth of the Northern Mariana
Islands.
(dd) Subsidiary has the same meaning
as in section 2(d) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(d)).
(ee) State insurance regulator means
the insurance commissioner, or a
similar official or agency, of a State that
is engaged in the supervision of
insurance companies under State
insurance law.
(ff) Swap dealer has the same meaning
as in section 1(a)(49) of the Commodity
Exchange Act (7 U.S.C. 1a(49)).
Subpart B—Proprietary Trading
§ 44.3
Prohibition on proprietary trading.
(a) Prohibition. Except as otherwise
provided in this subpart, a banking
entity may not engage in proprietary
trading. Proprietary trading means
engaging as principal for the trading
account of the banking entity in any
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purchase or sale of one or more
financial instruments.
(b) Definition of trading account. (1)
Trading account means any account that
is used by a banking entity to:
(i) Purchase or sell one or more
financial instruments principally for the
purpose of:
(A) Short-term resale;
(B) Benefitting from actual or
expected short-term price movements;
(C) Realizing short-term arbitrage
profits; or
(D) Hedging one or more positions
resulting from the purchases or sales of
financial instruments described in
paragraphs (b)(1)(i)(A), (B), or (C) of this
section;
(ii) Purchase or sell one or more
financial instruments that are both
market risk capital rule covered
positions and trading positions (or
hedges of other market risk capital rule
covered positions), if the banking entity,
or any affiliate of the banking entity, is
an insured depository institution, bank
holding company, or savings and loan
holding company, and calculates riskbased capital ratios under the market
risk capital rule; or
(iii) Purchase or sell one or more
financial instruments for any purpose, if
the banking entity:
(A) Is licensed or registered, or is
required to be licensed or registered, to
engage in the business of a dealer, swap
dealer, or security-based swap dealer, to
the extent the instrument is purchased
or sold in connection with the activities
that require the banking entity to be
licensed or registered as such; or
(B) Is engaged in the business of a
dealer, swap dealer, or security-based
swap dealer outside of the United
States, to the extent the instrument is
purchased or sold in connection with
the activities of such business.
(2) Rebuttable presumption for certain
purchases and sales. The purchase (or
sale) of a financial instrument by a
banking entity shall be presumed to be
for the trading account of the banking
entity under paragraph (b)(1)(i) of this
section if the banking entity holds the
financial instrument for fewer than sixty
days or substantially transfers the risk of
the financial instrument within sixty
days of the purchase (or sale), unless the
banking entity can demonstrate, based
on all relevant facts and circumstances,
that the banking entity did not purchase
(or sell) the financial instrument
principally for any of the purposes
described in paragraph (b)(1)(i) of this
section.
(c) Financial instrument. (1) Financial
instrument means:
(i) A security, including an option on
a security;
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(ii) A derivative, including an option
on a derivative; or
(iii) A contract of sale of a commodity
for future delivery, or option on a
contract of sale of a commodity for
future delivery.
(2) A financial instrument does not
include:
(i) A loan;
(ii) A commodity that is not:
(A) An excluded commodity (other
than foreign exchange or currency);
(B) A derivative;
(C) A contract of sale of a commodity
for future delivery; or
(D) An option on a contract of sale of
a commodity for future delivery; or
(iii) Foreign exchange or currency.
(d) Proprietary trading. Proprietary
trading does not include:
(1) Any purchase or sale of one or
more financial instruments by a banking
entity that arises under a repurchase or
reverse repurchase agreement pursuant
to which the banking entity has
simultaneously agreed, in writing, to
both purchase and sell a stated asset, at
stated prices, and on stated dates or on
demand with the same counterparty;
(2) Any purchase or sale of one or
more financial instruments by a banking
entity that arises under a transaction in
which the banking entity lends or
borrows a security temporarily to or
from another party pursuant to a written
securities lending agreement under
which the lender retains the economic
interests of an owner of such security,
and has the right to terminate the
transaction and to recall the loaned
security on terms agreed by the parties;
(3) Any purchase or sale of a security
by a banking entity for the purpose of
liquidity management in accordance
with a documented liquidity
management plan of the banking entity
that:
(i) Specifically contemplates and
authorizes the particular securities to be
used for liquidity management
purposes, the amount, types, and risks
of these securities that are consistent
with liquidity management, and the
liquidity circumstances in which the
particular securities may or must be
used;
(ii) Requires that any purchase or sale
of securities contemplated and
authorized by the plan be principally for
the purpose of managing the liquidity of
the banking entity, and not for the
purpose of short-term resale, benefitting
from actual or expected short-term price
movements, realizing short-term
arbitrage profits, or hedging a position
taken for such short-term purposes;
(iii) Requires that any securities
purchased or sold for liquidity
management purposes be highly liquid
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and limited to securities the market,
credit, and other risks of which the
banking entity does not reasonably
expect to give rise to appreciable profits
or losses as a result of short-term price
movements;
(iv) Limits any securities purchased or
sold for liquidity management purposes,
together with any other instruments
purchased or sold for such purposes, to
an amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan;
(v) Includes written policies and
procedures, internal controls, analysis,
and independent testing to ensure that
the purchase and sale of securities that
are not permitted under §§ 44.6(a) or (b)
of this subpart are for the purpose of
liquidity management and in
accordance with the liquidity
management plan described in
paragraph (d)(3) of this section; and
(vi) Is consistent with the OCC’s
supervisory requirements, guidance,
and expectations regarding liquidity
management;
(4) Any purchase or sale of one or
more financial instruments by a banking
entity that is a derivatives clearing
organization or a clearing agency in
connection with clearing financial
instruments;
(5) Any excluded clearing activities
by a banking entity that is a member of
a clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility;
(6) Any purchase or sale of one or
more financial instruments by a banking
entity, so long as:
(i) The purchase (or sale) satisfies an
existing delivery obligation of the
banking entity or its customers,
including to prevent or close out a
failure to deliver, in connection with
delivery, clearing, or settlement activity;
or
(ii) The purchase (or sale) satisfies an
obligation of the banking entity in
connection with a judicial,
administrative, self-regulatory
organization, or arbitration proceeding;
(7) Any purchase or sale of one or
more financial instruments by a banking
entity that is acting solely as agent,
broker, or custodian;
(8) Any purchase or sale of one or
more financial instruments by a banking
entity through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity that is
established and administered in
accordance with the law of the United
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States or a foreign sovereign, if the
purchase or sale is made directly or
indirectly by the banking entity as
trustee for the benefit of persons who
are or were employees of the banking
entity; or
(9) Any purchase or sale of one or
more financial instruments by a banking
entity in the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the financial instrument
as soon as practicable, and in no event
may the banking entity retain such
instrument for longer than such period
permitted by the OCC.
(e) Definition of other terms related to
proprietary trading. For purposes of this
subpart:
(1) Anonymous means that each party
to a purchase or sale is unaware of the
identity of the other party(ies) to the
purchase or sale.
(2) Clearing agency has the same
meaning as in section 3(a)(23) of the
Exchange Act (15 U.S.C. 78c(a)(23)).
(3) Commodity has the same meaning
as in section 1a(9) of the Commodity
Exchange Act (7 U.S.C. 1a(9)), except
that a commodity does not include any
security;
(4) Contract of sale of a commodity
for future delivery means a contract of
sale (as that term is defined in section
1a(13) of the Commodity Exchange Act
(7 U.S.C. 1a(13)) for future delivery (as
that term is defined in section 1a(27) of
the Commodity Exchange Act (7 U.S.C.
1a(27))).
(5) Derivatives clearing organization
means:
(i) A derivatives clearing organization
registered under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1);
(ii) A derivatives clearing organization
that, pursuant to CFTC regulation, is
exempt from the registration
requirements under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1); or
(iii) A foreign derivatives clearing
organization that, pursuant to CFTC
regulation, is permitted to clear for a
foreign board of trade that is registered
with the CFTC.
(6) Exchange, unless the context
otherwise requires, means any
designated contract market, swap
execution facility, or foreign board of
trade registered with the CFTC, or, for
purposes of securities or security-based
swaps, an exchange, as defined under
section 3(a)(1) of the Exchange Act (15
U.S.C. 78c(a)(1)), or security-based swap
execution facility, as defined under
section 3(a)(77) of the Exchange Act (15
U.S.C. 78c(a)(77)).
(7) Excluded clearing activities means:
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(i) With respect to customer
transactions cleared on a derivatives
clearing organization, a clearing agency,
or a designated financial market utility,
any purchase or sale necessary to
correct trading errors made by or on
behalf of a customer provided that such
purchase or sale is conducted in
accordance with, for transactions
cleared on a derivatives clearing
organization, the Commodity Exchange
Act, CFTC regulations, and the rules or
procedures of the derivatives clearing
organization, or, for transactions cleared
on a clearing agency, the rules or
procedures of the clearing agency, or,
for transactions cleared on a designated
financial market utility that is neither a
derivatives clearing organization nor a
clearing agency, the rules or procedures
of the designated financial market
utility;
(ii) Any purchase or sale in
connection with and related to the
management of a default or threatened
imminent default of a customer
provided that such purchase or sale is
conducted in accordance with, for
transactions cleared on a derivatives
clearing organization, the Commodity
Exchange Act, CFTC regulations, and
the rules or procedures of the
derivatives clearing organization, or, for
transactions cleared on a clearing
agency, the rules or procedures of the
clearing agency, or, for transactions
cleared on a designated financial market
utility that is neither a derivatives
clearing organization nor a clearing
agency, the rules or procedures of the
designated financial market utility;
(iii) Any purchase or sale in
connection with and related to the
management of a default or threatened
imminent default of a member of a
clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility;
(iv) Any purchase or sale in
connection with and related to the
management of the default or threatened
default of a clearing agency, a
derivatives clearing organization, or a
designated financial market utility; and
(v) Any purchase or sale that is
required by the rules or procedures of a
clearing agency, a derivatives clearing
organization, or a designated financial
market utility to mitigate the risk to the
clearing agency, derivatives clearing
organization, or designated financial
market utility that would result from the
clearing by a member of security-based
swaps that reference the member or an
affiliate of the member.
(8) Designated financial market utility
has the same meaning as in section
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62107
803(4) of the Dodd-Frank Act (12 U.S.C.
5462(4)).
(9) Issuer has the same meaning as in
section 2(a)(4) of the Securities Act of
1933 (15 U.S.C. 77b(a)(4)).
(10) Market risk capital rule covered
position and trading position means a
financial instrument that is both a
covered position and a trading position,
as those terms are respectively defined:
(i) In the case of a banking entity that
is a bank holding company, savings and
loan holding company, or insured
depository institution, under the market
risk capital rule that is applicable to the
banking entity; and
(ii) In the case of a banking entity that
is affiliated with a bank holding
company or savings and loan holding
company, other than a banking entity to
which a market risk capital rule is
applicable, under the market risk capital
rule that is applicable to the affiliated
bank holding company or savings and
loan holding company.
(11) Market risk capital rule means
the market risk capital rule that is
contained in subpart F of 12 CFR part
3, 12 CFR parts 208 and 225, or 12 CFR
part 324, as applicable.
(12) Municipal security means a
security that is a direct obligation of or
issued by, or an obligation guaranteed as
to principal or interest by, a State or any
political subdivision thereof, or any
agency or instrumentality of a State or
any political subdivision thereof, or any
municipal corporate instrumentality of
one or more States or political
subdivisions thereof.
(13) Trading desk means the smallest
discrete unit of organization of a
banking entity that purchases or sells
financial instruments for the trading
account of the banking entity or an
affiliate thereof.
§ 44.4 Permitted underwriting and market
making-related activities.
(a) Underwriting activities—(1)
Permitted underwriting activities. The
prohibition contained in § 44.3(a) does
not apply to a banking entity’s
underwriting activities conducted in
accordance with this paragraph (a).
(2) Requirements. The underwriting
activities of a banking entity are
permitted under paragraph (a)(1) of this
section only if:
(i) The banking entity is acting as an
underwriter for a distribution of
securities and the trading desk’s
underwriting position is related to such
distribution;
(ii) The amount and type of the
securities in the trading desk’s
underwriting position are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
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counterparties, and reasonable efforts
are made to sell or otherwise reduce the
underwriting position within a
reasonable period, taking into account
the liquidity, maturity, and depth of the
market for the relevant type of security;
(iii) The banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (a)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The products, instruments or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
(B) Limits for each trading desk, based
on the nature and amount of the trading
desk’s underwriting activities, including
the reasonably expected near term
demands of clients, customers, or
counterparties, on the:
(1) Amount, types, and risk of its
underwriting position;
(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held;
(C) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
(D) Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
(iv) The compensation arrangements
of persons performing the activities
described in this paragraph (a) are
designed not to reward or incentivize
prohibited proprietary trading; and
(v) The banking entity is licensed or
registered to engage in the activity
described in this paragraph (a) in
accordance with applicable law.
(3) Definition of distribution. For
purposes of this paragraph (a), a
distribution of securities means:
(i) An offering of securities, whether
or not subject to registration under the
Securities Act of 1933, that is
distinguished from ordinary trading
transactions by the presence of special
selling efforts and selling methods; or
(ii) An offering of securities made
pursuant to an effective registration
statement under the Securities Act of
1933.
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(4) Definition of underwriter. For
purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an
issuer or selling security holder to:
(A) Purchase securities from the
issuer or selling security holder for
distribution;
(B) Engage in a distribution of
securities for or on behalf of the issuer
or selling security holder; or
(C) Manage a distribution of securities
for or on behalf of the issuer or selling
security holder; or
(ii) A person who has agreed to
participate or is participating in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.
(5) Definition of selling security
holder. For purposes of this paragraph
(a), selling security holder means any
person, other than an issuer, on whose
behalf a distribution is made.
(6) Definition of underwriting
position. For purposes of this paragraph
(a), underwriting position means the
long or short positions in one or more
securities held by a banking entity or its
affiliate, and managed by a particular
trading desk, in connection with a
particular distribution of securities for
which such banking entity or affiliate is
acting as an underwriter.
(7) Definition of client, customer, and
counterparty. For purposes of this
paragraph (a), the terms client,
customer, and counterparty, on a
collective or individual basis, refer to
market participants that may transact
with the banking entity in connection
with a particular distribution for which
the banking entity is acting as
underwriter.
(b) Market making-related activities—
(1) Permitted market making-related
activities. The prohibition contained in
§ 44.3(a) does not apply to a banking
entity’s market making-related activities
conducted in accordance with this
paragraph (b).
(2) Requirements. The market makingrelated activities of a banking entity are
permitted under paragraph (b)(1) of this
section only if:
(i) The trading desk that establishes
and manages the financial exposure
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure and is willing and available to
quote, purchase and sell, or otherwise
enter into long and short positions in
those types of financial instruments for
its own account, in commercially
reasonable amounts and throughout
market cycles on a basis appropriate for
the liquidity, maturity, and depth of the
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market for the relevant types of financial
instruments;
(ii) The amount, types, and risks of
the financial instruments in the trading
desk’s market-maker inventory are
designed not to exceed, on an ongoing
basis, the reasonably expected near term
demands of clients, customers, or
counterparties, based on:
(A) The liquidity, maturity, and depth
of the market for the relevant types of
financial instrument(s); and
(B) Demonstrable analysis of
historical customer demand, current
inventory of financial instruments, and
market and other factors regarding the
amount, types, and risks, of or
associated with financial instruments in
which the trading desk makes a market,
including through block trades;
(iii) The banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (b)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The financial instruments each
trading desk stands ready to purchase
and sell in accordance with paragraph
(b)(2)(i) of this section;
(B) The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the limits
required under paragraph (b)(2)(iii)(C) of
this section; the products, instruments,
and exposures each trading desk may
use for risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and
inventory; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
desk to mitigate these risks are and
continue to be effective;
(C) Limits for each trading desk, based
on the nature and amount of the trading
desk’s market making-related activities,
that address the factors prescribed by
paragraph (b)(2)(ii) of this section, on:
(1) The amount, types, and risks of its
market-maker inventory;
(2) The amount, types, and risks of the
products, instruments, and exposures
the trading desk may use for risk
management purposes;
(3) The level of exposures to relevant
risk factors arising from its financial
exposure; and
(4) The period of time a financial
instrument may be held;
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(D) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
(E) Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis that the
basis for any temporary or permanent
increase to a trading desk’s limit(s) is
consistent with the requirements of this
paragraph (b), and independent review
of such demonstrable analysis and
approval;
(iv) To the extent that any limit
identified pursuant to paragraph
(b)(2)(iii)(C) of this section is exceeded,
the trading desk takes action to bring the
trading desk into compliance with the
limits as promptly as possible after the
limit is exceeded;
(v) The compensation arrangements of
persons performing the activities
described in this paragraph (b) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in activity
described in this paragraph (b) in
accordance with applicable law.
(3) Definition of client, customer, and
counterparty. For purposes of paragraph
(b) of this section, the terms client,
customer, and counterparty, on a
collective or individual basis refer to
market participants that make use of the
banking entity’s market making-related
services by obtaining such services,
responding to quotations, or entering
into a continuing relationship with
respect to such services, provided that:
(i) A trading desk or other
organizational unit of another banking
entity is not a client, customer, or
counterparty of the trading desk if that
other entity has trading assets and
liabilities of $50 billion or more as
measured in accordance with
§ 44.20(d)(1) of subpart D, unless:
(A) The trading desk documents how
and why a particular trading desk or
other organizational unit of the entity
should be treated as a client, customer,
or counterparty of the trading desk for
purposes of paragraph (b)(2) of this
section; or
(B) The purchase or sale by the
trading desk is conducted anonymously
on an exchange or similar trading
facility that permits trading on behalf of
a broad range of market participants.
(4) Definition of financial exposure.
For purposes of this paragraph (b),
financial exposure means the aggregate
risks of one or more financial
instruments and any associated loans,
commodities, or foreign exchange or
currency, held by a banking entity or its
affiliate and managed by a particular
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trading desk as part of the trading desk’s
market making-related activities.
(5) Definition of market-maker
inventory. For the purposes of this
paragraph (b), market-maker inventory
means all of the positions in the
financial instruments for which the
trading desk stands ready to make a
market in accordance with paragraph
(b)(2)(i) of this section, that are managed
by the trading desk, including the
trading desk’s open positions or
exposures arising from open
transactions.
§ 44.5 Permitted risk-mitigating hedging
activities.
(a) Permitted risk-mitigating hedging
activities. The prohibition contained in
§ 44.3(a) does not apply to the riskmitigating hedging activities of a
banking entity in connection with and
related to individual or aggregated
positions, contracts, or other holdings of
the banking entity and designed to
reduce the specific risks to the banking
entity in connection with and related to
such positions, contracts, or other
holdings.
(b) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under paragraph (a) of this
section only if:
(1) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(i) Reasonably designed written
policies and procedures regarding the
positions, techniques and strategies that
may be used for hedging, including
documentation indicating what
positions, contracts or other holdings a
particular trading desk may use in its
risk-mitigating hedging activities, as
well as position and aging limits with
respect to such positions, contracts or
other holdings;
(ii) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(iii) The conduct of analysis,
including correlation analysis, and
independent testing designed to ensure
that the positions, techniques and
strategies that may be used for hedging
may reasonably be expected to
demonstrably reduce or otherwise
significantly mitigate the specific,
identifiable risk(s) being hedged, and
such correlation analysis demonstrates
that the hedging activity demonstrably
reduces or otherwise significantly
mitigates the specific, identifiable risk(s)
being hedged;
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(2) The risk-mitigating hedging
activity:
(i) Is conducted in accordance with
the written policies, procedures, and
internal controls required under this
section;
(ii) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks, including market risk,
counterparty or other credit risk,
currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof;
(iii) Does not give rise, at the
inception of the hedge, to any
significant new or additional risk that is
not itself hedged contemporaneously in
accordance with this section;
(iv) Is subject to continuing review,
monitoring and management by the
banking entity that:
(A) Is consistent with the written
hedging policies and procedures
required under paragraph (b)(1) of this
section;
(B) Is designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates the specific, identifiable risks
that develop over time from the riskmitigating hedging activities undertaken
under this section and the underlying
positions, contracts, and other holdings
of the banking entity, based upon the
facts and circumstances of the
underlying and hedging positions,
contracts and other holdings of the
banking entity and the risks and
liquidity thereof; and
(C) Requires ongoing recalibration of
the hedging activity by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(2) of this section and is
not prohibited proprietary trading; and
(3) The compensation arrangements of
persons performing risk-mitigating
hedging activities are designed not to
reward or incentivize prohibited
proprietary trading.
(c) Documentation requirement—(1) A
banking entity must comply with the
requirements of paragraphs (c)(2) and
(3) of this section with respect to any
purchase or sale of financial
instruments made in reliance on this
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section for risk-mitigating hedging
purposes that is:
(i) Not established by the specific
trading desk establishing or responsible
for the underlying positions, contracts,
or other holdings the risks of which the
hedging activity is designed to reduce;
(ii) Established by the specific trading
desk establishing or responsible for the
underlying positions, contracts, or other
holdings the risks of which the
purchases or sales are designed to
reduce, but that is effected through a
financial instrument, exposure,
technique, or strategy that is not
specifically identified in the trading
desk’s written policies and procedures
established under paragraph (b)(1) of
this section or under § 44.4(b)(2)(iii)(B)
of this subpart as a product, instrument,
exposure, technique, or strategy such
trading desk may use for hedging; or
(iii) Established to hedge aggregated
positions across two or more trading
desks.
(2) In connection with any purchase
or sale identified in paragraph (c)(1) of
this section, a banking entity must, at a
minimum, and contemporaneously with
the purchase or sale, document:
(i) The specific, identifiable risk(s) of
the identified positions, contracts, or
other holdings of the banking entity that
the purchase or sale is designed to
reduce;
(ii) The specific risk-mitigating
strategy that the purchase or sale is
designed to fulfill; and
(iii) The trading desk or other
business unit that is establishing and
responsible for the hedge.
(3) A banking entity must create and
retain records sufficient to demonstrate
compliance with the requirements of
this paragraph (c) for a period that is no
less than five years in a form that allows
the banking entity to promptly produce
such records to the OCC on request, or
such longer period as required under
other law or this part.
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§ 44.6 Other permitted proprietary trading
activities.
(a) Permitted trading in domestic
government obligations. The prohibition
contained in § 44.3(a) does not apply to
the purchase or sale by a banking entity
of a financial instrument that is:
(1) An obligation of, or issued or
guaranteed by, the United States;
(2) An obligation, participation, or
other instrument of, or issued or
guaranteed by, an agency of the United
States, the Government National
Mortgage Association, the Federal
National Mortgage Association, the
Federal Home Loan Mortgage
Corporation, a Federal Home Loan
Bank, the Federal Agricultural Mortgage
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Corporation or a Farm Credit System
institution chartered under and subject
to the provisions of the Farm Credit Act
of 1971 (12 U.S.C. 2001 et seq.);
(3) An obligation of any State or any
political subdivision thereof, including
any municipal security; or
(4) An obligation of the FDIC, or any
entity formed by or on behalf of the
FDIC for purpose of facilitating the
disposal of assets acquired or held by
the FDIC in its corporate capacity or as
conservator or receiver under the
Federal Deposit Insurance Act or Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
(b) Permitted trading in foreign
government obligations—(1) Affiliates of
foreign banking entities in the United
States. The prohibition contained in
§ 44.3(a) does not apply to the purchase
or sale of a financial instrument that is
an obligation of, or issued or guaranteed
by, a foreign sovereign (including any
multinational central bank of which the
foreign sovereign is a member), or any
agency or political subdivision of such
foreign sovereign, by a banking entity,
so long as:
(i) The banking entity is organized
under or is directly or indirectly
controlled by a banking entity that is
organized under the laws of a foreign
sovereign and is not directly or
indirectly controlled by a top-tier
banking entity that is organized under
the laws of the United States;
(ii) The financial instrument is an
obligation of, or issued or guaranteed
by, the foreign sovereign under the laws
of which the foreign banking entity
referred to in paragraph (b)(1)(i) of this
section is organized (including any
multinational central bank of which the
foreign sovereign is a member), or any
agency or political subdivision of that
foreign sovereign; and
(iii) The purchase or sale as principal
is not made by an insured depository
institution.
(2) Foreign affiliates of a U.S. banking
entity. The prohibition contained in
§ 44.3(a) does not apply to the purchase
or sale of a financial instrument that is
an obligation of, or issued or guaranteed
by, a foreign sovereign (including any
multinational central bank of which the
foreign sovereign is a member), or any
agency or political subdivision of that
foreign sovereign, by a foreign entity
that is owned or controlled by a banking
entity organized or established under
the laws of the United States or any
State, so long as:
(i) The foreign entity is a foreign bank,
as defined in section 211.2(j) of the
Board’s Regulation K (12 CFR 211.2(j)),
or is regulated by the foreign sovereign
as a securities dealer;
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(ii) The financial instrument is an
obligation of, or issued or guaranteed
by, the foreign sovereign under the laws
of which the foreign entity is organized
(including any multinational central
bank of which the foreign sovereign is
a member), or any agency or political
subdivision of that foreign sovereign;
and
(iii) The financial instrument is
owned by the foreign entity and is not
financed by an affiliate that is located in
the United States or organized under the
laws of the United States or of any State.
(c) Permitted trading on behalf of
customers—(1) Fiduciary transactions.
The prohibition contained in § 44.3(a)
does not apply to the purchase or sale
of financial instruments by a banking
entity acting as trustee or in a similar
fiduciary capacity, so long as:
(i) The transaction is conducted for
the account of, or on behalf of, a
customer; and
(ii) The banking entity does not have
or retain beneficial ownership of the
financial instruments.
(2) Riskless principal transactions.
The prohibition contained in § 44.3(a)
does not apply to the purchase or sale
of financial instruments by a banking
entity acting as riskless principal in a
transaction in which the banking entity,
after receiving an order to purchase (or
sell) a financial instrument from a
customer, purchases (or sells) the
financial instrument for its own account
to offset a contemporaneous sale to (or
purchase from) the customer.
(d) Permitted trading by a regulated
insurance company. The prohibition
contained in § 44.3(a) does not apply to
the purchase or sale of financial
instruments by a banking entity that is
an insurance company or an affiliate of
an insurance company if:
(1) The insurance company or its
affiliate purchases or sells the financial
instruments solely for:
(i) The general account of the
insurance company; or
(ii) A separate account established by
the insurance company;
(2) The purchase or sale is conducted
in compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (d)(2) of this
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section is insufficient to protect the
safety and soundness of the covered
banking entity, or the financial stability
of the United States.
(e) Permitted trading activities of
foreign banking entities. (1) The
prohibition contained in § 44.3(a) does
not apply to the purchase or sale of
financial instruments by a banking
entity if:
(i) The banking entity is not organized
or directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of any
State;
(ii) The purchase or sale by the
banking entity is made pursuant to
paragraph (9) or (13) of section 4(c) of
the BHC Act; and
(iii) The purchase or sale meets the
requirements of paragraph (e)(3) of this
section.
(2) A purchase or sale of financial
instruments by a banking entity is made
pursuant to paragraph (9) or (13) of
section 4(c) of the BHC Act for purposes
of paragraph (e)(1)(ii) of this section
only if:
(i) The purchase or sale is conducted
in accordance with the requirements of
paragraph (e) of this section; and
(ii)(A) With respect to a banking
entity that is a foreign banking
organization, the banking entity meets
the qualifying foreign banking
organization requirements of section
211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c) or
(e)), as applicable; or
(B) With respect to a banking entity
that is not a foreign banking
organization, the banking entity is not
organized under the laws of the United
States or of any State and the banking
entity, on a fully-consolidated basis,
meets at least two of the following
requirements:
(1) Total assets of the banking entity
held outside of the United States exceed
total assets of the banking entity held in
the United States;
(2) Total revenues derived from the
business of the banking entity outside of
the United States exceed total revenues
derived from the business of the
banking entity in the United States; or
(3) Total net income derived from the
business of the banking entity outside of
the United States exceeds total net
income derived from the business of the
banking entity in the United States.
(3) A purchase or sale by a banking
entity is permitted for purposes of this
paragraph (e) if:
(i) The banking entity engaging as
principal in the purchase or sale
(including any personnel of the banking
entity or its affiliate that arrange,
negotiate or execute such purchase or
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sale) is not located in the United States
or organized under the laws of the
United States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State;
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State;
(iv) No financing for the banking
entity’s purchases or sales is provided,
directly or indirectly, by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
(v) The purchase or sale is not
conducted with or through any U.S.
entity, other than:
(A) A purchase or sale with the
foreign operations of a U.S. entity if no
personnel of such U.S. entity that are
located in the United States are
involved in the arrangement,
negotiation, or execution of such
purchase or sale;
(B) A purchase or sale with an
unaffiliated market intermediary acting
as principal, provided the purchase or
sale is promptly cleared and settled
through a clearing agency or derivatives
clearing organization acting as a central
counterparty; or
(C) A purchase or sale through an
unaffiliated market intermediary acting
as agent, provided the purchase or sale
is conducted anonymously on an
exchange or similar trading facility and
is promptly cleared and settled through
a clearing agency or derivatives clearing
organization acting as a central
counterparty.
(4) For purposes of this paragraph (e),
a U.S. entity is any entity that is, or is
controlled by, or is acting on behalf of,
or at the direction of, any other entity
that is, located in the United States or
organized under the laws of the United
States or of any State.
(5) For purposes of this paragraph (e),
a U.S. branch, agency, or subsidiary of
a foreign banking entity is considered to
be located in the United States;
however, the foreign bank that operates
or controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(6) For purposes of this paragraph (e),
unaffiliated market intermediary means
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an unaffiliated entity, acting as an
intermediary, that is:
(i) A broker or dealer registered with
the SEC under section 15 of the
Exchange Act or exempt from
registration or excluded from regulation
as such;
(ii) A swap dealer registered with the
CFTC under section 4s of the
Commodity Exchange Act or exempt
from registration or excluded from
regulation as such;
(iii) A security-based swap dealer
registered with the SEC under section
15F of the Exchange Act or exempt from
registration or excluded from regulation
as such; or
(iv) A futures commission merchant
registered with the CFTC under section
4f of the Commodity Exchange Act or
exempt from registration or excluded
from regulation as such.
§ 44.7 Limitations on permitted proprietary
trading activities.
(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ 44.4 through 44.6
if the transaction, class of transactions,
or activity would:
(1) Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
(2) Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
(3) Pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.
(b) Definition of material conflict of
interest. (1) For purposes of this section,
a material conflict of interest between a
banking entity and its clients,
customers, or counterparties exists if the
banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the banking entity’s interests being
materially adverse to the interests of its
client, customer, or counterparty with
respect to such transaction, class of
transactions, or activity, and the
banking entity has not taken at least one
of the actions in paragraph (b)(2) of this
section.
(2) Prior to effecting the specific
transaction or class or type of
transactions, or engaging in the specific
activity, the banking entity:
(i) Timely and effective disclosure. (A)
Has made clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
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counterparty to meaningfully
understand the conflict of interest; and
(B) Such disclosure is made in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
mitigate, any materially adverse effect
on the client, customer, or counterparty
created by the conflict of interest; or
(ii) Information barriers. Has
established, maintained, and enforced
information barriers that are
memorialized in written policies and
procedures, such as physical separation
of personnel, or functions, or limitations
on types of activity, that are reasonably
designed, taking into consideration the
nature of the banking entity’s business,
to prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A banking entity may not
rely on such information barriers if, in
the case of any specific transaction,
class or type of transactions or activity,
the banking entity knows or should
reasonably know that, notwithstanding
the banking entity’s establishment of
information barriers, the conflict of
interest may involve or result in a
materially adverse effect on a client,
customer, or counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
§§ 44.8–44.9
[Reserved]
Subpart C—Covered Funds Activities
and Investments
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§ 44.10 Prohibition on acquiring or
retaining an ownership interest in and
having certain relationships with a covered
fund.
(a) Prohibition. (1) Except as
otherwise provided in this subpart, a
banking entity may not, as principal,
directly or indirectly, acquire or retain
any ownership interest in or sponsor a
covered fund.
(2) Paragraph (a)(1) of this section
does not include acquiring or retaining
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an ownership interest in a covered fund
by a banking entity:
(i) Acting solely as agent, broker, or
custodian, so long as;
(A) The activity is conducted for the
account of, or on behalf of, a customer;
and
(B) The banking entity and its
affiliates do not have or retain beneficial
ownership of such ownership interest;
(ii) Through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity (or an affiliate
thereof) that is established and
administered in accordance with the
law of the United States or a foreign
sovereign, if the ownership interest is
held or controlled directly or indirectly
by the banking entity as trustee for the
benefit of persons who are or were
employees of the banking entity (or an
affiliate thereof);
(iii) In the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the ownership interest as
soon as practicable, and in no event may
the banking entity retain such
ownership interest for longer than such
period permitted by the OCC; or
(iv) On behalf of customers as trustee
or in a similar fiduciary capacity for a
customer that is not a covered fund, so
long as:
(A) The activity is conducted for the
account of, or on behalf of, the
customer; and
(B) The banking entity and its
affiliates do not have or retain beneficial
ownership of such ownership interest.
(b) Definition of covered fund. (1)
Except as provided in paragraph (c) of
this section, covered fund means:
(i) An issuer that would be an
investment company, as defined in the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.), but for section
3(c)(1) or 3(c)(7) of that Act (15 U.S.C.
80a–3(c)(1) or (7));
(ii) Any commodity pool under
section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10)) for
which:
(A) The commodity pool operator has
claimed an exemption under 17 CFR
4.7; or
(B)(1) A commodity pool operator is
registered with the CFTC as a
commodity pool operator in connection
with the operation of the commodity
pool;
(2) Substantially all participation
units of the commodity pool are owned
by qualified eligible persons under 17
CFR 4.7(a)(2) and (3); and
(3) Participation units of the
commodity pool have not been publicly
offered to persons who are not qualified
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eligible persons under 17 CFR 4.7(a)(2)
and (3); or
(iii) For any banking entity that is, or
is controlled directly or indirectly by a
banking entity that is, located in or
organized under the laws of the United
States or of any State, an entity that:
(A) Is organized or established outside
the United States and the ownership
interests of which are offered and sold
solely outside the United States;
(B) Is, or holds itself out as being, an
entity or arrangement that raises money
from investors primarily for the purpose
of investing in securities for resale or
other disposition or otherwise trading in
securities; and
(C)(1) Has as its sponsor that banking
entity (or an affiliate thereof); or
(2) Has issued an ownership interest
that is owned directly or indirectly by
that banking entity (or an affiliate
thereof).
(2) An issuer shall not be deemed to
be a covered fund under paragraph
(b)(1)(iii) of this section if, were the
issuer subject to U.S. securities laws, the
issuer could rely on an exclusion or
exemption from the definition of
‘‘investment company’’ under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) other than the
exclusions contained in section 3(c)(1)
and 3(c)(7) of that Act.
(3) For purposes of paragraph
(b)(1)(iii) of this section, a U.S. branch,
agency, or subsidiary of a foreign
banking entity is located in the United
States; however, the foreign bank that
operates or controls that branch, agency,
or subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(c) Notwithstanding paragraph (b) of
this section, unless the appropriate
Federal banking agencies, the SEC, and
the CFTC jointly determine otherwise, a
covered fund does not include:
(1) Foreign public funds. (i) Subject to
paragraphs (ii) and (iii) below, an issuer
that:
(A) Is organized or established outside
of the United States;
(B) Is authorized to offer and sell
ownership interests to retail investors in
the issuer’s home jurisdiction; and
(C) Sells ownership interests
predominantly through one or more
public offerings outside of the United
States.
(ii) With respect to a banking entity
that is, or is controlled directly or
indirectly by a banking entity that is,
located in or organized under the laws
of the United States or of any State and
any issuer for which such banking
entity acts as sponsor, the sponsoring
banking entity may not rely on the
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exemption in paragraph (c)(1)(i) of this
section for such issuer unless ownership
interests in the issuer are sold
predominantly to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring
banking entity or such issuer; and
(D) Directors and employees of such
entities.
(iii) For purposes of paragraph
(c)(1)(i)(C) of this section, the term
‘‘public offering’’ means a distribution
(as defined in § 44.4(a)(3) of subpart B)
of securities in any jurisdiction outside
the United States to investors, including
retail investors, provided that:
(A) The distribution complies with all
applicable requirements in the
jurisdiction in which such distribution
is being made;
(B) The distribution does not restrict
availability to investors having a
minimum level of net worth or net
investment assets; and
(C) The issuer has filed or submitted,
with the appropriate regulatory
authority in such jurisdiction, offering
disclosure documents that are publicly
available.
(2) Wholly-owned subsidiaries. An
entity, all of the outstanding ownership
interests of which are owned directly or
indirectly by the banking entity (or an
affiliate thereof), except that:
(i) Up to five percent of the entity’s
outstanding ownership interests, less
any amounts outstanding under
paragraph (c)(2)(ii) of this section, may
be held by employees or directors of the
banking entity or such affiliate
(including former employees or
directors if their ownership interest was
acquired while employed by or in the
service of the banking entity); and
(ii) Up to 0.5 percent of the entity’s
outstanding ownership interests may be
held by a third party if the ownership
interest is acquired or retained by the
third party for the purpose of
establishing corporate separateness or
addressing bankruptcy, insolvency, or
similar concerns.
(3) Joint ventures. A joint venture
between a banking entity or any of its
affiliates and one or more unaffiliated
persons, provided that the joint venture:
(i) Is comprised of no more than 10
unaffiliated co-venturers;
(ii) Is in the business of engaging in
activities that are permissible for the
banking entity or affiliate, other than
investing in securities for resale or other
disposition; and
(iii) Is not, and does not hold itself out
as being, an entity or arrangement that
raises money from investors primarily
for the purpose of investing in securities
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for resale or other disposition or
otherwise trading in securities.
(4) Acquisition vehicles. An issuer:
(i) Formed solely for the purpose of
engaging in a bona fide merger or
acquisition transaction; and
(ii) That exists only for such period as
necessary to effectuate the transaction.
(5) Foreign pension or retirement
funds. A plan, fund, or program
providing pension, retirement, or
similar benefits that is:
(i) Organized and administered
outside the United States;
(ii) A broad-based plan for employees
or citizens that is subject to regulation
as a pension, retirement, or similar plan
under the laws of the jurisdiction in
which the plan, fund, or program is
organized and administered; and
(iii) Established for the benefit of
citizens or residents of one or more
foreign sovereigns or any political
subdivision thereof.
(6) Insurance company separate
accounts. A separate account, provided
that no banking entity other than the
insurance company participates in the
account’s profits and losses.
(7) Bank owned life insurance. A
separate account that is used solely for
the purpose of allowing one or more
banking entities to purchase a life
insurance policy for which the banking
entity or entities is beneficiary,
provided that no banking entity that
purchases the policy:
(i) Controls the investment decisions
regarding the underlying assets or
holdings of the separate account; or
(ii) Participates in the profits and
losses of the separate account other than
in compliance with applicable
supervisory guidance regarding bank
owned life insurance.
(8) Loan securitizations—(i) Scope.
An issuing entity for asset-backed
securities that satisfies all the
conditions of this paragraph (c)(8) and
the assets or holdings of which are
comprised solely of:
(A) Loans as defined in § 44.2(s) of
subpart A;
(B) Rights or other assets designed to
assure the servicing or timely
distribution of proceeds to holders of
such securities and rights or other assets
that are related or incidental to
purchasing or otherwise acquiring and
holding the loans, provided that each
asset meets the requirements of
paragraph (c)(8)(iii) of this section;
(C) Interest rate or foreign exchange
derivatives that meet the requirements
of paragraph (c)(8)(iv) of this section;
and
(D) Special units of beneficial interest
and collateral certificates that meet the
requirements of paragraph (c)(8)(v) of
this section.
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62113
(ii) Impermissible assets. For purposes
of this paragraph (c)(8), the assets or
holdings of the issuing entity shall not
include any of the following:
(A) A security, including an assetbacked security, or an interest in an
equity or debt security other than as
permitted in paragraph (c)(8)(iii) of this
section;
(B) A derivative, other than a
derivative that meets the requirements
of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities.
Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may
hold securities if those securities are:
(A) Cash equivalents for purposes of
the rights and assets in paragraph
(c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts
previously contracted with respect to
the loans supporting the asset-backed
securities.
(iv) Derivatives. The holdings of
derivatives by the issuing entity shall be
limited to interest rate or foreign
exchange derivatives that satisfy all of
the following conditions:
(A) The written terms of the
derivative directly relate to the loans,
the asset-backed securities, or the
contractual rights of other assets
described in paragraph (c)(8)(i)(B) of
this section; and
(B) The derivatives reduce the interest
rate and/or foreign exchange risks
related to the loans, the asset-backed
securities, or the contractual rights or
other assets described in paragraph
(c)(8)(i)(B) of this section.
(v) Special units of beneficial interest
and collateral certificates. The assets or
holdings of the issuing entity may
include collateral certificates and
special units of beneficial interest
issued by a special purpose vehicle,
provided that:
(A) The special purpose vehicle that
issues the special unit of beneficial
interest or collateral certificate meets
the requirements in this paragraph
(c)(8);
(B) The special unit of beneficial
interest or collateral certificate is used
for the sole purpose of transferring to
the issuing entity for the loan
securitization the economic risks and
benefits of the assets that are
permissible for loan securitizations
under this paragraph (c)(8) and does not
directly or indirectly transfer any
interest in any other economic or
financial exposure;
(C) The special unit of beneficial
interest or collateral certificate is
created solely to satisfy legal
requirements or otherwise facilitate the
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structuring of the loan securitization;
and
(D) The special purpose vehicle that
issues the special unit of beneficial
interest or collateral certificate and the
issuing entity are established under the
direction of the same entity that
initiated the loan securitization.
(9) Qualifying asset-backed
commercial paper conduits. (i) An
issuing entity for asset-backed
commercial paper that satisfies all of the
following requirements:
(A) The asset-backed commercial
paper conduit holds only:
(1) Loans and other assets permissible
for a loan securitization under
paragraph (c)(8)(i) of this section; and
(2) Asset-backed securities supported
solely by assets that are permissible for
loan securitizations under paragraph
(c)(8)(i) of this section and acquired by
the asset-backed commercial paper
conduit as part of an initial issuance
either directly from the issuing entity of
the asset-backed securities or directly
from an underwriter in the distribution
of the asset-backed securities;
(B) The asset-backed commercial
paper conduit issues only asset-backed
securities, comprised of a residual
interest and securities with a legal
maturity of 397 days or less; and
(C) A regulated liquidity provider has
entered into a legally binding
commitment to provide full and
unconditional liquidity coverage with
respect to all of the outstanding assetbacked securities issued by the assetbacked commercial paper conduit (other
than any residual interest) in the event
that funds are required to redeem
maturing asset-backed securities.
(ii) For purposes of this paragraph
(c)(9), a regulated liquidity provider
means:
(A) A depository institution, as
defined in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c));
(B) A bank holding company, as
defined in section 2(a) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1841(a)), or a subsidiary thereof;
(C) A savings and loan holding
company, as defined in section 10a of
the Home Owners’ Loan Act (12 U.S.C.
1467a), provided all or substantially all
of the holding company’s activities are
permissible for a financial holding
company under section 4(k) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1843(k)), or a subsidiary thereof;
(D) A foreign bank whose home
country supervisor, as defined in
§ 211.21(q) of the Board’s Regulation K
(12 CFR 211.21(q)), has adopted capital
standards consistent with the Capital
Accord for the Basel Committee on
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banking Supervision, as amended, and
that is subject to such standards, or a
subsidiary thereof; or
(E) The United States or a foreign
sovereign.
(10) Qualifying covered bonds—(i)
Scope. An entity owning or holding a
dynamic or fixed pool of loans or other
assets as provided in paragraph (c)(8) of
this section for the benefit of the holders
of covered bonds, provided that the
assets in the pool are comprised solely
of assets that meet the conditions in
paragraph (c)(8)(i) of this section.
(ii) Covered bond. For purposes of this
paragraph (c)(10), a covered bond
means:
(A) A debt obligation issued by an
entity that meets the definition of
foreign banking organization, the
payment obligations of which are fully
and unconditionally guaranteed by an
entity that meets the conditions set forth
in paragraph (c)(10)(i) of this section; or
(B) A debt obligation of an entity that
meets the conditions set forth in
paragraph (c)(10)(i) of this section,
provided that the payment obligations
are fully and unconditionally
guaranteed by an entity that meets the
definition of foreign banking
organization and the entity is a whollyowned subsidiary, as defined in
paragraph (c)(2) of this section, of such
foreign banking organization.
(11) SBICs and public welfare
investment funds. An issuer:
(i) That is a small business investment
company, as defined in section 103(3) of
the Small Business Investment Act of
1958 (15 U.S.C. 662), or that has
received from the Small Business
Administration notice to proceed to
qualify for a license as a small business
investment company, which notice or
license has not been revoked; or
(ii) The business of which is to make
investments that are:
(A) Designed primarily to promote the
public welfare, of the type permitted
under paragraph (11) of section 5136 of
the Revised Statutes of the United States
(12 U.S.C. 24), including the welfare of
low- and moderate-income communities
or families (such as providing housing,
services, or jobs); or
(B) Qualified rehabilitation
expenditures with respect to a qualified
rehabilitated building or certified
historic structure, as such terms are
defined in section 47 of the Internal
Revenue Code of 1986 or a similar State
historic tax credit program.
(12) Registered investment companies
and excluded entities. An issuer:
(i) That is registered as an investment
company under section 8 of the
Investment Company Act of 1940 (15
U.S.C. 80a–8), or that is formed and
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operated pursuant to a written plan to
become a registered investment
company as described in § 44.20(e)(3) of
subpart D and that complies with the
requirements of section 18 of the
Investment Company Act of 1940 (15
U.S.C. 80a–18);
(ii) That may rely on an exclusion or
exemption from the definition of
‘‘investment company’’ under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) other than the
exclusions contained in section 3(c)(1)
and 3(c)(7) of that Act; or
(iii) That has elected to be regulated
as a business development company
pursuant to section 54(a) of that Act (15
U.S.C. 80a–53) and has not withdrawn
its election, or that is formed and
operated pursuant to a written plan to
become a business development
company as described in § 44.20(e)(3) of
subpart D and that complies with the
requirements of section 61 of the
Investment Company Act of 1940 (15
U.S.C. 80a–60).
(13) Issuers in conjunction with the
FDIC’s receivership or conservatorship
operations. An issuer that is an entity
formed by or on behalf of the FDIC for
the purpose of facilitating the disposal
of assets acquired in the FDIC’s capacity
as conservator or receiver under the
Federal Deposit Insurance Act or Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
(14) Other excluded issuers. (i) Any
issuer that the appropriate Federal
banking agencies, the SEC, and the
CFTC jointly determine the exclusion of
which is consistent with the purposes of
section 13 of the BHC Act.
(ii) A determination made under
paragraph (c)(14)(i) of this section will
be promptly made public.
(d) Definition of other terms related to
covered funds. For purposes of this
subpart:
(1) Applicable accounting standards
means U.S. generally accepted
accounting principles, or such other
accounting standards applicable to a
banking entity that the OCC determines
are appropriate and that the banking
entity uses in the ordinary course of its
business in preparing its consolidated
financial statements.
(2) Asset-backed security has the
meaning specified in Section 3(a)(79) of
the Exchange Act (15 U.S.C. 78c(a)(79)).
(3) Director has the same meaning as
provided in section 215.2(d)(1) of the
Board’s Regulation O (12 CFR
215.2(d)(1)).
(4) Issuer has the same meaning as in
section 2(a)(22) of the Investment
Company Act of 1940 (15 U.S.C. 80a–
2(a)(22)).
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(5) Issuing entity means with respect
to asset-backed securities the special
purpose vehicle that owns or holds the
pool assets underlying asset-backed
securities and in whose name the assetbacked securities supported or serviced
by the pool assets are issued.
(6) Ownership interest—(i) Ownership
interest means any equity, partnership,
or other similar interest. An ‘‘other
similar interest’’ means an interest that:
(A) Has the right to participate in the
selection or removal of a general
partner, managing member, member of
the board of directors or trustees,
investment manager, investment
adviser, or commodity trading advisor
of the covered fund (excluding the
rights of a creditor to exercise remedies
upon the occurrence of an event of
default or an acceleration event);
(B) Has the right under the terms of
the interest to receive a share of the
income, gains or profits of the covered
fund;
(C) Has the right to receive the
underlying assets of the covered fund
after all other interests have been
redeemed and/or paid in full (excluding
the rights of a creditor to exercise
remedies upon the occurrence of an
event of default or an acceleration
event);
(D) Has the right to receive all or a
portion of excess spread (the positive
difference, if any, between the aggregate
interest payments received from the
underlying assets of the covered fund
and the aggregate interest paid to the
holders of other outstanding interests);
(E) Provides under the terms of the
interest that the amounts payable by the
covered fund with respect to the interest
could be reduced based on losses arising
from the underlying assets of the
covered fund, such as allocation of
losses, write-downs or charge-offs of the
outstanding principal balance, or
reductions in the amount of interest due
and payable on the interest;
(F) Receives income on a pass-through
basis from the covered fund, or has a
rate of return that is determined by
reference to the performance of the
underlying assets of the covered fund;
or
(G) Any synthetic right to have,
receive, or be allocated any of the rights
in paragraphs (d)(6)(i)(A) through (F) of
this section.
(ii) Ownership interest does not
include: Restricted profit interest. An
interest held by an entity (or an
employee or former employee thereof)
in a covered fund for which the entity
(or employee thereof) serves as
investment manager, investment
adviser, commodity trading advisor, or
other service provider so long as:
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(A) The sole purpose and effect of the
interest is to allow the entity (or
employee or former employee thereof)
to share in the profits of the covered
fund as performance compensation for
the investment management, investment
advisory, commodity trading advisory,
or other services provided to the
covered fund by the entity (or employee
or former employee thereof), provided
that the entity (or employee or former
employee thereof) may be obligated
under the terms of such interest to
return profits previously received;
(B) All such profit, once allocated, is
distributed to the entity (or employee or
former employee thereof) promptly after
being earned or, if not so distributed, is
retained by the covered fund for the sole
purpose of establishing a reserve
amount to satisfy contractual obligations
with respect to subsequent losses of the
covered fund and such undistributed
profit of the entity (or employee or
former employee thereof) does not share
in the subsequent investment gains of
the covered fund;
(C) Any amounts invested in the
covered fund, including any amounts
paid by the entity (or employee or
former employee thereof) in connection
with obtaining the restricted profit
interest, are within the limits of § 44.12
of this subpart; and
(D) The interest is not transferable by
the entity (or employee or former
employee thereof) except to an affiliate
thereof (or an employee of the banking
entity or affiliate), to immediate family
members, or through the intestacy, of
the employee or former employee, or in
connection with a sale of the business
that gave rise to the restricted profit
interest by the entity (or employee or
former employee thereof) to an
unaffiliated party that provides
investment management, investment
advisory, commodity trading advisory,
or other services to the fund.
(7) Prime brokerage transaction means
any transaction that would be a covered
transaction, as defined in section
23A(b)(7) of the Federal Reserve Act (12
U.S.C. 371c(b)(7)), that is provided in
connection with custody, clearance and
settlement, securities borrowing or
lending services, trade execution,
financing, or data, operational, and
administrative support.
(8) Resident of the United States
means a person that is a ‘‘U.S. person’’
as defined in rule 902(k) of the SEC’s
Regulation S (17 CFR 230.902(k)).
(9) Sponsor means, with respect to a
covered fund:
(i) To serve as a general partner,
managing member, or trustee of a
covered fund, or to serve as a
commodity pool operator with respect
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62115
to a covered fund as defined in (b)(1)(ii)
of this section;
(ii) In any manner to select or to
control (or to have employees, officers,
or directors, or agents who constitute) a
majority of the directors, trustees, or
management of a covered fund; or
(iii) To share with a covered fund, for
corporate, marketing, promotional, or
other purposes, the same name or a
variation of the same name, except as
permitted under § 44.11(a)(6).
(10) Trustee. (i) For purposes of
paragraph (d)(9) of this section and
§ 44.11 of subpart C, a trustee does not
include:
(A) A trustee that does not exercise
investment discretion with respect to a
covered fund, including a trustee that is
subject to the direction of an
unaffiliated named fiduciary who is not
a trustee pursuant to section 403(a)(1) of
the Employee’s Retirement Income
Security Act (29 U.S.C. 1103(a)(1)); or
(B) A trustee that is subject to
fiduciary standards imposed under
foreign law that are substantially
equivalent to those described in
paragraph (d)(10)(i)(A) of this section;
(ii) Any entity that directs a person
described in paragraph (d)(10)(i) of this
section, or that possesses authority and
discretion to manage and control the
investment decisions of a covered fund
for which such person serves as trustee,
shall be considered to be a trustee of
such covered fund.
§ 44.11 Permitted organizing and offering,
underwriting, and market making with
respect to a covered fund.
(a) Organizing and offering a covered
fund in general. Notwithstanding
§ 44.10(a) of this subpart, a banking
entity is not prohibited from acquiring
or retaining an ownership interest in, or
acting as sponsor to, a covered fund in
connection with, directly or indirectly,
organizing and offering a covered fund,
including serving as a general partner,
managing member, trustee, or
commodity pool operator of the covered
fund and in any manner selecting or
controlling (or having employees,
officers, directors, or agents who
constitute) a majority of the directors,
trustees, or management of the covered
fund, including any necessary expenses
for the foregoing, only if:
(1) The banking entity (or an affiliate
thereof) provides bona fide trust,
fiduciary, investment advisory, or
commodity trading advisory services;
(2) The covered fund is organized and
offered only in connection with the
provision of bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services and only to
persons that are customers of such
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services of the banking entity (or an
affiliate thereof), pursuant to a written
plan or similar documentation outlining
how the banking entity or such affiliate
intends to provide advisory or similar
services to its customers through
organizing and offering such fund;
(3) The banking entity and its
affiliates do not acquire or retain an
ownership interest in the covered fund
except as permitted under § 44.12 of this
subpart;
(4) The banking entity and its
affiliates comply with the requirements
of § 44.14 of this subpart;
(5) The banking entity and its
affiliates do not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests;
(6) The covered fund, for corporate,
marketing, promotional, or other
purposes:
(i) Does not share the same name or
a variation of the same name with the
banking entity (or an affiliate thereof)
except that a covered fund may share
the same name or a variation of the
same name with a banking entity that is
an investment adviser to the covered
fund if:
(A) The investment adviser is not an
insured depository institution, a
company that controls an insured
depository institution, or a company
that is treated as a bank holding
company for purposes of section 8 of the
International Banking Act of 1978 (12
U.S.C. 3106); and
(B) The investment adviser does not
share the same name or a variation of
the same name as an insured depository
institution, a company that controls an
insured depository institution, or a
company that is treated as a bank
holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(ii) Does not use the word ‘‘bank’’ in
its name;
(7) No director or employee of the
banking entity (or an affiliate thereof)
takes or retains an ownership interest in
the covered fund, except for any
director or employee of the banking
entity or such affiliate who is directly
engaged in providing investment
advisory, commodity trading advisory,
or other services to the covered fund at
the time the director or employee takes
the ownership interest; and
(8) The banking entity:
(i) Clearly and conspicuously
discloses, in writing, to any prospective
and actual investor in the covered fund
(such as through disclosure in the
covered fund’s offering documents):
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(A) That ‘‘any losses in [such covered
fund] will be borne solely by investors
in [the covered fund] and not by [the
banking entity] or its affiliates;
therefore, [the banking entity’s] losses in
[such covered fund] will be limited to
losses attributable to the ownership
interests in the covered fund held by
[the banking entity] and any affiliate in
its capacity as investor in the [covered
fund] or as beneficiary of a restricted
profit interest held by [the banking
entity] or any affiliate’’;
(B) That such investor should read the
fund offering documents before
investing in the covered fund;
(C) That the ‘‘ownership interests in
the covered fund are not insured by the
FDIC, and are not deposits, obligations
of, or endorsed or guaranteed in any
way, by any banking entity’’ (unless that
happens to be the case); and
(D) The role of the banking entity and
its affiliates and employees in
sponsoring or providing any services to
the covered fund; and
(ii) Complies with any additional
rules of the appropriate Federal banking
agencies, the SEC, or the CFTC, as
provided in section 13(b)(2) of the BHC
Act, designed to ensure that losses in
such covered fund are borne solely by
investors in the covered fund and not by
the covered banking entity and its
affiliates.
(b) Organizing and offering an issuing
entity of asset-backed securities. (1)
Notwithstanding § 44.10(a) of this
subpart, a banking entity is not
prohibited from acquiring or retaining
an ownership interest in, or acting as
sponsor to, a covered fund that is an
issuing entity of asset-backed securities
in connection with, directly or
indirectly, organizing and offering that
issuing entity, so long as the banking
entity and its affiliates comply with all
of the requirements of paragraph (a)(3)
through (8) of this section.
(2) For purposes of this paragraph (b),
organizing and offering a covered fund
that is an issuing entity of asset-backed
securities means acting as the
securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)) of the issuing
entity, or acquiring or retaining an
ownership interest in the issuing entity
as required by section 15G of that Act
(15 U.S.C. 78o–11) and the
implementing regulations issued
thereunder.
(c) Underwriting and market making
in ownership interests of a covered
fund. The prohibition contained in
§ 44.10(a) of this subpart does not apply
to a banking entity’s underwriting
activities or market making-related
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activities involving a covered fund so
long as:
(1) Those activities are conducted in
accordance with the requirements of
§ 44.4(a) or § 44.4(b) of subpart B,
respectively;
(2) With respect to any banking entity
(or any affiliate thereof) that: Acts as a
sponsor, investment adviser or
commodity trading advisor to a
particular covered fund or otherwise
acquires and retains an ownership
interest in such covered fund in reliance
on paragraph (a) of this section; acquires
and retains an ownership interest in
such covered fund and is either a
securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)), or is acquiring
and retaining an ownership interest in
such covered fund in compliance with
section 15G of that Act (15 U.S.C. 78o–
11) and the implementing regulations
issued thereunder each as permitted by
paragraph (b) of this section; or, directly
or indirectly, guarantees, assumes, or
otherwise insures the obligations or
performance of the covered fund or of
any covered fund in which such fund
invests, then in each such case any
ownership interests acquired or retained
by the banking entity and its affiliates in
connection with underwriting and
market making related activities for that
particular covered fund are included in
the calculation of ownership interests
permitted to be held by the banking
entity and its affiliates under the
limitations of § 44.12(a)(2)(ii) and
§ 44.12(d) of this subpart; and
(3) With respect to any banking entity,
the aggregate value of all ownership
interests of the banking entity and its
affiliates in all covered funds acquired
and retained under § 44.11 of this
subpart, including all covered funds in
which the banking entity holds an
ownership interest in connection with
underwriting and market making related
activities permitted under this
paragraph (c), are included in the
calculation of all ownership interests
under § 44.12(a)(2)(iii) and § 44.12(d) of
this subpart.
§ 44.12
fund.
Permitted investment in a covered
(a) Authority and limitations on
permitted investments in covered funds.
(1) Notwithstanding the prohibition
contained in § 44.10(a) of this subpart,
a banking entity may acquire and retain
an ownership interest in a covered fund
that the banking entity or an affiliate
thereof organizes and offers pursuant to
§ 44.11, for the purposes of:
(i) Establishment. Establishing the
fund and providing the fund with
sufficient initial equity for investment to
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permit the fund to attract unaffiliated
investors, subject to the limits contained
in paragraphs (a)(2)(i) and (iii) of this
section; or
(ii) De minimis investment. Making
and retaining an investment in the
covered fund subject to the limits
contained in paragraphs (a)(2)(ii) and
(iii) of this section.
(2) Investment limits—(i) Seeding
period. With respect to an investment in
any covered fund made or held
pursuant to paragraph (a)(1)(i) of this
section, the banking entity and its
affiliates:
(A) Must actively seek unaffiliated
investors to reduce, through
redemption, sale, dilution, or other
methods, the aggregate amount of all
ownership interests of the banking
entity in the covered fund to the amount
permitted in paragraph (a)(2)(i)(B) of
this section; and
(B) Must, no later than 1 year after the
date of establishment of the fund (or
such longer period as may be provided
by the Board pursuant to paragraph (e)
of this section), conform its ownership
interest in the covered fund to the limits
in paragraph (a)(2)(ii) of this section;
(ii) Per-fund limits. (A) Except as
provided in paragraph (a)(2)(ii)(B) of
this section, an investment by a banking
entity and its affiliates in any covered
fund made or held pursuant to
paragraph (a)(1)(ii) of this section may
not exceed 3 percent of the total number
or value of the outstanding ownership
interests of the fund.
(B) An investment by a banking entity
and its affiliates in a covered fund that
is an issuing entity of asset-backed
securities may not exceed 3 percent of
the total fair market value of the
ownership interests of the fund
measured in accordance with paragraph
(b)(3) of this section, unless a greater
percentage is retained by the banking
entity and its affiliates in compliance
with the requirements of section 15G of
the Exchange Act (15 U.S.C. 78o–11)
and the implementing regulations
issued thereunder, in which case the
investment by the banking entity and its
affiliates in the covered fund may not
exceed the amount, number, or value of
ownership interests of the fund required
under section 15G of the Exchange Act
and the implementing regulations
issued thereunder.
(iii) Aggregate limit. The aggregate
value of all ownership interests of the
banking entity and its affiliates in all
covered funds acquired or retained
under this section may not exceed 3
percent of the tier 1 capital of the
banking entity, as provided under
paragraph (c) of this section, and shall
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be calculated as of the last day of each
calendar quarter.
(iv) Date of establishment. For
purposes of this section, the date of
establishment of a covered fund shall
be:
(A) In general. The date on which the
investment adviser or similar entity to
the covered fund begins making
investments pursuant to the written
investment strategy for the fund;
(B) Issuing entities of asset-backed
securities. In the case of an issuing
entity of asset-backed securities, the
date on which the assets are initially
transferred into the issuing entity of
asset-backed securities.
(b) Rules of construction—(1)
Attribution of ownership interests to a
covered banking entity. (i) For purposes
of paragraph (a)(2) of this section, the
amount and value of a banking entity’s
permitted investment in any single
covered fund shall include any
ownership interest held under § 44.12
directly by the banking entity, including
any affiliate of the banking entity.
(ii) Treatment of registered investment
companies, SEC-regulated business
development companies and foreign
public funds. For purposes of paragraph
(b)(1)(i) of this section, a registered
investment company, SEC-regulated
business development companies or
foreign public fund as described in
§ 44.10(c)(1) of this subpart will not be
considered to be an affiliate of the
banking entity so long as the banking
entity:
(A) Does not own, control, or hold
with the power to vote 25 percent or
more of the voting shares of the
company or fund; and
(B) Provides investment advisory,
commodity trading advisory,
administrative, and other services to the
company or fund in compliance with
the limitations under applicable
regulation, order, or other authority.
(iii) Covered funds. For purposes of
paragraph (b)(1)(i) of this section, a
covered fund will not be considered to
be an affiliate of a banking entity so long
as the covered fund is held in
compliance with the requirements of
this subpart.
(iv) Treatment of employee and
director investments financed by the
banking entity. For purposes of
paragraph (b)(1)(i) of this section, an
investment by a director or employee of
a banking entity who acquires an
ownership interest in his or her
personal capacity in a covered fund
sponsored by the banking entity will be
attributed to the banking entity if the
banking entity, directly or indirectly,
extends financing for the purpose of
enabling the director or employee to
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62117
acquire the ownership interest in the
fund and the financing is used to
acquire such ownership interest in the
covered fund.
(2) Calculation of permitted
ownership interests in a single covered
fund. Except as provided in paragraph
(b)(3) or (4), for purposes of determining
whether an investment in a single
covered fund complies with the
restrictions on ownership interests
under paragraphs (a)(2)(i)(B) and
(a)(2)(ii)(A) of this section:
(i) The aggregate number of the
outstanding ownership interests held by
the banking entity shall be the total
number of ownership interests held
under this section by the banking entity
in a covered fund divided by the total
number of ownership interests held by
all entities in that covered fund, as of
the last day of each calendar quarter
(both measured without regard to
committed funds not yet called for
investment);
(ii) The aggregate value of the
outstanding ownership interests held by
the banking entity shall be the aggregate
fair market value of all investments in
and capital contributions made to the
covered fund by the banking entity,
divided by the value of all investments
in and capital contributions made to
that covered fund by all entities, as of
the last day of each calendar quarter (all
measured without regard to committed
funds not yet called for investment). If
fair market value cannot be determined,
then the value shall be the historical
cost basis of all investments in and
contributions made by the banking
entity to the covered fund;
(iii) For purposes of the calculation
under paragraph (b)(2)(ii) of this section,
once a valuation methodology is chosen,
the banking entity must calculate the
value of its investment and the
investments of all others in the covered
fund in the same manner and according
to the same standards.
(3) Issuing entities of asset-backed
securities. In the case of an ownership
interest in an issuing entity of assetbacked securities, for purposes of
determining whether an investment in a
single covered fund complies with the
restrictions on ownership interests
under paragraphs (a)(2)(i)(B) and
(a)(2)(ii)(B) of this section:
(i) For securitizations subject to the
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11), the
calculations shall be made as of the date
and according to the valuation
methodology applicable pursuant to the
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11) and
the implementing regulations issued
thereunder; or
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(ii) For securitization transactions
completed prior to the compliance date
of such implementing regulations (or as
to which such implementing regulations
do not apply), the calculations shall be
made as of the date of establishment as
defined in paragraph (a)(2)(iv)(B) of this
section or such earlier date on which
the transferred assets have been valued
for purposes of transfer to the covered
fund, and thereafter only upon the date
on which additional securities of the
issuing entity of asset-backed securities
are priced for purposes of the sales of
ownership interests to unaffiliated
investors.
(iii) For securitization transactions
completed prior to the compliance date
of such implementing regulations (or as
to which such implementing regulations
do not apply), the aggregate value of the
outstanding ownership interests in the
covered fund shall be the fair market
value of the assets transferred to the
issuing entity of the securitization and
any other assets otherwise held by the
issuing entity at such time, determined
in a manner that is consistent with its
determination of the fair market value of
those assets for financial statement
purposes.
(iv) For purposes of the calculation
under paragraph (b)(3)(iii) of this
section, the valuation methodology used
to calculate the fair market value of the
ownership interests must be the same
for both the ownership interests held by
a banking entity and the ownership
interests held by all others in the
covered fund in the same manner and
according to the same standards.
(4) Multi-tier fund investments—(i)
Master-feeder fund investments. If the
principal investment strategy of a
covered fund (the ‘‘feeder fund’’) is to
invest substantially all of its assets in
another single covered fund (the
‘‘master fund’’), then for purposes of the
investment limitations in paragraphs
(a)(2)(i)(B) and (a)(2)(ii) of this section,
the banking entity’s permitted
investment in such funds shall be
measured only by reference to the value
of the master fund. The banking entity’s
permitted investment in the master fund
shall include any investment by the
banking entity in the master fund, as
well as the banking entity’s pro-rata
share of any ownership interest of the
master fund that is held through the
feeder fund; and
(ii) Fund-of-funds investments. If a
banking entity organizes and offers a
covered fund pursuant to § 44.11 of this
subpart for the purpose of investing in
other covered funds (a ‘‘fund of funds’’)
and that fund of funds itself invests in
another covered fund that the banking
entity is permitted to own, then the
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banking entity’s permitted investment
in that other fund shall include any
investment by the banking entity in that
other fund, as well as the banking
entity’s pro-rata share of any ownership
interest of the fund that is held through
the fund of funds. The investment of the
banking entity may not represent more
than 3 percent of the amount or value
of any single covered fund.
(c) Aggregate permitted investments
in all covered funds. (1) For purposes of
paragraph (a)(2)(iii) of this section, the
aggregate value of all ownership
interests held by a banking entity shall
be the sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest in covered funds
(together with any amounts paid by the
entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § 44.10(d)(6)(ii) of
this subpart), on a historical cost basis.
(2) Calculation of tier 1 capital. For
purposes of paragraph (a)(2)(iii) of this
section:
(i) Entities that are required to hold
and report tier 1 capital. If a banking
entity is required to calculate and report
tier 1 capital, the banking entity’s tier 1
capital shall be equal to the amount of
tier 1 capital of the banking entity as of
the last day of the most recent calendar
quarter, as reported to its primary
financial regulatory agency; and
(ii) If a banking entity is not required
to calculate and report tier 1 capital, the
banking entity’s tier 1 capital shall be
determined to be equal to:
(A) In the case of a banking entity that
is controlled, directly or indirectly, by a
depository institution that calculates
and reports tier 1 capital, be equal to the
amount of tier 1 capital reported by
such controlling depository institution
in the manner described in paragraph
(c)(2)(i) of this section;
(B) In the case of a banking entity that
is not controlled, directly or indirectly,
by a depository institution that
calculates and reports tier 1 capital:
(1) Bank holding company
subsidiaries. If the banking entity is a
subsidiary of a bank holding company
or company that is treated as a bank
holding company, be equal to the
amount of tier 1 capital reported by the
top-tier affiliate of such covered banking
entity that calculates and reports tier 1
capital in the manner described in
paragraph (c)(2)(i) of this section; and
(2) Other holding companies and any
subsidiary or affiliate thereof. If the
banking entity is not a subsidiary of a
bank holding company or a company
that is treated as a bank holding
company, be equal to the total amount
of shareholders’ equity of the top-tier
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affiliate within such organization as of
the last day of the most recent calendar
quarter that has ended, as determined
under applicable accounting standards.
(iii) Treatment of foreign banking
entities—(A) Foreign banking entities.
Except as provided in paragraph
(c)(2)(iii)(B) of this section, with respect
to a banking entity that is not itself, and
is not controlled directly or indirectly
by, a banking entity that is located or
organized under the laws of the United
States or of any State, the tier 1 capital
of the banking entity shall be the
consolidated tier 1 capital of the entity
as calculated under applicable home
country standards.
(B) U.S. affiliates of foreign banking
entities. With respect to a banking entity
that is located or organized under the
laws of the United States or of any State
and is controlled by a foreign banking
entity identified under paragraph
(c)(2)(iii)(A) of this section, the banking
entity’s tier 1 capital shall be as
calculated under paragraphs (c)(2)(i) or
(ii) of this section.
(d) Capital treatment for a permitted
investment in a covered fund. For
purposes of calculating compliance with
the applicable regulatory capital
requirements, a banking entity shall
deduct from the banking entity’s tier 1
capital (as determined under paragraph
(c)(2) of this section) the greater of:
(1) The sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest (together with any
amounts paid by the entity (or employee
thereof) in connection with obtaining a
restricted profit interest under
§ 44.10(d)(6)(ii) of subpart C), on a
historical cost basis, plus any earnings
received; and
(2) The fair market value of the
banking entity’s ownership interests in
the covered fund as determined under
paragraph (b)(2)(ii) or (b)(3) of this
section (together with any amounts paid
by the entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § 44.10(d)(6)(ii) of
subpart C), if the banking entity
accounts for the profits (or losses) of the
fund investment in its financial
statements.
(e) Extension of time to divest an
ownership interest. (1) Upon application
by a banking entity, the Board may
extend the period under paragraph
(a)(2)(i) of this section for up to 2
additional years if the Board finds that
an extension would be consistent with
safety and soundness and not
detrimental to the public interest. An
application for extension must:
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(i) Be submitted to the Board at least
90 days prior to the expiration of the
applicable time period;
(ii) Provide the reasons for
application, including information that
addresses the factors in paragraph (e)(2)
of this section; and
(iii) Explain the banking entity’s plan
for reducing the permitted investment
in a covered fund through redemption,
sale, dilution or other methods as
required in paragraph (a)(2) of this
section.
(2) Factors governing Board
determinations. In reviewing any
application under paragraph (e)(1) of
this section, the Board may consider all
the facts and circumstances related to
the permitted investment in a covered
fund, including:
(i) Whether the investment would
result, directly or indirectly, in a
material exposure by the banking entity
to high-risk assets or high-risk trading
strategies;
(ii) The contractual terms governing
the banking entity’s interest in the
covered fund;
(iii) The date on which the covered
fund is expected to have attracted
sufficient investments from investors
unaffiliated with the banking entity to
enable the banking entity to comply
with the limitations in paragraph
(a)(2)(i) of this section;
(iv) The total exposure of the covered
banking entity to the investment and the
risks that disposing of, or maintaining,
the investment in the covered fund may
pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of
divesting or disposing of the investment
within the applicable period;
(vi) Whether the investment or the
divestiture or conformance of the
investment would involve or result in a
material conflict of interest between the
banking entity and unaffiliated parties,
including clients, customers or
counterparties to which it owes a duty;
(vi) The banking entity’s prior efforts
to reduce through redemption, sale,
dilution, or other methods its ownership
interests in the covered fund, including
activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board
believes appropriate.
(3) Authority to impose restrictions on
activities or investment during any
extension period. The Board may
impose such conditions on any
extension approved under paragraph
(e)(1) of this section as the Board
determines are necessary or appropriate
to protect the safety and soundness of
the banking entity or the financial
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stability of the United States, address
material conflicts of interest or other
unsound banking practices, or otherwise
further the purposes of section 13 of the
BHC Act and this part.
(4) Consultation. In the case of a
banking entity that is primarily
regulated by another Federal banking
agency, the SEC, or the CFTC, the Board
will consult with such agency prior to
acting on an application by the banking
entity for an extension under paragraph
(e)(1) of this section.
§ 44.13 Other permitted covered fund
activities and investments.
(a) Permitted risk-mitigating hedging
activities. (1) The prohibition contained
in § 44.10(a) of this subpart does not
apply with respect to an ownership
interest in a covered fund acquired or
retained by a banking entity that is
designed to demonstrably reduce or
otherwise significantly mitigate the
specific, identifiable risks to the banking
entity in connection with a
compensation arrangement with an
employee of the banking entity or an
affiliate thereof that directly provides
investment advisory, commodity trading
advisory or other services to the covered
fund.
(2) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under this paragraph (a) only
if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures; and
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(ii) The acquisition or retention of the
ownership interest:
(A) Is made in accordance with the
written policies, procedures and
internal controls required under this
section;
(B) At the inception of the hedge, is
designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks arising in connection
with the compensation arrangement
with the employee that directly
provides investment advisory,
commodity trading advisory, or other
services to the covered fund;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
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62119
contemporaneously in accordance with
this section; and
(D) Is subject to continuing review,
monitoring and management by the
banking entity.
(iii) The compensation arrangement
relates solely to the covered fund in
which the banking entity or any affiliate
has acquired an ownership interest
pursuant to this paragraph and such
compensation arrangement provides
that any losses incurred by the banking
entity on such ownership interest will
be offset by corresponding decreases in
amounts payable under such
compensation arrangement.
(b) Certain permitted covered fund
activities and investments outside of the
United States. (1) The prohibition
contained in § 44.10(a) of this subpart
does not apply to the acquisition or
retention of any ownership interest in,
or the sponsorship of, a covered fund by
a banking entity only if:
(i) The banking entity is not organized
or directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of one
or more States;
(ii) The activity or investment by the
banking entity is pursuant to paragraph
(9) or (13) of section 4(c) of the BHC Act;
(iii) No ownership interest in the
covered fund is offered for sale or sold
to a resident of the United States; and
(iv) The activity or investment occurs
solely outside of the United States.
(2) An activity or investment by the
banking entity is pursuant to paragraph
(9) or (13) of section 4(c) of the BHC Act
for purposes of paragraph (b)(1)(ii) of
this section only if:
(i) The activity or investment is
conducted in accordance with the
requirements of this section; and
(ii)(A) With respect to a banking
entity that is a foreign banking
organization, the banking entity meets
the qualifying foreign banking
organization requirements of section
211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c) or
(e)), as applicable; or
(B) With respect to a banking entity
that is not a foreign banking
organization, the banking entity is not
organized under the laws of the United
States or of one or more States and the
banking entity, on a fully-consolidated
basis, meets at least two of the following
requirements:
(1) Total assets of the banking entity
held outside of the United States exceed
total assets of the banking entity held in
the United States;
(2) Total revenues derived from the
business of the banking entity outside of
the United States exceed total revenues
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derived from the business of the
banking entity in the United States; or
(3) Total net income derived from the
business of the banking entity outside of
the United States exceeds total net
income derived from the business of the
banking entity in the United States.
(3) An ownership interest in a covered
fund is not offered for sale or sold to a
resident of the United States for
purposes of paragraph (b)(1)(iii) of this
section only if it is sold or has been sold
pursuant to an offering that does not
target residents of the United States.
(4) An activity or investment occurs
solely outside of the United States for
purposes of paragraph (b)(1)(iv) of this
section only if:
(i) The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
and is not controlled directly or
indirectly by, a banking entity that is
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
laws of the United States or of any State;
(iii) The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
as principal directly or indirectly on a
consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
(iv) No financing for the banking
entity’s ownership or sponsorship is
provided, directly or indirectly, by any
branch or affiliate that is located in the
United States or organized under the
laws of the United States or of any State.
(5) For purposes of this section, a U.S.
branch, agency, or subsidiary of a
foreign bank, or any subsidiary thereof,
is located in the United States; however,
a foreign bank of which that branch,
agency, or subsidiary is a part is not
considered to be located in the United
States solely by virtue of operation of
the U.S. branch, agency, or subsidiary.
(c) Permitted covered fund interests
and activities by a regulated insurance
company. The prohibition contained in
§ 44.10(a) of this subpart does not apply
to the acquisition or retention by an
insurance company, or an affiliate
thereof, of any ownership interest in, or
the sponsorship of, a covered fund only
if:
(1) The insurance company or its
affiliate acquires and retains the
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ownership interest solely for the general
account of the insurance company or for
one or more separate accounts
established by the insurance company;
(2) The acquisition and retention of
the ownership interest is conducted in
compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (c)(2) of this
section is insufficient to protect the
safety and soundness of the banking
entity, or the financial stability of the
United States.
§ 44.14 Limitations on relationships with a
covered fund.
(a) Relationships with a covered fund.
(1) Except as provided for in paragraph
(a)(2) of this section, no banking entity
that serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, that
organizes and offers a covered fund
pursuant to § 44.11 of this subpart, or
that continues to hold an ownership
interest in accordance with § 44.11(b) of
this subpart, and no affiliate of such
entity, may enter into a transaction with
the covered fund, or with any other
covered fund that is controlled by such
covered fund, that would be a covered
transaction as defined in section 23A of
the Federal Reserve Act (12 U.S.C.
371c(b)(7)), as if such banking entity
and the affiliate thereof were a member
bank and the covered fund were an
affiliate thereof.
(2) Notwithstanding paragraph (a)(1)
of this section, a banking entity may:
(i) Acquire and retain any ownership
interest in a covered fund in accordance
with the requirements of § 44.11,
§ 44.12, or § 44.13 of this subpart; and
(ii) Enter into any prime brokerage
transaction with any covered fund in
which a covered fund managed,
sponsored, or advised by such banking
entity (or an affiliate thereof) has taken
an ownership interest, if:
(A) The banking entity is in
compliance with each of the limitations
set forth in § 44.11 of this subpart with
respect to a covered fund organized and
offered by such banking entity (or an
affiliate thereof);
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(B) The chief executive officer (or
equivalent officer) of the banking entity
certifies in writing annually to the OCC
(with a duty to update the certification
if the information in the certification
materially changes) that the banking
entity does not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests; and
(C) The Board has not determined that
such transaction is inconsistent with the
safe and sound operation and condition
of the banking entity.
(b) Restrictions on transactions with
covered funds. A banking entity that
serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, or that
organizes and offers a covered fund
pursuant to § 44.11 of this subpart, or
that continues to hold an ownership
interest in accordance with § 44.11(b) of
this subpart, shall be subject to section
23B of the Federal Reserve Act (12
U.S.C. 371c–1), as if such banking entity
were a member bank and such covered
fund were an affiliate thereof.
(c) Restrictions on prime brokerage
transactions. A prime brokerage
transaction permitted under paragraph
(a)(2)(ii) of this section shall be subject
to section 23B of the Federal Reserve
Act (12 U.S.C. 371c–1) as if the
counterparty were an affiliate of the
banking entity.
§ 44.15 Other limitations on permitted
covered fund activities and investments.
(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ 44.11 through
44.13 of this subpart if the transaction,
class of transactions, or activity would:
(1) Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
(2) Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
(3) Pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.
(b) Definition of material conflict of
interest. (1) For purposes of this section,
a material conflict of interest between a
banking entity and its clients,
customers, or counterparties exists if the
banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the banking entity’s interests being
materially adverse to the interests of its
client, customer, or counterparty with
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respect to such transaction, class of
transactions, or activity, and the
banking entity has not taken at least one
of the actions in paragraph (b)(2) of this
section.
(2) Prior to effecting the specific
transaction or class or type of
transactions, or engaging in the specific
activity, the banking entity:
(i) Timely and effective disclosure. (A)
Has made clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest; and
(B) Such disclosure is made in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
mitigate, any materially adverse effect
on the client, customer, or counterparty
created by the conflict of interest; or
(ii) Information barriers. Has
established, maintained, and enforced
information barriers that are
memorialized in written policies and
procedures, such as physical separation
of personnel, or functions, or limitations
on types of activity, that are reasonably
designed, taking into consideration the
nature of the banking entity’s business,
to prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A banking entity may not
rely on such information barriers if, in
the case of any specific transaction,
class or type of transactions or activity,
the banking entity knows or should
reasonably know that, notwithstanding
the banking entity’s establishment of
information barriers, the conflict of
interest may involve or result in a
materially adverse effect on a client,
customer, or counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
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§ 44.16 Ownership of interests in and
sponsorship of issuers of certain
collateralized debt obligations backed by
trust-preferred securities.
(a) The prohibition contained in
§ 44.10(a)(1) does not apply to the
ownership by a banking entity of an
interest in, or sponsorship of, any issuer
if:
(1) The issuer was established, and
the interest was issued, before May 19,
2010;
(2) The banking entity reasonably
believes that the offering proceeds
received by the issuer were invested
primarily in Qualifying TruPS
Collateral; and
(3) The banking entity acquired such
interest on or before December 10, 2013
(or acquired such interest in connection
with a merger with or acquisition of a
banking entity that acquired the interest
on or before December 10, 2013).
(b) For purposes of this § 44.16,
Qualifying TruPS Collateral shall mean
any trust preferred security or
subordinated debt instrument issued
prior to May 19, 2010 by a depository
institution holding company that, as of
the end of any reporting period within
12 months immediately preceding the
issuance of such trust preferred security
or subordinated debt instrument, had
total consolidated assets of less than
$15,000,000,000 or issued prior to May
19, 2010 by a mutual holding company.
(c) Notwithstanding paragraph (a)(3)
of this section, a banking entity may act
as a market maker with respect to the
interests of an issuer described in
paragraph (a) of this section in
accordance with the applicable
provisions of §§ 44.4 and 44.11.
(d) Without limiting the applicability
of paragraph (a) of this section, the
Board, the FDIC and the OCC will make
public a non-exclusive list of issuers
that meet the requirements of paragraph
(a). A banking entity may rely on the list
published by the Board, the FDIC and
the OCC.
§§ 44.17–44.19
[Reserved]
Subpart D—Compliance Program
Requirement; Violations
§ 44.20
Program for compliance; reporting.
(a) Program requirement. Each
banking entity shall develop and
provide for the continued
administration of a compliance program
reasonably designed to ensure and
monitor compliance with the
prohibitions and restrictions on
proprietary trading and covered fund
activities and investments set forth in
section 13 of the BHC Act and this part.
The terms, scope and detail of the
compliance program shall be
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appropriate for the types, size, scope
and complexity of activities and
business structure of the banking entity.
(b) Contents of compliance program.
Except as provided in paragraph (f) of
this section, the compliance program
required by paragraph (a) of this section,
at a minimum, shall include:
(1) Written policies and procedures
reasonably designed to document,
describe, monitor and limit trading
activities subject to subpart B (including
those permitted under §§ 44.3 to 44.6 of
subpart B), including setting,
monitoring and managing required
limits set out in §§ 44.4 and 44.5, and
activities and investments with respect
to a covered fund subject to subpart C
(including those permitted under
§§ 44.11 through 44.14 of subpart C)
conducted by the banking entity to
ensure that all activities and
investments conducted by the banking
entity that are subject to section 13 of
the BHC Act and this part comply with
section 13 of the BHC Act and this part;
(2) A system of internal controls
reasonably designed to monitor
compliance with section 13 of the BHC
Act and this part and to prevent the
occurrence of activities or investments
that are prohibited by section 13 of the
BHC Act and this part;
(3) A management framework that
clearly delineates responsibility and
accountability for compliance with
section 13 of the BHC Act and this part
and includes appropriate management
review of trading limits, strategies,
hedging activities, investments,
incentive compensation and other
matters identified in this part or by
management as requiring attention;
(4) Independent testing and audit of
the effectiveness of the compliance
program conducted periodically by
qualified personnel of the banking
entity or by a qualified outside party;
(5) Training for trading personnel and
managers, as well as other appropriate
personnel, to effectively implement and
enforce the compliance program; and
(6) Records sufficient to demonstrate
compliance with section 13 of the BHC
Act and this part, which a banking
entity must promptly provide to the
OCC upon request and retain for a
period of no less than 5 years or such
longer period as required by the OCC.
(c) Additional standards. In addition
to the requirements in paragraph (b) of
this section, the compliance program of
a banking entity must satisfy the
requirements and other standards
contained in appendix B, if:
(1) The banking entity engages in
proprietary trading permitted under
subpart B and is required to comply
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with the reporting requirements of
paragraph (d) of this section;
(2) The banking entity has reported
total consolidated assets as of the
previous calendar year end of $50
billion or more or, in the case of a
foreign banking entity, has total U.S.
assets as of the previous calendar year
end of $50 billion or more (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity
operating, located or organized in the
United States); or
(3) The OCC notifies the banking
entity in writing that it must satisfy the
requirements and other standards
contained in appendix B to this part.
(d) Reporting requirements under
appendix A to this part. (1) A banking
entity engaged in proprietary trading
activity permitted under subpart B shall
comply with the reporting requirements
described in appendix A, if:
(i) The banking entity (other than a
foreign banking entity as provided in
paragraph (d)(1)(ii) of this section) has,
together with its affiliates and
subsidiaries, trading assets and
liabilities (excluding trading assets and
liabilities involving obligations of or
guaranteed by the United States or any
agency of the United States) the average
gross sum of which (on a worldwide
consolidated basis) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the threshold established in
paragraph (d)(2) of this section;
(ii) In the case of a foreign banking
entity, the average gross sum of the
trading assets and liabilities of the
combined U.S. operations of the foreign
banking entity (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity
operating, located or organized in the
United States and excluding trading
assets and liabilities involving
obligations of or guaranteed by the
United States or any agency of the
United States) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the threshold established in
paragraph (d)(2) of this section; or
(iii) The OCC notifies the banking
entity in writing that it must satisfy the
reporting requirements contained in
appendix A.
(2) The threshold for reporting under
paragraph (d)(1) of this section shall be
$50 billion beginning on June 30, 2014;
$25 billion beginning on April 30, 2016;
and $10 billion beginning on December
31, 2016.
(3) Frequency of reporting: Unless the
OCC notifies the banking entity in
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writing that it must report on a different
basis, a banking entity with $50 billion
or more in trading assets and liabilities
(as calculated in accordance with
paragraph (d)(1) of this section) shall
report the information required by
appendix A for each calendar month
within 30 days of the end of the relevant
calendar month; beginning with
information for the month of January
2015, such information shall be reported
within 10 days of the end of each
calendar month. Any other banking
entity subject to appendix A shall report
the information required by appendix A
for each calendar quarter within 30 days
of the end of that calendar quarter
unless the OCC notifies the banking
entity in writing that it must report on
a different basis.
(e) Additional documentation for
covered funds. Any banking entity that
has more than $10 billion in total
consolidated assets as reported on
December 31 of the previous two
calendar years shall maintain records
that include:
(1) Documentation of the exclusions
or exemptions other than sections
3(c)(1) and 3(c)(7) of the Investment
Company Act of 1940 relied on by each
fund sponsored by the banking entity
(including all subsidiaries and affiliates)
in determining that such fund is not a
covered fund;
(2) For each fund sponsored by the
banking entity (including all
subsidiaries and affiliates) for which the
banking entity relies on one or more of
the exclusions from the definition of
covered fund provided by § 44.10(c)(1),
§ 44.10(c)(5), § 44.10(c)(8), § 44.10(c)(9),
or § 44.10(c)(10) of subpart C,
documentation supporting the banking
entity’s determination that the fund is
not a covered fund pursuant to one or
more of those exclusions;
(3) For each seeding vehicle described
in § 44.10(c)(12)(i) or (iii) of subpart C
that will become a registered investment
company or SEC-regulated business
development company, a written plan
documenting the banking entity’s
determination that the seeding vehicle
will become a registered investment
company or SEC-regulated business
development company; the period of
time during which the vehicle will
operate as a seeding vehicle; and the
banking entity’s plan to market the
vehicle to third-party investors and
convert it into a registered investment
company or SEC-regulated business
development company within the time
period specified in § 44.12(a)(2)(i)(B) of
subpart C;
(4) For any banking entity that is, or
is controlled directly or indirectly by a
banking entity that is, located in or
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organized under the laws of the United
States or of any State, if the aggregate
amount of ownership interests in
foreign public funds that are described
in § 44.10(c)(1) of subpart C owned by
such banking entity (including
ownership interests owned by any
affiliate that is controlled directly or
indirectly by a banking entity that is
located in or organized under the laws
of the United States or of any State)
exceeds $50 million at the end of two
or more consecutive calendar quarters,
beginning with the next succeeding
calendar quarter, documentation of the
value of the ownership interests owned
by the banking entity (and such
affiliates) in each foreign public fund
and each jurisdiction in which any such
foreign public fund is organized,
calculated as of the end of each calendar
quarter, which documentation must
continue until the banking entity’s
aggregate amount of ownership interests
in foreign public funds is below $50
million for two consecutive calendar
quarters; and
(5) For purposes of paragraph (e)(4) of
this section, a U.S. branch, agency, or
subsidiary of a foreign banking entity is
located in the United States; however,
the foreign bank that operates or
controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(f) Simplified programs for less active
banking entities—(1) Banking entities
with no covered activities. A banking
entity that does not engage in activities
or investments pursuant to subpart B or
subpart C (other than trading activities
permitted pursuant to § 44.6(a) of
subpart B) may satisfy the requirements
of this section by establishing the
required compliance program prior to
becoming engaged in such activities or
making such investments (other than
trading activities permitted pursuant to
§ 44.6(a) of subpart B).
(2) Banking entities with modest
activities. A banking entity with total
consolidated assets of $10 billion or less
as reported on December 31 of the
previous two calendar years that
engages in activities or investments
pursuant to subpart B or subpart C
(other than trading activities permitted
under § 44.6(a) of subpart B) may satisfy
the requirements of this section by
including in its existing compliance
policies and procedures appropriate
references to the requirements of section
13 of the BHC Act and this part and
adjustments as appropriate given the
activities, size, scope and complexity of
the banking entity.
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§ 44.21 Termination of activities or
investments; penalties for violations.
(a) Any banking entity that engages in
an activity or makes an investment in
violation of section 13 of the BHC Act
or this part, or acts in a manner that
functions as an evasion of the
requirements of section 13 of the BHC
Act or this part, including through an
abuse of any activity or investment
permitted under subparts B or C, or
otherwise violates the restrictions and
requirements of section 13 of the BHC
Act or this part, shall, upon discovery,
promptly terminate the activity and, as
relevant, dispose of the investment.
(b) Whenever the OCC finds
reasonable cause to believe any banking
entity has engaged in an activity or
made an investment in violation of
section 13 of the BHC Act or this part,
or engaged in any activity or made any
investment that functions as an evasion
of the requirements of section 13 of the
BHC Act or this part, the OCC may take
any action permitted by law to enforce
compliance with section 13 of the BHC
Act and this part, including directing
the banking entity to restrict, limit, or
terminate any or all activities under this
part and dispose of any investment.
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Appendix A to Part 44—Reporting and
Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and
recordkeeping requirements that certain
banking entities must satisfy in connection
with the restrictions on proprietary trading
set forth in subpart B (‘‘proprietary trading
restrictions’’). Pursuant to § 44.20(d), this
appendix generally applies to a banking
entity that, together with its affiliates and
subsidiaries, has significant trading assets
and liabilities. These entities are required to
(i) furnish periodic reports to the OCC
regarding a variety of quantitative
measurements of their covered trading
activities, which vary depending on the
scope and size of covered trading activities,
and (ii) create and maintain records
documenting the preparation and content of
these reports. The requirements of this
appendix must be incorporated into the
banking entity’s internal compliance program
under § 44.20 and Appendix B.
b. The purpose of this appendix is to assist
banking entities and the OCC in:
(i) Better understanding and evaluating the
scope, type, and profile of the banking
entity’s covered trading activities;
(ii) Monitoring the banking entity’s covered
trading activities;
(iii) Identifying covered trading activities
that warrant further review or examination
by the banking entity to verify compliance
with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading
activities of trading desks engaged in market
making-related activities subject to § 44.4(b)
are consistent with the requirements
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governing permitted market making-related
activities;
(v) Evaluating whether the covered trading
activities of trading desks that are engaged in
permitted trading activity subject to §§ 44.4,
44.5, or 44.6(a)–(b) (i.e., underwriting and
market making-related related activity, riskmitigating hedging, or trading in certain
government obligations) are consistent with
the requirement that such activity not result,
directly or indirectly, in a material exposure
to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular
covered trading activities of the banking
entity, and the individual trading desks of
the banking entity, to help establish the
appropriate frequency and scope of
examination by the OCC of such activities;
and
(vii) Assessing and addressing the risks
associated with the banking entity’s covered
trading activities.
c. The quantitative measurements that
must be furnished pursuant to this appendix
are not intended to serve as a dispositive tool
for the identification of permissible or
impermissible activities.
d. In order to allow banking entities and
the Agencies to evaluate the effectiveness of
these metrics, banking entities must collect
and report these metrics for all trading desks
beginning on the dates established in § 44.20
of the final rule. The Agencies will review
the data collected and revise this collection
requirement as appropriate based on a review
of the data collected prior to September 30,
2015.
e. In addition to the quantitative
measurements required in this appendix, a
banking entity may need to develop and
implement other quantitative measurements
in order to effectively monitor its covered
trading activities for compliance with section
13 of the BHC Act and this part and to have
an effective compliance program, as required
by § 44.20 and Appendix B to this part. The
effectiveness of particular quantitative
measurements may differ based on the profile
of the banking entity’s businesses in general
and, more specifically, of the particular
trading desk, including types of instruments
traded, trading activities and strategies, and
history and experience (e.g., whether the
trading desk is an established, successful
market maker or a new entrant to a
competitive market). In all cases, banking
entities must ensure that they have robust
measures in place to identify and monitor the
risks taken in their trading activities, to
ensure that the activities are within risk
tolerances established by the banking entity,
and to monitor and examine for compliance
with the proprietary trading restrictions in
this part.
f. On an ongoing basis, banking entities
must carefully monitor, review, and evaluate
all furnished quantitative measurements, as
well as any others that they choose to utilize
in order to maintain compliance with section
13 of the BHC Act and this part. All
measurement results that indicate a
heightened risk of impermissible proprietary
trading, including with respect to otherwisepermitted activities under §§ 44.4 through
44.6(a) and (b), or that result in a material
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exposure to high-risk assets or high-risk
trading strategies, must be escalated within
the banking entity for review, further
analysis, explanation to the OCC, and
remediation, where appropriate. The
quantitative measurements discussed in this
appendix should be helpful to banking
entities in identifying and managing the risks
related to their covered trading activities.
II. Definitions
The terms used in this appendix have the
same meanings as set forth in §§ 44.2 and
44.3. In addition, for purposes of this
appendix, the following definitions apply:
Calculation period means the period of
time for which a particular quantitative
measurement must be calculated.
Comprehensive profit and loss means the
net profit or loss of a trading desk’s material
sources of trading revenue over a specific
period of time, including, for example, any
increase or decrease in the market value of
a trading desk’s holdings, dividend income,
and interest income and expense.
Covered trading activity means trading
conducted by a trading desk under §§ 44.4,
44.5, 44.6(a), or 44.6(b). A banking entity may
include trading under §§ 44.3(d), 44.6(c),
44.6(d) or 44.6(e).
Measurement frequency means the
frequency with which a particular
quantitative metric must be calculated and
recorded.
Trading desk means the smallest discrete
unit of organization of a banking entity that
purchases or sells financial instruments for
the trading account of the banking entity or
an affiliate thereof.
III. Reporting and Recordkeeping of
Quantitative Measurements
a. Scope of Required Reporting
General scope. Each banking entity made
subject to this part by § 44.20 must furnish
the following quantitative measurements for
each trading desk of the banking entity,
calculated in accordance with this appendix:
• Risk and Position Limits and Usage;
• Risk Factor Sensitivities;
• Value-at-Risk and Stress VaR;
• Comprehensive Profit and Loss
Attribution;
• Inventory Turnover;
• Inventory Aging; and
• Customer-Facing Trade Ratio.
b. Frequency of Required Calculation and
Reporting
A banking entity must calculate any
applicable quantitative measurement for each
trading day. A banking entity must report
each applicable quantitative measurement to
the OCC on the reporting schedule
established in § 44.20 unless otherwise
requested by the OCC. All quantitative
measurements for any calendar month must
be reported within the time period required
by § 44.20.
c. Recordkeeping
A banking entity must, for any quantitative
measurement furnished to the OCC pursuant
to this appendix and § 44.20(d), create and
maintain records documenting the
preparation and content of these reports, as
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well as such information as is necessary to
permit the OCC to verify the accuracy of such
reports, for a period of 5 years from the end
of the calendar year for which the
measurement was taken.
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IV. Quantitative Measurements
a. Risk-Management Measurements
1. Risk and Position Limits and Usage
i. Description: For purposes of this
appendix, Risk and Position Limits are the
constraints that define the amount of risk that
a trading desk is permitted to take at a point
in time, as defined by the banking entity for
a specific trading desk. Usage represents the
portion of the trading desk’s limits that are
accounted for by the current activity of the
desk. Risk and position limits and their usage
are key risk management tools used to
control and monitor risk taking and include,
but are not limited, to the limits set out in
§ 44.4 and § 44.5. A number of the metrics
that are described below, including ‘‘Risk
Factor Sensitivities’’ and ‘‘Value-at-Risk and
Stress Value-at-Risk,’’ relate to a trading
desk’s risk and position limits and are useful
in evaluating and setting these limits in the
broader context of the trading desk’s overall
activities, particularly for the market making
activities under § 44.4(b) and hedging activity
under § 44.5. Accordingly, the limits required
under § 44.4(b)(2)(iii) and § 44.5(b)(1)(i) must
meet the applicable requirements under
§ 44.4(b)(2)(iii) and § 44.5(b)(1)(i) and also
must include appropriate metrics for the
trading desk limits including, at a minimum,
the ‘‘Risk Factor Sensitivities’’ and ‘‘Value-atRisk and Stress Value-at-Risk’’ metrics except
to the extent any of the ‘‘Risk Factor
Sensitivities’’ or ‘‘Value-at-Risk and Stress
Value-at-Risk’’ metrics are demonstrably
ineffective for measuring and monitoring the
risks of a trading desk based on the types of
positions traded by, and risk exposures of,
that desk.
ii. General Calculation Guidance: Risk and
Position Limits must be reported in the
format used by the banking entity for the
purposes of risk management of each trading
desk. Risk and Position Limits are often
expressed in terms of risk measures, such as
VaR and Risk Factor Sensitivities, but may
also be expressed in terms of other
observable criteria, such as net open
positions. When criteria other than VaR or
Risk Factor Sensitivities are used to define
the Risk and Position Limits, both the value
of the Risk and Position Limits and the value
of the variables used to assess whether these
limits have been reached must be reported.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
2. Risk Factor Sensitivities
i. Description: For purposes of this
appendix, Risk Factor Sensitivities are
changes in a trading desk’s Comprehensive
Profit and Loss that are expected to occur in
the event of a change in one or more
underlying variables that are significant
sources of the trading desk’s profitability and
risk.
ii. General Calculation Guidance: A
banking entity must report the Risk Factor
Sensitivities that are monitored and managed
as part of the trading desk’s overall risk
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management policy. The underlying data and
methods used to compute a trading desk’s
Risk Factor Sensitivities will depend on the
specific function of the trading desk and the
internal risk management models employed.
The number and type of Risk Factor
Sensitivities that are monitored and managed
by a trading desk, and furnished to the OCC,
will depend on the explicit risks assumed by
the trading desk. In general, however,
reported Risk Factor Sensitivities must be
sufficiently granular to account for a
preponderance of the expected price
variation in the trading desk’s holdings.
A. Trading desks must take into account
any relevant factors in calculating Risk Factor
Sensitivities, including, for example, the
following with respect to particular asset
classes:
• Commodity derivative positions: Risk
factors with respect to the related
commodities set out in 17 CFR 20.2, the
maturity of the positions, volatility and/or
correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), and the maturity profile of
the positions;
• Credit positions: Risk factors with
respect to credit spreads that are sufficiently
granular to account for specific credit sectors
and market segments, the maturity profile of
the positions, and risk factors with respect to
interest rates of all relevant maturities;
• Credit-related derivative positions: Risk
factor sensitivities, for example credit
spreads, shifts (parallel and non-parallel) in
credit spreads—volatility, and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
and the maturity profile of the positions;
• Equity derivative positions: Risk factor
sensitivities such as equity positions,
volatility, and/or correlation sensitivities
(expressed in a manner that demonstrates
any significant non-linearities), and the
maturity profile of the positions;
• Equity positions: Risk factors for equity
prices and risk factors that differentiate
between important equity market sectors and
segments, such as a small capitalization
equities and international equities;
• Foreign exchange derivative positions:
Risk factors with respect to major currency
pairs and maturities, exposure to interest
rates at relevant maturities, volatility, and/or
correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), as well as the maturity
profile of the positions; and
• Interest rate positions, including interest
rate derivative positions: Risk factors with
respect to major interest rate categories and
maturities and volatility and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
and shifts (parallel and non-parallel) in the
interest rate curve, as well as the maturity
profile of the positions.
B. The methods used by a banking entity
to calculate sensitivities to a common factor
shared by multiple trading desks, such as an
equity price factor, must be applied
consistently across its trading desks so that
the sensitivities can be compared from one
trading desk to another.
iii. Calculation Period: One trading day.
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iv. Measurement Frequency: Daily.
3. Value-at-Risk and Stress Value-at-Risk
i. Description: For purposes of this
appendix, Value-at-Risk (‘‘VaR’’) is the
commonly used percentile measurement of
the risk of future financial loss in the value
of a given set of aggregated positions over a
specified period of time, based on current
market conditions. For purposes of this
appendix, Stress Value-at-Risk (‘‘Stress VaR’’)
is the percentile measurement of the risk of
future financial loss in the value of a given
set of aggregated positions over a specified
period of time, based on market conditions
during a period of significant financial stress.
ii. General Calculation Guidance: Banking
entities must compute and report VaR and
Stress VaR by employing generally accepted
standards and methods of calculation. VaR
should reflect a loss in a trading desk that is
expected to be exceeded less than one
percent of the time over a one-day period.
For those banking entities that are subject to
regulatory capital requirements imposed by a
Federal banking agency, VaR and Stress VaR
must be computed and reported in a manner
that is consistent with such regulatory capital
requirements. In cases where a trading desk
does not have a standalone VaR or Stress VaR
calculation but is part of a larger aggregation
of positions for which a VaR or Stress VaR
calculation is performed, a VaR or Stress VaR
calculation that includes only the trading
desk’s holdings must be performed consistent
with the VaR or Stress VaR model and
methodology used for the larger aggregation
of positions.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this
appendix, Comprehensive Profit and Loss
Attribution is an analysis that attributes the
daily fluctuation in the value of a trading
desk’s positions to various sources. First, the
daily profit and loss of the aggregated
positions is divided into three categories: (i)
Profit and loss attributable to a trading desk’s
existing positions that were also positions
held by the trading desk as of the end of the
prior day (‘‘existing positions’’); (ii) profit
and loss attributable to new positions
resulting from the current day’s trading
activity (‘‘new positions’’); and (iii) residual
profit and loss that cannot be specifically
attributed to existing positions or new
positions. The sum of (i), (ii), and (iii) must
equal the trading desk’s comprehensive profit
and loss at each point in time. In addition,
profit and loss measurements must calculate
volatility of comprehensive profit and loss
(i.e., the standard deviation of the trading
desk’s one-day profit and loss, in dollar
terms) for the reporting period for at least a
30-, 60- and 90-day lag period, from the end
of the reporting period, and any other period
that the banking entity deems necessary to
meet the requirements of the rule.
A. The comprehensive profit and loss
associated with existing positions must
reflect changes in the value of these positions
on the applicable day. The comprehensive
profit and loss from existing positions must
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be further attributed, as applicable, to
changes in (i) the specific Risk Factors and
other factors that are monitored and managed
as part of the trading desk’s overall risk
management policies and procedures; and (ii)
any other applicable elements, such as cash
flows, carry, changes in reserves, and the
correction, cancellation, or exercise of a
trade.
B. The comprehensive profit and loss
attributed to new positions must reflect
commissions and fee income or expense and
market gains or losses associated with
transactions executed on the applicable day.
New positions include purchases and sales of
financial instruments and other assets/
liabilities and negotiated amendments to
existing positions. The comprehensive profit
and loss from new positions may be reported
in the aggregate and does not need to be
further attributed to specific sources.
C. The portion of comprehensive profit and
loss that cannot be specifically attributed to
known sources must be allocated to a
residual category identified as an
unexplained portion of the comprehensive
profit and loss. Significant unexplained
profit and loss must be escalated for further
investigation and analysis.
ii. General Calculation Guidance: The
specific categories used by a trading desk in
the attribution analysis and amount of detail
for the analysis should be tailored to the type
and amount of trading activities undertaken
by the trading desk. The new position
attribution must be computed by calculating
the difference between the prices at which
instruments were bought and/or sold and the
prices at which those instruments are marked
to market at the close of business on that day
multiplied by the notional or principal
amount of each purchase or sale. Any fees,
commissions, or other payments received
(paid) that are associated with transactions
executed on that day must be added
(subtracted) from such difference. These
factors must be measured consistently over
time to facilitate historical comparisons.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
c. Customer-Facing Activity Measurements
1. Inventory Turnover
i. Description: For purposes of this
appendix, Inventory Turnover is a ratio that
measures the turnover of a trading desk’s
inventory. The numerator of the ratio is the
absolute value of all transactions over the
reporting period. The denominator of the
ratio is the value of the trading desk’s
inventory at the beginning of the reporting
period.
ii. General Calculation Guidance: For
purposes of this appendix, for derivatives,
other than options and interest rate
derivatives, value means gross notional
value, for options, value means delta
adjusted notional value, and for interest rate
derivatives, value means 10-year bond
equivalent value.
iii. Calculation Period: 30 days, 60 days,
and 90 days.
iv. Measurement Frequency: Daily.
2. Inventory Aging
i. Description: For purposes of this
appendix, Inventory Aging generally
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describes a schedule of the trading desk’s
aggregate assets and liabilities and the
amount of time that those assets and
liabilities have been held. Inventory Aging
should measure the age profile of the trading
desk’s assets and liabilities.
ii. General Calculation Guidance: In
general, Inventory Aging must be computed
using a trading desk’s trading activity data
and must identify the value of a trading
desk’s aggregate assets and liabilities.
Inventory Aging must include two schedules,
an asset-aging schedule and a liability-aging
schedule. Each schedule must record the
value of assets or liabilities held over all
holding periods. For derivatives, other than
options, and interest rate derivatives, value
means gross notional value, for options,
value means delta adjusted notional value
and, for interest rate derivatives, value means
10-year bond equivalent value.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Customer-Facing Trade Ratio—Trade
Count Based and Value Based
i. Description: For purposes of this
appendix, the Customer-Facing Trade Ratio
is a ratio comparing (i) the transactions
involving a counterparty that is a customer
of the trading desk to (ii) the transactions
involving a counterparty that is not a
customer of the trading desk. A trade count
based ratio must be computed that records
the number of transactions involving a
counterparty that is a customer of the trading
desk and the number of transactions
involving a counterparty that is not a
customer of the trading desk. A value based
ratio must be computed that records the
value of transactions involving a
counterparty that is a customer of the trading
desk and the value of transactions involving
a counterparty that is not a customer of the
trading desk.
ii. General Calculation Guidance: For
purposes of calculating the Customer-Facing
Trade Ratio, a counterparty is considered to
be a customer of the trading desk if the
counterparty is a market participant that
makes use of the banking entity’s market
making-related services by obtaining such
services, responding to quotations, or
entering into a continuing relationship with
respect to such services. However, a trading
desk or other organizational unit of another
banking entity would not be a client,
customer, or counterparty of the trading desk
if the other entity has trading assets and
liabilities of $50 billion or more as measured
in accordance with § 44.20(d)(1) unless the
trading desk documents how and why a
particular trading desk or other
organizational unit of the entity should be
treated as a client, customer, or counterparty
of the trading desk. Transactions conducted
anonymously on an exchange or similar
trading facility that permits trading on behalf
of a broad range of market participants would
be considered transactions with customers of
the trading desk. For derivatives, other than
options, and interest rate derivatives, value
means gross notional value, for options,
value means delta adjusted notional value,
and for interest rate derivatives, value means
10-year bond equivalent value.
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iii. Calculation Period: 30 days, 60 days,
and 90 days.
iv. Measurement Frequency: Daily.
Appendix B to Part 44—Enhanced
Minimum Standards for Compliance
Programs
I. Overview
Section 44.20(c) requires certain banking
entities to establish, maintain, and enforce an
enhanced compliance program that includes
the requirements and standards in this
Appendix as well as the minimum written
policies and procedures, internal controls,
management framework, independent
testing, training, and recordkeeping
provisions outlined in § 44.20. This
Appendix sets forth additional minimum
standards with respect to the establishment,
oversight, maintenance, and enforcement by
these banking entities of an enhanced
internal compliance program for ensuring
and monitoring compliance with the
prohibitions and restrictions on proprietary
trading and covered fund activities and
investments set forth in section 13 of the
BHC Act and this part.
a. This compliance program must:
1. Be reasonably designed to identify,
document, monitor, and report the permitted
trading and covered fund activities and
investments of the banking entity; identify,
monitor and promptly address the risks of
these covered activities and investments and
potential areas of noncompliance; and
prevent activities or investments prohibited
by, or that do not comply with, section 13 of
the BHC Act and this part;
2. Establish and enforce appropriate limits
on the covered activities and investments of
the banking entity, including limits on the
size, scope, complexity, and risks of the
individual activities or investments
consistent with the requirements of section
13 of the BHC Act and this part;
3. Subject the effectiveness of the
compliance program to periodic independent
review and testing, and ensure that the
entity’s internal audit, corporate compliance
and internal control functions involved in
review and testing are effective and
independent;
4. Make senior management, and others as
appropriate, accountable for the effective
implementation of the compliance program,
and ensure that the board of directors and
chief executive officer (or equivalent) of the
banking entity review the effectiveness of the
compliance program; and
5. Facilitate supervision and examination
by the Agencies of the banking entity’s
permitted trading and covered fund activities
and investments.
II. Enhanced Compliance Program
a. Proprietary Trading Activities. A
banking entity must establish, maintain and
enforce a compliance program that includes
written policies and procedures that are
appropriate for the types, size, and
complexity of, and risks associated with, its
permitted trading activities. The compliance
program may be tailored to the types of
trading activities conducted by the banking
entity, and must include a detailed
description of controls established by the
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banking entity to reasonably ensure that its
trading activities are conducted in
accordance with the requirements and
limitations applicable to those trading
activities under section 13 of the BHC Act
and this part, and provide for appropriate
revision of the compliance program before
expansion of the trading activities of the
banking entity. A banking entity must devote
adequate resources and use knowledgeable
personnel in conducting, supervising and
managing its trading activities, and promote
consistency, independence and rigor in
implementing its risk controls and
compliance efforts. The compliance program
must be updated with a frequency sufficient
to account for changes in the activities of the
banking entity, results of independent testing
of the program, identification of weaknesses
in the program, and changes in legal,
regulatory or other requirements.
1. Trading Desks: The banking entity must
have written policies and procedures
governing each trading desk that include a
description of:
i. The process for identifying, authorizing
and documenting financial instruments each
trading desk may purchase or sell, with
separate documentation for market makingrelated activities conducted in reliance on
§ 44.4(b) and for hedging activity conducted
in reliance on § 44.5;
ii. A mapping for each trading desk to the
division, business line, or other
organizational structure that is responsible
for managing and overseeing the trading
desk’s activities;
iii. The mission (i.e., the type of trading
activity, such as market-making, trading in
sovereign debt, etc.) and strategy (i.e.,
methods for conducting authorized trading
activities) of each trading desk;
iv. The activities that the trading desk is
authorized to conduct, including (i)
authorized instruments and products, and (ii)
authorized hedging strategies, techniques and
instruments;
v. The types and amount of risks allocated
by the banking entity to each trading desk to
implement the mission and strategy of the
trading desk, including an enumeration of
material risks resulting from the activities in
which the trading desk is authorized to
engage (including but not limited to price
risks, such as basis, volatility and correlation
risks, as well as counterparty credit risk).
Risk assessments must take into account both
the risks inherent in the trading activity and
the strength and effectiveness of controls
designed to mitigate those risks;
vi. How the risks allocated to each trading
desk will be measured;
vii. Why the allocated risks levels are
appropriate to the activities authorized for
the trading desk;
viii. The limits on the holding period of,
and the risk associated with, financial
instruments under the responsibility of the
trading desk;
ix. The process for setting new or revised
limits, as well as escalation procedures for
granting exceptions to any limits or to any
policies or procedures governing the desk,
the analysis that will be required to support
revising limits or granting exceptions, and
the process for independently reviewing and
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documenting those exceptions and the
underlying analysis;
x. The process for identifying,
documenting and approving new products,
trading strategies, and hedging strategies;
xi. The types of clients, customers, and
counterparties with whom the trading desk
may trade; and
xii. The compensation arrangements,
including incentive arrangements, for
employees associated with the trading desk,
which may not be designed to reward or
incentivize prohibited proprietary trading or
excessive or imprudent risk-taking.
2. Description of risks and risk
management processes: The compliance
program for the banking entity must include
a comprehensive description of the risk
management program for the trading activity
of the banking entity. The compliance
program must also include a description of
the governance, approval, reporting,
escalation, review and other processes the
banking entity will use to reasonably ensure
that trading activity is conducted in
compliance with section 13 of the BHC Act
and this part. Trading activity in similar
financial instruments should be subject to
similar governance, limits, testing, controls,
and review, unless the banking entity
specifically determines to establish different
limits or processes and documents those
differences. Descriptions must include, at a
minimum, the following elements:
i. A description of the supervisory and risk
management structure governing all trading
activity, including a description of processes
for initial and senior-level review of new
products and new strategies;
ii. A description of the process for
developing, documenting, testing, approving
and reviewing all models used for valuing,
identifying and monitoring the risks of
trading activity and related positions,
including the process for periodic
independent testing of the reliability and
accuracy of those models;
iii. A description of the process for
developing, documenting, testing, approving
and reviewing the limits established for each
trading desk;
iv. A description of the process by which
a security may be purchased or sold pursuant
to the liquidity management plan, including
the process for authorizing and monitoring
such activity to ensure compliance with the
banking entity’s liquidity management plan
and the restrictions on liquidity management
activities in this part;
v. A description of the management review
process, including escalation procedures, for
approving any temporary exceptions or
permanent adjustments to limits on the
activities, positions, strategies, or risks
associated with each trading desk; and
vi. The role of the audit, compliance, risk
management and other relevant units for
conducting independent testing of trading
and hedging activities, techniques and
strategies.
3. Authorized risks, instruments, and
products. The banking entity must
implement and enforce limits and internal
controls for each trading desk that are
reasonably designed to ensure that trading
activity is conducted in conformance with
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section 13 of the BHC Act and this part and
with the banking entity’s written policies and
procedures. The banking entity must
establish and enforce risk limits appropriate
for the activity of each trading desk. These
limits should be based on probabilistic and
non-probabilistic measures of potential loss
(e.g., Value-at-Risk and notional exposure,
respectively), and measured under normal
and stress market conditions. At a minimum,
these internal controls must monitor,
establish and enforce limits on:
i. The financial instruments (including, at
a minimum, by type and exposure) that the
trading desk may trade;
ii. The types and levels of risks that may
be taken by each trading desk; and
iii. The types of hedging instruments used,
hedging strategies employed, and the amount
of risk effectively hedged.
4. Hedging policies and procedures. The
banking entity must establish, maintain, and
enforce written policies and procedures
regarding the use of risk-mitigating hedging
instruments and strategies that, at a
minimum, describe:
i. The positions, techniques and strategies
that each trading desk may use to hedge the
risk of its positions;
ii. The manner in which the banking entity
will identify the risks arising in connection
with and related to the individual or
aggregated positions, contracts or other
holdings of the banking entity that are to be
hedged and determine that those risks have
been properly and effectively hedged;
iii. The level of the organization at which
hedging activity and management will occur;
iv. The manner in which hedging strategies
will be monitored and the personnel
responsible for such monitoring;
v. The risk management processes used to
control unhedged or residual risks; and
vi. The process for developing,
documenting, testing, approving and
reviewing all hedging positions, techniques
and strategies permitted for each trading desk
and for the banking entity in reliance on
§ 44.5.
5. Analysis and quantitative
measurements. The banking entity must
perform robust analysis and quantitative
measurement of its trading activities that is
reasonably designed to ensure that the
trading activity of each trading desk is
consistent with the banking entity’s
compliance program; monitor and assist in
the identification of potential and actual
prohibited proprietary trading activity; and
prevent the occurrence of prohibited
proprietary trading. Analysis and models
used to determine, measure and limit risk
must be rigorously tested and be reviewed by
management responsible for trading activity
to ensure that trading activities, limits,
strategies, and hedging activities do not
understate the risk and exposure to the
banking entity or allow prohibited
proprietary trading. This review should
include periodic and independent backtesting and revision of activities, limits,
strategies and hedging as appropriate to
contain risk and ensure compliance. In
addition to the quantitative measurements
reported by any banking entity subject to
Appendix A to this part, each banking entity
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must develop and implement, to the extent
appropriate to facilitate compliance with this
part, additional quantitative measurements
specifically tailored to the particular risks,
practices, and strategies of its trading desks.
The banking entity’s analysis and
quantitative measurements must incorporate
the quantitative measurements reported by
the banking entity pursuant to Appendix A
(if applicable) and include, at a minimum,
the following:
i. Internal controls and written policies and
procedures reasonably designed to ensure the
accuracy and integrity of quantitative
measurements;
ii. Ongoing, timely monitoring and review
of calculated quantitative measurements;
iii. The establishment of numerical
thresholds and appropriate trading measures
for each trading desk and heightened review
of trading activity not consistent with those
thresholds to ensure compliance with section
13 of the BHC Act and this part, including
analysis of the measurement results or other
information, appropriate escalation
procedures, and documentation related to the
review; and
iv. Immediate review and compliance
investigation of the trading desk’s activities,
escalation to senior management with
oversight responsibilities for the applicable
trading desk, timely notification to the OCC,
appropriate remedial action (e.g., divesting of
impermissible positions, cessation of
impermissible activity, disciplinary actions),
and documentation of the investigation
findings and remedial action taken when
quantitative measurements or other
information, considered together with the
facts and circumstances, or findings of
internal audit, independent testing or other
review suggest a reasonable likelihood that
the trading desk has violated any part of
section 13 of the BHC Act or this part.
6. Other Compliance Matters. In addition
to the requirements specified above, the
banking entity’s compliance program must:
i. Identify activities of each trading desk
that will be conducted in reliance on
exemptions contained in §§ 44.4 through
44.6, including an explanation of:
A. How and where in the organization the
activity occurs; and
B. Which exemption is being relied on and
how the activity meets the specific
requirements for reliance on the applicable
exemption;
ii. Include an explanation of the process for
documenting, approving and reviewing
actions taken pursuant to the liquidity
management plan, where in the organization
this activity occurs, the securities permissible
for liquidity management, the process for
ensuring that liquidity management activities
are not conducted for the purpose of
prohibited proprietary trading, and the
process for ensuring that securities
purchased as part of the liquidity
management plan are highly liquid and
conform to the requirements of this part;
iii. Describe how the banking entity
monitors for and prohibits potential or actual
material exposure to high-risk assets or highrisk trading strategies presented by each
trading desk that relies on the exemptions
contained in §§ 44.3(d)(3), and 44.4 through
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44.6, which must take into account potential
or actual exposure to:
A. Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
B. Assets whose changes in value cannot
be adequately mitigated by effective hedging;
C. New products with rapid growth,
including those that do not have a market
history;
D. Assets or strategies that include
significant embedded leverage;
E. Assets or strategies that have
demonstrated significant historical volatility;
F. Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
G. Assets or strategies that result in large
and significant concentrations to sectors, risk
factors, or counterparties;
iv. Establish responsibility for compliance
with the reporting and recordkeeping
requirements of subpart B and § 44.20; and
v. Establish policies for monitoring and
prohibiting potential or actual material
conflicts of interest between the banking
entity and its clients, customers, or
counterparties.
7. Remediation of violations. The banking
entity’s compliance program must be
reasonably designed and established to
effectively monitor and identify for further
analysis any trading activity that may
indicate potential violations of section 13 of
the BHC Act and this part and to prevent
actual violations of section 13 of the BHC Act
and this part. The compliance program must
describe procedures for identifying and
remedying violations of section 13 of the
BHC Act and this part, and must include, at
a minimum, a requirement to promptly
document, address and remedy any violation
of section 13 of the BHC Act or this part, and
document all proposed and actual
remediation efforts. The compliance program
must include specific written policies and
procedures that are reasonably designed to
assess the extent to which any activity
indicates that modification to the banking
entity’s compliance program is warranted
and to ensure that appropriate modifications
are implemented. The written policies and
procedures must provide for prompt
notification to appropriate management,
including senior management and the board
of directors, of any material weakness or
significant deficiencies in the design or
implementation of the compliance program
of the banking entity.
b. Covered Fund Activities or Investments.
A banking entity must establish, maintain
and enforce a compliance program that
includes written policies and procedures that
are appropriate for the types, size,
complexity and risks of the covered fund and
related activities conducted and investments
made, by the banking entity.
1. Identification of covered funds. The
banking entity’s compliance program must
provide a process, which must include
appropriate management review and
independent testing, for identifying and
documenting covered funds that each unit
within the banking entity’s organization
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sponsors or organizes and offers, and covered
funds in which each such unit invests. In
addition to the documentation requirements
for covered funds, as specified under
§ 44.20(e), the documentation must include
information that identifies all pools that the
banking entity sponsors or has an interest in
and the type of exemption from the
Commodity Exchange Act (whether or not
the pool relies on section 4.7 of the
regulations under the Commodity Exchange
Act), and the amount of ownership interest
the banking entity has in those pools.
2. Identification of covered fund activities
and investments. The banking entity’s
compliance program must identify,
document and map each unit within the
organization that is permitted to acquire or
hold an interest in any covered fund or
sponsor any covered fund and map each unit
to the division, business line, or other
organizational structure that will be
responsible for managing and overseeing that
unit’s activities and investments.
3. Explanation of compliance. The banking
entity’s compliance program must explain
how:
i. The banking entity monitors for and
prohibits potential or actual material
conflicts of interest between the banking
entity and its clients, customers, or
counterparties related to its covered fund
activities and investments;
ii. The banking entity monitors for and
prohibits potential or actual transactions or
activities that may threaten the safety and
soundness of the banking entity related to its
covered fund activities and investments; and
iii. The banking entity monitors for and
prohibits potential or actual material
exposure to high-risk assets or high-risk
trading strategies presented by its covered
fund activities and investments, taking into
account potential or actual exposure to:
A. Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
B. Assets whose changes in values cannot
be adequately mitigated by effective hedging;
C. New products with rapid growth,
including those that do not have a market
history;
D. Assets or strategies that include
significant embedded leverage;
E. Assets or strategies that have
demonstrated significant historical volatility;
F. Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
G. Assets or strategies that expose the
banking entity to large and significant
concentrations with respect to sectors, risk
factors, or counterparties;
4. Description and documentation of
covered fund activities and investments. For
each organizational unit engaged in covered
fund activities and investments, the banking
entity’s compliance program must document:
i. The covered fund activities and
investments that the unit is authorized to
conduct;
ii. The banking entity’s plan for actively
seeking unaffiliated investors to ensure that
any investment by the banking entity
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conforms to the limits contained in § 44.12 or
registered in compliance with the securities
laws and thereby exempt from those limits
within the time periods allotted in § 44.12;
and
iii. How it complies with the requirements
of subpart C.
5. Internal Controls. A banking entity must
establish, maintain, and enforce internal
controls that are reasonably designed to
ensure that its covered fund activities or
investments comply with the requirements of
section 13 of the BHC Act and this part and
are appropriate given the limits on risk
established by the banking entity. These
written internal controls must be reasonably
designed and established to effectively
monitor and identify for further analysis any
covered fund activity or investment that may
indicate potential violations of section 13 of
the BHC Act or this part. The internal
controls must, at a minimum require:
i. Monitoring and limiting the banking
entity’s individual and aggregate investments
in covered funds;
ii. Monitoring the amount and timing of
seed capital investments for compliance with
the limitations under subpart C (including
but not limited to the redemption, sale or
disposition requirements) of § 44.12, and the
effectiveness of efforts to seek unaffiliated
investors to ensure compliance with those
limits;
iii. Calculating the individual and
aggregate levels of ownership interests in one
or more covered fund required by § 44.12;
iv. Attributing the appropriate instruments
to the individual and aggregate ownership
interest calculations above;
v. Making disclosures to prospective and
actual investors in any covered fund
organized and offered or sponsored by the
banking entity, as provided under
§ 44.11(a)(8);
vi. Monitoring for and preventing any
relationship or transaction between the
banking entity and a covered fund that is
prohibited under § 44.14, including where
the banking entity has been designated as the
sponsor, investment manager, investment
adviser, or commodity trading advisor to a
covered fund by another banking entity; and
vii. Appropriate management review and
supervision across legal entities of the
banking entity to ensure that services and
products provided by all affiliated entities
comply with the limitation on services and
products contained in § 44.14.
6. Remediation of violations. The banking
entity’s compliance program must be
reasonably designed and established to
effectively monitor and identify for further
analysis any covered fund activity or
investment that may indicate potential
violations of section 13 of the BHC Act or
this part and to prevent actual violations of
section 13 of the BHC Act and this part. The
banking entity’s compliance program must
describe procedures for identifying and
remedying violations of section 13 of the
BHC Act and this part, and must include, at
a minimum, a requirement to promptly
document, address and remedy any violation
of section 13 of the BHC Act or this part,
including § 44.21, and document all
proposed and actual remediation efforts. The
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compliance program must include specific
written policies and procedures that are
reasonably designed to assess the extent to
which any activity or investment indicates
that modification to the banking entity’s
compliance program is warranted and to
ensure that appropriate modifications are
implemented. The written policies and
procedures must provide for prompt
notification to appropriate management,
including senior management and the board
of directors, of any material weakness or
significant deficiencies in the design or
implementation of the compliance program
of the banking entity.
III. Responsibility and Accountability for the
Compliance Program
a. A banking entity must establish,
maintain, and enforce a governance and
management framework to manage its
business and employees with a view to
preventing violations of section 13 of the
BHC Act and this part. A banking entity must
have an appropriate management framework
reasonably designed to ensure that:
Appropriate personnel are responsible and
accountable for the effective implementation
and enforcement of the compliance program;
a clear reporting line with a chain of
responsibility is delineated; and the
compliance program is reviewed periodically
by senior management. The board of
directors (or equivalent governance body)
and senior management should have the
appropriate authority and access to personnel
and information within the organizations as
well as appropriate resources to conduct
their oversight activities effectively.
1. Corporate governance. The banking
entity must adopt a written compliance
program approved by the board of directors,
an appropriate committee of the board, or
equivalent governance body, and senior
management.
2. Management procedures. The banking
entity must establish, maintain, and enforce
a governance framework that is reasonably
designed to achieve compliance with section
13 of the BHC Act and this part, which, at
a minimum, provides for:
i. The designation of appropriate senior
management or committee of senior
management with authority to carry out the
management responsibilities of the banking
entity for each trading desk and for each
organizational unit engaged in covered fund
activities;
ii. Written procedures addressing the
management of the activities of the banking
entity that are reasonably designed to achieve
compliance with section 13 of the BHC Act
and this part, including:
A. A description of the management
system, including the titles, qualifications,
and locations of managers and the specific
responsibilities of each person with respect
to the banking entity’s activities governed by
section 13 of the BHC Act and this part; and
B. Procedures for determining
compensation arrangements for traders
engaged in underwriting or market makingrelated activities under § 44.4 or riskmitigating hedging activities under § 44.5 so
that such compensation arrangements are
designed not to reward or incentivize
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prohibited proprietary trading and
appropriately balance risk and financial
results in a manner that does not encourage
employees to expose the banking entity to
excessive or imprudent risk.
3. Business line managers. Managers with
responsibility for one or more trading desks
of the banking entity are accountable for the
effective implementation and enforcement of
the compliance program with respect to the
applicable trading desk(s).
4. Board of directors, or similar corporate
body, and senior management. The board of
directors, or similar corporate body, and
senior management are responsible for
setting and communicating an appropriate
culture of compliance with section 13 of the
BHC Act and this part and ensuring that
appropriate policies regarding the
management of trading activities and covered
fund activities or investments are adopted to
comply with section 13 of the BHC Act and
this part. The board of directors or similar
corporate body (such as a designated
committee of the board or an equivalent
governance body) must ensure that senior
management is fully capable, qualified, and
properly motivated to manage compliance
with this part in light of the organization’s
business activities and the expectations of
the board of directors. The board of directors
or similar corporate body must also ensure
that senior management has established
appropriate incentives and adequate
resources to support compliance with this
part, including the implementation of a
compliance program meeting the
requirements of this appendix into
management goals and compensation
structures across the banking entity.
5. Senior management. Senior management
is responsible for implementing and
enforcing the approved compliance program.
Senior management must also ensure that
effective corrective action is taken when
failures in compliance with section 13 of the
BHC Act and this part are identified. Senior
management and control personnel charged
with overseeing compliance with section 13
of the BHC Act and this part should review
the compliance program for the banking
entity periodically and report to the board, or
an appropriate committee thereof, on the
effectiveness of the compliance program and
compliance matters with a frequency
appropriate to the size, scope, and risk
profile of the banking entity’s trading
activities and covered fund activities or
investments, which shall be at least annually.
6. CEO attestation. Based on a review by
the CEO of the banking entity, the CEO of the
banking entity must, annually, attest in
writing to the OCC that the banking entity
has in place processes to establish, maintain,
enforce, review, test and modify the
compliance program established under this
Appendix and § 44.20 of this part in a
manner reasonably designed to achieve
compliance with section 13 of the BHC Act
and this part. In the case of a U.S. branch or
agency of a foreign banking entity, the
attestation may be provided for the entire
U.S. operations of the foreign banking entity
by the senior management officer of the
United States operations of the foreign
banking entity who is located in the United
States.
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IV. Independent Testing
a. Independent testing must occur with a
frequency appropriate to the size, scope, and
risk profile of the banking entity’s trading
and covered fund activities or investments,
which shall be at least annually. This
independent testing must include an
evaluation of:
1. The overall adequacy and effectiveness
of the banking entity’s compliance program,
including an analysis of the extent to which
the program contains all the required
elements of this appendix;
2. The effectiveness of the banking entity’s
internal controls, including an analysis and
documentation of instances in which such
internal controls have been breached, and
how such breaches were addressed and
resolved; and
3. The effectiveness of the banking entity’s
management procedures.
b. A banking entity must ensure that
independent testing regarding the
effectiveness of the banking entity’s
compliance program is conducted by a
qualified independent party, such as the
banking entity’s internal audit department,
compliance personnel or risk managers
independent of the organizational unit being
tested, outside auditors, consultants, or other
qualified independent parties. A banking
entity must promptly take appropriate action
to remedy any significant deficiencies or
material weaknesses in its compliance
program and to terminate any violations of
section 13 of the BHC Act or this part.
V. Training
Banking entities must provide adequate
training to personnel and managers of the
banking entity engaged in activities or
investments governed by section 13 of the
BHC Act or this part, as well as other
appropriate supervisory, risk, independent
testing, and audit personnel, in order to
effectively implement and enforce the
compliance program. This training should
occur with a frequency appropriate to the
size and the risk profile of the banking
entity’s trading activities and covered fund
activities or investments.
VI. Recordkeeping
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Banking entities must create and retain
records sufficient to demonstrate compliance
and support the operations and effectiveness
of the compliance program. A banking entity
must retain these records for a period that is
no less than 5 years or such longer period as
required by the OCC in a form that allows it
to promptly produce such records to the OCC
on request.
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE
12 CFR Chapter II
Authority and Issuance
For the reasons stated in the Common
Preamble, the Board amends chapter I of
Title 12, Code of Federal Regulations as
follows:
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PART 248—PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS (Regulation VV)
16. The authority citation for part 248
continues to read as follows:
■
Authority: 12 U.S.C. 1851, 12 U.S.C. 221
et seq., 12 U.S.C. 1818, 12 U.S.C. 1841 et seq.,
and 12 U.S.C. 3103 et seq.
Subpart A—Authority and Definitions
17. Section 248.2 is revised to read as
follows:
■
§ 248.2
Definitions.
Unless otherwise specified, for
purposes of this part:
(a) Affiliate has the same meaning as
in section 2(k) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(k)).
(b) Bank holding company has the
same meaning as in section 2 of the
Bank Holding Company Act of 1956 (12
U.S.C. 1841).
(c) Banking entity. (1) Except as
provided in paragraph (c)(2) of this
section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an
insured depository institution;
(iii) Any company that is treated as a
bank holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any
entity described in paragraphs (c)(1)(i),
(ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a
banking entity under paragraph (c)(1)(i),
(ii), or (iii) of this section;
(ii) A portfolio company held under
the authority contained in section
4(k)(4)(H) or (I) of the BHC Act (12
U.S.C. 1843(k)(4)(H), (I)), or any
portfolio concern, as defined under 13
CFR 107.50, that is controlled by a small
business investment company, as
defined in section 103(3) of the Small
Business Investment Act of 1958 (15
U.S.C. 662), so long as the portfolio
company or portfolio concern is not
itself a banking entity under paragraph
(c)(1)(i), (ii), or (iii) of this section; or
(iii) The FDIC acting in its corporate
capacity or as conservator or receiver
under the Federal Deposit Insurance Act
or Title II of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
(d) Board means the Board of
Governors of the Federal Reserve
System.
(e) CFTC means the Commodity
Futures Trading Commission.
(f) Dealer has the same meaning as in
section 3(a)(5) of the Exchange Act (15
U.S.C. 78c(a)(5)).
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(g) Depository institution has the same
meaning as in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)).
(h) Derivative. (1) Except as provided
in paragraph (h)(2) of this section,
derivative means:
(i) Any swap, as that term is defined
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)), or
security-based swap, as that term is
defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68));
(ii) Any purchase or sale of a
commodity, that is not an excluded
commodity, for deferred shipment or
delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as
that term is defined in section 1a(24) of
the Commodity Exchange Act (7 U.S.C.
1a(24)) or foreign exchange swap (as
that term is defined in section 1a(25) of
the Commodity Exchange Act (7 U.S.C.
1a(25));
(iv) Any agreement, contract, or
transaction in foreign currency
described in section 2(c)(2)(C)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(C)(i));
(v) Any agreement, contract, or
transaction in a commodity other than
foreign currency described in section
2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under
section 19 of the Commodity Exchange
Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or
other agreement, contract, or transaction
that the CFTC and SEC have further
defined by joint regulation,
interpretation, or other action as not
within the definition of swap, as that
term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C.
1a(47)), or security-based swap, as that
term is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)); or
(ii) Any identified banking product, as
defined in section 402(b) of the Legal
Certainty for Bank Products Act of 2000
(7 U.S.C. 27(b)), that is subject to section
403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the
immediate family of the employee.
(j) Exchange Act means the Securities
Exchange Act of 1934 (15 U.S.C. 78a et
seq.).
(k) Excluded commodity has the same
meaning as in section 1a(19) of the
Commodity Exchange Act (7 U.S.C.
1a(19)).
(l) FDIC means the Federal Deposit
Insurance Corporation.
(m) Federal banking agencies means
the Board, the Office of the Comptroller
of the Currency, and the FDIC.
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(n) Foreign banking organization has
the same meaning as in § 211.21(o) of
the Board’s Regulation K (12 CFR
211.21(o)), but does not include a
foreign bank, as defined in section
1(b)(7) of the International Banking Act
of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the
Commonwealth of Puerto Rico, Guam,
American Samoa, the United States
Virgin Islands, or the Commonwealth of
the Northern Mariana Islands.
(o) Foreign insurance regulator means
the insurance commissioner, or a
similar official or agency, of any country
other than the United States that is
engaged in the supervision of insurance
companies under foreign insurance law.
(p) General account means all of the
assets of an insurance company except
those allocated to one or more separate
accounts.
(q) Insurance company means a
company that is organized as an
insurance company, primarily and
predominantly engaged in writing
insurance or reinsuring risks
underwritten by insurance companies,
subject to supervision as such by a state
insurance regulator or a foreign
insurance regulator, and not operated
for the purpose of evading the
provisions of section 13 of the BHC Act
(12 U.S.C. 1851).
(r) Insured depository institution has
the same meaning as in section 3(c) of
the Federal Deposit Insurance Act (12
U.S.C. 1813(c)), but does not include:
(1) An insured depository institution
that is described in section 2(c)(2)(D) of
the BHC Act (12 U.S.C. 1841(c)(2)(D));
or
(2) An insured depository institution
if it has, and if every company that
controls it has, total consolidated assets
of $10 billion or less and total trading
assets and trading liabilities, on a
consolidated basis, that are 5 percent or
less of total consolidated assets.
(s) Limited trading assets and
liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together
with its affiliates and subsidiaries,
trading assets and liabilities (excluding
trading assets and liabilities attributable
to trading activities permitted pursuant
to § 248.6(a)(1) and (2) of subpart B) the
average gross sum of which over the
previous consecutive four quarters, as
measured as of the last day of each of
the four previous calendar quarters, is
less than $1 billion; and
(ii) The Board has not determined
pursuant to § 248.20(g) or (h) of this part
that the banking entity should not be
treated as having limited trading assets
and liabilities.
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(2) With respect to a banking entity
other than a banking entity described in
paragraph (s)(3) of this section, trading
assets and liabilities for purposes of this
paragraph (s) means trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 248.6(a)(1) and (2) of subpart B) on a
worldwide consolidated basis.
(3)(i) With respect to a banking entity
that is a foreign banking organization or
a subsidiary of a foreign banking
organization, trading assets and
liabilities for purposes of this paragraph
(s) means the trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 248.6(a)(1) and (2) of subpart B) of the
combined U.S. operations of the top-tier
foreign banking organization (including
all subsidiaries, affiliates, branches, and
agencies of the foreign banking
organization operating, located, or
organized in the United States).
(ii) For purposes of paragraph (s)(3)(i)
of this section, a U.S. branch, agency, or
subsidiary of a banking entity is located
in the United States; however, the
foreign bank that operates or controls
that branch, agency, or subsidiary is not
considered to be located in the United
States solely by virtue of operating or
controlling the U.S. branch, agency, or
subsidiary. For purposes of paragraph
(s)(3)(i) of this section, all foreign
operations of a U.S. agency, branch, or
subsidiary of a foreign banking
organization are considered to be
located in the United States, including
branches outside the United States that
are managed or controlled by a U.S.
branch or agency of the foreign banking
organization, for purposes of calculating
the banking entity’s U.S. trading assets
and liabilities.
(t) Loan means any loan, lease,
extension of credit, or secured or
unsecured receivable that is not a
security or derivative.
(u) Moderate trading assets and
liabilities means, with respect to a
banking entity, that the banking entity
does not have significant trading assets
and liabilities or limited trading assets
and liabilities.
(v) Primary financial regulatory
agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act (12 U.S.C. 5301(12)).
(w) Purchase includes any contract to
buy, purchase, or otherwise acquire. For
security futures products, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a commodity future, purchase
includes any contract, agreement, or
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transaction for future delivery. With
respect to a derivative, purchase
includes the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(x) Qualifying foreign banking
organization means a foreign banking
organization that qualifies as such under
§ 211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c), or
(e)).
(y) SEC means the Securities and
Exchange Commission.
(z) Sale and sell each include any
contract to sell or otherwise dispose of.
For security futures products, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a commodity future, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a derivative, such terms
include the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(aa) Security has the meaning
specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(bb) Security-based swap dealer has
the same meaning as in section 3(a)(71)
of the Exchange Act (15 U.S.C.
78c(a)(71)).
(cc) Security future has the meaning
specified in section 3(a)(55) of the
Exchange Act (15 U.S.C. 78c(a)(55)).
(dd) Separate account means an
account established and maintained by
an insurance company in connection
with one or more insurance contracts to
hold assets that are legally segregated
from the insurance company’s other
assets, under which income, gains, and
losses, whether or not realized, from
assets allocated to such account, are, in
accordance with the applicable contract,
credited to or charged against such
account without regard to other income,
gains, or losses of the insurance
company.
(ee) Significant trading assets and
liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together
with its affiliates and subsidiaries,
trading assets and liabilities the average
gross sum of which over the previous
consecutive four quarters, as measured
as of the last day of each of the four
previous calendar quarters, equals or
exceeds $20 billion; or
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(ii) The Board has determined
pursuant to § 248.20(h) of this part that
the banking entity should be treated as
having significant trading assets and
liabilities.
(2) With respect to a banking entity,
other than a banking entity described in
paragraph (ee)(3) of this section, trading
assets and liabilities for purposes of this
paragraph (ee) means trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 248.6(a)(1) and (2) of subpart B) on a
worldwide consolidated basis.
(3)(i) With respect to a banking entity
that is a foreign banking organization or
a subsidiary of a foreign banking
organization, trading assets and
liabilities for purposes of this paragraph
(ee) means the trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 248.6(a)(1) and (2) of subpart B) of the
combined U.S. operations of the top-tier
foreign banking organization (including
all subsidiaries, affiliates, branches, and
agencies of the foreign banking
organization operating, located, or
organized in the United States as well
as branches outside the United States
that are managed or controlled by a
branch or agency of the foreign banking
entity operating, located or organized in
the United States).
(ii) For purposes of paragraph
(ee)(3)(i) of this section, a U.S. branch,
agency, or subsidiary of a banking entity
is located in the United States; however,
the foreign bank that operates or
controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary. For
purposes of paragraph (ee)(3)(i) of this
section, all foreign operations of a U.S.
agency, branch, or subsidiary of a
foreign banking organization are
considered to be located in the United
States for purposes of calculating the
banking entity’s U.S. trading assets and
liabilities.
(ff) State means any State, the District
of Columbia, the Commonwealth of
Puerto Rico, Guam, American Samoa,
the United States Virgin Islands, and the
Commonwealth of the Northern Mariana
Islands.
(gg) Subsidiary has the same meaning
as in section 2(d) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(d)).
(hh) State insurance regulator means
the insurance commissioner, or a
similar official or agency, of a State that
is engaged in the supervision of
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insurance companies under State
insurance law.
(ii) Swap dealer has the same meaning
as in section 1(a)(49) of the Commodity
Exchange Act (7 U.S.C. 1a(49)).
Subpart B—Proprietary Trading
18. Section 248.3 is amended by:
a. Revising paragraphs (b) and (d)(3),
(8), and (9);
■ b. Adding paragraphs (d)(10) through
(13);
■ c. Redesignating paragraphs (e)(5)
through (13) as paragraphs (e)(6)
through (14);
■ d. Adding new paragraph (e)(5); and
■ e. Revising newly redesignated
paragraphs (e)(11), (12), and (14).
The revisions and additions read as
follows:
■
■
§ 248.3
Prohibition on proprietary trading.
*
*
*
*
*
(b) Definition of trading account. (1)
Trading account. Trading account
means:
(i) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments principally
for the purpose of short-term resale,
benefitting from actual or expected
short-term price movements, realizing
short-term arbitrage profits, or hedging
one or more of the positions resulting
from the purchases or sales of financial
instruments described in this paragraph;
(ii) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments that are both
market risk capital rule covered
positions and trading positions (or
hedges of other market risk capital rule
covered positions), if the banking entity,
or any affiliate with which the banking
entity is consolidated for regulatory
reporting purposes, calculates riskbased capital ratios under the market
risk capital rule; or
(iii) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments, if the
banking entity:
(A) Is licensed or registered, or is
required to be licensed or registered, to
engage in the business of a dealer, swap
dealer, or security-based swap dealer, to
the extent the instrument is purchased
or sold in connection with the activities
that require the banking entity to be
licensed or registered as such; or
(B) Is engaged in the business of a
dealer, swap dealer, or security-based
swap dealer outside of the United
States, to the extent the instrument is
purchased or sold in connection with
the activities of such business.
(2) Trading account application for
certain banking entities. (i) A banking
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entity that is subject to paragraph
(b)(1)(ii) of this section in determining
the scope of its trading account is not
subject to paragraph (b)(1)(i) of this
section.
(ii) A banking entity that does not
calculate risk-based capital ratios under
the market risk capital rule and is not
a consolidated affiliate for regulatory
reporting purposes of a banking entity
that calculates risk based capital ratios
under the market risk capital rule may
elect to apply paragraph (b)(1)(ii) of this
section in determining the scope of its
trading account as if it were subject to
that paragraph. A banking entity that
elects under this subsection to apply
paragraph (b)(1)(ii) of this section in
determining the scope of its trading
account as if it were subject to that
paragraph is not required to apply
paragraph (b)(1)(i) of this section.
(3) Consistency of account election for
certain banking entities. (i) Any election
or change to an election under
paragraph (b)(2)(ii) of this section must
apply to the electing banking entity and
all of its wholly owned subsidiaries.
The primary financial regulatory agency
of a banking entity that is affiliated with
but is not a wholly owned subsidiary of
such electing banking entity may
require that the banking entity be
subject to this uniform application
requirement if the primary financial
regulatory agency determines that it is
necessary to prevent evasion of the
requirements of this part after notice
and opportunity for response as
provided in subpart D of this part.
(ii) A banking entity that does not
elect under paragraph (b)(2)(ii) of this
section to be subject to the trading
account definition in (b)(1)(ii) may
continue to apply the trading account
definition in paragraph (b)(1)(i) of this
section for one year from the date on
which it becomes, or becomes a
consolidated affiliate for regulatory
reporting purposes with, a banking
entity that calculates risk-based capital
ratios under the market risk capital rule.
(4) Rebuttable presumption for certain
purchases and sales. The purchase (or
sale) of a financial instrument by a
banking entity shall be presumed not to
be for the trading account of the banking
entity under paragraph (b)(1)(i) of this
section if the banking entity holds the
financial instrument for sixty days or
longer and does not transfer
substantially all of the risk of the
financial instrument within sixty days
of the purchase (or sale).
*
*
*
*
*
(d) * * *
(3) Any purchase or sale of a security,
foreign exchange forward (as that term
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is defined in section 1a(24) of the
Commodity Exchange Act (7 U.S.C.
1a(24)), foreign exchange swap (as that
term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C.
1a(25)), or cross-currency swap by a
banking entity for the purpose of
liquidity management in accordance
with a documented liquidity
management plan of the banking entity
that:
(i) Specifically contemplates and
authorizes the particular financial
instruments to be used for liquidity
management purposes, the amount,
types, and risks of these financial
instruments that are consistent with
liquidity management, and the liquidity
circumstances in which the particular
financial instruments may or must be
used;
(ii) Requires that any purchase or sale
of financial instruments contemplated
and authorized by the plan be
principally for the purpose of managing
the liquidity of the banking entity, and
not for the purpose of short-term resale,
benefitting from actual or expected
short-term price movements, realizing
short-term arbitrage profits, or hedging a
position taken for such short-term
purposes;
(iii) Requires that any financial
instruments purchased or sold for
liquidity management purposes be
highly liquid and limited to financial
instruments the market, credit, and
other risks of which the banking entity
does not reasonably expect to give rise
to appreciable profits or losses as a
result of short-term price movements;
(iv) Limits any financial instruments
purchased or sold for liquidity
management purposes, together with
any other financial instruments
purchased or sold for such purposes, to
an amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan;
(v) Includes written policies and
procedures, internal controls, analysis,
and independent testing to ensure that
the purchase and sale of financial
instruments that are not permitted
under § 248.6(a) or (b) of this subpart are
for the purpose of liquidity management
and in accordance with the liquidity
management plan described in this
paragraph (d)(3); and
(vi) Is consistent with the Board’s
supervisory requirements regarding
liquidity management;
*
*
*
*
*
(8) Any purchase or sale of one or
more financial instruments by a banking
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entity through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity that is
established and administered in
accordance with the law of the United
States or a foreign sovereign, if the
purchase or sale is made directly or
indirectly by the banking entity as
trustee for the benefit of persons who
are or were employees of the banking
entity;
(9) Any purchase or sale of one or
more financial instruments by a banking
entity in the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the financial instrument
as soon as practicable, and in no event
may the banking entity retain such
instrument for longer than such period
permitted by the Board;
(10) Any purchase or sale of one or
more financial instruments that was
made in error by a banking entity in the
course of conducting a permitted or
excluded activity or is a subsequent
transaction to correct such an error;
(11) Contemporaneously entering into
a customer-driven swap or customerdriven security-based swap and a
matched swap or security-based swap if:
(i) The banking entity retains no more
than minimal price risk; and
(ii) The banking entity is not a
registered dealer, swap dealer, or
security-based swap dealer;
(12) Any purchase or sale of one or
more financial instruments that the
banking entity uses to hedge mortgage
servicing rights or mortgage servicing
assets in accordance with a documented
hedging strategy; or
(13) Any purchase or sale of a
financial instrument that does not meet
the definition of trading asset or trading
liability under the applicable reporting
form for a banking entity as of January
1, 2020.
(e) * * *
(5) Cross-currency swap means a swap
in which one party exchanges with
another party principal and interest rate
payments in one currency for principal
and interest rate payments in another
currency, and the exchange of principal
occurs on the date the swap is entered
into, with a reversal of the exchange of
principal at a later date that is agreed
upon when the swap is entered into.
*
*
*
*
*
(11) Market risk capital rule covered
position and trading position means a
financial instrument that meets the
criteria to be a covered position and a
trading position, as those terms are
respectively defined, without regard to
whether the financial instrument is
reported as a covered position or trading
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position on any applicable regulatory
reporting forms:
(i) In the case of a banking entity that
is a bank holding company, savings and
loan holding company, or insured
depository institution, under the market
risk capital rule that is applicable to the
banking entity; and
(ii) In the case of a banking entity that
is affiliated with a bank holding
company or savings and loan holding
company, other than a banking entity to
which a market risk capital rule is
applicable, under the market risk capital
rule that is applicable to the affiliated
bank holding company or savings and
loan holding company.
(12) Market risk capital rule means
the market risk capital rule that is
contained in 12 CFR part 3 with respect
to a banking entity for which the OCC
is the primary financial regulatory
agency, 12 CFR part 217 with respect to
a banking entity for which the Board is
the primary financial regulatory agency,
or 12 CFR part 324 with respect to a
banking entity for which the FDIC is the
primary financial regulatory agency.
*
*
*
*
*
(14) Trading desk means a unit of
organization of a banking entity that
purchases or sells financial instruments
for the trading account of the banking
entity or an affiliate thereof that is:
(i)(A) Structured by the banking entity
to implement a well-defined business
strategy;
(B) Organized to ensure appropriate
setting, monitoring, and management
review of the desk’s trading and hedging
limits, current and potential future loss
exposures, and strategies; and
(C) Characterized by a clearly defined
unit that:
(1) Engages in coordinated trading
activity with a unified approach to its
key elements;
(2) Operates subject to a common and
calibrated set of risk metrics, risk levels,
and joint trading limits;
(3) Submits compliance reports and
other information as a unit for
monitoring by management; and
(4) Books its trades together; or
(ii) For a banking entity that
calculates risk-based capital ratios
under the market risk capital rule, or a
consolidated affiliate for regulatory
reporting purposes of a banking entity
that calculates risk-based capital ratios
under the market risk capital rule,
established by the banking entity or its
affiliate for purposes of market risk
capital calculations under the market
risk capital rule.
■ 19. Section 248.4 is revised to read as
follows:
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§ 248.4 Permitted underwriting and market
making-related activities.
(a) Underwriting activities—(1)
Permitted underwriting activities. The
prohibition contained in § 248.3(a) does
not apply to a banking entity’s
underwriting activities conducted in
accordance with this paragraph (a).
(2) Requirements. The underwriting
activities of a banking entity are
permitted under paragraph (a)(1) of this
section only if:
(i) The banking entity is acting as an
underwriter for a distribution of
securities and the trading desk’s
underwriting position is related to such
distribution;
(ii)(A) The amount and type of the
securities in the trading desk’s
underwriting position are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, taking into account the
liquidity, maturity, and depth of the
market for the relevant types of
securities; and
(B) Reasonable efforts are made to sell
or otherwise reduce the underwriting
position within a reasonable period,
taking into account the liquidity,
maturity, and depth of the market for
the relevant types of securities;
(iii) In the case of a banking entity
with significant trading assets and
liabilities, the banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (a)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The products, instruments or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
(B) Limits for each trading desk, in
accordance with paragraph (a)(2)(ii)(A)
of this section;
(C) Written authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
and
(D) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits.
(iv) A banking entity with significant
trading assets and liabilities may satisfy
the requirements in paragraphs
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(a)(2)(iii)(B) and (C) of this section by
complying with the requirements set
forth in paragraph (c) of this section;
(v) The compensation arrangements of
persons performing the activities
described in this paragraph (a) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in the activity
described in this paragraph (a) in
accordance with applicable law.
(3) Definition of distribution. For
purposes of this paragraph (a), a
distribution of securities means:
(i) An offering of securities, whether
or not subject to registration under the
Securities Act of 1933, that is
distinguished from ordinary trading
transactions by the presence of special
selling efforts and selling methods; or
(ii) An offering of securities made
pursuant to an effective registration
statement under the Securities Act of
1933.
(4) Definition of underwriter. For
purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an
issuer or selling security holder to:
(A) Purchase securities from the
issuer or selling security holder for
distribution;
(B) Engage in a distribution of
securities for or on behalf of the issuer
or selling security holder; or
(C) Manage a distribution of securities
for or on behalf of the issuer or selling
security holder; or
(ii) A person who has agreed to
participate or is participating in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.
(5) Definition of selling security
holder. For purposes of this paragraph
(a), selling security holder means any
person, other than an issuer, on whose
behalf a distribution is made.
(6) Definition of underwriting
position. For purposes of this section,
underwriting position means the long or
short positions in one or more securities
held by a banking entity or its affiliate,
and managed by a particular trading
desk, in connection with a particular
distribution of securities for which such
banking entity or affiliate is acting as an
underwriter.
(7) Definition of client, customer, and
counterparty. For purposes of this
paragraph (a), the terms client,
customer, and counterparty, on a
collective or individual basis, refer to
market participants that may transact
with the banking entity in connection
with a particular distribution for which
the banking entity is acting as
underwriter.
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(b) Market making-related activities—
(1) Permitted market making-related
activities. The prohibition contained in
§ 248.3(a) does not apply to a banking
entity’s market making-related activities
conducted in accordance with this
paragraph (b).
(2) Requirements. The market makingrelated activities of a banking entity are
permitted under paragraph (b)(1) of this
section only if:
(i) The trading desk that establishes
and manages the financial exposure,
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure, and is willing and available to
quote, purchase and sell, or otherwise
enter into long and short positions in
those types of financial instruments for
its own account, in commercially
reasonable amounts and throughout
market cycles on a basis appropriate for
the liquidity, maturity, and depth of the
market for the relevant types of financial
instruments;
(ii) The trading desk’s market-making
related activities are designed not to
exceed, on an ongoing basis, the
reasonably expected near term demands
of clients, customers, or counterparties,
taking into account the liquidity,
maturity, and depth of the market for
the relevant types of financial
instruments;
(iii) In the case of a banking entity
with significant trading assets and
liabilities, the banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of this paragraph
(b), including reasonably designed
written policies and procedures,
internal controls, analysis and
independent testing identifying and
addressing:
(A) The financial instruments each
trading desk stands ready to purchase
and sell in accordance with paragraph
(b)(2)(i) of this section;
(B) The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the limits
required under paragraph (b)(2)(iii)(C) of
this section; the products, instruments,
and exposures each trading desk may
use for risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and
positions; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
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desk to mitigate these risks are and
continue to be effective;
(C) Limits for each trading desk, in
accordance with paragraph (b)(2)(ii) of
this section;
(D) Written authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
and
(E) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits.
(iv) A banking entity with significant
trading assets and liabilities may satisfy
the requirements in paragraphs
(b)(2)(iii)(C) and (D) of this section by
complying with the requirements set
forth in paragraph (c) of this section.
(v) The compensation arrangements of
persons performing the activities
described in this paragraph (b) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in activity
described in this paragraph (b) in
accordance with applicable law.
(3) Definition of client, customer, and
counterparty. For purposes of this
paragraph (b), the terms client,
customer, and counterparty, on a
collective or individual basis refer to
market participants that make use of the
banking entity’s market making-related
services by obtaining such services,
responding to quotations, or entering
into a continuing relationship with
respect to such services, provided that:
(i) A trading desk or other
organizational unit of another banking
entity is not a client, customer, or
counterparty of the trading desk if that
other entity has trading assets and
liabilities of $50 billion or more as
measured in accordance with the
methodology described in § 248.2(ee) of
this part, unless:
(A) The trading desk documents how
and why a particular trading desk or
other organizational unit of the entity
should be treated as a client, customer,
or counterparty of the trading desk for
purposes of paragraph (b)(2) of this
section; or
(B) The purchase or sale by the
trading desk is conducted anonymously
on an exchange or similar trading
facility that permits trading on behalf of
a broad range of market participants.
(ii) [Reserved]
(4) Definition of financial exposure.
For purposes of this section, financial
exposure means the aggregate risks of
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one or more financial instruments and
any associated loans, commodities, or
foreign exchange or currency, held by a
banking entity or its affiliate and
managed by a particular trading desk as
part of the trading desk’s market
making-related activities.
(5) Definition of market-maker
positions. For the purposes of this
section, market-maker positions means
all of the positions in the financial
instruments for which the trading desk
stands ready to make a market in
accordance with paragraph (b)(2)(i) of
this section, that are managed by the
trading desk, including the trading
desk’s open positions or exposures
arising from open transactions.
(c) Rebuttable presumption of
compliance—(1) Internal limits. (i) A
banking entity shall be presumed to
meet the requirement in paragraph
(a)(2)(ii)(A) or (b)(2)(ii) of this section
with respect to the purchase or sale of
a financial instrument if the banking
entity has established and implements,
maintains, and enforces the internal
limits for the relevant trading desk as
described in paragraph (c)(1)(ii) of this
section.
(ii)(A) With respect to underwriting
activities conducted pursuant to
paragraph (a) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall be available
to each trading desk that establishes,
implements, maintains, and enforces
internal limits that should take into
account the liquidity, maturity, and
depth of the market for the relevant
types of securities and are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, based on the nature and
amount of the trading desk’s
underwriting activities, on the:
(1) Amount, types, and risk of its
underwriting position;
(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held.
(B) With respect to market makingrelated activities conducted pursuant to
paragraph (b) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall be available
to each trading desk that establishes,
implements, maintains, and enforces
internal limits that should take into
account the liquidity, maturity, and
depth of the market for the relevant
types of financial instruments and are
designed not to exceed the reasonably
expected near term demands of clients,
customers, or counterparties, based on
the nature and amount of the trading
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desk’s market-making related activities,
that address the:
(1) Amount, types, and risks of its
market-maker positions;
(2) Amount, types, and risks of the
products, instruments, and exposures
the trading desk may use for risk
management purposes;
(3) Level of exposures to relevant risk
factors arising from its financial
exposure; and
(4) Period of time a financial
instrument may be held.
(2) Supervisory review and oversight.
The limits described in paragraph (c)(1)
of this section shall be subject to
supervisory review and oversight by the
Board on an ongoing basis.
(3) Limit breaches and increases. (i)
With respect to any limit set pursuant
to paragraph (c)(1)(ii)(A) or (B) of this
section, a banking entity shall maintain
and make available to the Board upon
request records regarding:
(A) Any limit that is exceeded; and
(B) Any temporary or permanent
increase to any limit(s), in each case in
the form and manner as directed by the
Board.
(ii) In the event of a breach or increase
of any limit set pursuant to paragraph
(c)(1)(ii)(A) or (B) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall continue to
be available only if the banking entity:
(A) Takes action as promptly as
possible after a breach to bring the
trading desk into compliance; and
(B) Follows established written
authorization procedures, including
escalation procedures that require
review and approval of any trade that
exceeds a trading desk’s limit(s),
demonstrable analysis of the basis for
any temporary or permanent increase to
a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval.
(4) Rebutting the presumption. The
presumption in paragraph (c)(1)(i) of
this section may be rebutted by the
Board if the Board determines, taking
into account the liquidity, maturity, and
depth of the market for the relevant
types of financial instruments and based
on all relevant facts and circumstances,
that a trading desk is engaging in
activity that is not based on the
reasonably expected near term demands
of clients, customers, or counterparties.
The Board’s rebuttal of the presumption
in paragraph (c)(1)(i) must be made in
accordance with the notice and
response procedures in subpart D of this
part.
■ 20. Section 248.5 is amended by
revising paragraphs (b) and (c)(1)
introductory text and adding paragraph
(c)(4) to read as follows:
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§ 248.5 Permitted risk-mitigating hedging
activities.
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*
*
*
*
*
(b) Requirements. (1) The riskmitigating hedging activities of a
banking entity that has significant
trading assets and liabilities are
permitted under paragraph (a) of this
section only if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures regarding the
positions, techniques and strategies that
may be used for hedging, including
documentation indicating what
positions, contracts or other holdings a
particular trading desk may use in its
risk-mitigating hedging activities, as
well as position and aging limits with
respect to such positions, contracts or
other holdings;
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(C) The conduct of analysis and
independent testing designed to ensure
that the positions, techniques and
strategies that may be used for hedging
may reasonably be expected to reduce or
otherwise significantly mitigate the
specific, identifiable risk(s) being
hedged;
(ii) The risk-mitigating hedging
activity:
(A) Is conducted in accordance with
the written policies, procedures, and
internal controls required under this
section;
(B) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks, including
market risk, counterparty or other credit
risk, currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section;
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(D) Is subject to continuing review,
monitoring and management by the
banking entity that:
(1) Is consistent with the written
hedging policies and procedures
required under paragraph (b)(1)(i) of this
section;
(2) Is designed to reduce or otherwise
significantly mitigate the specific,
identifiable risks that develop over time
from the risk-mitigating hedging
activities undertaken under this section
and the underlying positions, contracts,
and other holdings of the banking
entity, based upon the facts and
circumstances of the underlying and
hedging positions, contracts and other
holdings of the banking entity and the
risks and liquidity thereof; and
(3) Requires ongoing recalibration of
the hedging activity by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(1)(ii) of this section and is
not prohibited proprietary trading; and
(iii) The compensation arrangements
of persons performing risk-mitigating
hedging activities are designed not to
reward or incentivize prohibited
proprietary trading.
(2) The risk-mitigating hedging
activities of a banking entity that does
not have significant trading assets and
liabilities are permitted under paragraph
(a) of this section only if the riskmitigating hedging activity:
(i) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks, including
market risk, counterparty or other credit
risk, currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to
ongoing recalibration by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(2) of this section and is
not prohibited proprietary trading.
(c) * * *
(1) A banking entity that has
significant trading assets and liabilities
must comply with the requirements of
paragraphs (c)(2) and (3) of this section,
unless the requirements of paragraph
(c)(4) of this section are met, with
respect to any purchase or sale of
financial instruments made in reliance
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62135
on this section for risk-mitigating
hedging purposes that is:
*
*
*
*
*
(4) The requirements of paragraphs
(c)(2) and (3) of this section do not
apply to the purchase or sale of a
financial instrument described in
paragraph (c)(1) of this section if:
(i) The financial instrument
purchased or sold is identified on a
written list of pre-approved financial
instruments that are commonly used by
the trading desk for the specific type of
hedging activity for which the financial
instrument is being purchased or sold;
and
(ii) At the time the financial
instrument is purchased or sold, the
hedging activity (including the purchase
or sale of the financial instrument)
complies with written, pre-approved
limits for the trading desk purchasing or
selling the financial instrument for
hedging activities undertaken for one or
more other trading desks. The limits
shall be appropriate for the:
(A) Size, types, and risks of the
hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased
and sold for hedging activities by the
trading desk; and
(C) Levels and duration of the risk
exposures being hedged.
■ 21. Section 248.6 is amended by
revising paragraph (e)(3), removing
paragraphs (e)(4) and (6), and
redesignating paragraph (e)(5) as
paragraph (e)(4).
The revision reads as follows:
§ 248.6 Other permitted proprietary trading
activities.
*
*
*
*
*
(e) * * *
(3) A purchase or sale by a banking
entity is permitted for purposes of this
paragraph (e) if:
(i) The banking entity engaging as
principal in the purchase or sale
(including relevant personnel) is not
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State; and
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
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States or organized under the laws of
the United States or of any State.
*
*
*
*
*
Subpart C—Covered Funds Activities
and Investments
§ 248.12
22. Section 248.10 is amended by
revising paragraphs (c)(7)(ii) and
(c)(8)(i)(A) to read as follows:
■
*
*
*
*
*
(c) * * *
(7) * * *
(ii) Participates in the profits and
losses of the separate account other than
in compliance with applicable
requirements regarding bank owned life
insurance.
(8) * * *
(i) * * *
(A) Loans as defined in § 248.2(t) of
subpart A;
*
*
*
*
*
■ 23. Section 248.11 is amended by
revising paragraph (c) to read as follows:
§ 248.11 Permitted organizing and
offering, underwriting, and market making
with respect to a covered fund.
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*
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*
(c) Underwriting and market making
in ownership interests of a covered
fund. The prohibition contained in
§ 248.10(a) does not apply to a banking
entity’s underwriting activities or
market making-related activities
involving a covered fund so long as:
(1) Those activities are conducted in
accordance with the requirements of
§ 248.4(a) or (b), respectively; and
(2) With respect to any banking entity
(or any affiliate thereof) that: Acts as a
sponsor, investment adviser or
commodity trading advisor to a
particular covered fund or otherwise
acquires and retains an ownership
interest in such covered fund in reliance
on paragraph (a) of this section; or
acquires and retains an ownership
interest in such covered fund and is
either a securitizer, as that term is used
in section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)), or is acquiring
and retaining an ownership interest in
such covered fund in compliance with
section 15G of that Act (15 U.S.C.78o–
11) and the implementing regulations
issued thereunder each as permitted by
paragraph (b) of this section, then in
each such case any ownership interests
acquired or retained by the banking
entity and its affiliates in connection
with underwriting and market making
related activities for that particular
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[Amended]
24. Section 248.12 is amended by
redesignating the second instance of
paragraph (e)(2)(vi) as paragraph
(e)(2)(vii).
■ 25. Section 248.13 is amended by
revising paragraphs (a), (b)(3) and (4),
and (c) to read as follows:
■
§ 248.10 Prohibition on Acquiring or
Retaining an Ownership Interest in and
Having Certain Relationships with a
Covered Fund.
*
covered fund are included in the
calculation of ownership interests
permitted to be held by the banking
entity and its affiliates under the
limitations of § 248.12(a)(2)(ii) and (iii)
and (d).
§ 248.13 Other permitted covered fund
activities and investments.
(a) Permitted risk-mitigating hedging
activities. (1) The prohibition contained
in § 248.10(a) does not apply with
respect to an ownership interest in a
covered fund acquired or retained by a
banking entity that is designed to reduce
or otherwise significantly mitigate the
specific, identifiable risks to the banking
entity in connection with:
(i) A compensation arrangement with
an employee of the banking entity or an
affiliate thereof that directly provides
investment advisory, commodity trading
advisory or other services to the covered
fund; or
(ii) A position taken by the banking
entity when acting as intermediary on
behalf of a customer that is not itself a
banking entity to facilitate the exposure
by the customer to the profits and losses
of the covered fund.
(2) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under this paragraph (a) only
if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program in
accordance with subpart D of this part
that is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures; and
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(ii) The acquisition or retention of the
ownership interest:
(A) Is made in accordance with the
written policies, procedures, and
internal controls required under this
section;
(B) At the inception of the hedge, is
designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks arising:
(1) Out of a transaction conducted
solely to accommodate a specific
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customer request with respect to the
covered fund; or
(2) In connection with the
compensation arrangement with the
employee that directly provides
investment advisory, commodity trading
advisory, or other services to the
covered fund;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section; and
(D) Is subject to continuing review,
monitoring and management by the
banking entity.
(iii) With respect to risk-mitigating
hedging activity conducted pursuant to
paragraph (a)(1)(i), the compensation
arrangement relates solely to the
covered fund in which the banking
entity or any affiliate has acquired an
ownership interest pursuant to
paragraph (a)(1)(i) and such
compensation arrangement provides
that any losses incurred by the banking
entity on such ownership interest will
be offset by corresponding decreases in
amounts payable under such
compensation arrangement.
(b) * * *
(3) An ownership interest in a covered
fund is not offered for sale or sold to a
resident of the United States for
purposes of paragraph (b)(1)(iii) of this
section only if it is not sold and has not
been sold pursuant to an offering that
targets residents of the United States in
which the banking entity or any affiliate
of the banking entity participates. If the
banking entity or an affiliate sponsors or
serves, directly or indirectly, as the
investment manager, investment
adviser, commodity pool operator or
commodity trading advisor to a covered
fund, then the banking entity or affiliate
will be deemed for purposes of this
paragraph (b)(3) to participate in any
offer or sale by the covered fund of
ownership interests in the covered fund.
(4) An activity or investment occurs
solely outside of the United States for
purposes of paragraph (b)(1)(iv) of this
section only if:
(i) The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
and is not controlled directly or
indirectly by, a banking entity that is
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
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laws of the United States or of any State;
and
(iii) The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
as principal directly or indirectly on a
consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State.
*
*
*
*
*
(c) Permitted covered fund interests
and activities by a regulated insurance
company. The prohibition contained in
§ 248.10(a) of this subpart does not
apply to the acquisition or retention by
an insurance company, or an affiliate
thereof, of any ownership interest in, or
the sponsorship of, a covered fund only
if:
(1) The insurance company or its
affiliate acquires and retains the
ownership interest solely for the general
account of the insurance company or for
one or more separate accounts
established by the insurance company;
(2) The acquisition and retention of
the ownership interest is conducted in
compliance with, and subject to, the
insurance company investment laws
and regulations of the State or
jurisdiction in which such insurance
company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law or
regulation described in paragraph (c)(2)
of this section is insufficient to protect
the safety and soundness of the banking
entity, or the financial stability of the
United States.
■ 26. Section 248.14 is amended by
revising paragraph (a)(2)(ii)(B) to read as
follows:
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§ 248.14 Limitations on relationships with
a covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or
equivalent officer) of the banking entity
certifies in writing annually no later
than March 31 to the Board (with a duty
to update the certification if the
information in the certification
materially changes) that the banking
entity does not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests; and
*
*
*
*
*
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Subpart D—Compliance Program
Requirement; Violations
27. Section 248.20 is amended by
revising paragraphs (a), (b) introductory
text, (c), (d), (e) introductory text, and
(f)(2) and adding paragraphs (g), (h), and
(i) to read as follows:
■
§ 248.20 Program for compliance;
reporting.
(a) Program requirement. Each
banking entity (other than a banking
entity with limited trading assets and
liabilities) shall develop and provide for
the continued administration of a
compliance program reasonably
designed to ensure and monitor
compliance with the prohibitions and
restrictions on proprietary trading and
covered fund activities and investments
set forth in section 13 of the BHC Act
and this part. The terms, scope, and
detail of the compliance program shall
be appropriate for the types, size, scope,
and complexity of activities and
business structure of the banking entity.
(b) Banking entities with significant
trading assets and liabilities. With
respect to a banking entity with
significant trading assets and liabilities,
the compliance program required by
paragraph (a) of this section, at a
minimum, shall include:
*
*
*
*
*
(c) CEO attestation. The CEO of a
banking entity that has significant
trading assets and liabilities must, based
on a review by the CEO of the banking
entity, attest in writing to the Board,
each year no later than March 31, that
the banking entity has in place
processes to establish, maintain,
enforce, review, test and modify the
compliance program required by
paragraph (b) of this section in a manner
reasonably designed to achieve
compliance with section 13 of the BHC
Act and this part. In the case of a U.S.
branch or agency of a foreign banking
entity, the attestation may be provided
for the entire U.S. operations of the
foreign banking entity by the senior
management officer of the U.S.
operations of the foreign banking entity
who is located in the United States.
(d) Reporting requirements under
appendix A to this part. (1) A banking
entity engaged in proprietary trading
activity permitted under subpart B shall
comply with the reporting requirements
described in appendix A to this part, if:
(i) The banking entity has significant
trading assets and liabilities; or
(ii) The Board notifies the banking
entity in writing that it must satisfy the
reporting requirements contained in
appendix A to this part.
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62137
(2) Frequency of reporting: Unless the
Board notifies the banking entity in
writing that it must report on a different
basis, a banking entity subject to
appendix A to this part shall report the
information required by appendix A for
each quarter within 30 days of the end
of the quarter.
(e) Additional documentation for
covered funds. A banking entity with
significant trading assets and liabilities
shall maintain records that include:
*
*
*
*
*
(f) * * *
(2) Banking entities with moderate
trading assets and liabilities. A banking
entity with moderate trading assets and
liabilities may satisfy the requirements
of this section by including in its
existing compliance policies and
procedures appropriate references to the
requirements of section 13 of the BHC
Act and this part and adjustments as
appropriate given the activities, size,
scope, and complexity of the banking
entity.
(g) Rebuttable presumption of
compliance for banking entities with
limited trading assets and liabilities—
(1) Rebuttable presumption. Except as
otherwise provided in this paragraph, a
banking entity with limited trading
assets and liabilities shall be presumed
to be compliant with subpart B and
subpart C of this part and shall have no
obligation to demonstrate compliance
with this part on an ongoing basis.
(2) Rebuttal of presumption. If upon
examination or audit, the Board
determines that the banking entity has
engaged in proprietary trading or
covered fund activities that are
otherwise prohibited under subpart B or
subpart C of this part, the Board may
require the banking entity to be treated
under this part as if it did not have
limited trading assets and liabilities.
The Board’s rebuttal of the presumption
in this paragraph must be made in
accordance with the notice and
response procedures in paragraph (i) of
this section.
(h) Reservation of authority.
Notwithstanding any other provision of
this part, the Board retains its authority
to require a banking entity without
significant trading assets and liabilities
to apply any requirements of this part
that would otherwise apply if the
banking entity had significant or
moderate trading assets and liabilities if
the Board determines that the size or
complexity of the banking entity’s
trading or investment activities, or the
risk of evasion of subpart B or subpart
C of this part, does not warrant a
presumption of compliance under
paragraph (g) of this section or treatment
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as a banking entity with moderate
trading assets and liabilities, as
applicable. The Board’s exercise of this
reservation of authority must be made in
accordance with the notice and
response procedures in paragraph (i) of
this section.
(i) Notice and response procedures—
(1) Notice. The Board will notify the
banking entity in writing of any
determination requiring notice under
this part and will provide an
explanation of the determination.
(2) Response. The banking entity may
respond to any or all items in the notice
described in paragraph (i)(1) of this
section. The response should include
any matters that the banking entity
would have the Board consider in
deciding whether to make the
determination. The response must be in
writing and delivered to the designated
Board official within 30 days after the
date on which the banking entity
received the notice. The Board may
shorten the time period when, in the
opinion of the Board, the activities or
condition of the banking entity so
requires, provided that the banking
entity is informed of the time period at
the time of notice, or with the consent
of the banking entity. In its discretion,
the Board may extend the time period
for good cause.
(3) Waiver. Failure to respond within
30 days or such other time period as
may be specified by the Board shall
constitute a waiver of any objections to
the Board’s determination.
(4) Decision. The Board will notify the
banking entity of the decision in
writing. The notice will include an
explanation of the decision.
■ 28. Revise appendix A to part 248 to
read as follows:
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Appendix A to Part 248—Reporting and
Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and
recordkeeping requirements that certain
banking entities must satisfy in connection
with the restrictions on proprietary trading
set forth in subpart B (‘‘proprietary trading
restrictions’’). Pursuant to § 248.20(d), this
appendix applies to a banking entity that,
together with its affiliates and subsidiaries,
has significant trading assets and liabilities.
These entities are required to (i) furnish
periodic reports to the Board regarding a
variety of quantitative measurements of their
covered trading activities, which vary
depending on the scope and size of covered
trading activities, and (ii) create and maintain
records documenting the preparation and
content of these reports. The requirements of
this appendix must be incorporated into the
banking entity’s internal compliance program
under § 248.20.
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b. The purpose of this appendix is to assist
banking entities and the Board in:
(1) Better understanding and evaluating the
scope, type, and profile of the banking
entity’s covered trading activities;
(2) Monitoring the banking entity’s covered
trading activities;
(3) Identifying covered trading activities
that warrant further review or examination
by the banking entity to verify compliance
with the proprietary trading restrictions;
(4) Evaluating whether the covered trading
activities of trading desks engaged in market
making-related activities subject to § 248.4(b)
are consistent with the requirements
governing permitted market making-related
activities;
(5) Evaluating whether the covered trading
activities of trading desks that are engaged in
permitted trading activity subject to § 248.4,
248.5, or 248.6(a)–(b) (i.e., underwriting and
market making-related activity, riskmitigating hedging, or trading in certain
government obligations) are consistent with
the requirement that such activity not result,
directly or indirectly, in a material exposure
to high-risk assets or high-risk trading
strategies;
(6) Identifying the profile of particular
covered trading activities of the banking
entity, and the individual trading desks of
the banking entity, to help establish the
appropriate frequency and scope of
examination by Board of such activities; and
(7) Assessing and addressing the risks
associated with the banking entity’s covered
trading activities.
c. Information that must be furnished
pursuant to this appendix is not intended to
serve as a dispositive tool for the
identification of permissible or
impermissible activities.
d. In addition to the quantitative
measurements required in this appendix, a
banking entity may need to develop and
implement other quantitative measurements
in order to effectively monitor its covered
trading activities for compliance with section
13 of the BHC Act and this part and to have
an effective compliance program, as required
by § 248.20. The effectiveness of particular
quantitative measurements may differ based
on the profile of the banking entity’s
businesses in general and, more specifically,
of the particular trading desk, including
types of instruments traded, trading activities
and strategies, and history and experience
(e.g., whether the trading desk is an
established, successful market maker or a
new entrant to a competitive market). In all
cases, banking entities must ensure that they
have robust measures in place to identify and
monitor the risks taken in their trading
activities, to ensure that the activities are
within risk tolerances established by the
banking entity, and to monitor and examine
for compliance with the proprietary trading
restrictions in this part.
e. On an ongoing basis, banking entities
must carefully monitor, review, and evaluate
all furnished quantitative measurements, as
well as any others that they choose to utilize
in order to maintain compliance with section
13 of the BHC Act and this part. All
measurement results that indicate a
heightened risk of impermissible proprietary
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trading, including with respect to otherwisepermitted activities under § 248.4 through
248.6(a)–(b), or that result in a material
exposure to high-risk assets or high-risk
trading strategies, must be escalated within
the banking entity for review, further
analysis, explanation to Board, and
remediation, where appropriate. The
quantitative measurements discussed in this
appendix should be helpful to banking
entities in identifying and managing the risks
related to their covered trading activities.
II. Definitions
The terms used in this appendix have the
same meanings as set forth in § 248.2 and
§ 248.3. In addition, for purposes of this
appendix, the following definitions apply:
Applicability identifies the trading desks
for which a banking entity is required to
calculate and report a particular quantitative
measurement based on the type of covered
trading activity conducted by the trading
desk.
Calculation period means the period of
time for which a particular quantitative
measurement must be calculated.
Comprehensive profit and loss means the
net profit or loss of a trading desk’s material
sources of trading revenue over a specific
period of time, including, for example, any
increase or decrease in the market value of
a trading desk’s holdings, dividend income,
and interest income and expense.
Covered trading activity means trading
conducted by a trading desk under § 248.4,
§ 248.5, § 248.6(a), or § 248.6(b). A banking
entity may include in its covered trading
activity trading conducted under § 248.3(d),
§ 248.6(c), § 248.6(d) or § 248.6(e).
Measurement frequency means the
frequency with which a particular
quantitative metric must be calculated and
recorded.
Trading day means a calendar day on
which a trading desk is open for trading.
III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each
banking entity made subject to this appendix
by § 248.20 must furnish the following
quantitative measurements, as applicable, for
each trading desk of the banking entity
engaged in covered trading activities and
calculate these quantitative measurements in
accordance with this appendix:
i. Internal Limits and Usage;
ii. Value-at-Risk;
iii. Comprehensive Profit and Loss
Attribution;
iv. Positions; and
v. Transaction Volumes.
2. Trading desk information. Each banking
entity made subject to this appendix by
§ 248.20 must provide certain descriptive
information, as further described in this
appendix, regarding each trading desk
engaged in covered trading activities.
3. Quantitative measurements identifying
information. Each banking entity made
subject to this appendix by § 248.20 must
provide certain identifying and descriptive
information, as further described in this
appendix, regarding its quantitative
measurements.
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4. Narrative statement. Each banking entity
made subject to this appendix by § 248.20
may provide an optional narrative statement,
as further described in this appendix.
5. File identifying information. Each
banking entity made subject to this appendix
by § 248.20 must provide file identifying
information in each submission to the Board
pursuant to this appendix, including the
name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the
Board, and identification of the reporting
period and creation date and time.
b. Trading Desk Information
1. Each banking entity must provide
descriptive information regarding each
trading desk engaged in covered trading
activities, including:
i. Name of the trading desk used internally
by the banking entity and a unique
identification label for the trading desk;
ii. Identification of each type of covered
trading activity in which the trading desk is
engaged;
iii. Brief description of the general strategy
of the trading desk;
v. A list identifying each Agency receiving
the submission of the trading desk;
2. Indication of whether each calendar date
is a trading day or not a trading day for the
trading desk; and
3. Currency reported and daily currency
conversion rate.
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c. Quantitative Measurements Identifying
Information
Each banking entity must provide the
following information regarding the
quantitative measurements:
1. An Internal Limits Information Schedule
that provides identifying and descriptive
information for each limit reported pursuant
to the Internal Limits and Usage quantitative
measurement, including the name of the
limit, a unique identification label for the
limit, a description of the limit, the unit of
measurement for the limit, the type of limit,
and identification of the corresponding risk
factor attribution in the particular case that
the limit type is a limit on a risk factor
sensitivity and profit and loss attribution to
the same risk factor is reported; and
2. A Risk Factor Attribution Information
Schedule that provides identifying and
descriptive information for each risk factor
attribution reported pursuant to the
Comprehensive Profit and Loss Attribution
quantitative measurement, including the
name of the risk factor or other factor, a
unique identification label for the risk factor
or other factor, a description of the risk factor
or other factor, and the risk factor or other
factor’s change unit.
d. Narrative Statement
Each banking entity made subject to this
appendix by § 248.20 may submit in a
separate electronic document a Narrative
Statement to the Board with any information
the banking entity views as relevant for
assessing the information reported. The
Narrative Statement may include further
description of or changes to calculation
methods, identification of material events,
description of and reasons for changes in the
banking entity’s trading desk structure or
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trading desk strategies, and when any such
changes occurred.
e. Frequency and Method of Required
Calculation and Reporting
A banking entity must calculate any
applicable quantitative measurement for each
trading day. A banking entity must report the
Trading Desk Information, the Quantitative
Measurements Identifying Information, and
each applicable quantitative measurement
electronically to the Board on the reporting
schedule established in § 248.20 unless
otherwise requested by the Board. A banking
entity must report the Trading Desk
Information, the Quantitative Measurements
Identifying Information, and each applicable
quantitative measurement to the Board in
accordance with the XML Schema specified
and published on the Board’s website.
f. Recordkeeping
A banking entity must, for any quantitative
measurement furnished to the Board
pursuant to this appendix and § 248.20(d),
create and maintain records documenting the
preparation and content of these reports, as
well as such information as is necessary to
permit the Board to verify the accuracy of
such reports, for a period of five years from
the end of the calendar year for which the
measurement was taken. A banking entity
must retain the Narrative Statement, the
Trading Desk Information, and the
Quantitative Measurements Identifying
Information for a period of five years from
the end of the calendar year for which the
information was reported to the Board.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Internal Limits and Usage
i. Description: For purposes of this
appendix, Internal Limits are the constraints
that define the amount of risk and the
positions that a trading desk is permitted to
take at a point in time, as defined by the
banking entity for a specific trading desk.
Usage represents the value of the trading
desk’s risk or positions that are accounted for
by the current activity of the desk. Internal
limits and their usage are key compliance
and risk management tools used to control
and monitor risk taking and include, but are
not limited to, the limits set out in §§ 248.4
and 248.5. A trading desk’s risk limits,
commonly including a limit on ‘‘Value-atRisk,’’ are useful in the broader context of the
trading desk’s overall activities, particularly
for the market making activities under
§ 248.4(b) and hedging activity under § 248.5.
Accordingly, the limits required under
§§ 248.4(b)(2)(iii)(C) and 248.5(b)(1)(i)(A)
must meet the applicable requirements under
§§ 248.4(b)(2)(iii)(C) and 248.5(b)(1)(i)(A) and
also must include appropriate metrics for the
trading desk limits including, at a minimum,
‘‘Value-at-Risk’’ except to the extent the
‘‘Value-at-Risk’’ metric is demonstrably
ineffective for measuring and monitoring the
risks of a trading desk based on the types of
positions traded by, and risk exposures of,
that desk.
A. A banking entity must provide the
following information for each limit reported
pursuant to this quantitative measurement:
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The unique identification label for the limit
reported in the Internal Limits Information
Schedule, the limit size (distinguishing
between an upper and a lower limit), and the
value of usage of the limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
2. Value-at-Risk
i. Description: For purposes of this
appendix, Value-at-Risk (‘‘VaR’’) is the
measurement of the risk of future financial
loss in the value of a trading desk’s
aggregated positions at the ninety-nine
percent confidence level over a one-day
period, based on current market conditions.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this
appendix, Comprehensive Profit and Loss
Attribution is an analysis that attributes the
daily fluctuation in the value of a trading
desk’s positions to various sources. First, the
daily profit and loss of the aggregated
positions is divided into two categories: (i)
Profit and loss attributable to a trading desk’s
existing positions that were also positions
held by the trading desk as of the end of the
prior day (‘‘existing positions’’); and (ii)
profit and loss attributable to new positions
resulting from the current day’s trading
activity (‘‘new positions’’).
A. The comprehensive profit and loss
associated with existing positions must
reflect changes in the value of these positions
on the applicable day. The comprehensive
profit and loss from existing positions must
be further attributed, as applicable, to (i)
changes in the specific risk factors and other
factors that are monitored and managed as
part of the trading desk’s overall risk
management policies and procedures; and (ii)
any other applicable elements, such as cash
flows, carry, changes in reserves, and the
correction, cancellation, or exercise of a
trade.
B. For the attribution of comprehensive
profit and loss from existing positions to
specific risk factors and other factors, a
banking entity must provide the following
information for the factors that explain the
preponderance of the profit or loss changes
due to risk factor changes: The unique
identification label for the risk factor or other
factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss
due to the risk factor or other factor change.
C. The comprehensive profit and loss
attributed to new positions must reflect
commissions and fee income or expense and
market gains or losses associated with
transactions executed on the applicable day.
New positions include purchases and sales of
financial instruments and other assets/
liabilities and negotiated amendments to
existing positions. The comprehensive profit
and loss from new positions may be reported
in the aggregate and does not need to be
further attributed to specific sources.
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D. The portion of comprehensive profit and
loss from existing positions that is not
attributed to changes in specific risk factors
and other factors must be allocated to a
residual category. Significant unexplained
profit and loss must be escalated for further
investigation and analysis.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
c. Positions and Transaction Volumes
Measurements
1. Positions
i. Description: For purposes of this
appendix, Positions is the value of securities
and derivatives positions managed by the
trading desk. For purposes of the Positions
quantitative measurement, do not include in
the Positions calculation for ‘‘securities’’
those securities that are also ‘‘derivatives,’’ as
those terms are defined under subpart A;
instead, report those securities that are also
derivatives as ‘‘derivatives.’’ 1 A banking
entity must separately report the trading
desk’s market value of long securities
positions, short securities positions,
derivatives receivables, and derivatives
payables.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely
on § 248.4(a) or § 248.4(b) to conduct
underwriting activity or market-makingrelated activity, respectively.
2. Transaction Volumes
i. Description: For purposes of this
appendix, Transaction Volumes measures
three exclusive categories of covered trading
activity conducted by a trading desk. A
banking entity is required to report the value
and number of security and derivative
transactions conducted by the trading desk
with: (i) Customers, excluding internal
transactions; (ii) non-customers, excluding
internal transactions; and (iii) trading desks
and other organizational units where the
transaction is booked into either the same
banking entity or an affiliated banking entity.
For securities, value means gross market
value. For derivatives, value means gross
notional value. For purposes of calculating
the Transaction Volumes quantitative
measurement, do not include in the
Transaction Volumes calculation for
‘‘securities’’ those securities that are also
‘‘derivatives,’’ as those terms are defined
under subpart A; instead, report those
securities that are also derivatives as
‘‘derivatives.’’ 2 Further, for purposes of the
Transaction Volumes quantitative
measurement, a customer of a trading desk
that relies on § 248.4(a) to conduct
underwriting activity is a market participant
identified in § 248.4(a)(7), and a customer of
a trading desk that relies on § 248.4(b) to
conduct market making-related activity is a
market participant identified in § 248.4(b)(3).
ii. Calculation Period: One trading day.
1 See § 248.2(h), (aa). For example, under this
part, a security-based swap is both a ‘‘security’’ and
a ‘‘derivative.’’ For purposes of the Positions
quantitative measurement, security-based swaps are
reported as derivatives rather than securities.
2 See § 248.2(h), (aa).
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iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely
on § 248.4(a) or § 248.4(b) to conduct
underwriting activity or market-makingrelated activity, respectively.
Appendix B to Part 248 [Removed]
29. Appendix B to part 248 is
removed.
■ 30. Effective January 1, 2020, until
December 31, 2020, appendix Z to part
248 is added to read as follows:
■
Appendix Z to Part 248—Proprietary
Trading and Certain Interests in and
Relationships With Covered Funds
(Alternative Compliance)
Note: The content of this appendix
reproduces the regulation implementing
Section 13 of the Bank Holding Company Act
as of November 13, 2019.
Subpart A—Authority and Definitions
§ 248.1 Authority, purpose, scope, and
relationship to other authorities.
(a) Authority. This part (Regulation
VV) is issued by the Board under
section 13 of the Bank Holding
Company Act of 1956, as amended (12
U.S.C. 1851), as well as under the
Federal Reserve Act, as amended (12
U.S.C. 221 et seq.); section 8 of the
Federal Deposit Insurance Act, as
amended (12 U.S.C. 1818); the Bank
Holding Company Act of 1956, as
amended (12 U.S.C. 1841 et seq.); and
the International Banking Act of 1978,
as amended (12 U.S.C. 3101 et seq.).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes
prohibitions and restrictions on
proprietary trading and on investments
in or relationships with covered funds
by certain banking entities, including
state member banks, bank holding
companies, savings and loan holding
companies, other companies that
control an insured depository
institution, foreign banking
organizations, and certain subsidiaries
thereof. This part implements section 13
of the Bank Holding Company Act by
defining terms used in the statute and
related terms, establishing prohibitions
and restrictions on proprietary trading
and on investments in or relationships
with covered funds, and explaining the
statute’s requirements.
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to banking
entities for which the Board is
authorized to issue regulations under
section 13(b)(2) of the Bank Holding
Company Act (12 U.S.C. 1851(b)(2)) and
take actions under section 13(e) of that
Act (12 U.S.C. 1851(e)). These include
any state bank that is a member of the
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Federal Reserve System, any company
that controls an insured depository
institution (including a bank holding
company and savings and loan holding
company), any company that is treated
as a bank holding company for purposes
of section 8 of the International Banking
Act (12 U.S.C. 3106), and any subsidiary
of the foregoing other than a subsidiary
for which the OCC, FDIC, CFTC, or SEC
is the primary financial regulatory
agency (as defined in section 2(12) of
the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (12
U.S.C. 5301(12)), but do not include
such entities to the extent they are not
within the definition of banking entity
in § 248.2(c).
(d) Relationship to other authorities.
Except as otherwise provided under
section 13 of the BHC Act or this part,
and notwithstanding any other
provision of law, the prohibitions and
restrictions under section 13 of BHC Act
and this part shall apply to the activities
of a banking entity, even if such
activities are authorized for the banking
entity under other applicable provisions
of law.
(e) Preservation of authority. Nothing
in this part limits in any way the
authority of the Board to impose on a
banking entity identified in paragraph
(c) of this section additional
requirements or restrictions with respect
to any activity, investment, or
relationship covered under section 13 of
the Bank Holding Company Act or this
part, or additional penalties for
violation of this part provided under
any other applicable provision of law.
§ 248.2
Definitions.
Unless otherwise specified, for
purposes of this part:
(a) Affiliate has the same meaning as
in section 2(k) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(k)).
(b) Bank holding company has the
same meaning as in section 2 of the
Bank Holding Company Act of 1956 (12
U.S.C. 1841).
(c) Banking entity. (1) Except as
provided in paragraph (c)(2) of this
section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an
insured depository institution;
(iii) Any company that is treated as a
bank holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any
entity described in paragraphs (c)(1)(i),
(ii), or (iii) of this section.
(2) Banking entity does not include:
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(i) A covered fund that is not itself a
banking entity under paragraphs
(c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under
the authority contained in section
4(k)(4)(H) or (I) of the BHC Act (12
U.S.C. 1843(k)(4)(H), (I)), or any
portfolio concern, as defined under 13
CFR 107.50, that is controlled by a small
business investment company, as
defined in section 103(3) of the Small
Business Investment Act of 1958 (15
U.S.C. 662), so long as the portfolio
company or portfolio concern is not
itself a banking entity under paragraphs
(c)(1)(i), (ii), or (iii) of this section; or
(iii) The FDIC acting in its corporate
capacity or as conservator or receiver
under the Federal Deposit Insurance Act
or Title II of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
(d) Board means the Board of
Governors of the Federal Reserve
System.
(e) CFTC means the Commodity
Futures Trading Commission.
(f) Dealer has the same meaning as in
section 3(a)(5) of the Exchange Act (15
U.S.C. 78c(a)(5)).
(g) Depository institution has the same
meaning as in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)).
(h) Derivative. (1) Except as provided
in paragraph (h)(2) of this section,
derivative means:
(i) Any swap, as that term is defined
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)), or
security-based swap, as that term is
defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68));
(ii) Any purchase or sale of a
commodity, that is not an excluded
commodity, for deferred shipment or
delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as
that term is defined in section 1a(24) of
the Commodity Exchange Act (7 U.S.C.
1a(24)) or foreign exchange swap (as
that term is defined in section 1a(25) of
the Commodity Exchange Act (7 U.S.C.
1a(25));
(iv) Any agreement, contract, or
transaction in foreign currency
described in section 2(c)(2)(C)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(C)(i));
(v) Any agreement, contract, or
transaction in a commodity other than
foreign currency described in section
2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under
section 19 of the Commodity Exchange
Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
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(i) Any consumer, commercial, or
other agreement, contract, or transaction
that the CFTC and SEC have further
defined by joint regulation,
interpretation, guidance, or other action
as not within the definition of swap, as
that term is defined in section 1a(47) of
the Commodity Exchange Act (7 U.S.C.
1a(47)), or security-based swap, as that
term is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)); or
(ii) Any identified banking product, as
defined in section 402(b) of the Legal
Certainty for Bank Products Act of 2000
(7 U.S.C. 27(b)), that is subject to section
403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the
immediate family of the employee.
(j) Exchange Act means the Securities
Exchange Act of 1934 (15 U.S.C. 78a et
seq.).
(k) Excluded commodity has the same
meaning as in section 1a(19) of the
Commodity Exchange Act (7 U.S.C.
1a(19)).
(l) FDIC means the Federal Deposit
Insurance Corporation.
(m) Federal banking agencies means
the Board, the Office of the Comptroller
of the Currency, and the FDIC.
(n) Foreign banking organization has
the same meaning as in section
211.21(o) of the Board’s Regulation K
(12 CFR 211.21(o)), but does not include
a foreign bank, as defined in section
1(b)(7) of the International Banking Act
of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the
Commonwealth of Puerto Rico, Guam,
American Samoa, the United States
Virgin Islands, or the Commonwealth of
the Northern Mariana Islands.
(o) Foreign insurance regulator means
the insurance commissioner, or a
similar official or agency, of any country
other than the United States that is
engaged in the supervision of insurance
companies under foreign insurance law.
(p) General account means all of the
assets of an insurance company except
those allocated to one or more separate
accounts.
(q) Insurance company means a
company that is organized as an
insurance company, primarily and
predominantly engaged in writing
insurance or reinsuring risks
underwritten by insurance companies,
subject to supervision as such by a state
insurance regulator or a foreign
insurance regulator, and not operated
for the purpose of evading the
provisions of section 13 of the BHC Act
(12 U.S.C. 1851).
(r) Insured depository institution,
unless otherwise indicated, has the
same meaning as in section 3(c) of the
Federal Deposit Insurance Act (12
U.S.C. 1813(c)), but does not include:
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(1) An insured depository institution
that is described in section 2(c)(2)(D) of
the BHC Act (12 U.S.C. 1841(c)(2)(D));
or
(2) An insured depository institution
if it has, and if every company that
controls it has, total consolidated assets
of $10 billion or less and total trading
assets and trading liabilities, on a
consolidated basis, that are 5 percent or
less of total consolidated assets.
(s) Loan means any loan, lease,
extension of credit, or secured or
unsecured receivable that is not a
security or derivative.
(t) Primary financial regulatory
agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act (12 U.S.C. 5301(12)).
(u) Purchase includes any contract to
buy, purchase, or otherwise acquire. For
security futures products, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a commodity future, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a derivative, purchase
includes the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(v) Qualifying foreign banking
organization means a foreign banking
organization that qualifies as such under
section 211.23(a), (c) or (e) of the
Board’s Regulation K (12 CFR 211.23(a),
(c), or (e)).
(w) SEC means the Securities and
Exchange Commission.
(x) Sale and sell each include any
contract to sell or otherwise dispose of.
For security futures products, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a commodity future, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a derivative, such terms
include the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(y) Security has the meaning specified
in section 3(a)(10) of the Exchange Act
(15 U.S.C. 78c(a)(10)).
(z) Security-based swap dealer has the
same meaning as in section 3(a)(71) of
the Exchange Act (15 U.S.C. 78c(a)(71)).
(aa) Security future has the meaning
specified in section 3(a)(55) of the
Exchange Act (15 U.S.C. 78c(a)(55)).
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(bb) Separate account means an
account established and maintained by
an insurance company in connection
with one or more insurance contracts to
hold assets that are legally segregated
from the insurance company’s other
assets, under which income, gains, and
losses, whether or not realized, from
assets allocated to such account, are, in
accordance with the applicable contract,
credited to or charged against such
account without regard to other income,
gains, or losses of the insurance
company.
(cc) State means any State, the District
of Columbia, the Commonwealth of
Puerto Rico, Guam, American Samoa,
the United States Virgin Islands, and the
Commonwealth of the Northern Mariana
Islands.
(dd) Subsidiary has the same meaning
as in section 2(d) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(d)).
(ee) State insurance regulator means
the insurance commissioner, or a
similar official or agency, of a State that
is engaged in the supervision of
insurance companies under State
insurance law.
(ff) Swap dealer has the same meaning
as in section 1(a)(49) of the Commodity
Exchange Act (7 U.S.C. 1a(49)).
Subpart B—Proprietary Trading
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§ 248.3
Prohibition on proprietary trading.
(a) Prohibition. Except as otherwise
provided in this subpart, a banking
entity may not engage in proprietary
trading. Proprietary trading means
engaging as principal for the trading
account of the banking entity in any
purchase or sale of one or more
financial instruments.
(b) Definition of trading account. (1)
Trading account means any account that
is used by a banking entity to:
(i) Purchase or sell one or more
financial instruments principally for the
purpose of:
(A) Short-term resale;
(B) Benefitting from actual or
expected short-term price movements;
(C) Realizing short-term arbitrage
profits; or
(D) Hedging one or more positions
resulting from the purchases or sales of
financial instruments described in
paragraphs (b)(1)(i)(A), (B), or (C) of this
section;
(ii) Purchase or sell one or more
financial instruments that are both
market risk capital rule covered
positions and trading positions (or
hedges of other market risk capital rule
covered positions), if the banking entity,
or any affiliate of the banking entity, is
an insured depository institution, bank
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holding company, or savings and loan
holding company, and calculates riskbased capital ratios under the market
risk capital rule; or
(iii) Purchase or sell one or more
financial instruments for any purpose, if
the banking entity:
(A) Is licensed or registered, or is
required to be licensed or registered, to
engage in the business of a dealer, swap
dealer, or security-based swap dealer, to
the extent the instrument is purchased
or sold in connection with the activities
that require the banking entity to be
licensed or registered as such; or
(B) Is engaged in the business of a
dealer, swap dealer, or security-based
swap dealer outside of the United
States, to the extent the instrument is
purchased or sold in connection with
the activities of such business.
(2) Rebuttable presumption for certain
purchases and sales. The purchase (or
sale) of a financial instrument by a
banking entity shall be presumed to be
for the trading account of the banking
entity under paragraph (b)(1)(i) of this
section if the banking entity holds the
financial instrument for fewer than sixty
days or substantially transfers the risk of
the financial instrument within sixty
days of the purchase (or sale), unless the
banking entity can demonstrate, based
on all relevant facts and circumstances,
that the banking entity did not purchase
(or sell) the financial instrument
principally for any of the purposes
described in paragraph (b)(1)(i) of this
section.
(c) Financial instrument. (1) Financial
instrument means:
(i) A security, including an option on
a security;
(ii) A derivative, including an option
on a derivative; or
(iii) A contract of sale of a commodity
for future delivery, or option on a
contract of sale of a commodity for
future delivery.
(2) A financial instrument does not
include:
(i) A loan;
(ii) A commodity that is not:
(A) An excluded commodity (other
than foreign exchange or currency);
(B) A derivative;
(C) A contract of sale of a commodity
for future delivery; or
(D) An option on a contract of sale of
a commodity for future delivery; or
(iii) Foreign exchange or currency.
(d) Proprietary trading. Proprietary
trading does not include:
(1) Any purchase or sale of one or
more financial instruments by a banking
entity that arises under a repurchase or
reverse repurchase agreement pursuant
to which the banking entity has
simultaneously agreed, in writing, to
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both purchase and sell a stated asset, at
stated prices, and on stated dates or on
demand with the same counterparty;
(2) Any purchase or sale of one or
more financial instruments by a banking
entity that arises under a transaction in
which the banking entity lends or
borrows a security temporarily to or
from another party pursuant to a written
securities lending agreement under
which the lender retains the economic
interests of an owner of such security,
and has the right to terminate the
transaction and to recall the loaned
security on terms agreed by the parties;
(3) Any purchase or sale of a security
by a banking entity for the purpose of
liquidity management in accordance
with a documented liquidity
management plan of the banking entity
that:
(i) Specifically contemplates and
authorizes the particular securities to be
used for liquidity management
purposes, the amount, types, and risks
of these securities that are consistent
with liquidity management, and the
liquidity circumstances in which the
particular securities may or must be
used;
(ii) Requires that any purchase or sale
of securities contemplated and
authorized by the plan be principally for
the purpose of managing the liquidity of
the banking entity, and not for the
purpose of short-term resale, benefitting
from actual or expected short-term price
movements, realizing short-term
arbitrage profits, or hedging a position
taken for such short-term purposes;
(iii) Requires that any securities
purchased or sold for liquidity
management purposes be highly liquid
and limited to securities the market,
credit, and other risks of which the
banking entity does not reasonably
expect to give rise to appreciable profits
or losses as a result of short-term price
movements;
(iv) Limits any securities purchased or
sold for liquidity management purposes,
together with any other instruments
purchased or sold for such purposes, to
an amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan;
(v) Includes written policies and
procedures, internal controls, analysis,
and independent testing to ensure that
the purchase and sale of securities that
are not permitted under §§ 248.6(a) or
(b) of this subpart are for the purpose of
liquidity management and in
accordance with the liquidity
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management plan described in
paragraph (d)(3) of this section; and
(vi) Is consistent with The Board’s
supervisory requirements, guidance,
and expectations regarding liquidity
management;
(4) Any purchase or sale of one or
more financial instruments by a banking
entity that is a derivatives clearing
organization or a clearing agency in
connection with clearing financial
instruments;
(5) Any excluded clearing activities
by a banking entity that is a member of
a clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility;
(6) Any purchase or sale of one or
more financial instruments by a banking
entity, so long as:
(i) The purchase (or sale) satisfies an
existing delivery obligation of the
banking entity or its customers,
including to prevent or close out a
failure to deliver, in connection with
delivery, clearing, or settlement activity;
or
(ii) The purchase (or sale) satisfies an
obligation of the banking entity in
connection with a judicial,
administrative, self-regulatory
organization, or arbitration proceeding;
(7) Any purchase or sale of one or
more financial instruments by a banking
entity that is acting solely as agent,
broker, or custodian;
(8) Any purchase or sale of one or
more financial instruments by a banking
entity through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity that is
established and administered in
accordance with the law of the United
States or a foreign sovereign, if the
purchase or sale is made directly or
indirectly by the banking entity as
trustee for the benefit of persons who
are or were employees of the banking
entity; or
(9) Any purchase or sale of one or
more financial instruments by a banking
entity in the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the financial instrument
as soon as practicable, and in no event
may the banking entity retain such
instrument for longer than such period
permitted by the Board.
(e) Definition of other terms related to
proprietary trading. For purposes of this
subpart:
(1) Anonymous means that each party
to a purchase or sale is unaware of the
identity of the other party(ies) to the
purchase or sale.
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(2) Clearing agency has the same
meaning as in section 3(a)(23) of the
Exchange Act (15 U.S.C. 78c(a)(23)).
(3) Commodity has the same meaning
as in section 1a(9) of the Commodity
Exchange Act (7 U.S.C. 1a(9)), except
that a commodity does not include any
security;
(4) Contract of sale of a commodity
for future delivery means a contract of
sale (as that term is defined in section
1a(13) of the Commodity Exchange Act
(7 U.S.C. 1a(13)) for future delivery (as
that term is defined in section 1a(27) of
the Commodity Exchange Act (7 U.S.C.
1a(27))).
(5) Derivatives clearing organization
means:
(i) A derivatives clearing organization
registered under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1);
(ii) A derivatives clearing organization
that, pursuant to CFTC regulation, is
exempt from the registration
requirements under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1); or
(iii) A foreign derivatives clearing
organization that, pursuant to CFTC
regulation, is permitted to clear for a
foreign board of trade that is registered
with the CFTC.
(6) Exchange, unless the context
otherwise requires, means any
designated contract market, swap
execution facility, or foreign board of
trade registered with the CFTC, or, for
purposes of securities or security-based
swaps, an exchange, as defined under
section 3(a)(1) of the Exchange Act (15
U.S.C. 78c(a)(1)), or security-based swap
execution facility, as defined under
section 3(a)(77) of the Exchange Act (15
U.S.C. 78c(a)(77)).
(7) Excluded clearing activities means:
(i) With respect to customer
transactions cleared on a derivatives
clearing organization, a clearing agency,
or a designated financial market utility,
any purchase or sale necessary to
correct trading errors made by or on
behalf of a customer provided that such
purchase or sale is conducted in
accordance with, for transactions
cleared on a derivatives clearing
organization, the Commodity Exchange
Act, CFTC regulations, and the rules or
procedures of the derivatives clearing
organization, or, for transactions cleared
on a clearing agency, the rules or
procedures of the clearing agency, or,
for transactions cleared on a designated
financial market utility that is neither a
derivatives clearing organization nor a
clearing agency, the rules or procedures
of the designated financial market
utility;
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(ii) Any purchase or sale in
connection with and related to the
management of a default or threatened
imminent default of a customer
provided that such purchase or sale is
conducted in accordance with, for
transactions cleared on a derivatives
clearing organization, the Commodity
Exchange Act, CFTC regulations, and
the rules or procedures of the
derivatives clearing organization, or, for
transactions cleared on a clearing
agency, the rules or procedures of the
clearing agency, or, for transactions
cleared on a designated financial market
utility that is neither a derivatives
clearing organization nor a clearing
agency, the rules or procedures of the
designated financial market utility;
(iii) Any purchase or sale in
connection with and related to the
management of a default or threatened
imminent default of a member of a
clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility;
(iv) Any purchase or sale in
connection with and related to the
management of the default or threatened
default of a clearing agency, a
derivatives clearing organization, or a
designated financial market utility; and
(v) Any purchase or sale that is
required by the rules or procedures of a
clearing agency, a derivatives clearing
organization, or a designated financial
market utility to mitigate the risk to the
clearing agency, derivatives clearing
organization, or designated financial
market utility that would result from the
clearing by a member of security-based
swaps that reference the member or an
affiliate of the member.
(8) Designated financial market utility
has the same meaning as in section
803(4) of the Dodd-Frank Act (12 U.S.C.
5462(4)).
(9) Issuer has the same meaning as in
section 2(a)(4) of the Securities Act of
1933 (15 U.S.C. 77b(a)(4)).
(10) Market risk capital rule covered
position and trading position means a
financial instrument that is both a
covered position and a trading position,
as those terms are respectively defined:
(i) In the case of a banking entity that
is a bank holding company, savings and
loan holding company, or insured
depository institution, under the market
risk capital rule that is applicable to the
banking entity; and
(ii) In the case of a banking entity that
is affiliated with a bank holding
company or savings and loan holding
company, other than a banking entity to
which a market risk capital rule is
applicable, under the market risk capital
rule that is applicable to the affiliated
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bank holding company or savings and
loan holding company.
(11) Market risk capital rule means
the market risk capital rule that is
contained in subpart F of 12 CFR part
3, 12 CFR parts 208 and 225, or 12 CFR
part 324, as applicable.
(12) Municipal security means a
security that is a direct obligation of or
issued by, or an obligation guaranteed as
to principal or interest by, a State or any
political subdivision thereof, or any
agency or instrumentality of a State or
any political subdivision thereof, or any
municipal corporate instrumentality of
one or more States or political
subdivisions thereof.
(13) Trading desk means the smallest
discrete unit of organization of a
banking entity that purchases or sells
financial instruments for the trading
account of the banking entity or an
affiliate thereof.
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§ 248.4 Permitted underwriting and market
making-related activities.
(a) Underwriting activities—(1)
Permitted underwriting activities. The
prohibition contained in § 248.3(a) does
not apply to a banking entity’s
underwriting activities conducted in
accordance with this paragraph (a).
(2) Requirements. The underwriting
activities of a banking entity are
permitted under paragraph (a)(1) of this
section only if:
(i) The banking entity is acting as an
underwriter for a distribution of
securities and the trading desk’s
underwriting position is related to such
distribution;
(ii) The amount and type of the
securities in the trading desk’s
underwriting position are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, and reasonable efforts
are made to sell or otherwise reduce the
underwriting position within a
reasonable period, taking into account
the liquidity, maturity, and depth of the
market for the relevant type of security;
(iii) The banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (a)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The products, instruments or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
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(B) Limits for each trading desk, based
on the nature and amount of the trading
desk’s underwriting activities, including
the reasonably expected near term
demands of clients, customers, or
counterparties, on the:
(1) Amount, types, and risk of its
underwriting position;
(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held;
(C) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
(D) Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
(iv) The compensation arrangements
of persons performing the activities
described in this paragraph (a) are
designed not to reward or incentivize
prohibited proprietary trading; and
(v) The banking entity is licensed or
registered to engage in the activity
described in this paragraph (a) in
accordance with applicable law.
(3) Definition of distribution. For
purposes of this paragraph (a), a
distribution of securities means:
(i) An offering of securities, whether
or not subject to registration under the
Securities Act of 1933, that is
distinguished from ordinary trading
transactions by the presence of special
selling efforts and selling methods; or
(ii) An offering of securities made
pursuant to an effective registration
statement under the Securities Act of
1933.
(4) Definition of underwriter. For
purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an
issuer or selling security holder to:
(A) Purchase securities from the
issuer or selling security holder for
distribution;
(B) Engage in a distribution of
securities for or on behalf of the issuer
or selling security holder; or
(C) Manage a distribution of securities
for or on behalf of the issuer or selling
security holder; or
(ii) A person who has agreed to
participate or is participating in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.
(5) Definition of selling security
holder. For purposes of this paragraph
(a), selling security holder means any
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person, other than an issuer, on whose
behalf a distribution is made.
(6) Definition of underwriting
position. For purposes of this paragraph
(a), underwriting position means the
long or short positions in one or more
securities held by a banking entity or its
affiliate, and managed by a particular
trading desk, in connection with a
particular distribution of securities for
which such banking entity or affiliate is
acting as an underwriter.
(7) Definition of client, customer, and
counterparty. For purposes of this
paragraph (a), the terms client,
customer, and counterparty, on a
collective or individual basis, refer to
market participants that may transact
with the banking entity in connection
with a particular distribution for which
the banking entity is acting as
underwriter.
(b) Market making-related activities—
(1) Permitted market making-related
activities. The prohibition contained in
§ 248.3(a) does not apply to a banking
entity’s market making-related activities
conducted in accordance with this
paragraph (b).
(2) Requirements. The market makingrelated activities of a banking entity are
permitted under paragraph (b)(1) of this
section only if:
(i) The trading desk that establishes
and manages the financial exposure
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure and is willing and available to
quote, purchase and sell, or otherwise
enter into long and short positions in
those types of financial instruments for
its own account, in commercially
reasonable amounts and throughout
market cycles on a basis appropriate for
the liquidity, maturity, and depth of the
market for the relevant types of financial
instruments;
(ii) The amount, types, and risks of
the financial instruments in the trading
desk’s market-maker inventory are
designed not to exceed, on an ongoing
basis, the reasonably expected near term
demands of clients, customers, or
counterparties, based on:
(A) The liquidity, maturity, and depth
of the market for the relevant types of
financial instrument(s); and
(B) Demonstrable analysis of
historical customer demand, current
inventory of financial instruments, and
market and other factors regarding the
amount, types, and risks, of or
associated with financial instruments in
which the trading desk makes a market,
including through block trades;
(iii) The banking entity has
established and implements, maintains,
and enforces an internal compliance
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program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (b)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The financial instruments each
trading desk stands ready to purchase
and sell in accordance with paragraph
(b)(2)(i) of this section;
(B) The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the limits
required under paragraph (b)(2)(iii)(C) of
this section; the products, instruments,
and exposures each trading desk may
use for risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and
inventory; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
desk to mitigate these risks are and
continue to be effective;
(C) Limits for each trading desk, based
on the nature and amount of the trading
desk’s market making-related activities,
that address the factors prescribed by
paragraph (b)(2)(ii) of this section, on:
(1) The amount, types, and risks of its
market-maker inventory;
(2) The amount, types, and risks of the
products, instruments, and exposures
the trading desk may use for risk
management purposes;
(3) The level of exposures to relevant
risk factors arising from its financial
exposure; and
(4) The period of time a financial
instrument may be held;
(D) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
(E) Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis that the
basis for any temporary or permanent
increase to a trading desk’s limit(s) is
consistent with the requirements of this
paragraph (b), and independent review
of such demonstrable analysis and
approval;
(iv) To the extent that any limit
identified pursuant to paragraph
(b)(2)(iii)(C) of this section is exceeded,
the trading desk takes action to bring the
trading desk into compliance with the
limits as promptly as possible after the
limit is exceeded;
(v) The compensation arrangements of
persons performing the activities
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described in this paragraph (b) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in activity
described in this paragraph (b) in
accordance with applicable law.
(3) Definition of client, customer, and
counterparty. For purposes of paragraph
(b) of this section, the terms client,
customer, and counterparty, on a
collective or individual basis refer to
market participants that make use of the
banking entity’s market making-related
services by obtaining such services,
responding to quotations, or entering
into a continuing relationship with
respect to such services, provided that:
(i) A trading desk or other
organizational unit of another banking
entity is not a client, customer, or
counterparty of the trading desk if that
other entity has trading assets and
liabilities of $50 billion or more as
measured in accordance with
§ 248.20(d)(1) of subpart D, unless:
(A) The trading desk documents how
and why a particular trading desk or
other organizational unit of the entity
should be treated as a client, customer,
or counterparty of the trading desk for
purposes of paragraph (b)(2) of this
section; or
(B) The purchase or sale by the
trading desk is conducted anonymously
on an exchange or similar trading
facility that permits trading on behalf of
a broad range of market participants.
(4) Definition of financial exposure.
For purposes of this paragraph (b),
financial exposure means the aggregate
risks of one or more financial
instruments and any associated loans,
commodities, or foreign exchange or
currency, held by a banking entity or its
affiliate and managed by a particular
trading desk as part of the trading desk’s
market making-related activities.
(5) Definition of market-maker
inventory. For the purposes of this
paragraph (b), market-maker inventory
means all of the positions in the
financial instruments for which the
trading desk stands ready to make a
market in accordance with paragraph
(b)(2)(i) of this section, that are managed
by the trading desk, including the
trading desk’s open positions or
exposures arising from open
transactions.
§ 248.5 Permitted risk-mitigating hedging
activities.
(a) Permitted risk-mitigating hedging
activities. The prohibition contained in
§ 248.3(a) does not apply to the riskmitigating hedging activities of a
banking entity in connection with and
related to individual or aggregated
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62145
positions, contracts, or other holdings of
the banking entity and designed to
reduce the specific risks to the banking
entity in connection with and related to
such positions, contracts, or other
holdings.
(b) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under paragraph (a) of this
section only if:
(1) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(i) Reasonably designed written
policies and procedures regarding the
positions, techniques and strategies that
may be used for hedging, including
documentation indicating what
positions, contracts or other holdings a
particular trading desk may use in its
risk-mitigating hedging activities, as
well as position and aging limits with
respect to such positions, contracts or
other holdings;
(ii) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(iii) The conduct of analysis,
including correlation analysis, and
independent testing designed to ensure
that the positions, techniques and
strategies that may be used for hedging
may reasonably be expected to
demonstrably reduce or otherwise
significantly mitigate the specific,
identifiable risk(s) being hedged, and
such correlation analysis demonstrates
that the hedging activity demonstrably
reduces or otherwise significantly
mitigates the specific, identifiable risk(s)
being hedged;
(2) The risk-mitigating hedging
activity:
(i) Is conducted in accordance with
the written policies, procedures, and
internal controls required under this
section;
(ii) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks, including market risk,
counterparty or other credit risk,
currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
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positions, contracts or other holdings
and the risks and liquidity thereof;
(iii) Does not give rise, at the
inception of the hedge, to any
significant new or additional risk that is
not itself hedged contemporaneously in
accordance with this section;
(iv) Is subject to continuing review,
monitoring and management by the
banking entity that:
(A) Is consistent with the written
hedging policies and procedures
required under paragraph (b)(1) of this
section;
(B) Is designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates the specific, identifiable risks
that develop over time from the riskmitigating hedging activities undertaken
under this section and the underlying
positions, contracts, and other holdings
of the banking entity, based upon the
facts and circumstances of the
underlying and hedging positions,
contracts and other holdings of the
banking entity and the risks and
liquidity thereof; and
(C) Requires ongoing recalibration of
the hedging activity by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(2) of this section and is
not prohibited proprietary trading; and
(3) The compensation arrangements of
persons performing risk-mitigating
hedging activities are designed not to
reward or incentivize prohibited
proprietary trading.
(c) Documentation requirement. (1) A
banking entity must comply with the
requirements of paragraphs (c)(2) and
(3) of this section with respect to any
purchase or sale of financial
instruments made in reliance on this
section for risk-mitigating hedging
purposes that is:
(i) Not established by the specific
trading desk establishing or responsible
for the underlying positions, contracts,
or other holdings the risks of which the
hedging activity is designed to reduce;
(ii) Established by the specific trading
desk establishing or responsible for the
underlying positions, contracts, or other
holdings the risks of which the
purchases or sales are designed to
reduce, but that is effected through a
financial instrument, exposure,
technique, or strategy that is not
specifically identified in the trading
desk’s written policies and procedures
established under paragraph (b)(1) of
this section or under § 248.4(b)(2)(iii)(B)
of this subpart as a product, instrument,
exposure, technique, or strategy such
trading desk may use for hedging; or
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(iii) Established to hedge aggregated
positions across two or more trading
desks.
(2) In connection with any purchase
or sale identified in paragraph (c)(1) of
this section, a banking entity must, at a
minimum, and contemporaneously with
the purchase or sale, document:
(i) The specific, identifiable risk(s) of
the identified positions, contracts, or
other holdings of the banking entity that
the purchase or sale is designed to
reduce;
(ii) The specific risk-mitigating
strategy that the purchase or sale is
designed to fulfill; and
(iii) The trading desk or other
business unit that is establishing and
responsible for the hedge.
(3) A banking entity must create and
retain records sufficient to demonstrate
compliance with the requirements of
this paragraph (c) for a period that is no
less than five years in a form that allows
the banking entity to promptly produce
such records to the Board on request, or
such longer period as required under
other law or this part.
§ 248.6 Other permitted proprietary trading
activities.
(a) Permitted trading in domestic
government obligations. The prohibition
contained in § 248.3(a) does not apply to
the purchase or sale by a banking entity
of a financial instrument that is:
(1) An obligation of, or issued or
guaranteed by, the United States;
(2) An obligation, participation, or
other instrument of, or issued or
guaranteed by, an agency of the United
States, the Government National
Mortgage Association, the Federal
National Mortgage Association, the
Federal Home Loan Mortgage
Corporation, a Federal Home Loan
Bank, the Federal Agricultural Mortgage
Corporation or a Farm Credit System
institution chartered under and subject
to the provisions of the Farm Credit Act
of 1971 (12 U.S.C. 2001 et seq.);
(3) An obligation of any State or any
political subdivision thereof, including
any municipal security; or
(4) An obligation of the FDIC, or any
entity formed by or on behalf of the
FDIC for purpose of facilitating the
disposal of assets acquired or held by
the FDIC in its corporate capacity or as
conservator or receiver under the
Federal Deposit Insurance Act or Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
(b) Permitted trading in foreign
government obligations—(1) Affiliates of
foreign banking entities in the United
States. The prohibition contained in
§ 248.3(a) does not apply to the
purchase or sale of a financial
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instrument that is an obligation of, or
issued or guaranteed by, a foreign
sovereign (including any multinational
central bank of which the foreign
sovereign is a member), or any agency
or political subdivision of such foreign
sovereign, by a banking entity, so long
as:
(i) The banking entity is organized
under or is directly or indirectly
controlled by a banking entity that is
organized under the laws of a foreign
sovereign and is not directly or
indirectly controlled by a top-tier
banking entity that is organized under
the laws of the United States;
(ii) The financial instrument is an
obligation of, or issued or guaranteed
by, the foreign sovereign under the laws
of which the foreign banking entity
referred to in paragraph (b)(1)(i) of this
section is organized (including any
multinational central bank of which the
foreign sovereign is a member), or any
agency or political subdivision of that
foreign sovereign; and
(iii) The purchase or sale as principal
is not made by an insured depository
institution.
(2) Foreign affiliates of a U.S. banking
entity. The prohibition contained in
§ 248.3(a) does not apply to the
purchase or sale of a financial
instrument that is an obligation of, or
issued or guaranteed by, a foreign
sovereign (including any multinational
central bank of which the foreign
sovereign is a member), or any agency
or political subdivision of that foreign
sovereign, by a foreign entity that is
owned or controlled by a banking entity
organized or established under the laws
of the United States or any State, so long
as:
(i) The foreign entity is a foreign bank,
as defined in section 211.2(j) of the
Board’s Regulation K (12 CFR 211.2(j)),
or is regulated by the foreign sovereign
as a securities dealer;
(ii) The financial instrument is an
obligation of, or issued or guaranteed
by, the foreign sovereign under the laws
of which the foreign entity is organized
(including any multinational central
bank of which the foreign sovereign is
a member), or any agency or political
subdivision of that foreign sovereign;
and
(iii) The financial instrument is
owned by the foreign entity and is not
financed by an affiliate that is located in
the United States or organized under the
laws of the United States or of any State.
(c) Permitted trading on behalf of
customers—(1) Fiduciary transactions.
The prohibition contained in § 248.3(a)
does not apply to the purchase or sale
of financial instruments by a banking
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entity acting as trustee or in a similar
fiduciary capacity, so long as:
(i) The transaction is conducted for
the account of, or on behalf of, a
customer; and
(ii) The banking entity does not have
or retain beneficial ownership of the
financial instruments.
(2) Riskless principal transactions.
The prohibition contained in § 248.3(a)
does not apply to the purchase or sale
of financial instruments by a banking
entity acting as riskless principal in a
transaction in which the banking entity,
after receiving an order to purchase (or
sell) a financial instrument from a
customer, purchases (or sells) the
financial instrument for its own account
to offset a contemporaneous sale to (or
purchase from) the customer.
(d) Permitted trading by a regulated
insurance company. The prohibition
contained in § 248.3(a) does not apply to
the purchase or sale of financial
instruments by a banking entity that is
an insurance company or an affiliate of
an insurance company if:
(1) The insurance company or its
affiliate purchases or sells the financial
instruments solely for:
(i) The general account of the
insurance company; or
(ii) A separate account established by
the insurance company;
(2) The purchase or sale is conducted
in compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (d)(2) of this
section is insufficient to protect the
safety and soundness of the covered
banking entity, or the financial stability
of the United States.
(e) Permitted trading activities of
foreign banking entities. (1) The
prohibition contained in § 248.3(a) does
not apply to the purchase or sale of
financial instruments by a banking
entity if:
(i) The banking entity is not organized
or directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of any
State;
(ii) The purchase or sale by the
banking entity is made pursuant to
paragraph (9) or (13) of section 4(c) of
the BHC Act; and
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(iii) The purchase or sale meets the
requirements of paragraph (e)(3) of this
section.
(2) A purchase or sale of financial
instruments by a banking entity is made
pursuant to paragraph (9) or (13) of
section 4(c) of the BHC Act for purposes
of paragraph (e)(1)(ii) of this section
only if:
(i) The purchase or sale is conducted
in accordance with the requirements of
paragraph (e) of this section; and
(ii)(A) With respect to a banking
entity that is a foreign banking
organization, the banking entity meets
the qualifying foreign banking
organization requirements of section
211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c) or
(e)), as applicable; or
(B) With respect to a banking entity
that is not a foreign banking
organization, the banking entity is not
organized under the laws of the United
States or of any State and the banking
entity, on a fully-consolidated basis,
meets at least two of the following
requirements:
(1) Total assets of the banking entity
held outside of the United States exceed
total assets of the banking entity held in
the United States;
(2) Total revenues derived from the
business of the banking entity outside of
the United States exceed total revenues
derived from the business of the
banking entity in the United States; or
(3) Total net income derived from the
business of the banking entity outside of
the United States exceeds total net
income derived from the business of the
banking entity in the United States.
(3) A purchase or sale by a banking
entity is permitted for purposes of this
paragraph (e) if:
(i) The banking entity engaging as
principal in the purchase or sale
(including any personnel of the banking
entity or its affiliate that arrange,
negotiate or execute such purchase or
sale) is not located in the United States
or organized under the laws of the
United States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State;
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State;
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62147
(iv) No financing for the banking
entity’s purchases or sales is provided,
directly or indirectly, by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
(v) The purchase or sale is not
conducted with or through any U.S.
entity, other than:
(A) A purchase or sale with the
foreign operations of a U.S. entity if no
personnel of such U.S. entity that are
located in the United States are
involved in the arrangement,
negotiation, or execution of such
purchase or sale;
(B) A purchase or sale with an
unaffiliated market intermediary acting
as principal, provided the purchase or
sale is promptly cleared and settled
through a clearing agency or derivatives
clearing organization acting as a central
counterparty; or
(C) A purchase or sale through an
unaffiliated market intermediary acting
as agent, provided the purchase or sale
is conducted anonymously on an
exchange or similar trading facility and
is promptly cleared and settled through
a clearing agency or derivatives clearing
organization acting as a central
counterparty.
(4) For purposes of this paragraph (e),
a U.S. entity is any entity that is, or is
controlled by, or is acting on behalf of,
or at the direction of, any other entity
that is, located in the United States or
organized under the laws of the United
States or of any State.
(5) For purposes of this paragraph (e),
a U.S. branch, agency, or subsidiary of
a foreign banking entity is considered to
be located in the United States;
however, the foreign bank that operates
or controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(6) For purposes of this paragraph (e),
unaffiliated market intermediary means
an unaffiliated entity, acting as an
intermediary, that is:
(i) A broker or dealer registered with
the SEC under section 15 of the
Exchange Act or exempt from
registration or excluded from regulation
as such;
(ii) A swap dealer registered with the
CFTC under section 4s of the
Commodity Exchange Act or exempt
from registration or excluded from
regulation as such;
(iii) A security-based swap dealer
registered with the SEC under section
15F of the Exchange Act or exempt from
registration or excluded from regulation
as such; or
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(iv) A futures commission merchant
registered with the CFTC under section
4f of the Commodity Exchange Act or
exempt from registration or excluded
from regulation as such.
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§ 248.7 Limitations on permitted
proprietary trading activities.
(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ 248.4 through
248.6 if the transaction, class of
transactions, or activity would:
(1) Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
(2) Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
(3) Pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.
(b) Definition of material conflict of
interest. (1) For purposes of this section,
a material conflict of interest between a
banking entity and its clients,
customers, or counterparties exists if the
banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the banking entity’s interests being
materially adverse to the interests of its
client, customer, or counterparty with
respect to such transaction, class of
transactions, or activity, and the
banking entity has not taken at least one
of the actions in paragraph (b)(2) of this
section.
(2) Prior to effecting the specific
transaction or class or type of
transactions, or engaging in the specific
activity, the banking entity:
(i) Timely and effective disclosure. (A)
Has made clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest; and
(B) Such disclosure is made in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
mitigate, any materially adverse effect
on the client, customer, or counterparty
created by the conflict of interest; or
(ii) Information barriers. Has
established, maintained, and enforced
information barriers that are
memorialized in written policies and
procedures, such as physical separation
of personnel, or functions, or limitations
on types of activity, that are reasonably
designed, taking into consideration the
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nature of the banking entity’s business,
to prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A banking entity may not
rely on such information barriers if, in
the case of any specific transaction,
class or type of transactions or activity,
the banking entity knows or should
reasonably know that, notwithstanding
the banking entity’s establishment of
information barriers, the conflict of
interest may involve or result in a
materially adverse effect on a client,
customer, or counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
§§ 248.8–248.9
[Reserved]
Subpart C—Covered Funds Activities
and Investments
§ 248.10 Prohibition on acquiring or
retaining an ownership interest in and
having certain relationships with a covered
fund.
(a) Prohibition. (1) Except as
otherwise provided in this subpart, a
banking entity may not, as principal,
directly or indirectly, acquire or retain
any ownership interest in or sponsor a
covered fund.
(2) Paragraph (a)(1) of this section
does not include acquiring or retaining
an ownership interest in a covered fund
by a banking entity:
(i) Acting solely as agent, broker, or
custodian, so long as;
(A) The activity is conducted for the
account of, or on behalf of, a customer;
and
(B) The banking entity and its
affiliates do not have or retain beneficial
ownership of such ownership interest;
(ii) Through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity (or an affiliate
thereof) that is established and
administered in accordance with the
law of the United States or a foreign
sovereign, if the ownership interest is
held or controlled directly or indirectly
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by the banking entity as trustee for the
benefit of persons who are or were
employees of the banking entity (or an
affiliate thereof);
(iii) In the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the ownership interest as
soon as practicable, and in no event may
the banking entity retain such
ownership interest for longer than such
period permitted by the Board; or
(iv) On behalf of customers as trustee
or in a similar fiduciary capacity for a
customer that is not a covered fund, so
long as:
(A) The activity is conducted for the
account of, or on behalf of, the
customer; and
(B) The banking entity and its
affiliates do not have or retain beneficial
ownership of such ownership interest.
(b) Definition of covered fund. (1)
Except as provided in paragraph (c) of
this section, covered fund means:
(i) An issuer that would be an
investment company, as defined in the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.), but for section
3(c)(1) or 3(c)(7) of that Act (15 U.S.C.
80a–3(c)(1) or (7));
(ii) Any commodity pool under
section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10)) for
which:
(A) The commodity pool operator has
claimed an exemption under 17 CFR
4.7; or
(B)(1) A commodity pool operator is
registered with the CFTC as a
commodity pool operator in connection
with the operation of the commodity
pool;
(2) Substantially all participation
units of the commodity pool are owned
by qualified eligible persons under 17
CFR 4.7(a)(2) and (3); and
(3) Participation units of the
commodity pool have not been publicly
offered to persons who are not qualified
eligible persons under 17 CFR 4.7(a)(2)
and (3); or
(iii) For any banking entity that is, or
is controlled directly or indirectly by a
banking entity that is, located in or
organized under the laws of the United
States or of any State, an entity that:
(A) Is organized or established outside
the United States and the ownership
interests of which are offered and sold
solely outside the United States;
(B) Is, or holds itself out as being, an
entity or arrangement that raises money
from investors primarily for the purpose
of investing in securities for resale or
other disposition or otherwise trading in
securities; and
(C)(1) Has as its sponsor that banking
entity (or an affiliate thereof); or
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(2) Has issued an ownership interest
that is owned directly or indirectly by
that banking entity (or an affiliate
thereof).
(2) An issuer shall not be deemed to
be a covered fund under paragraph
(b)(1)(iii) of this section if, were the
issuer subject to U.S. securities laws, the
issuer could rely on an exclusion or
exemption from the definition of
‘‘investment company’’ under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) other than the
exclusions contained in section 3(c)(1)
and 3(c)(7) of that Act.
(3) For purposes of paragraph
(b)(1)(iii) of this section, a U.S. branch,
agency, or subsidiary of a foreign
banking entity is located in the United
States; however, the foreign bank that
operates or controls that branch, agency,
or subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(c) Notwithstanding paragraph (b) of
this section, unless the appropriate
Federal banking agencies, the SEC, and
the CFTC jointly determine otherwise, a
covered fund does not include:
(1) Foreign public funds. (i) Subject to
paragraphs (ii) and (iii) below, an issuer
that:
(A) Is organized or established outside
of the United States;
(B) Is authorized to offer and sell
ownership interests to retail investors in
the issuer’s home jurisdiction; and
(C) Sells ownership interests
predominantly through one or more
public offerings outside of the United
States.
(ii) With respect to a banking entity
that is, or is controlled directly or
indirectly by a banking entity that is,
located in or organized under the laws
of the United States or of any State and
any issuer for which such banking
entity acts as sponsor, the sponsoring
banking entity may not rely on the
exemption in paragraph (c)(1)(i) of this
section for such issuer unless ownership
interests in the issuer are sold
predominantly to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring
banking entity or such issuer; and
(D) Directors and employees of such
entities.
(iii) For purposes of paragraph
(c)(1)(i)(C) of this section, the term
‘‘public offering’’ means a distribution
(as defined in § 248.4(a)(3) of subpart B)
of securities in any jurisdiction outside
the United States to investors, including
retail investors, provided that:
(A) The distribution complies with all
applicable requirements in the
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jurisdiction in which such distribution
is being made;
(B) The distribution does not restrict
availability to investors having a
minimum level of net worth or net
investment assets; and
(C) The issuer has filed or submitted,
with the appropriate regulatory
authority in such jurisdiction, offering
disclosure documents that are publicly
available.
(2) Wholly-owned subsidiaries. An
entity, all of the outstanding ownership
interests of which are owned directly or
indirectly by the banking entity (or an
affiliate thereof), except that:
(i) Up to five percent of the entity’s
outstanding ownership interests, less
any amounts outstanding under
paragraph (c)(2)(ii) of this section, may
be held by employees or directors of the
banking entity or such affiliate
(including former employees or
directors if their ownership interest was
acquired while employed by or in the
service of the banking entity); and
(ii) Up to 0.5 percent of the entity’s
outstanding ownership interests may be
held by a third party if the ownership
interest is acquired or retained by the
third party for the purpose of
establishing corporate separateness or
addressing bankruptcy, insolvency, or
similar concerns.
(3) Joint ventures. A joint venture
between a banking entity or any of its
affiliates and one or more unaffiliated
persons, provided that the joint venture:
(i) Is comprised of no more than 10
unaffiliated co-venturers;
(ii) Is in the business of engaging in
activities that are permissible for the
banking entity or affiliate, other than
investing in securities for resale or other
disposition; and
(iii) Is not, and does not hold itself out
as being, an entity or arrangement that
raises money from investors primarily
for the purpose of investing in securities
for resale or other disposition or
otherwise trading in securities.
(4) Acquisition vehicles. An issuer:
(i) Formed solely for the purpose of
engaging in a bona fide merger or
acquisition transaction; and
(ii) That exists only for such period as
necessary to effectuate the transaction.
(5) Foreign pension or retirement
funds. A plan, fund, or program
providing pension, retirement, or
similar benefits that is:
(i) Organized and administered
outside the United States;
(ii) A broad-based plan for employees
or citizens that is subject to regulation
as a pension, retirement, or similar plan
under the laws of the jurisdiction in
which the plan, fund, or program is
organized and administered; and
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(iii) Established for the benefit of
citizens or residents of one or more
foreign sovereigns or any political
subdivision thereof.
(6) Insurance company separate
accounts. A separate account, provided
that no banking entity other than the
insurance company participates in the
account’s profits and losses.
(7) Bank owned life insurance. A
separate account that is used solely for
the purpose of allowing one or more
banking entities to purchase a life
insurance policy for which the banking
entity or entities is beneficiary,
provided that no banking entity that
purchases the policy:
(i) Controls the investment decisions
regarding the underlying assets or
holdings of the separate account; or
(ii) Participates in the profits and
losses of the separate account other than
in compliance with applicable
supervisory guidance regarding bank
owned life insurance.
(8) Loan securitizations—(i) Scope.
An issuing entity for asset-backed
securities that satisfies all the
conditions of this paragraph (c)(8) and
the assets or holdings of which are
comprised solely of:
(A) Loans as defined in § 248.2(s) of
subpart A;
(B) Rights or other assets designed to
assure the servicing or timely
distribution of proceeds to holders of
such securities and rights or other assets
that are related or incidental to
purchasing or otherwise acquiring and
holding the loans, provided that each
asset meets the requirements of
paragraph (c)(8)(iii) of this section;
(C) Interest rate or foreign exchange
derivatives that meet the requirements
of paragraph (c)(8)(iv) of this section;
and
(D) Special units of beneficial interest
and collateral certificates that meet the
requirements of paragraph (c)(8)(v) of
this section.
(ii) Impermissible assets. For purposes
of this paragraph (c)(8), the assets or
holdings of the issuing entity shall not
include any of the following:
(A) A security, including an assetbacked security, or an interest in an
equity or debt security other than as
permitted in paragraph (c)(8)(iii) of this
section;
(B) A derivative, other than a
derivative that meets the requirements
of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities.
Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may
hold securities if those securities are:
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(A) Cash equivalents for purposes of
the rights and assets in paragraph
(c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts
previously contracted with respect to
the loans supporting the asset-backed
securities.
(iv) Derivatives. The holdings of
derivatives by the issuing entity shall be
limited to interest rate or foreign
exchange derivatives that satisfy all of
the following conditions:
(A) The written terms of the
derivative directly relate to the loans,
the asset-backed securities, or the
contractual rights of other assets
described in paragraph (c)(8)(i)(B) of
this section; and
(B) The derivatives reduce the interest
rate and/or foreign exchange risks
related to the loans, the asset-backed
securities, or the contractual rights or
other assets described in paragraph
(c)(8)(i)(B) of this section.
(v) Special units of beneficial interest
and collateral certificates. The assets or
holdings of the issuing entity may
include collateral certificates and
special units of beneficial interest
issued by a special purpose vehicle,
provided that:
(A) The special purpose vehicle that
issues the special unit of beneficial
interest or collateral certificate meets
the requirements in this paragraph
(c)(8);
(B) The special unit of beneficial
interest or collateral certificate is used
for the sole purpose of transferring to
the issuing entity for the loan
securitization the economic risks and
benefits of the assets that are
permissible for loan securitizations
under this paragraph (c)(8) and does not
directly or indirectly transfer any
interest in any other economic or
financial exposure;
(C) The special unit of beneficial
interest or collateral certificate is
created solely to satisfy legal
requirements or otherwise facilitate the
structuring of the loan securitization;
and
(D) The special purpose vehicle that
issues the special unit of beneficial
interest or collateral certificate and the
issuing entity are established under the
direction of the same entity that
initiated the loan securitization.
(9) Qualifying asset-backed
commercial paper conduits. (i) An
issuing entity for asset-backed
commercial paper that satisfies all of the
following requirements:
(A) The asset-backed commercial
paper conduit holds only:
(1) Loans and other assets permissible
for a loan securitization under
paragraph (c)(8)(i) of this section; and
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(2) Asset-backed securities supported
solely by assets that are permissible for
loan securitizations under paragraph
(c)(8)(i) of this section and acquired by
the asset-backed commercial paper
conduit as part of an initial issuance
either directly from the issuing entity of
the asset-backed securities or directly
from an underwriter in the distribution
of the asset-backed securities;
(B) The asset-backed commercial
paper conduit issues only asset-backed
securities, comprised of a residual
interest and securities with a legal
maturity of 397 days or less; and
(C) A regulated liquidity provider has
entered into a legally binding
commitment to provide full and
unconditional liquidity coverage with
respect to all of the outstanding assetbacked securities issued by the assetbacked commercial paper conduit (other
than any residual interest) in the event
that funds are required to redeem
maturing asset-backed securities.
(ii) For purposes of this paragraph
(c)(9), a regulated liquidity provider
means:
(A) A depository institution, as
defined in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c));
(B) A bank holding company, as
defined in section 2(a) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1841(a)), or a subsidiary thereof;
(C) A savings and loan holding
company, as defined in section 10a of
the Home Owners’ Loan Act (12 U.S.C.
1467a), provided all or substantially all
of the holding company’s activities are
permissible for a financial holding
company under section 4(k) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1843(k)), or a subsidiary thereof;
(D) A foreign bank whose home
country supervisor, as defined in
§ 211.21(q) of the Board’s Regulation K
(12 CFR 211.21(q)), has adopted capital
standards consistent with the Capital
Accord for the Basel Committee on
banking Supervision, as amended, and
that is subject to such standards, or a
subsidiary thereof; or
(E) The United States or a foreign
sovereign.
(10) Qualifying covered bonds—(i)
Scope. An entity owning or holding a
dynamic or fixed pool of loans or other
assets as provided in paragraph (c)(8) of
this section for the benefit of the holders
of covered bonds, provided that the
assets in the pool are comprised solely
of assets that meet the conditions in
paragraph (c)(8)(i) of this section.
(ii) Covered bond. For purposes of this
paragraph (c)(10), a covered bond
means:
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(A) A debt obligation issued by an
entity that meets the definition of
foreign banking organization, the
payment obligations of which are fully
and unconditionally guaranteed by an
entity that meets the conditions set forth
in paragraph (c)(10)(i) of this section; or
(B) A debt obligation of an entity that
meets the conditions set forth in
paragraph (c)(10)(i) of this section,
provided that the payment obligations
are fully and unconditionally
guaranteed by an entity that meets the
definition of foreign banking
organization and the entity is a whollyowned subsidiary, as defined in
paragraph (c)(2) of this section, of such
foreign banking organization.
(11) SBICs and public welfare
investment funds. An issuer:
(i) That is a small business investment
company, as defined in section 103(3) of
the Small Business Investment Act of
1958 (15 U.S.C. 662), or that has
received from the Small Business
Administration notice to proceed to
qualify for a license as a small business
investment company, which notice or
license has not been revoked; or
(ii) The business of which is to make
investments that are:
(A) Designed primarily to promote the
public welfare, of the type permitted
under paragraph (11) of section 5136 of
the Revised Statutes of the United States
(12 U.S.C. 24), including the welfare of
low- and moderate-income communities
or families (such as providing housing,
services, or jobs); or
(B) Qualified rehabilitation
expenditures with respect to a qualified
rehabilitated building or certified
historic structure, as such terms are
defined in section 47 of the Internal
Revenue Code of 1986 or a similar State
historic tax credit program.
(12) Registered investment companies
and excluded entities. An issuer:
(i) That is registered as an investment
company under section 8 of the
Investment Company Act of 1940 (15
U.S.C. 80a–8), or that is formed and
operated pursuant to a written plan to
become a registered investment
company as described in § 248.20(e)(3)
of subpart D and that complies with the
requirements of section 18 of the
Investment Company Act of 1940 (15
U.S.C. 80a–18);
(ii) That may rely on an exclusion or
exemption from the definition of
‘‘investment company’’ under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) other than the
exclusions contained in section 3(c)(1)
and 3(c)(7) of that Act; or
(iii) That has elected to be regulated
as a business development company
pursuant to section 54(a) of that Act (15
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U.S.C. 80a–53) and has not withdrawn
its election, or that is formed and
operated pursuant to a written plan to
become a business development
company as described in § 248.20(e)(3)
of subpart D and that complies with the
requirements of section 61 of the
Investment Company Act of 1940 (15
U.S.C. 80a–60).
(13) Issuers in conjunction with the
FDIC’s receivership or conservatorship
operations. An issuer that is an entity
formed by or on behalf of the FDIC for
the purpose of facilitating the disposal
of assets acquired in the FDIC’s capacity
as conservator or receiver under the
Federal Deposit Insurance Act or Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
(14) Other excluded issuers. (i) Any
issuer that the appropriate Federal
banking agencies, the SEC, and the
CFTC jointly determine the exclusion of
which is consistent with the purposes of
section 13 of the BHC Act.
(ii) A determination made under
paragraph (c)(14)(i) of this section will
be promptly made public.
(d) Definition of other terms related to
covered funds. For purposes of this
subpart:
(1) Applicable accounting standards
means U.S. generally accepted
accounting principles, or such other
accounting standards applicable to a
banking entity that the Board
determines are appropriate and that the
banking entity uses in the ordinary
course of its business in preparing its
consolidated financial statements.
(2) Asset-backed security has the
meaning specified in Section 3(a)(79) of
the Exchange Act (15 U.S.C. 78c(a)(79)).
(3) Director has the same meaning as
provided in section 215.2(d)(1) of the
Board’s Regulation O (12 CFR
215.2(d)(1)).
(4) Issuer has the same meaning as in
section 2(a)(22) of the Investment
Company Act of 1940 (15 U.S.C. 80a–
2(a)(22)).
(5) Issuing entity means with respect
to asset-backed securities the special
purpose vehicle that owns or holds the
pool assets underlying asset-backed
securities and in whose name the assetbacked securities supported or serviced
by the pool assets are issued.
(6) Ownership interest—(i) Ownership
interest means any equity, partnership,
or other similar interest. An ‘‘other
similar interest’’ means an interest that:
(A) Has the right to participate in the
selection or removal of a general
partner, managing member, member of
the board of directors or trustees,
investment manager, investment
adviser, or commodity trading advisor
of the covered fund (excluding the
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rights of a creditor to exercise remedies
upon the occurrence of an event of
default or an acceleration event);
(B) Has the right under the terms of
the interest to receive a share of the
income, gains or profits of the covered
fund;
(C) Has the right to receive the
underlying assets of the covered fund
after all other interests have been
redeemed and/or paid in full (excluding
the rights of a creditor to exercise
remedies upon the occurrence of an
event of default or an acceleration
event);
(D) Has the right to receive all or a
portion of excess spread (the positive
difference, if any, between the aggregate
interest payments received from the
underlying assets of the covered fund
and the aggregate interest paid to the
holders of other outstanding interests);
(E) Provides under the terms of the
interest that the amounts payable by the
covered fund with respect to the interest
could be reduced based on losses arising
from the underlying assets of the
covered fund, such as allocation of
losses, write-downs or charge-offs of the
outstanding principal balance, or
reductions in the amount of interest due
and payable on the interest;
(F) Receives income on a pass-through
basis from the covered fund, or has a
rate of return that is determined by
reference to the performance of the
underlying assets of the covered fund;
or
(G) Any synthetic right to have,
receive, or be allocated any of the rights
in paragraphs (d)(6)(i)(A) through (F) of
this section.
(ii) Ownership interest does not
include: Restricted profit interest. An
interest held by an entity (or an
employee or former employee thereof)
in a covered fund for which the entity
(or employee thereof) serves as
investment manager, investment
adviser, commodity trading advisor, or
other service provider so long as:
(A) The sole purpose and effect of the
interest is to allow the entity (or
employee or former employee thereof)
to share in the profits of the covered
fund as performance compensation for
the investment management, investment
advisory, commodity trading advisory,
or other services provided to the
covered fund by the entity (or employee
or former employee thereof), provided
that the entity (or employee or former
employee thereof) may be obligated
under the terms of such interest to
return profits previously received;
(B) All such profit, once allocated, is
distributed to the entity (or employee or
former employee thereof) promptly after
being earned or, if not so distributed, is
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retained by the covered fund for the sole
purpose of establishing a reserve
amount to satisfy contractual obligations
with respect to subsequent losses of the
covered fund and such undistributed
profit of the entity (or employee or
former employee thereof) does not share
in the subsequent investment gains of
the covered fund;
(C) Any amounts invested in the
covered fund, including any amounts
paid by the entity (or employee or
former employee thereof) in connection
with obtaining the restricted profit
interest, are within the limits of § 248.12
of this subpart; and
(D) The interest is not transferable by
the entity (or employee or former
employee thereof) except to an affiliate
thereof (or an employee of the banking
entity or affiliate), to immediate family
members, or through the intestacy, of
the employee or former employee, or in
connection with a sale of the business
that gave rise to the restricted profit
interest by the entity (or employee or
former employee thereof) to an
unaffiliated party that provides
investment management, investment
advisory, commodity trading advisory,
or other services to the fund.
(7) Prime brokerage transaction means
any transaction that would be a covered
transaction, as defined in section
23A(b)(7) of the Federal Reserve Act (12
U.S.C. 371c(b)(7)), that is provided in
connection with custody, clearance and
settlement, securities borrowing or
lending services, trade execution,
financing, or data, operational, and
administrative support.
(8) Resident of the United States
means a person that is a ‘‘U.S. person’’
as defined in rule 902(k) of the SEC’s
Regulation S (17 CFR 230.902(k)).
(9) Sponsor means, with respect to a
covered fund:
(i) To serve as a general partner,
managing member, or trustee of a
covered fund, or to serve as a
commodity pool operator with respect
to a covered fund as defined in (b)(1)(ii)
of this section;
(ii) In any manner to select or to
control (or to have employees, officers,
or directors, or agents who constitute) a
majority of the directors, trustees, or
management of a covered fund; or
(iii) To share with a covered fund, for
corporate, marketing, promotional, or
other purposes, the same name or a
variation of the same name, except as
permitted under § 248.11(a)(6).
(10) Trustee. (i) For purposes of
paragraph (d)(9) of this section and
§ 248.11 of subpart C, a trustee does not
include:
(A) A trustee that does not exercise
investment discretion with respect to a
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covered fund, including a trustee that is
subject to the direction of an
unaffiliated named fiduciary who is not
a trustee pursuant to section 403(a)(1) of
the Employee’s Retirement Income
Security Act (29 U.S.C. 1103(a)(1)); or
(B) A trustee that is subject to
fiduciary standards imposed under
foreign law that are substantially
equivalent to those described in
paragraph (d)(10)(i)(A) of this section;
(ii) Any entity that directs a person
described in paragraph (d)(10)(i) of this
section, or that possesses authority and
discretion to manage and control the
investment decisions of a covered fund
for which such person serves as trustee,
shall be considered to be a trustee of
such covered fund.
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§ 248.11 Permitted organizing and
offering, underwriting, and market making
with respect to a covered fund.
(a) Organizing and offering a covered
fund in general. Notwithstanding
§ 248.10(a) of this subpart, a banking
entity is not prohibited from acquiring
or retaining an ownership interest in, or
acting as sponsor to, a covered fund in
connection with, directly or indirectly,
organizing and offering a covered fund,
including serving as a general partner,
managing member, trustee, or
commodity pool operator of the covered
fund and in any manner selecting or
controlling (or having employees,
officers, directors, or agents who
constitute) a majority of the directors,
trustees, or management of the covered
fund, including any necessary expenses
for the foregoing, only if:
(1) The banking entity (or an affiliate
thereof) provides bona fide trust,
fiduciary, investment advisory, or
commodity trading advisory services;
(2) The covered fund is organized and
offered only in connection with the
provision of bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services and only to
persons that are customers of such
services of the banking entity (or an
affiliate thereof), pursuant to a written
plan or similar documentation outlining
how the banking entity or such affiliate
intends to provide advisory or similar
services to its customers through
organizing and offering such fund;
(3) The banking entity and its
affiliates do not acquire or retain an
ownership interest in the covered fund
except as permitted under § 248.12 of
this subpart;
(4) The banking entity and its
affiliates comply with the requirements
of § 248.14 of this subpart;
(5) The banking entity and its
affiliates do not, directly or indirectly,
guarantee, assume, or otherwise insure
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the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests;
(6) The covered fund, for corporate,
marketing, promotional, or other
purposes:
(i) Does not share the same name or
a variation of the same name with the
banking entity (or an affiliate thereof)
except that a covered fund may share
the same name or a variation of the
same name with a banking entity that is
an investment adviser to the covered
fund if:
(A) The investment adviser is not an
insured depository institution, a
company that controls an insured
depository institution, or a company
that is treated as a bank holding
company for purposes of section 8 of the
International Banking Act of 1978 (12
U.S.C. 3106); and
(B) The investment adviser does not
share the same name or a variation of
the same name as an insured depository
institution, a company that controls an
insured depository institution, or a
company that is treated as a bank
holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(ii) Does not use the word ‘‘bank’’ in
its name;
(7) No director or employee of the
banking entity (or an affiliate thereof)
takes or retains an ownership interest in
the covered fund, except for any
director or employee of the banking
entity or such affiliate who is directly
engaged in providing investment
advisory, commodity trading advisory,
or other services to the covered fund at
the time the director or employee takes
the ownership interest; and
(8) The banking entity:
(i) Clearly and conspicuously
discloses, in writing, to any prospective
and actual investor in the covered fund
(such as through disclosure in the
covered fund’s offering documents):
(A) That ‘‘any losses in [such covered
fund] will be borne solely by investors
in [the covered fund] and not by [the
banking entity] or its affiliates;
therefore, [the banking entity’s] losses in
[such covered fund] will be limited to
losses attributable to the ownership
interests in the covered fund held by
[the banking entity] and any affiliate in
its capacity as investor in the [covered
fund] or as beneficiary of a restricted
profit interest held by [the banking
entity] or any affiliate’’;
(B) That such investor should read the
fund offering documents before
investing in the covered fund;
(C) That the ‘‘ownership interests in
the covered fund are not insured by the
FDIC, and are not deposits, obligations
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of, or endorsed or guaranteed in any
way, by any banking entity’’ (unless that
happens to be the case); and
(D) The role of the banking entity and
its affiliates and employees in
sponsoring or providing any services to
the covered fund; and
(ii) Complies with any additional
rules of the appropriate Federal banking
agencies, the SEC, or the CFTC, as
provided in section 13(b)(2) of the BHC
Act, designed to ensure that losses in
such covered fund are borne solely by
investors in the covered fund and not by
the covered banking entity and its
affiliates.
(b) Organizing and offering an issuing
entity of asset-backed securities. (1)
Notwithstanding § 248.10(a) of this
subpart, a banking entity is not
prohibited from acquiring or retaining
an ownership interest in, or acting as
sponsor to, a covered fund that is an
issuing entity of asset-backed securities
in connection with, directly or
indirectly, organizing and offering that
issuing entity, so long as the banking
entity and its affiliates comply with all
of the requirements of paragraph (a)(3)
through (8) of this section.
(2) For purposes of this paragraph (b),
organizing and offering a covered fund
that is an issuing entity of asset-backed
securities means acting as the
securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)) of the issuing
entity, or acquiring or retaining an
ownership interest in the issuing entity
as required by section 15G of that Act
(15 U.S.C. 78o–11) and the
implementing regulations issued
thereunder.
(c) Underwriting and market making
in ownership interests of a covered
fund. The prohibition contained in
§ 248.10(a) of this subpart does not
apply to a banking entity’s underwriting
activities or market making-related
activities involving a covered fund so
long as:
(1) Those activities are conducted in
accordance with the requirements of
§ 248.4(a) or § 248.4(b) of subpart B,
respectively;
(2) With respect to any banking entity
(or any affiliate thereof) that: Acts as a
sponsor, investment adviser or
commodity trading advisor to a
particular covered fund or otherwise
acquires and retains an ownership
interest in such covered fund in reliance
on paragraph (a) of this section; acquires
and retains an ownership interest in
such covered fund and is either a
securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)), or is acquiring
and retaining an ownership interest in
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such covered fund in compliance with
section 15G of that Act (15 U.S.C. 78o–
11) and the implementing regulations
issued thereunder each as permitted by
paragraph (b) of this section; or, directly
or indirectly, guarantees, assumes, or
otherwise insures the obligations or
performance of the covered fund or of
any covered fund in which such fund
invests, then in each such case any
ownership interests acquired or retained
by the banking entity and its affiliates in
connection with underwriting and
market making related activities for that
particular covered fund are included in
the calculation of ownership interests
permitted to be held by the banking
entity and its affiliates under the
limitations of § 248.12(a)(2)(ii) and
§ 248.12(d) of this subpart; and
(3) With respect to any banking entity,
the aggregate value of all ownership
interests of the banking entity and its
affiliates in all covered funds acquired
and retained under § 248.11 of this
subpart, including all covered funds in
which the banking entity holds an
ownership interest in connection with
underwriting and market making related
activities permitted under this
paragraph (c), are included in the
calculation of all ownership interests
under § 248.12(a)(2)(iii) and § 248.12(d)
of this subpart.
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§ 248.12 Permitted investment in a
covered fund.
(a) Authority and limitations on
permitted investments in covered funds.
(1) Notwithstanding the prohibition
contained in § 248.10(a) of this subpart,
a banking entity may acquire and retain
an ownership interest in a covered fund
that the banking entity or an affiliate
thereof organizes and offers pursuant to
§ 248.11, for the purposes of:
(i) Establishment. Establishing the
fund and providing the fund with
sufficient initial equity for investment to
permit the fund to attract unaffiliated
investors, subject to the limits contained
in paragraphs (a)(2)(i) and (iii) of this
section; or
(ii) De minimis investment. Making
and retaining an investment in the
covered fund subject to the limits
contained in paragraphs (a)(2)(ii) and
(iii) of this section.
(2) Investment limits—(i) Seeding
period. With respect to an investment in
any covered fund made or held
pursuant to paragraph (a)(1)(i) of this
section, the banking entity and its
affiliates:
(A) Must actively seek unaffiliated
investors to reduce, through
redemption, sale, dilution, or other
methods, the aggregate amount of all
ownership interests of the banking
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entity in the covered fund to the amount
permitted in paragraph (a)(2)(i)(B) of
this section; and
(B) Must, no later than 1 year after the
date of establishment of the fund (or
such longer period as may be provided
by the Board pursuant to paragraph (e)
of this section), conform its ownership
interest in the covered fund to the limits
in paragraph (a)(2)(ii) of this section;
(ii) Per-fund limits. (A) Except as
provided in paragraph (a)(2)(ii)(B) of
this section, an investment by a banking
entity and its affiliates in any covered
fund made or held pursuant to
paragraph (a)(1)(ii) of this section may
not exceed 3 percent of the total number
or value of the outstanding ownership
interests of the fund.
(B) An investment by a banking entity
and its affiliates in a covered fund that
is an issuing entity of asset-backed
securities may not exceed 3 percent of
the total fair market value of the
ownership interests of the fund
measured in accordance with paragraph
(b)(3) of this section, unless a greater
percentage is retained by the banking
entity and its affiliates in compliance
with the requirements of section 15G of
the Exchange Act (15 U.S.C. 78o–11)
and the implementing regulations
issued thereunder, in which case the
investment by the banking entity and its
affiliates in the covered fund may not
exceed the amount, number, or value of
ownership interests of the fund required
under section 15G of the Exchange Act
and the implementing regulations
issued thereunder.
(iii) Aggregate limit. The aggregate
value of all ownership interests of the
banking entity and its affiliates in all
covered funds acquired or retained
under this section may not exceed 3
percent of the tier 1 capital of the
banking entity, as provided under
paragraph (c) of this section, and shall
be calculated as of the last day of each
calendar quarter.
(iv) Date of establishment. For
purposes of this section, the date of
establishment of a covered fund shall
be:
(A) In general. The date on which the
investment adviser or similar entity to
the covered fund begins making
investments pursuant to the written
investment strategy for the fund;
(B) Issuing entities of asset-backed
securities. In the case of an issuing
entity of asset-backed securities, the
date on which the assets are initially
transferred into the issuing entity of
asset-backed securities.
(b) Rules of construction—(1)
Attribution of ownership interests to a
covered banking entity. (i) For purposes
of paragraph (a)(2) of this section, the
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62153
amount and value of a banking entity’s
permitted investment in any single
covered fund shall include any
ownership interest held under § 248.12
directly by the banking entity, including
any affiliate of the banking entity.
(ii) Treatment of registered investment
companies, SEC-regulated business
development companies and foreign
public funds. For purposes of paragraph
(b)(1)(i) of this section, a registered
investment company, SEC-regulated
business development companies or
foreign public fund as described in
§ 248.10(c)(1) of this subpart will not be
considered to be an affiliate of the
banking entity so long as the banking
entity:
(A) Does not own, control, or hold
with the power to vote 25 percent or
more of the voting shares of the
company or fund; and
(B) Provides investment advisory,
commodity trading advisory,
administrative, and other services to the
company or fund in compliance with
the limitations under applicable
regulation, order, or other authority.
(iii) Covered funds. For purposes of
paragraph (b)(1)(i) of this section, a
covered fund will not be considered to
be an affiliate of a banking entity so long
as the covered fund is held in
compliance with the requirements of
this subpart.
(iv) Treatment of employee and
director investments financed by the
banking entity. For purposes of
paragraph (b)(1)(i) of this section, an
investment by a director or employee of
a banking entity who acquires an
ownership interest in his or her
personal capacity in a covered fund
sponsored by the banking entity will be
attributed to the banking entity if the
banking entity, directly or indirectly,
extends financing for the purpose of
enabling the director or employee to
acquire the ownership interest in the
fund and the financing is used to
acquire such ownership interest in the
covered fund.
(2) Calculation of permitted
ownership interests in a single covered
fund. Except as provided in paragraph
(b)(3) or (4), for purposes of determining
whether an investment in a single
covered fund complies with the
restrictions on ownership interests
under paragraphs (a)(2)(i)(B) and
(a)(2)(ii)(A) of this section:
(i) The aggregate number of the
outstanding ownership interests held by
the banking entity shall be the total
number of ownership interests held
under this section by the banking entity
in a covered fund divided by the total
number of ownership interests held by
all entities in that covered fund, as of
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the last day of each calendar quarter
(both measured without regard to
committed funds not yet called for
investment);
(ii) The aggregate value of the
outstanding ownership interests held by
the banking entity shall be the aggregate
fair market value of all investments in
and capital contributions made to the
covered fund by the banking entity,
divided by the value of all investments
in and capital contributions made to
that covered fund by all entities, as of
the last day of each calendar quarter (all
measured without regard to committed
funds not yet called for investment). If
fair market value cannot be determined,
then the value shall be the historical
cost basis of all investments in and
contributions made by the banking
entity to the covered fund;
(iii) For purposes of the calculation
under paragraph (b)(2)(ii) of this section,
once a valuation methodology is chosen,
the banking entity must calculate the
value of its investment and the
investments of all others in the covered
fund in the same manner and according
to the same standards.
(3) Issuing entities of asset-backed
securities. In the case of an ownership
interest in an issuing entity of assetbacked securities, for purposes of
determining whether an investment in a
single covered fund complies with the
restrictions on ownership interests
under paragraphs (a)(2)(i)(B) and
(a)(2)(ii)(B) of this section:
(i) For securitizations subject to the
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11), the
calculations shall be made as of the date
and according to the valuation
methodology applicable pursuant to the
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11) and
the implementing regulations issued
thereunder; or
(ii) For securitization transactions
completed prior to the compliance date
of such implementing regulations (or as
to which such implementing regulations
do not apply), the calculations shall be
made as of the date of establishment as
defined in paragraph (a)(2)(iv)(B) of this
section or such earlier date on which
the transferred assets have been valued
for purposes of transfer to the covered
fund, and thereafter only upon the date
on which additional securities of the
issuing entity of asset-backed securities
are priced for purposes of the sales of
ownership interests to unaffiliated
investors.
(iii) For securitization transactions
completed prior to the compliance date
of such implementing regulations (or as
to which such implementing regulations
do not apply), the aggregate value of the
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outstanding ownership interests in the
covered fund shall be the fair market
value of the assets transferred to the
issuing entity of the securitization and
any other assets otherwise held by the
issuing entity at such time, determined
in a manner that is consistent with its
determination of the fair market value of
those assets for financial statement
purposes.
(iv) For purposes of the calculation
under paragraph (b)(3)(iii) of this
section, the valuation methodology used
to calculate the fair market value of the
ownership interests must be the same
for both the ownership interests held by
a banking entity and the ownership
interests held by all others in the
covered fund in the same manner and
according to the same standards.
(4) Multi-tier fund investments—(i)
Master-feeder fund investments. If the
principal investment strategy of a
covered fund (the ‘‘feeder fund’’) is to
invest substantially all of its assets in
another single covered fund (the
‘‘master fund’’), then for purposes of the
investment limitations in paragraphs
(a)(2)(i)(B) and (a)(2)(ii) of this section,
the banking entity’s permitted
investment in such funds shall be
measured only by reference to the value
of the master fund. The banking entity’s
permitted investment in the master fund
shall include any investment by the
banking entity in the master fund, as
well as the banking entity’s pro-rata
share of any ownership interest of the
master fund that is held through the
feeder fund; and
(ii) Fund-of-funds investments. If a
banking entity organizes and offers a
covered fund pursuant to § 248.11 of
this subpart for the purpose of investing
in other covered funds (a ‘‘fund of
funds’’) and that fund of funds itself
invests in another covered fund that the
banking entity is permitted to own, then
the banking entity’s permitted
investment in that other fund shall
include any investment by the banking
entity in that other fund, as well as the
banking entity’s pro-rata share of any
ownership interest of the fund that is
held through the fund of funds. The
investment of the banking entity may
not represent more than 3 percent of the
amount or value of any single covered
fund.
(c) Aggregate permitted investments
in all covered funds. (1) For purposes of
paragraph (a)(2)(iii) of this section, the
aggregate value of all ownership
interests held by a banking entity shall
be the sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest in covered funds
(together with any amounts paid by the
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entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § 248.10(d)(6)(ii) of
this subpart), on a historical cost basis.
(2) Calculation of tier 1 capital. For
purposes of paragraph (a)(2)(iii) of this
section:
(i) Entities that are required to hold
and report tier 1 capital. If a banking
entity is required to calculate and report
tier 1 capital, the banking entity’s tier 1
capital shall be equal to the amount of
tier 1 capital of the banking entity as of
the last day of the most recent calendar
quarter, as reported to its primary
financial regulatory agency; and
(ii) If a banking entity is not required
to calculate and report tier 1 capital, the
banking entity’s tier 1 capital shall be
determined to be equal to:
(A) In the case of a banking entity that
is controlled, directly or indirectly, by a
depository institution that calculates
and reports tier 1 capital, be equal to the
amount of tier 1 capital reported by
such controlling depository institution
in the manner described in paragraph
(c)(2)(i) of this section;
(B) In the case of a banking entity that
is not controlled, directly or indirectly,
by a depository institution that
calculates and reports tier 1 capital:
(1) Bank holding company
subsidiaries. If the banking entity is a
subsidiary of a bank holding company
or company that is treated as a bank
holding company, be equal to the
amount of tier 1 capital reported by the
top-tier affiliate of such covered banking
entity that calculates and reports tier 1
capital in the manner described in
paragraph (c)(2)(i) of this section; and
(2) Other holding companies and any
subsidiary or affiliate thereof. If the
banking entity is not a subsidiary of a
bank holding company or a company
that is treated as a bank holding
company, be equal to the total amount
of shareholders’ equity of the top-tier
affiliate within such organization as of
the last day of the most recent calendar
quarter that has ended, as determined
under applicable accounting standards.
(iii) Treatment of foreign banking
entities—(A) Foreign banking entities.
Except as provided in paragraph
(c)(2)(iii)(B) of this section, with respect
to a banking entity that is not itself, and
is not controlled directly or indirectly
by, a banking entity that is located or
organized under the laws of the United
States or of any State, the tier 1 capital
of the banking entity shall be the
consolidated tier 1 capital of the entity
as calculated under applicable home
country standards.
(B) U.S. affiliates of foreign banking
entities. With respect to a banking entity
that is located or organized under the
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laws of the United States or of any State
and is controlled by a foreign banking
entity identified under paragraph
(c)(2)(iii)(A) of this section, the banking
entity’s tier 1 capital shall be as
calculated under paragraphs (c)(2)(i) or
(ii) of this section.
(d) Capital treatment for a permitted
investment in a covered fund. For
purposes of calculating compliance with
the applicable regulatory capital
requirements, a banking entity shall
deduct from the banking entity’s tier 1
capital (as determined under paragraph
(c)(2) of this section) the greater of:
(1) The sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest (together with any
amounts paid by the entity (or employee
thereof) in connection with obtaining a
restricted profit interest under
§ 248.10(d)(6)(ii) of subpart C), on a
historical cost basis, plus any earnings
received; and
(2) The fair market value of the
banking entity’s ownership interests in
the covered fund as determined under
paragraph (b)(2)(ii) or (b)(3) of this
section (together with any amounts paid
by the entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § 248.10(d)(6)(ii) of
subpart C), if the banking entity
accounts for the profits (or losses) of the
fund investment in its financial
statements.
(e) Extension of time to divest an
ownership interest. (1) Upon application
by a banking entity, the Board may
extend the period under paragraph
(a)(2)(i) of this section for up to 2
additional years if the Board finds that
an extension would be consistent with
safety and soundness and not
detrimental to the public interest. An
application for extension must:
(i) Be submitted to the Board at least
90 days prior to the expiration of the
applicable time period;
(ii) Provide the reasons for
application, including information that
addresses the factors in paragraph (e)(2)
of this section; and
(iii) Explain the banking entity’s plan
for reducing the permitted investment
in a covered fund through redemption,
sale, dilution or other methods as
required in paragraph (a)(2) of this
section.
(2) Factors governing the Board
determinations. In reviewing any
application under paragraph (e)(1) of
this section, the Board may consider all
the facts and circumstances related to
the permitted investment in a covered
fund, including:
(i) Whether the investment would
result, directly or indirectly, in a
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material exposure by the banking entity
to high-risk assets or high-risk trading
strategies;
(ii) The contractual terms governing
the banking entity’s interest in the
covered fund;
(iii) The date on which the covered
fund is expected to have attracted
sufficient investments from investors
unaffiliated with the banking entity to
enable the banking entity to comply
with the limitations in paragraph
(a)(2)(i) of this section;
(iv) The total exposure of the covered
banking entity to the investment and the
risks that disposing of, or maintaining,
the investment in the covered fund may
pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of
divesting or disposing of the investment
within the applicable period;
(vi) Whether the investment or the
divestiture or conformance of the
investment would involve or result in a
material conflict of interest between the
banking entity and unaffiliated parties,
including clients, customers or
counterparties to which it owes a duty;
(vi) The banking entity’s prior efforts
to reduce through redemption, sale,
dilution, or other methods its ownership
interests in the covered fund, including
activities related to the marketing of
interests in such covered fund;
(vii) [Reserved]
(viii) Market conditions; and
(ix) Any other factor that the Board
believes appropriate.
(3) Authority to impose restrictions on
activities or investment during any
extension period. The Board may
impose such conditions on any
extension approved under paragraph
(e)(1) of this section as the Board
determines are necessary or appropriate
to protect the safety and soundness of
the banking entity or the financial
stability of the United States, address
material conflicts of interest or other
unsound banking practices, or otherwise
further the purposes of section 13 of the
BHC Act and this part.
(4) Consultation. In the case of a
banking entity that is primarily
regulated by another Federal banking
agency, the SEC, or the CFTC, the Board
will consult with such agency prior to
acting on an application by the banking
entity for an extension under paragraph
(e)(1) of this section.
§ 248.13 Other permitted covered fund
activities and investments.
(a) Permitted risk-mitigating hedging
activities. (1) The prohibition contained
in § 248.10(a) of this subpart does not
apply with respect to an ownership
interest in a covered fund acquired or
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62155
retained by a banking entity that is
designed to demonstrably reduce or
otherwise significantly mitigate the
specific, identifiable risks to the banking
entity in connection with a
compensation arrangement with an
employee of the banking entity or an
affiliate thereof that directly provides
investment advisory, commodity trading
advisory or other services to the covered
fund.
(2) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under this paragraph (a) only
if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures; and
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(ii) The acquisition or retention of the
ownership interest:
(A) Is made in accordance with the
written policies, procedures and
internal controls required under this
section;
(B) At the inception of the hedge, is
designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks arising in connection
with the compensation arrangement
with the employee that directly
provides investment advisory,
commodity trading advisory, or other
services to the covered fund;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section; and
(D) Is subject to continuing review,
monitoring and management by the
banking entity.
(iii) The compensation arrangement
relates solely to the covered fund in
which the banking entity or any affiliate
has acquired an ownership interest
pursuant to this paragraph and such
compensation arrangement provides
that any losses incurred by the banking
entity on such ownership interest will
be offset by corresponding decreases in
amounts payable under such
compensation arrangement.
(b) Certain permitted covered fund
activities and investments outside of the
United States. (1) The prohibition
contained in § 248.10(a) of this subpart
does not apply to the acquisition or
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retention of any ownership interest in,
or the sponsorship of, a covered fund by
a banking entity only if:
(i) The banking entity is not organized
or directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of one
or more States;
(ii) The activity or investment by the
banking entity is pursuant to paragraph
(9) or (13) of section 4(c) of the BHC Act;
(iii) No ownership interest in the
covered fund is offered for sale or sold
to a resident of the United States; and
(iv) The activity or investment occurs
solely outside of the United States.
(2) An activity or investment by the
banking entity is pursuant to paragraph
(9) or (13) of section 4(c) of the BHC Act
for purposes of paragraph (b)(1)(ii) of
this section only if:
(i) The activity or investment is
conducted in accordance with the
requirements of this section; and
(ii)(A) With respect to a banking
entity that is a foreign banking
organization, the banking entity meets
the qualifying foreign banking
organization requirements of section
211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c) or
(e)), as applicable; or
(B) With respect to a banking entity
that is not a foreign banking
organization, the banking entity is not
organized under the laws of the United
States or of one or more States and the
banking entity, on a fully-consolidated
basis, meets at least two of the following
requirements:
(1) Total assets of the banking entity
held outside of the United States exceed
total assets of the banking entity held in
the United States;
(2) Total revenues derived from the
business of the banking entity outside of
the United States exceed total revenues
derived from the business of the
banking entity in the United States; or
(3) Total net income derived from the
business of the banking entity outside of
the United States exceeds total net
income derived from the business of the
banking entity in the United States.
(3) An ownership interest in a covered
fund is not offered for sale or sold to a
resident of the United States for
purposes of paragraph (b)(1)(iii) of this
section only if it is sold or has been sold
pursuant to an offering that does not
target residents of the United States.
(4) An activity or investment occurs
solely outside of the United States for
purposes of paragraph (b)(1)(iv) of this
section only if:
(i) The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
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and is not controlled directly or
indirectly by, a banking entity that is
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
laws of the United States or of any State;
(iii) The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
as principal directly or indirectly on a
consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
(iv) No financing for the banking
entity’s ownership or sponsorship is
provided, directly or indirectly, by any
branch or affiliate that is located in the
United States or organized under the
laws of the United States or of any State.
(5) For purposes of this section, a U.S.
branch, agency, or subsidiary of a
foreign bank, or any subsidiary thereof,
is located in the United States; however,
a foreign bank of which that branch,
agency, or subsidiary is a part is not
considered to be located in the United
States solely by virtue of operation of
the U.S. branch, agency, or subsidiary.
(c) Permitted covered fund interests
and activities by a regulated insurance
company. The prohibition contained in
§ 248.10(a) of this subpart does not
apply to the acquisition or retention by
an insurance company, or an affiliate
thereof, of any ownership interest in, or
the sponsorship of, a covered fund only
if:
(1) The insurance company or its
affiliate acquires and retains the
ownership interest solely for the general
account of the insurance company or for
one or more separate accounts
established by the insurance company;
(2) The acquisition and retention of
the ownership interest is conducted in
compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (c)(2) of this
section is insufficient to protect the
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safety and soundness of the banking
entity, or the financial stability of the
United States.
§ 248.14 Limitations on relationships with
a covered fund.
(a) Relationships with a covered fund.
(1) Except as provided for in paragraph
(a)(2) of this section, no banking entity
that serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, that
organizes and offers a covered fund
pursuant to § 248.11 of this subpart, or
that continues to hold an ownership
interest in accordance with § 248.11(b)
of this subpart, and no affiliate of such
entity, may enter into a transaction with
the covered fund, or with any other
covered fund that is controlled by such
covered fund, that would be a covered
transaction as defined in section 23A of
the Federal Reserve Act (12 U.S.C.
371c(b)(7)), as if such banking entity
and the affiliate thereof were a member
bank and the covered fund were an
affiliate thereof.
(2) Notwithstanding paragraph (a)(1)
of this section, a banking entity may:
(i) Acquire and retain any ownership
interest in a covered fund in accordance
with the requirements of § 248.11,
§ 248.12, or § 248.13 of this subpart; and
(ii) Enter into any prime brokerage
transaction with any covered fund in
which a covered fund managed,
sponsored, or advised by such banking
entity (or an affiliate thereof) has taken
an ownership interest, if:
(A) The banking entity is in
compliance with each of the limitations
set forth in § 248.11 of this subpart with
respect to a covered fund organized and
offered by such banking entity (or an
affiliate thereof);
(B) The chief executive officer (or
equivalent officer) of the banking entity
certifies in writing annually to the
Board (with a duty to update the
certification if the information in the
certification materially changes) that the
banking entity does not, directly or
indirectly, guarantee, assume, or
otherwise insure the obligations or
performance of the covered fund or of
any covered fund in which such
covered fund invests; and
(C) The Board has not determined that
such transaction is inconsistent with the
safe and sound operation and condition
of the banking entity.
(b) Restrictions on transactions with
covered funds. A banking entity that
serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, or that
organizes and offers a covered fund
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pursuant to § 248.11 of this subpart, or
that continues to hold an ownership
interest in accordance with § 248.11(b)
of this subpart, shall be subject to
section 23B of the Federal Reserve Act
(12 U.S.C. 371c–1), as if such banking
entity were a member bank and such
covered fund were an affiliate thereof.
(c) Restrictions on prime brokerage
transactions. A prime brokerage
transaction permitted under paragraph
(a)(2)(ii) of this section shall be subject
to section 23B of the Federal Reserve
Act (12 U.S.C. 371c–1) as if the
counterparty were an affiliate of the
banking entity.
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§ 248.15 Other limitations on permitted
covered fund activities.
(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ 248.11 through
248.13 of this subpart if the transaction,
class of transactions, or activity would:
(1) Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
(2) Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
(3) Pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.
(b) Definition of material conflict of
interest. (1) For purposes of this section,
a material conflict of interest between a
banking entity and its clients,
customers, or counterparties exists if the
banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the banking entity’s interests being
materially adverse to the interests of its
client, customer, or counterparty with
respect to such transaction, class of
transactions, or activity, and the
banking entity has not taken at least one
of the actions in paragraph (b)(2) of this
section.
(2) Prior to effecting the specific
transaction or class or type of
transactions, or engaging in the specific
activity, the banking entity:
(i) Timely and effective disclosure. (A)
Has made clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest; and
(B) Such disclosure is made in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
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mitigate, any materially adverse effect
on the client, customer, or counterparty
created by the conflict of interest; or
(ii) Information barriers. Has
established, maintained, and enforced
information barriers that are
memorialized in written policies and
procedures, such as physical separation
of personnel, or functions, or limitations
on types of activity, that are reasonably
designed, taking into consideration the
nature of the banking entity’s business,
to prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A banking entity may not
rely on such information barriers if, in
the case of any specific transaction,
class or type of transactions or activity,
the banking entity knows or should
reasonably know that, notwithstanding
the banking entity’s establishment of
information barriers, the conflict of
interest may involve or result in a
materially adverse effect on a client,
customer, or counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
§ 248.16 Ownership of interests in and
sponsorship of issuers of certain
collateralized debt obligations backed by
trust-preferred securities.
(a) The prohibition contained in
§ 248.10(a)(1) does not apply to the
ownership by a banking entity of an
interest in, or sponsorship of, any issuer
if:
(1) The issuer was established, and
the interest was issued, before May 19,
2010;
(2) The banking entity reasonably
believes that the offering proceeds
received by the issuer were invested
primarily in Qualifying TruPS
Collateral; and
(3) The banking entity acquired such
interest on or before December 10, 2013
(or acquired such interest in connection
with a merger with or acquisition of a
banking entity that acquired the interest
on or before December 10, 2013).
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(b) For purposes of this § 248.16,
Qualifying TruPS Collateral shall mean
any trust preferred security or
subordinated debt instrument issued
prior to May 19, 2010 by a depository
institution holding company that, as of
the end of any reporting period within
12 months immediately preceding the
issuance of such trust preferred security
or subordinated debt instrument, had
total consolidated assets of less than
$15,000,000,000 or issued prior to May
19, 2010 by a mutual holding company.
(c) Notwithstanding paragraph (a)(3)
of this section, a banking entity may act
as a market maker with respect to the
interests of an issuer described in
paragraph (a) of this section in
accordance with the applicable
provisions of §§ 248.4 and 248.11.
(d) Without limiting the applicability
of paragraph (a) of this section, the
Board, the FDIC and the OCC will make
public a non-exclusive list of issuers
that meet the requirements of paragraph
(a). A banking entity may rely on the list
published by the Board, the FDIC and
the OCC.
§§ 248.17–248.19
[Reserved]
Subpart D—Compliance Program
Requirement; Violations
§ 248.20 Program for compliance;
reporting.
(a) Program requirement. Each
banking entity shall develop and
provide for the continued
administration of a compliance program
reasonably designed to ensure and
monitor compliance with the
prohibitions and restrictions on
proprietary trading and covered fund
activities and investments set forth in
section 13 of the BHC Act and this part.
The terms, scope and detail of the
compliance program shall be
appropriate for the types, size, scope
and complexity of activities and
business structure of the banking entity.
(b) Contents of compliance program.
Except as provided in paragraph (f) of
this section, the compliance program
required by paragraph (a) of this section,
at a minimum, shall include:
(1) Written policies and procedures
reasonably designed to document,
describe, monitor and limit trading
activities subject to subpart B (including
those permitted under §§ 248.3 to 248.6
of subpart B), including setting,
monitoring and managing required
limits set out in §§ 248.4 and 248.5, and
activities and investments with respect
to a covered fund subject to subpart C
(including those permitted under
§§ 248.11 through 248.14 of subpart C)
conducted by the banking entity to
ensure that all activities and
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investments conducted by the banking
entity that are subject to section 13 of
the BHC Act and this part comply with
section 13 of the BHC Act and this part;
(2) A system of internal controls
reasonably designed to monitor
compliance with section 13 of the BHC
Act and this part and to prevent the
occurrence of activities or investments
that are prohibited by section 13 of the
BHC Act and this part;
(3) A management framework that
clearly delineates responsibility and
accountability for compliance with
section 13 of the BHC Act and this part
and includes appropriate management
review of trading limits, strategies,
hedging activities, investments,
incentive compensation and other
matters identified in this part or by
management as requiring attention;
(4) Independent testing and audit of
the effectiveness of the compliance
program conducted periodically by
qualified personnel of the banking
entity or by a qualified outside party;
(5) Training for trading personnel and
managers, as well as other appropriate
personnel, to effectively implement and
enforce the compliance program; and
(6) Records sufficient to demonstrate
compliance with section 13 of the BHC
Act and this part, which a banking
entity must promptly provide to the
Board upon request and retain for a
period of no less than 5 years or such
longer period as required by the Board.
(c) Additional standards. In addition
to the requirements in paragraph (b) of
this section, the compliance program of
a banking entity must satisfy the
requirements and other standards
contained in appendix B, if:
(1) The banking entity engages in
proprietary trading permitted under
subpart B and is required to comply
with the reporting requirements of
paragraph (d) of this section;
(2) The banking entity has reported
total consolidated assets as of the
previous calendar year end of $50
billion or more or, in the case of a
foreign banking entity, has total U.S.
assets as of the previous calendar year
end of $50 billion or more (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity
operating, located or organized in the
United States); or
(3) The Board notifies the banking
entity in writing that it must satisfy the
requirements and other standards
contained in appendix B to this part.
(d) Reporting requirements under
appendix A to this part. (1) A banking
entity engaged in proprietary trading
activity permitted under subpart B shall
comply with the reporting requirements
described in appendix A, if:
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(i) The banking entity (other than a
foreign banking entity as provided in
paragraph (d)(1)(ii) of this section) has,
together with its affiliates and
subsidiaries, trading assets and
liabilities (excluding trading assets and
liabilities involving obligations of or
guaranteed by the United States or any
agency of the United States) the average
gross sum of which (on a worldwide
consolidated basis) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the threshold established in
paragraph (d)(2) of this section;
(ii) In the case of a foreign banking
entity, the average gross sum of the
trading assets and liabilities of the
combined U.S. operations of the foreign
banking entity (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity
operating, located or organized in the
United States and excluding trading
assets and liabilities involving
obligations of or guaranteed by the
United States or any agency of the
United States) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the threshold established in
paragraph (d)(2) of this section; or
(iii) The Board notifies the banking
entity in writing that it must satisfy the
reporting requirements contained in
appendix A.
(2) The threshold for reporting under
paragraph (d)(1) of this section shall be
$50 billion beginning on June 30, 2014;
$25 billion beginning on April 30, 2016;
and $10 billion beginning on December
31, 2016.
(3) Frequency of reporting: Unless the
Board notifies the banking entity in
writing that it must report on a different
basis, a banking entity with $50 billion
or more in trading assets and liabilities
(as calculated in accordance with
paragraph (d)(1) of this section) shall
report the information required by
appendix A for each calendar month
within 30 days of the end of the relevant
calendar month; beginning with
information for the month of January
2015, such information shall be reported
within 10 days of the end of each
calendar month. Any other banking
entity subject to appendix A shall report
the information required by appendix A
for each calendar quarter within 30 days
of the end of that calendar quarter
unless the Board notifies the banking
entity in writing that it must report on
a different basis.
(e) Additional documentation for
covered funds. Any banking entity that
has more than $10 billion in total
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consolidated assets as reported on
December 31 of the previous two
calendar years shall maintain records
that include:
(1) Documentation of the exclusions
or exemptions other than sections
3(c)(1) and 3(c)(7) of the Investment
Company Act of 1940 relied on by each
fund sponsored by the banking entity
(including all subsidiaries and affiliates)
in determining that such fund is not a
covered fund;
(2) For each fund sponsored by the
banking entity (including all
subsidiaries and affiliates) for which the
banking entity relies on one or more of
the exclusions from the definition of
covered fund provided by
§§ 248.10(c)(1), 248.10(c)(5),
248.10(c)(8), 248.10(c)(9), or
248.10(c)(10) of subpart C,
documentation supporting the banking
entity’s determination that the fund is
not a covered fund pursuant to one or
more of those exclusions;
(3) For each seeding vehicle described
in § 248.10(c)(12)(i) or (iii) of subpart C
that will become a registered investment
company or SEC-regulated business
development company, a written plan
documenting the banking entity’s
determination that the seeding vehicle
will become a registered investment
company or SEC-regulated business
development company; the period of
time during which the vehicle will
operate as a seeding vehicle; and the
banking entity’s plan to market the
vehicle to third-party investors and
convert it into a registered investment
company or SEC-regulated business
development company within the time
period specified in § 248.12(a)(2)(i)(B) of
subpart C;
(4) For any banking entity that is, or
is controlled directly or indirectly by a
banking entity that is, located in or
organized under the laws of the United
States or of any State, if the aggregate
amount of ownership interests in
foreign public funds that are described
in § 248.10(c)(1) of subpart C owned by
such banking entity (including
ownership interests owned by any
affiliate that is controlled directly or
indirectly by a banking entity that is
located in or organized under the laws
of the United States or of any State)
exceeds $50 million at the end of two
or more consecutive calendar quarters,
beginning with the next succeeding
calendar quarter, documentation of the
value of the ownership interests owned
by the banking entity (and such
affiliates) in each foreign public fund
and each jurisdiction in which any such
foreign public fund is organized,
calculated as of the end of each calendar
quarter, which documentation must
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continue until the banking entity’s
aggregate amount of ownership interests
in foreign public funds is below $50
million for two consecutive calendar
quarters; and
(5) For purposes of paragraph (e)(4) of
this section, a U.S. branch, agency, or
subsidiary of a foreign banking entity is
located in the United States; however,
the foreign bank that operates or
controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(f) Simplified programs for less active
banking entities—(1) Banking entities
with no covered activities. A banking
entity that does not engage in activities
or investments pursuant to subpart B or
subpart C (other than trading activities
permitted pursuant to § 248.6(a) of
subpart B) may satisfy the requirements
of this section by establishing the
required compliance program prior to
becoming engaged in such activities or
making such investments (other than
trading activities permitted pursuant to
§ 248.6(a) of subpart B).
(2) Banking entities with modest
activities. A banking entity with total
consolidated assets of $10 billion or less
as reported on December 31 of the
previous two calendar years that
engages in activities or investments
pursuant to subpart B or subpart C
(other than trading activities permitted
under § 248.6(a) of subpart B) may
satisfy the requirements of this section
by including in its existing compliance
policies and procedures appropriate
references to the requirements of section
13 of the BHC Act and this part and
adjustments as appropriate given the
activities, size, scope and complexity of
the banking entity.
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§ 248.21 Termination of activities or
investments; penalties for violations.
(a) Any banking entity that engages in
an activity or makes an investment in
violation of section 13 of the BHC Act
or this part, or acts in a manner that
functions as an evasion of the
requirements of section 13 of the BHC
Act or this part, including through an
abuse of any activity or investment
permitted under subparts B or C, or
otherwise violates the restrictions and
requirements of section 13 of the BHC
Act or this part, shall, upon discovery,
promptly terminate the activity and, as
relevant, dispose of the investment.
(b) Whenever the Board finds
reasonable cause to believe any banking
entity has engaged in an activity or
made an investment in violation of
section 13 of the BHC Act or this part,
or engaged in any activity or made any
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investment that functions as an evasion
of the requirements of section 13 of the
BHC Act or this part, the Board may
take any action permitted by law to
enforce compliance with section 13 of
the BHC Act and this part, including
directing the banking entity to restrict,
limit, or terminate any or all activities
under this part and dispose of any
investment.
Appendix A to Part 248—Reporting and
Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and
recordkeeping requirements that certain
banking entities must satisfy in connection
with the restrictions on proprietary trading
set forth in subpart B (‘‘proprietary trading
restrictions’’). Pursuant to § 248.20(d), this
appendix generally applies to a banking
entity that, together with its affiliates and
subsidiaries, has significant trading assets
and liabilities. These entities are required to
(i) furnish periodic reports to the Board
regarding a variety of quantitative
measurements of their covered trading
activities, which vary depending on the
scope and size of covered trading activities,
and (ii) create and maintain records
documenting the preparation and content of
these reports. The requirements of this
appendix must be incorporated into the
banking entity’s internal compliance program
under § 248.20 and Appendix B.
b. The purpose of this appendix is to assist
banking entities and the Board in:
(i) Better understanding and evaluating the
scope, type, and profile of the banking
entity’s covered trading activities;
(ii) Monitoring the banking entity’s covered
trading activities;
(iii) Identifying covered trading activities
that warrant further review or examination
by the banking entity to verify compliance
with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading
activities of trading desks engaged in market
making-related activities subject to § 248.4(b)
are consistent with the requirements
governing permitted market making-related
activities;
(v) Evaluating whether the covered trading
activities of trading desks that are engaged in
permitted trading activity subject to §§ 248.4,
248.5, or 248.6(a)–(b) (i.e., underwriting and
market making-related related activity, riskmitigating hedging, or trading in certain
government obligations) are consistent with
the requirement that such activity not result,
directly or indirectly, in a material exposure
to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular
covered trading activities of the banking
entity, and the individual trading desks of
the banking entity, to help establish the
appropriate frequency and scope of
examination by the Board of such activities;
and
(vii) Assessing and addressing the risks
associated with the banking entity’s covered
trading activities.
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c. The quantitative measurements that
must be furnished pursuant to this appendix
are not intended to serve as a dispositive tool
for the identification of permissible or
impermissible activities.
d. In order to allow banking entities and
the Agencies to evaluate the effectiveness of
these metrics, banking entities must collect
and report these metrics for all trading desks
beginning on the dates established in
§ 248.20 of the final rule. The Agencies will
review the data collected and revise this
collection requirement as appropriate based
on a review of the data collected prior to
September 30, 2015.
e. In addition to the quantitative
measurements required in this appendix, a
banking entity may need to develop and
implement other quantitative measurements
in order to effectively monitor its covered
trading activities for compliance with section
13 of the BHC Act and this part and to have
an effective compliance program, as required
by § 248.20 and Appendix B to this part. The
effectiveness of particular quantitative
measurements may differ based on the profile
of the banking entity’s businesses in general
and, more specifically, of the particular
trading desk, including types of instruments
traded, trading activities and strategies, and
history and experience (e.g., whether the
trading desk is an established, successful
market maker or a new entrant to a
competitive market). In all cases, banking
entities must ensure that they have robust
measures in place to identify and monitor the
risks taken in their trading activities, to
ensure that the activities are within risk
tolerances established by the banking entity,
and to monitor and examine for compliance
with the proprietary trading restrictions in
this part.
f. On an ongoing basis, banking entities
must carefully monitor, review, and evaluate
all furnished quantitative measurements, as
well as any others that they choose to utilize
in order to maintain compliance with section
13 of the BHC Act and this part. All
measurement results that indicate a
heightened risk of impermissible proprietary
trading, including with respect to otherwisepermitted activities under §§ 248.4 through
248.6(a) and (b), or that result in a material
exposure to high-risk assets or high-risk
trading strategies, must be escalated within
the banking entity for review, further
analysis, explanation to the Board, and
remediation, where appropriate. The
quantitative measurements discussed in this
appendix should be helpful to banking
entities in identifying and managing the risks
related to their covered trading activities.
II. Definitions
The terms used in this appendix have the
same meanings as set forth in §§ 248.2 and
248.3. In addition, for purposes of this
appendix, the following definitions apply:
Calculation period means the period of
time for which a particular quantitative
measurement must be calculated.
Comprehensive profit and loss means the
net profit or loss of a trading desk’s material
sources of trading revenue over a specific
period of time, including, for example, any
increase or decrease in the market value of
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a trading desk’s holdings, dividend income,
and interest income and expense.
Covered trading activity means trading
conducted by a trading desk under §§ 248.4,
248.5, 248.6(a), or 248.6(b). A banking entity
may include trading under §§ 248.3(d),
248.6(c), 248.6(d) or 248.6(e).
Measurement frequency means the
frequency with which a particular
quantitative metric must be calculated and
recorded.
Trading desk means the smallest discrete
unit of organization of a banking entity that
purchases or sells financial instruments for
the trading account of the banking entity or
an affiliate thereof.
III. Reporting and Recordkeeping of
Quantitative Measurements
a. Scope of Required Reporting
General scope. Each banking entity made
subject to this part by § 248.20 must furnish
the following quantitative measurements for
each trading desk of the banking entity,
calculated in accordance with this appendix:
• Risk and Position Limits and Usage;
• Risk Factor Sensitivities;
• Value-at-Risk and Stress VaR;
• Comprehensive Profit and Loss
Attribution;
• Inventory Turnover;
• Inventory Aging; and
• Customer-Facing Trade Ratio
b. Frequency of Required Calculation and
Reporting
A banking entity must calculate any
applicable quantitative measurement for each
trading day. A banking entity must report
each applicable quantitative measurement to
the Board on the reporting schedule
established in § 248.20 unless otherwise
requested by the Board. All quantitative
measurements for any calendar month must
be reported within the time period required
by § 248.20.
c. Recordkeeping
A banking entity must, for any quantitative
measurement furnished to the Board
pursuant to this appendix and § 248.20(d),
create and maintain records documenting the
preparation and content of these reports, as
well as such information as is necessary to
permit the Board to verify the accuracy of
such reports, for a period of 5 years from the
end of the calendar year for which the
measurement was taken.
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IV. Quantitative Measurements
a. Risk-Management Measurements
1. Risk and Position Limits and Usage
i. Description: For purposes of this
appendix, Risk and Position Limits are the
constraints that define the amount of risk that
a trading desk is permitted to take at a point
in time, as defined by the banking entity for
a specific trading desk. Usage represents the
portion of the trading desk’s limits that are
accounted for by the current activity of the
desk. Risk and position limits and their usage
are key risk management tools used to
control and monitor risk taking and include,
but are not limited, to the limits set out in
§ 248.4 and § 248.5. A number of the metrics
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that are described below, including ‘‘Risk
Factor Sensitivities’’ and ‘‘Value-at-Risk and
Stress Value-at-Risk,’’ relate to a trading
desk’s risk and position limits and are useful
in evaluating and setting these limits in the
broader context of the trading desk’s overall
activities, particularly for the market making
activities under § 248.4(b) and hedging
activity under § 248.5. Accordingly, the
limits required under § 248.4(b)(2)(iii) and
§ 248.5(b)(1)(i) must meet the applicable
requirements under § 248.4(b)(2)(iii) and
§ 248.5(b)(1)(i) and also must include
appropriate metrics for the trading desk
limits including, at a minimum, the ‘‘Risk
Factor Sensitivities’’ and ‘‘Value-at-Risk and
Stress Value-at-Risk’’ metrics except to the
extent any of the ‘‘Risk Factor Sensitivities’’
or ‘‘Value-at-Risk and Stress Value-at-Risk’’
metrics are demonstrably ineffective for
measuring and monitoring the risks of a
trading desk based on the types of positions
traded by, and risk exposures of, that desk.
ii. General Calculation Guidance: Risk and
Position Limits must be reported in the
format used by the banking entity for the
purposes of risk management of each trading
desk. Risk and Position Limits are often
expressed in terms of risk measures, such as
VaR and Risk Factor Sensitivities, but may
also be expressed in terms of other
observable criteria, such as net open
positions. When criteria other than VaR or
Risk Factor Sensitivities are used to define
the Risk and Position Limits, both the value
of the Risk and Position Limits and the value
of the variables used to assess whether these
limits have been reached must be reported.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
2. Risk Factor Sensitivities
i. Description: For purposes of this
appendix, Risk Factor Sensitivities are
changes in a trading desk’s Comprehensive
Profit and Loss that are expected to occur in
the event of a change in one or more
underlying variables that are significant
sources of the trading desk’s profitability and
risk.
ii. General Calculation Guidance: A
banking entity must report the Risk Factor
Sensitivities that are monitored and managed
as part of the trading desk’s overall risk
management policy. The underlying data and
methods used to compute a trading desk’s
Risk Factor Sensitivities will depend on the
specific function of the trading desk and the
internal risk management models employed.
The number and type of Risk Factor
Sensitivities that are monitored and managed
by a trading desk, and furnished to the Board,
will depend on the explicit risks assumed by
the trading desk. In general, however,
reported Risk Factor Sensitivities must be
sufficiently granular to account for a
preponderance of the expected price
variation in the trading desk’s holdings.
A. Trading desks must take into account
any relevant factors in calculating Risk Factor
Sensitivities, including, for example, the
following with respect to particular asset
classes:
• Commodity derivative positions: Risk
factors with respect to the related
commodities set out in 17 CFR 20.2, the
maturity of the positions, volatility and/or
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correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), and the maturity profile of
the positions;
• Credit positions: Risk factors with
respect to credit spreads that are sufficiently
granular to account for specific credit sectors
and market segments, the maturity profile of
the positions, and risk factors with respect to
interest rates of all relevant maturities;
• Credit-related derivative positions: Risk
factor sensitivities, for example credit
spreads, shifts (parallel and non-parallel) in
credit spreads—volatility, and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
and the maturity profile of the positions;
• Equity derivative positions: Risk factor
sensitivities such as equity positions,
volatility, and/or correlation sensitivities
(expressed in a manner that demonstrates
any significant non-linearities), and the
maturity profile of the positions;
• Equity positions: Risk factors for equity
prices and risk factors that differentiate
between important equity market sectors and
segments, such as a small capitalization
equities and international equities;
• Foreign exchange derivative positions:
Risk factors with respect to major currency
pairs and maturities, exposure to interest
rates at relevant maturities, volatility, and/or
correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), as well as the maturity
profile of the positions; and
• Interest rate positions, including interest
rate derivative positions: Risk factors with
respect to major interest rate categories and
maturities and volatility and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
and shifts (parallel and non-parallel) in the
interest rate curve, as well as the maturity
profile of the positions.
B. The methods used by a banking entity
to calculate sensitivities to a common factor
shared by multiple trading desks, such as an
equity price factor, must be applied
consistently across its trading desks so that
the sensitivities can be compared from one
trading desk to another.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Value-at-Risk and Stress Value-at-Risk
i. Description: For purposes of this
appendix, Value-at-Risk (‘‘VaR’’) is the
commonly used percentile measurement of
the risk of future financial loss in the value
of a given set of aggregated positions over a
specified period of time, based on current
market conditions. For purposes of this
appendix, Stress Value-at-Risk (‘‘Stress VaR’’)
is the percentile measurement of the risk of
future financial loss in the value of a given
set of aggregated positions over a specified
period of time, based on market conditions
during a period of significant financial stress.
ii. General Calculation Guidance: Banking
entities must compute and report VaR and
Stress VaR by employing generally accepted
standards and methods of calculation. VaR
should reflect a loss in a trading desk that is
expected to be exceeded less than one
percent of the time over a one-day period.
For those banking entities that are subject to
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regulatory capital requirements imposed by a
Federal banking agency, VaR and Stress VaR
must be computed and reported in a manner
that is consistent with such regulatory capital
requirements. In cases where a trading desk
does not have a standalone VaR or Stress VaR
calculation but is part of a larger aggregation
of positions for which a VaR or Stress VaR
calculation is performed, a VaR or Stress VaR
calculation that includes only the trading
desk’s holdings must be performed consistent
with the VaR or Stress VaR model and
methodology used for the larger aggregation
of positions.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this
appendix, Comprehensive Profit and Loss
Attribution is an analysis that attributes the
daily fluctuation in the value of a trading
desk’s positions to various sources. First, the
daily profit and loss of the aggregated
positions is divided into three categories: (i)
Profit and loss attributable to a trading desk’s
existing positions that were also positions
held by the trading desk as of the end of the
prior day (‘‘existing positions’’); (ii) profit
and loss attributable to new positions
resulting from the current day’s trading
activity (‘‘new positions’’); and (iii) residual
profit and loss that cannot be specifically
attributed to existing positions or new
positions. The sum of (i), (ii), and (iii) must
equal the trading desk’s comprehensive profit
and loss at each point in time. In addition,
profit and loss measurements must calculate
volatility of comprehensive profit and loss
(i.e., the standard deviation of the trading
desk’s one-day profit and loss, in dollar
terms) for the reporting period for at least a
30-, 60- and 90-day lag period, from the end
of the reporting period, and any other period
that the banking entity deems necessary to
meet the requirements of the rule.
A. The comprehensive profit and loss
associated with existing positions must
reflect changes in the value of these positions
on the applicable day. The comprehensive
profit and loss from existing positions must
be further attributed, as applicable, to
changes in (i) the specific Risk Factors and
other factors that are monitored and managed
as part of the trading desk’s overall risk
management policies and procedures; and (ii)
any other applicable elements, such as cash
flows, carry, changes in reserves, and the
correction, cancellation, or exercise of a
trade.
B. The comprehensive profit and loss
attributed to new positions must reflect
commissions and fee income or expense and
market gains or losses associated with
transactions executed on the applicable day.
New positions include purchases and sales of
financial instruments and other assets/
liabilities and negotiated amendments to
existing positions. The comprehensive profit
and loss from new positions may be reported
in the aggregate and does not need to be
further attributed to specific sources.
C. The portion of comprehensive profit and
loss that cannot be specifically attributed to
known sources must be allocated to a
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residual category identified as an
unexplained portion of the comprehensive
profit and loss. Significant unexplained
profit and loss must be escalated for further
investigation and analysis.
ii. General Calculation Guidance: The
specific categories used by a trading desk in
the attribution analysis and amount of detail
for the analysis should be tailored to the type
and amount of trading activities undertaken
by the trading desk. The new position
attribution must be computed by calculating
the difference between the prices at which
instruments were bought and/or sold and the
prices at which those instruments are marked
to market at the close of business on that day
multiplied by the notional or principal
amount of each purchase or sale. Any fees,
commissions, or other payments received
(paid) that are associated with transactions
executed on that day must be added
(subtracted) from such difference. These
factors must be measured consistently over
time to facilitate historical comparisons.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
c. Customer-Facing Activity Measurements
1. Inventory Turnover
i. Description: For purposes of this
appendix, Inventory Turnover is a ratio that
measures the turnover of a trading desk’s
inventory. The numerator of the ratio is the
absolute value of all transactions over the
reporting period. The denominator of the
ratio is the value of the trading desk’s
inventory at the beginning of the reporting
period.
ii. General Calculation Guidance: For
purposes of this appendix, for derivatives,
other than options and interest rate
derivatives, value means gross notional
value, for options, value means delta
adjusted notional value, and for interest rate
derivatives, value means 10-year bond
equivalent value.
iii. Calculation Period: 30 days, 60 days,
and 90 days.
iv. Measurement Frequency: Daily.
2. Inventory Aging
i. Description: For purposes of this
appendix, Inventory Aging generally
describes a schedule of the trading desk’s
aggregate assets and liabilities and the
amount of time that those assets and
liabilities have been held. Inventory Aging
should measure the age profile of the trading
desk’s assets and liabilities.
ii. General Calculation Guidance: In
general, Inventory Aging must be computed
using a trading desk’s trading activity data
and must identify the value of a trading
desk’s aggregate assets and liabilities.
Inventory Aging must include two schedules,
an asset-aging schedule and a liability-aging
schedule. Each schedule must record the
value of assets or liabilities held over all
holding periods. For derivatives, other than
options, and interest rate derivatives, value
means gross notional value, for options,
value means delta adjusted notional value
and, for interest rate derivatives, value means
10-year bond equivalent value.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
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3. Customer-Facing Trade Ratio—Trade
Count Based and Value Based
i. Description: For purposes of this
appendix, the Customer-Facing Trade Ratio
is a ratio comparing (i) the transactions
involving a counterparty that is a customer
of the trading desk to (ii) the transactions
involving a counterparty that is not a
customer of the trading desk. A trade count
based ratio must be computed that records
the number of transactions involving a
counterparty that is a customer of the trading
desk and the number of transactions
involving a counterparty that is not a
customer of the trading desk. A value based
ratio must be computed that records the
value of transactions involving a
counterparty that is a customer of the trading
desk and the value of transactions involving
a counterparty that is not a customer of the
trading desk.
ii. General Calculation Guidance: For
purposes of calculating the Customer-Facing
Trade Ratio, a counterparty is considered to
be a customer of the trading desk if the
counterparty is a market participant that
makes use of the banking entity’s market
making-related services by obtaining such
services, responding to quotations, or
entering into a continuing relationship with
respect to such services. However, a trading
desk or other organizational unit of another
banking entity would not be a client,
customer, or counterparty of the trading desk
if the other entity has trading assets and
liabilities of $50 billion or more as measured
in accordance with § 248.20(d)(1) unless the
trading desk documents how and why a
particular trading desk or other
organizational unit of the entity should be
treated as a client, customer, or counterparty
of the trading desk. Transactions conducted
anonymously on an exchange or similar
trading facility that permits trading on behalf
of a broad range of market participants would
be considered transactions with customers of
the trading desk. For derivatives, other than
options, and interest rate derivatives, value
means gross notional value, for options,
value means delta adjusted notional value,
and for interest rate derivatives, value means
10-year bond equivalent value.
iii. Calculation Period: 30 days, 60 days,
and 90 days.
iv. Measurement Frequency: Daily.
Appendix B to Part 248—Enhanced
Minimum Standards for Compliance
Programs
I. Overview
Section 248.20(c) requires certain banking
entities to establish, maintain, and enforce an
enhanced compliance program that includes
the requirements and standards in this
Appendix as well as the minimum written
policies and procedures, internal controls,
management framework, independent
testing, training, and recordkeeping
provisions outlined in § 248.20. This
Appendix sets forth additional minimum
standards with respect to the establishment,
oversight, maintenance, and enforcement by
these banking entities of an enhanced
internal compliance program for ensuring
and monitoring compliance with the
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prohibitions and restrictions on proprietary
trading and covered fund activities and
investments set forth in section 13 of the
BHC Act and this part.
a. This compliance program must:
1. Be reasonably designed to identify,
document, monitor, and report the permitted
trading and covered fund activities and
investments of the banking entity; identify,
monitor and promptly address the risks of
these covered activities and investments and
potential areas of noncompliance; and
prevent activities or investments prohibited
by, or that do not comply with, section 13 of
the BHC Act and this part;
2. Establish and enforce appropriate limits
on the covered activities and investments of
the banking entity, including limits on the
size, scope, complexity, and risks of the
individual activities or investments
consistent with the requirements of section
13 of the BHC Act and this part;
3. Subject the effectiveness of the
compliance program to periodic independent
review and testing, and ensure that the
entity’s internal audit, corporate compliance
and internal control functions involved in
review and testing are effective and
independent;
4. Make senior management, and others as
appropriate, accountable for the effective
implementation of the compliance program,
and ensure that the board of directors and
chief executive officer (or equivalent) of the
banking entity review the effectiveness of the
compliance program; and
5. Facilitate supervision and examination
by the Agencies of the banking entity’s
permitted trading and covered fund activities
and investments.
II. Enhanced Compliance Program
a. Proprietary Trading Activities. A
banking entity must establish, maintain and
enforce a compliance program that includes
written policies and procedures that are
appropriate for the types, size, and
complexity of, and risks associated with, its
permitted trading activities. The compliance
program may be tailored to the types of
trading activities conducted by the banking
entity, and must include a detailed
description of controls established by the
banking entity to reasonably ensure that its
trading activities are conducted in
accordance with the requirements and
limitations applicable to those trading
activities under section 13 of the BHC Act
and this part, and provide for appropriate
revision of the compliance program before
expansion of the trading activities of the
banking entity. A banking entity must devote
adequate resources and use knowledgeable
personnel in conducting, supervising and
managing its trading activities, and promote
consistency, independence and rigor in
implementing its risk controls and
compliance efforts. The compliance program
must be updated with a frequency sufficient
to account for changes in the activities of the
banking entity, results of independent testing
of the program, identification of weaknesses
in the program, and changes in legal,
regulatory or other requirements.
1. Trading Desks: The banking entity must
have written policies and procedures
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governing each trading desk that include a
description of:
i. The process for identifying, authorizing
and documenting financial instruments each
trading desk may purchase or sell, with
separate documentation for market makingrelated activities conducted in reliance on
§ 248.4(b) and for hedging activity conducted
in reliance on § 248.5;
ii. A mapping for each trading desk to the
division, business line, or other
organizational structure that is responsible
for managing and overseeing the trading
desk’s activities;
iii. The mission (i.e., the type of trading
activity, such as market-making, trading in
sovereign debt, etc.) and strategy (i.e.,
methods for conducting authorized trading
activities) of each trading desk;
iv. The activities that the trading desk is
authorized to conduct, including (i)
authorized instruments and products, and (ii)
authorized hedging strategies, techniques and
instruments;
v. The types and amount of risks allocated
by the banking entity to each trading desk to
implement the mission and strategy of the
trading desk, including an enumeration of
material risks resulting from the activities in
which the trading desk is authorized to
engage (including but not limited to price
risks, such as basis, volatility and correlation
risks, as well as counterparty credit risk).
Risk assessments must take into account both
the risks inherent in the trading activity and
the strength and effectiveness of controls
designed to mitigate those risks;
vi. How the risks allocated to each trading
desk will be measured;
vii. Why the allocated risks levels are
appropriate to the activities authorized for
the trading desk;
viii. The limits on the holding period of,
and the risk associated with, financial
instruments under the responsibility of the
trading desk;
ix. The process for setting new or revised
limits, as well as escalation procedures for
granting exceptions to any limits or to any
policies or procedures governing the desk,
the analysis that will be required to support
revising limits or granting exceptions, and
the process for independently reviewing and
documenting those exceptions and the
underlying analysis;
x. The process for identifying,
documenting and approving new products,
trading strategies, and hedging strategies;
xi. The types of clients, customers, and
counterparties with whom the trading desk
may trade; and
xii. The compensation arrangements,
including incentive arrangements, for
employees associated with the trading desk,
which may not be designed to reward or
incentivize prohibited proprietary trading or
excessive or imprudent risk-taking.
2. Description of risks and risk
management processes: The compliance
program for the banking entity must include
a comprehensive description of the risk
management program for the trading activity
of the banking entity. The compliance
program must also include a description of
the governance, approval, reporting,
escalation, review and other processes the
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banking entity will use to reasonably ensure
that trading activity is conducted in
compliance with section 13 of the BHC Act
and this part. Trading activity in similar
financial instruments should be subject to
similar governance, limits, testing, controls,
and review, unless the banking entity
specifically determines to establish different
limits or processes and documents those
differences. Descriptions must include, at a
minimum, the following elements:
i. A description of the supervisory and risk
management structure governing all trading
activity, including a description of processes
for initial and senior-level review of new
products and new strategies;
ii. A description of the process for
developing, documenting, testing, approving
and reviewing all models used for valuing,
identifying and monitoring the risks of
trading activity and related positions,
including the process for periodic
independent testing of the reliability and
accuracy of those models;
iii. A description of the process for
developing, documenting, testing, approving
and reviewing the limits established for each
trading desk;
iv. A description of the process by which
a security may be purchased or sold pursuant
to the liquidity management plan, including
the process for authorizing and monitoring
such activity to ensure compliance with the
banking entity’s liquidity management plan
and the restrictions on liquidity management
activities in this part;
v. A description of the management review
process, including escalation procedures, for
approving any temporary exceptions or
permanent adjustments to limits on the
activities, positions, strategies, or risks
associated with each trading desk; and
vi. The role of the audit, compliance, risk
management and other relevant units for
conducting independent testing of trading
and hedging activities, techniques and
strategies.
3. Authorized risks, instruments, and
products. The banking entity must
implement and enforce limits and internal
controls for each trading desk that are
reasonably designed to ensure that trading
activity is conducted in conformance with
section 13 of the BHC Act and this part and
with the banking entity’s written policies and
procedures. The banking entity must
establish and enforce risk limits appropriate
for the activity of each trading desk. These
limits should be based on probabilistic and
non-probabilistic measures of potential loss
(e.g., Value-at-Risk and notional exposure,
respectively), and measured under normal
and stress market conditions. At a minimum,
these internal controls must monitor,
establish and enforce limits on:
i. The financial instruments (including, at
a minimum, by type and exposure) that the
trading desk may trade;
ii. The types and levels of risks that may
be taken by each trading desk; and
iii. The types of hedging instruments used,
hedging strategies employed, and the amount
of risk effectively hedged.
4. Hedging policies and procedures. The
banking entity must establish, maintain, and
enforce written policies and procedures
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regarding the use of risk-mitigating hedging
instruments and strategies that, at a
minimum, describe:
i. The positions, techniques and strategies
that each trading desk may use to hedge the
risk of its positions;
ii. The manner in which the banking entity
will identify the risks arising in connection
with and related to the individual or
aggregated positions, contracts or other
holdings of the banking entity that are to be
hedged and determine that those risks have
been properly and effectively hedged;
iii. The level of the organization at which
hedging activity and management will occur;
iv. The manner in which hedging strategies
will be monitored and the personnel
responsible for such monitoring;
v. The risk management processes used to
control unhedged or residual risks; and
vi. The process for developing,
documenting, testing, approving and
reviewing all hedging positions, techniques
and strategies permitted for each trading desk
and for the banking entity in reliance on
§ 248.5.
5. Analysis and quantitative
measurements. The banking entity must
perform robust analysis and quantitative
measurement of its trading activities that is
reasonably designed to ensure that the
trading activity of each trading desk is
consistent with the banking entity’s
compliance program; monitor and assist in
the identification of potential and actual
prohibited proprietary trading activity; and
prevent the occurrence of prohibited
proprietary trading. Analysis and models
used to determine, measure and limit risk
must be rigorously tested and be reviewed by
management responsible for trading activity
to ensure that trading activities, limits,
strategies, and hedging activities do not
understate the risk and exposure to the
banking entity or allow prohibited
proprietary trading. This review should
include periodic and independent backtesting and revision of activities, limits,
strategies and hedging as appropriate to
contain risk and ensure compliance. In
addition to the quantitative measurements
reported by any banking entity subject to
Appendix A to this part, each banking entity
must develop and implement, to the extent
appropriate to facilitate compliance with this
part, additional quantitative measurements
specifically tailored to the particular risks,
practices, and strategies of its trading desks.
The banking entity’s analysis and
quantitative measurements must incorporate
the quantitative measurements reported by
the banking entity pursuant to Appendix A
(if applicable) and include, at a minimum,
the following:
i. Internal controls and written policies and
procedures reasonably designed to ensure the
accuracy and integrity of quantitative
measurements;
ii. Ongoing, timely monitoring and review
of calculated quantitative measurements;
iii. The establishment of numerical
thresholds and appropriate trading measures
for each trading desk and heightened review
of trading activity not consistent with those
thresholds to ensure compliance with section
13 of the BHC Act and this part, including
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analysis of the measurement results or other
information, appropriate escalation
procedures, and documentation related to the
review; and
iv. Immediate review and compliance
investigation of the trading desk’s activities,
escalation to senior management with
oversight responsibilities for the applicable
trading desk, timely notification to the Board,
appropriate remedial action (e.g., divesting of
impermissible positions, cessation of
impermissible activity, disciplinary actions),
and documentation of the investigation
findings and remedial action taken when
quantitative measurements or other
information, considered together with the
facts and circumstances, or findings of
internal audit, independent testing or other
review suggest a reasonable likelihood that
the trading desk has violated any part of
section 13 of the BHC Act or this part.
6. Other Compliance Matters. In addition
to the requirements specified above, the
banking entity’s compliance program must:
i. Identify activities of each trading desk
that will be conducted in reliance on
exemptions contained in §§ 248.4 through
248.6, including an explanation of:
A. How and where in the organization the
activity occurs; and
B. Which exemption is being relied on and
how the activity meets the specific
requirements for reliance on the applicable
exemption;
ii. Include an explanation of the process for
documenting, approving and reviewing
actions taken pursuant to the liquidity
management plan, where in the organization
this activity occurs, the securities permissible
for liquidity management, the process for
ensuring that liquidity management activities
are not conducted for the purpose of
prohibited proprietary trading, and the
process for ensuring that securities
purchased as part of the liquidity
management plan are highly liquid and
conform to the requirements of this part;
iii. Describe how the banking entity
monitors for and prohibits potential or actual
material exposure to high-risk assets or highrisk trading strategies presented by each
trading desk that relies on the exemptions
contained in §§ 248.3(d)(3), and 248.4
through 248.6, which must take into account
potential or actual exposure to:
A. Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
B. Assets whose changes in value cannot
be adequately mitigated by effective hedging;
C. New products with rapid growth,
including those that do not have a market
history;
D. Assets or strategies that include
significant embedded leverage;
E. Assets or strategies that have
demonstrated significant historical volatility;
F. Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
G. Assets or strategies that result in large
and significant concentrations to sectors, risk
factors, or counterparties;
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iv. Establish responsibility for compliance
with the reporting and recordkeeping
requirements of subpart B and § 248.20; and
v. Establish policies for monitoring and
prohibiting potential or actual material
conflicts of interest between the banking
entity and its clients, customers, or
counterparties.
7. Remediation of violations. The banking
entity’s compliance program must be
reasonably designed and established to
effectively monitor and identify for further
analysis any trading activity that may
indicate potential violations of section 13 of
the BHC Act and this part and to prevent
actual violations of section 13 of the BHC Act
and this part. The compliance program must
describe procedures for identifying and
remedying violations of section 13 of the
BHC Act and this part, and must include, at
a minimum, a requirement to promptly
document, address and remedy any violation
of section 13 of the BHC Act or this part, and
document all proposed and actual
remediation efforts. The compliance program
must include specific written policies and
procedures that are reasonably designed to
assess the extent to which any activity
indicates that modification to the banking
entity’s compliance program is warranted
and to ensure that appropriate modifications
are implemented. The written policies and
procedures must provide for prompt
notification to appropriate management,
including senior management and the board
of directors, of any material weakness or
significant deficiencies in the design or
implementation of the compliance program
of the banking entity.
b. Covered Fund Activities or Investments.
A banking entity must establish, maintain
and enforce a compliance program that
includes written policies and procedures that
are appropriate for the types, size,
complexity and risks of the covered fund and
related activities conducted and investments
made, by the banking entity.
1. Identification of covered funds. The
banking entity’s compliance program must
provide a process, which must include
appropriate management review and
independent testing, for identifying and
documenting covered funds that each unit
within the banking entity’s organization
sponsors or organizes and offers, and covered
funds in which each such unit invests. In
addition to the documentation requirements
for covered funds, as specified under
§ 248.20(e), the documentation must include
information that identifies all pools that the
banking entity sponsors or has an interest in
and the type of exemption from the
Commodity Exchange Act (whether or not
the pool relies on section 4.7 of the
regulations under the Commodity Exchange
Act), and the amount of ownership interest
the banking entity has in those pools.
2. Identification of covered fund activities
and investments. The banking entity’s
compliance program must identify,
document and map each unit within the
organization that is permitted to acquire or
hold an interest in any covered fund or
sponsor any covered fund and map each unit
to the division, business line, or other
organizational structure that will be
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responsible for managing and overseeing that
unit’s activities and investments.
3. Explanation of compliance. The banking
entity’s compliance program must explain
how:
i. The banking entity monitors for and
prohibits potential or actual material
conflicts of interest between the banking
entity and its clients, customers, or
counterparties related to its covered fund
activities and investments;
ii. The banking entity monitors for and
prohibits potential or actual transactions or
activities that may threaten the safety and
soundness of the banking entity related to its
covered fund activities and investments; and
iii. The banking entity monitors for and
prohibits potential or actual material
exposure to high-risk assets or high-risk
trading strategies presented by its covered
fund activities and investments, taking into
account potential or actual exposure to:
A. Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
B. Assets whose changes in values cannot
be adequately mitigated by effective hedging;
C. New products with rapid growth,
including those that do not have a market
history;
D. Assets or strategies that include
significant embedded leverage;
E. Assets or strategies that have
demonstrated significant historical volatility;
F. Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
G. Assets or strategies that expose the
banking entity to large and significant
concentrations with respect to sectors, risk
factors, or counterparties;
4. Description and documentation of
covered fund activities and investments. For
each organizational unit engaged in covered
fund activities and investments, the banking
entity’s compliance program must document:
i. The covered fund activities and
investments that the unit is authorized to
conduct;
ii. The banking entity’s plan for actively
seeking unaffiliated investors to ensure that
any investment by the banking entity
conforms to the limits contained in § 248.12
or registered in compliance with the
securities laws and thereby exempt from
those limits within the time periods allotted
in§ 248.12; and
iii. How it complies with the requirements
of subpart C.
5. Internal Controls. A banking entity must
establish, maintain, and enforce internal
controls that are reasonably designed to
ensure that its covered fund activities or
investments comply with the requirements of
section 13 of the BHC Act and this part and
are appropriate given the limits on risk
established by the banking entity. These
written internal controls must be reasonably
designed and established to effectively
monitor and identify for further analysis any
covered fund activity or investment that may
indicate potential violations of section 13 of
the BHC Act or this part. The internal
controls must, at a minimum require:
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i. Monitoring and limiting the banking
entity’s individual and aggregate investments
in covered funds;
ii. Monitoring the amount and timing of
seed capital investments for compliance with
the limitations under subpart C (including
but not limited to the redemption, sale or
disposition requirements) of § 248.12, and
the effectiveness of efforts to seek unaffiliated
investors to ensure compliance with those
limits;
iii. Calculating the individual and
aggregate levels of ownership interests in one
or more covered fund required by § 248.12;
iv. Attributing the appropriate instruments
to the individual and aggregate ownership
interest calculations above;
v. Making disclosures to prospective and
actual investors in any covered fund
organized and offered or sponsored by the
banking entity, as provided under
§ 248.11(a)(8);
vi. Monitoring for and preventing any
relationship or transaction between the
banking entity and a covered fund that is
prohibited under § 248.14, including where
the banking entity has been designated as the
sponsor, investment manager, investment
adviser, or commodity trading advisor to a
covered fund by another banking entity; and
vii. Appropriate management review and
supervision across legal entities of the
banking entity to ensure that services and
products provided by all affiliated entities
comply with the limitation on services and
products contained in § 248.14.
6. Remediation of violations. The banking
entity’s compliance program must be
reasonably designed and established to
effectively monitor and identify for further
analysis any covered fund activity or
investment that may indicate potential
violations of section 13 of the BHC Act or
this part and to prevent actual violations of
section 13 of the BHC Act and this part. The
banking entity’s compliance program must
describe procedures for identifying and
remedying violations of section 13 of the
BHC Act and this part, and must include, at
a minimum, a requirement to promptly
document, address and remedy any violation
of section 13 of the BHC Act or this part,
including § 248.21, and document all
proposed and actual remediation efforts. The
compliance program must include specific
written policies and procedures that are
reasonably designed to assess the extent to
which any activity or investment indicates
that modification to the banking entity’s
compliance program is warranted and to
ensure that appropriate modifications are
implemented. The written policies and
procedures must provide for prompt
notification to appropriate management,
including senior management and the board
of directors, of any material weakness or
significant deficiencies in the design or
implementation of the compliance program
of the banking entity.
III. Responsibility and Accountability for the
Compliance Program
a. A banking entity must establish,
maintain, and enforce a governance and
management framework to manage its
business and employees with a view to
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preventing violations of section 13 of the
BHC Act and this part. A banking entity must
have an appropriate management framework
reasonably designed to ensure that:
Appropriate personnel are responsible and
accountable for the effective implementation
and enforcement of the compliance program;
a clear reporting line with a chain of
responsibility is delineated; and the
compliance program is reviewed periodically
by senior management. The board of
directors (or equivalent governance body)
and senior management should have the
appropriate authority and access to personnel
and information within the organizations as
well as appropriate resources to conduct
their oversight activities effectively.
1. Corporate governance. The banking
entity must adopt a written compliance
program approved by the board of directors,
an appropriate committee of the board, or
equivalent governance body, and senior
management.
2. Management procedures. The banking
entity must establish, maintain, and enforce
a governance framework that is reasonably
designed to achieve compliance with section
13 of the BHC Act and this part, which, at
a minimum, provides for:
i. The designation of appropriate senior
management or committee of senior
management with authority to carry out the
management responsibilities of the banking
entity for each trading desk and for each
organizational unit engaged in covered fund
activities;
ii. Written procedures addressing the
management of the activities of the banking
entity that are reasonably designed to achieve
compliance with section 13 of the BHC Act
and this part, including:
A. A description of the management
system, including the titles, qualifications,
and locations of managers and the specific
responsibilities of each person with respect
to the banking entity’s activities governed by
section 13 of the BHC Act and this part; and
B. Procedures for determining
compensation arrangements for traders
engaged in underwriting or market makingrelated activities under § 248.4 or riskmitigating hedging activities under § 248.5 so
that such compensation arrangements are
designed not to reward or incentivize
prohibited proprietary trading and
appropriately balance risk and financial
results in a manner that does not encourage
employees to expose the banking entity to
excessive or imprudent risk.
3. Business line managers. Managers with
responsibility for one or more trading desks
of the banking entity are accountable for the
effective implementation and enforcement of
the compliance program with respect to the
applicable trading desk(s).
4. The Board of directors, or similar
corporate body, and senior management. The
board of directors, or similar corporate body,
and senior management are responsible for
setting and communicating an appropriate
culture of compliance with section 13 of the
BHC Act and this part and ensuring that
appropriate policies regarding the
management of trading activities and covered
fund activities or investments are adopted to
comply with section 13 of the BHC Act and
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this part. The board of directors or similar
corporate body (such as a designated
committee of the board or an equivalent
governance body) must ensure that senior
management is fully capable, qualified, and
properly motivated to manage compliance
with this part in light of the organization’s
business activities and the expectations of
the board of directors. The board of directors
or similar corporate body must also ensure
that senior management has established
appropriate incentives and adequate
resources to support compliance with this
part, including the implementation of a
compliance program meeting the
requirements of this appendix into
management goals and compensation
structures across the banking entity.
5. Senior management. Senior management
is responsible for implementing and
enforcing the approved compliance program.
Senior management must also ensure that
effective corrective action is taken when
failures in compliance with section 13 of the
BHC Act and this part are identified. Senior
management and control personnel charged
with overseeing compliance with section 13
of the BHC Act and this part should review
the compliance program for the banking
entity periodically and report to the board, or
an appropriate committee thereof, on the
effectiveness of the compliance program and
compliance matters with a frequency
appropriate to the size, scope, and risk
profile of the banking entity’s trading
activities and covered fund activities or
investments, which shall be at least annually.
6. CEO attestation. Based on a review by
the CEO of the banking entity, the CEO of the
banking entity must, annually, attest in
writing to the Board that the banking entity
has in place processes to establish, maintain,
enforce, review, test and modify the
compliance program established under this
Appendix and § 248.20 of this part in a
manner reasonably designed to achieve
compliance with section 13 of the BHC Act
and this part. In the case of a U.S. branch or
agency of a foreign banking entity, the
attestation may be provided for the entire
U.S. operations of the foreign banking entity
by the senior management officer of the
United States operations of the foreign
banking entity who is located in the United
States.
IV. Independent Testing
a. Independent testing must occur with a
frequency appropriate to the size, scope, and
risk profile of the banking entity’s trading
and covered fund activities or investments,
which shall be at least annually. This
independent testing must include an
evaluation of:
1. The overall adequacy and effectiveness
of the banking entity’s compliance program,
including an analysis of the extent to which
the program contains all the required
elements of this appendix;
2. The effectiveness of the banking entity’s
internal controls, including an analysis and
documentation of instances in which such
internal controls have been breached, and
how such breaches were addressed and
resolved; and
3. The effectiveness of the banking entity’s
management procedures.
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b. A banking entity must ensure that
independent testing regarding the
effectiveness of the banking entity’s
compliance program is conducted by a
qualified independent party, such as the
banking entity’s internal audit department,
compliance personnel or risk managers
independent of the organizational unit being
tested, outside auditors, consultants, or other
qualified independent parties. A banking
entity must promptly take appropriate action
to remedy any significant deficiencies or
material weaknesses in its compliance
program and to terminate any violations of
section 13 of the BHC Act or this part.
V. Training
Banking entities must provide adequate
training to personnel and managers of the
banking entity engaged in activities or
investments governed by section 13 of the
BHC Act or this part, as well as other
appropriate supervisory, risk, independent
testing, and audit personnel, in order to
effectively implement and enforce the
compliance program. This training should
occur with a frequency appropriate to the
size and the risk profile of the banking
entity’s trading activities and covered fund
activities or investments.
VI. Recordkeeping
Banking entities must create and retain
records sufficient to demonstrate compliance
and support the operations and effectiveness
of the compliance program. A banking entity
must retain these records for a period that is
no less than 5 years or such longer period as
required by the Board in a form that allows
it to promptly produce such records to the
Board on request.
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Chapter I
Authority and Issuance
For the reasons stated in the Common
Preamble, the Federal Deposit Insurance
Corporation amends chapter III of Title
12, Code of Federal Regulations as
follows:
PART 351—PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS
31. The authority citation for part 351
continues to read as follows:
■
Authority: 12 U.S.C. 1851; 1811 et seq.;
3101 et seq.; and 5412.
Subpart A—Authority and Definitions
32. Section 351.2 is revised to read as
follows:
■
§ 351.2
Definitions.
Unless otherwise specified, for
purposes of this part:
(a) Affiliate has the same meaning as
in section 2(k) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(k)).
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62165
(b) Bank holding company has the
same meaning as in section 2 of the
Bank Holding Company Act of 1956 (12
U.S.C. 1841).
(c) Banking entity. (1) Except as
provided in paragraph (c)(2) of this
section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an
insured depository institution;
(iii) Any company that is treated as a
bank holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any
entity described in paragraph (c)(1)(i),
(ii), or (iii) of this section.
(2) Banking entity does not include:
(vii) A covered fund that is not itself
a banking entity under paragraph
(c)(1)(i), (ii), or (iii) of this section;
(viii) A portfolio company held under
the authority contained in section
4(k)(4)(H) or (I) of the BHC Act (12
U.S.C. 1843(k)(4)(H), (I)), or any
portfolio concern, as defined under 13
CFR 107.50, that is controlled by a small
business investment company, as
defined in section 103(3) of the Small
Business Investment Act of 1958 (15
U.S.C. 662), so long as the portfolio
company or portfolio concern is not
itself a banking entity under paragraph
(c)(1)(i), (ii), or (iii) of this section; or
(ix) The FDIC acting in its corporate
capacity or as conservator or receiver
under the Federal Deposit Insurance Act
or Title II of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
(d) Board means the Board of
Governors of the Federal Reserve
System.
(e) CFTC means the Commodity
Futures Trading Commission.
(f) Dealer has the same meaning as in
section 3(a)(5) of the Exchange Act (15
U.S.C. 78c(a)(5)).
(g) Depository institution has the same
meaning as in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)).
(h) Derivative. (1) Except as provided
in paragraph (h)(2) of this section,
derivative means:
(i) Any swap, as that term is defined
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)), or
security-based swap, as that term is
defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68));
(ii) Any purchase or sale of a
commodity, that is not an excluded
commodity, for deferred shipment or
delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as
that term is defined in section 1a(24) of
the Commodity Exchange Act (7 U.S.C.
1a(24)) or foreign exchange swap (as
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that term is defined in section 1a(25) of
the Commodity Exchange Act (7 U.S.C.
1a(25));
(iv) Any agreement, contract, or
transaction in foreign currency
described in section 2(c)(2)(C)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(C)(i));
(v) Any agreement, contract, or
transaction in a commodity other than
foreign currency described in section
2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under
section 19 of the Commodity Exchange
Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or
other agreement, contract, or transaction
that the CFTC and SEC have further
defined by joint regulation,
interpretation, or other action as not
within the definition of swap, as that
term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C.
1a(47)), or security-based swap, as that
term is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)); or
(ii) Any identified banking product, as
defined in section 402(b) of the Legal
Certainty for Bank Products Act of 2000
(7 U.S.C. 27(b)), that is subject to section
403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the
immediate family of the employee.
(j) Exchange Act means the Securities
Exchange Act of 1934 (15 U.S.C. 78a et
seq.).
(k) Excluded commodity has the same
meaning as in section 1a(19) of the
Commodity Exchange Act (7 U.S.C.
1a(19)).
(l) FDIC means the Federal Deposit
Insurance Corporation.
(m) Federal banking agencies means
the Board, the Office of the Comptroller
of the Currency, and the FDIC.
(n) Foreign banking organization has
the same meaning as in § 211.21(o) of
the Board’s Regulation K (12 CFR
211.21(o)), but does not include a
foreign bank, as defined in section
1(b)(7) of the International Banking Act
of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the
Commonwealth of Puerto Rico, Guam,
American Samoa, the United States
Virgin Islands, or the Commonwealth of
the Northern Mariana Islands.
(o) Foreign insurance regulator means
the insurance commissioner, or a
similar official or agency, of any country
other than the United States that is
engaged in the supervision of insurance
companies under foreign insurance law.
(p) General account means all of the
assets of an insurance company except
those allocated to one or more separate
accounts.
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(q) Insurance company means a
company that is organized as an
insurance company, primarily and
predominantly engaged in writing
insurance or reinsuring risks
underwritten by insurance companies,
subject to supervision as such by a state
insurance regulator or a foreign
insurance regulator, and not operated
for the purpose of evading the
provisions of section 13 of the BHC Act
(12 U.S.C. 1851).
(r) Insured depository institution has
the same meaning as in section 3(c) of
the Federal Deposit Insurance Act (12
U.S.C. 1813(c)), but does not include:
(1) An insured depository institution
that is described in section 2(c)(2)(D) of
the BHC Act (12 U.S.C. 1841(c)(2)(D));
or
(2) An insured depository institution
if it has, and if every company that
controls it has, total consolidated assets
of $10 billion or less and total trading
assets and trading liabilities, on a
consolidated basis, that are 5 percent or
less of total consolidated assets.
(s) Limited trading assets and
liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together
with its affiliates and subsidiaries,
trading assets and liabilities (excluding
trading assets and liabilities attributable
to trading activities permitted pursuant
to § 351.6(a)(1) and (2) of subpart B) the
average gross sum of which over the
previous consecutive four quarters, as
measured as of the last day of each of
the four previous calendar quarters, is
less than $1 billion; and
(ii) The FDIC has not determined
pursuant to § 351.20(g) or (h) of this part
that the banking entity should not be
treated as having limited trading assets
and liabilities.
(2) With respect to a banking entity
other than a banking entity described in
paragraph (s)(3) of this section, trading
assets and liabilities for purposes of this
paragraph (s) means trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 351.6(a)(1) and (2) of subpart B) on a
worldwide consolidated basis.
(3)(i) With respect to a banking entity
that is a foreign banking organization or
a subsidiary of a foreign banking
organization, trading assets and
liabilities for purposes of this paragraph
(s) means the trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 351.6(a)(1) and (2) of subpart B) of the
combined U.S. operations of the top-tier
foreign banking organization (including
all subsidiaries, affiliates, branches, and
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agencies of the foreign banking
organization operating, located, or
organized in the United States).
(ii) For purposes of paragraph (s)(3)(i)
of this section, a U.S. branch, agency, or
subsidiary of a banking entity is located
in the United States; however, the
foreign bank that operates or controls
that branch, agency, or subsidiary is not
considered to be located in the United
States solely by virtue of operating or
controlling the U.S. branch, agency, or
subsidiary. For purposes of paragraph
(s)(3)(i) of this section, all foreign
operations of a U.S. agency, branch, or
subsidiary of a foreign banking
organization are considered to be
located in the United States, including
branches outside the United States that
are managed or controlled by a U.S.
branch or agency of the foreign banking
organization, for purposes of calculating
the banking entity’s U.S. trading assets
and liabilities.
(t) Loan means any loan, lease,
extension of credit, or secured or
unsecured receivable that is not a
security or derivative.
(u) Moderate trading assets and
liabilities means, with respect to a
banking entity, that the banking entity
does not have significant trading assets
and liabilities or limited trading assets
and liabilities.
(v) Primary financial regulatory
agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act (12 U.S.C. 5301(12)).
(w) Purchase includes any contract to
buy, purchase, or otherwise acquire. For
security futures products, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a commodity future, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a derivative, purchase
includes the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(x) Qualifying foreign banking
organization means a foreign banking
organization that qualifies as such under
§ 211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c), or
(e)).
(y) SEC means the Securities and
Exchange Commission.
(z) Sale and sell each include any
contract to sell or otherwise dispose of.
For security futures products, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a commodity future, such
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terms include any contract, agreement,
or transaction for future delivery. With
respect to a derivative, such terms
include the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(aa) Security has the meaning
specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(bb) Security-based swap dealer has
the same meaning as in section 3(a)(71)
of the Exchange Act (15 U.S.C.
78c(a)(71)).
(cc) Security future has the meaning
specified in section 3(a)(55) of the
Exchange Act (15 U.S.C. 78c(a)(55)).
(dd) Separate account means an
account established and maintained by
an insurance company in connection
with one or more insurance contracts to
hold assets that are legally segregated
from the insurance company’s other
assets, under which income, gains, and
losses, whether or not realized, from
assets allocated to such account, are, in
accordance with the applicable contract,
credited to or charged against such
account without regard to other income,
gains, or losses of the insurance
company.
(ee) Significant trading assets and
liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together
with its affiliates and subsidiaries,
trading assets and liabilities the average
gross sum of which over the previous
consecutive four quarters, as measured
as of the last day of each of the four
previous calendar quarters, equals or
exceeds $20 billion; or
(ii) The FDIC has determined
pursuant to § 351.20(h) of this part that
the banking entity should be treated as
having significant trading assets and
liabilities.
(2) With respect to a banking entity,
other than a banking entity described in
paragraph (ee)(3) of this section, trading
assets and liabilities for purposes of this
paragraph (ee) means trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 351.6(a)(1) and (2) of subpart B) on a
worldwide consolidated basis.
(3)(i) With respect to a banking entity
that is a foreign banking organization or
a subsidiary of a foreign banking
organization, trading assets and
liabilities for purposes of this paragraph
(ee) means the trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
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§ 351.6(a)(1) and (2) of subpart B) of the
combined U.S. operations of the top-tier
foreign banking organization (including
all subsidiaries, affiliates, branches, and
agencies of the foreign banking
organization operating, located, or
organized in the United States as well
as branches outside the United States
that are managed or controlled by a
branch or agency of the foreign banking
entity operating, located or organized in
the United States).
(ii) For purposes of paragraph
(ee)(3)(i) of this section, a U.S. branch,
agency, or subsidiary of a banking entity
is located in the United States; however,
the foreign bank that operates or
controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary. For
purposes of paragraph (ee)(3)(i) of this
section, all foreign operations of a U.S.
agency, branch, or subsidiary of a
foreign banking organization are
considered to be located in the United
States for purposes of calculating the
banking entity’s U.S. trading assets and
liabilities.
(ff) State means any State, the District
of Columbia, the Commonwealth of
Puerto Rico, Guam, American Samoa,
the United States Virgin Islands, and the
Commonwealth of the Northern Mariana
Islands.
(gg) Subsidiary has the same meaning
as in section 2(d) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(d)).
(hh) State insurance regulator means
the insurance commissioner, or a
similar official or agency, of a State that
is engaged in the supervision of
insurance companies under State
insurance law.
(ii) Swap dealer has the same meaning
as in section 1(a)(49) of the Commodity
Exchange Act (7 U.S.C. 1a(49)).
Subpart B—Proprietary Trading
33. Section 351.3 is amended by:
a. Revising paragraphs (b) and (d)(3),
(8), and (9);
■ b. Adding paragraphs (d)(10) through
(13);
■ c. Redesignating paragraphs (e)(5)
through (13) as paragraphs (e)(6)
through (14);
■ d. Adding new paragraph (e)(5); and
■ e. Revising redesignated paragraphs
(e)(11), (12), and (14).
The revisions and additions read as
follows:
■
■
§ 351.3
*
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Prohibition on proprietary trading.
*
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*
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62167
(b) Definition of trading account. (1)
Trading account. Trading account
means:
(i) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments principally
for the purpose of short-term resale,
benefitting from actual or expected
short-term price movements, realizing
short-term arbitrage profits, or hedging
one or more of the positions resulting
from the purchases or sales of financial
instruments described in this paragraph;
(ii) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments that are both
market risk capital rule covered
positions and trading positions (or
hedges of other market risk capital rule
covered positions), if the banking entity,
or any affiliate with which the banking
entity is consolidated for regulatory
reporting purposes, calculates riskbased capital ratios under the market
risk capital rule; or
(iii) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments, if the
banking entity:
(A) Is licensed or registered, or is
required to be licensed or registered, to
engage in the business of a dealer, swap
dealer, or security-based swap dealer, to
the extent the instrument is purchased
or sold in connection with the activities
that require the banking entity to be
licensed or registered as such; or
(B) Is engaged in the business of a
dealer, swap dealer, or security-based
swap dealer outside of the United
States, to the extent the instrument is
purchased or sold in connection with
the activities of such business.
(2) Trading account application for
certain banking entities. (i) A banking
entity that is subject to paragraph
(b)(1)(ii) of this section in determining
the scope of its trading account is not
subject to paragraph (b)(1)(i) of this
section.
(ii) A banking entity that does not
calculate risk-based capital ratios under
the market risk capital rule and is not
a consolidated affiliate for regulatory
reporting purposes of a banking entity
that calculates risk based capital ratios
under the market risk capital rule may
elect to apply paragraph (b)(1)(ii) of this
section in determining the scope of its
trading account as if it were subject to
that paragraph. A banking entity that
elects under this subsection to apply
paragraph (b)(1)(ii) of this section in
determining the scope of its trading
account as if it were subject to that
paragraph is not required to apply
paragraph (b)(1)(i) of this section.
(3) Consistency of account election for
certain banking entities. (i) Any election
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or change to an election under
paragraph (b)(2)(ii) of this section must
apply to the electing banking entity and
all of its wholly owned subsidiaries.
The primary financial regulatory agency
of a banking entity that is affiliated with
but is not a wholly owned subsidiary of
such electing banking entity may
require that the banking entity be
subject to this uniform application
requirement if the primary financial
regulatory agency determines that it is
necessary to prevent evasion of the
requirements of this part after notice
and opportunity for response as
provided in subpart D of this part.
(ii) A banking entity that does not
elect under paragraph (b)(2)(ii) of this
section to be subject to the trading
account definition in (b)(1)(ii) of this
section may continue to apply the
trading account definition in paragraph
(b)(1)(i) of this section for one year from
the date on which it becomes, or
becomes a consolidated affiliate for
regulatory reporting purposes with, a
banking entity that calculates risk-based
capital ratios under the market risk
capital rule.
(4) Rebuttable presumption for certain
purchases and sales. The purchase (or
sale) of a financial instrument by a
banking entity shall be presumed not to
be for the trading account of the banking
entity under paragraph (b)(1)(i) of this
section if the banking entity holds the
financial instrument for sixty days or
longer and does not transfer
substantially all of the risk of the
financial instrument within sixty days
of the purchase (or sale).
*
*
*
*
*
(d) * * *
(3) Any purchase or sale of a security,
foreign exchange forward (as that term
is defined in section 1a(24) of the
Commodity Exchange Act (7 U.S.C.
1a(24)), foreign exchange swap (as that
term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C.
1a(25)), or cross-currency swap by a
banking entity for the purpose of
liquidity management in accordance
with a documented liquidity
management plan of the banking entity
that:
(i) Specifically contemplates and
authorizes the particular financial
instruments to be used for liquidity
management purposes, the amount,
types, and risks of these financial
instruments that are consistent with
liquidity management, and the liquidity
circumstances in which the particular
financial instruments may or must be
used;
(ii) Requires that any purchase or sale
of financial instruments contemplated
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and authorized by the plan be
principally for the purpose of managing
the liquidity of the banking entity, and
not for the purpose of short-term resale,
benefitting from actual or expected
short-term price movements, realizing
short-term arbitrage profits, or hedging a
position taken for such short-term
purposes;
(iii) Requires that any financial
instruments purchased or sold for
liquidity management purposes be
highly liquid and limited to financial
instruments the market, credit, and
other risks of which the banking entity
does not reasonably expect to give rise
to appreciable profits or losses as a
result of short-term price movements;
(iv) Limits any financial instruments
purchased or sold for liquidity
management purposes, together with
any other financial instruments
purchased or sold for such purposes, to
an amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan;
(v) Includes written policies and
procedures, internal controls, analysis,
and independent testing to ensure that
the purchase and sale of financial
instruments that are not permitted
under § 351.6(a) or (b) of this subpart are
for the purpose of liquidity management
and in accordance with the liquidity
management plan described in this
paragraph (d)(3); and
(vi) Is consistent with the FDIC’s
regulatory requirements regarding
liquidity management;
*
*
*
*
*
(8) Any purchase or sale of one or
more financial instruments by a banking
entity through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity that is
established and administered in
accordance with the law of the United
States or a foreign sovereign, if the
purchase or sale is made directly or
indirectly by the banking entity as
trustee for the benefit of persons who
are or were employees of the banking
entity;
(9) Any purchase or sale of one or
more financial instruments by a banking
entity in the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the financial instrument
as soon as practicable, and in no event
may the banking entity retain such
instrument for longer than such period
permitted by the FDIC;
(10) Any purchase or sale of one or
more financial instruments that was
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made in error by a banking entity in the
course of conducting a permitted or
excluded activity or is a subsequent
transaction to correct such an error;
(11) Contemporaneously entering into
a customer-driven swap or customerdriven security-based swap and a
matched swap or security-based swap if:
(i) The banking entity retains no more
than minimal price risk; and
(ii) The banking entity is not a
registered dealer, swap dealer, or
security-based swap dealer;
(12) Any purchase or sale of one or
more financial instruments that the
banking entity uses to hedge mortgage
servicing rights or mortgage servicing
assets in accordance with a documented
hedging strategy; or
(13) Any purchase or sale of a
financial instrument that does not meet
the definition of trading asset or trading
liability under the applicable reporting
form for a banking entity as of January
1, 2020.
(e) * * *
(5) Cross-currency swap means a swap
in which one party exchanges with
another party principal and interest rate
payments in one currency for principal
and interest rate payments in another
currency, and the exchange of principal
occurs on the date the swap is entered
into, with a reversal of the exchange of
principal at a later date that is agreed
upon when the swap is entered into.
*
*
*
*
*
(11) Market risk capital rule covered
position and trading position means a
financial instrument that meets the
criteria to be a covered position and a
trading position, as those terms are
respectively defined, without regard to
whether the financial instrument is
reported as a covered position or trading
position on any applicable regulatory
reporting forms:
(i) In the case of a banking entity that
is a bank holding company, savings and
loan holding company, or insured
depository institution, under the market
risk capital rule that is applicable to the
banking entity; and
(ii) In the case of a banking entity that
is affiliated with a bank holding
company or savings and loan holding
company, other than a banking entity to
which a market risk capital rule is
applicable, under the market risk capital
rule that is applicable to the affiliated
bank holding company or savings and
loan holding company.
(12) Market risk capital rule means
the market risk capital rule that is
contained in 12 CFR part 3, subpart F,
with respect to a banking entity for
which the OCC is the primary financial
regulatory agency, 12 CFR part 217 with
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respect to a banking entity for which the
Board is the primary financial
regulatory agency, or 12 CFR part 324
with respect to a banking entity for
which the FDIC is the primary financial
regulatory agency.
*
*
*
*
*
(14) Trading desk means a unit of
organization of a banking entity that
purchases or sells financial instruments
for the trading account of the banking
entity or an affiliate thereof that is:
(i)(A) Structured by the banking entity
to implement a well-defined business
strategy;
(B) Organized to ensure appropriate
setting, monitoring, and management
review of the desk’s trading and hedging
limits, current and potential future loss
exposures, and strategies; and
(C) Characterized by a clearly defined
unit that:
(1) Engages in coordinated trading
activity with a unified approach to its
key elements;
(2) Operates subject to a common and
calibrated set of risk metrics, risk levels,
and joint trading limits;
(3) Submits compliance reports and
other information as a unit for
monitoring by management; and
(4) Books its trades together; or
(ii) For a banking entity that
calculates risk-based capital ratios
under the market risk capital rule, or a
consolidated affiliate for regulatory
reporting purposes of a banking entity
that calculates risk-based capital ratios
under the market risk capital rule,
established by the banking entity or its
affiliate for purposes of market risk
capital calculations under the market
risk capital rule.
■ 34. Section 351.4 is revised to read as
follows:
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§ 351.4 Permitted underwriting and market
making-related activities.
(a) Underwriting activities—(1)
Permitted underwriting activities. The
prohibition contained in § 351.3(a) does
not apply to a banking entity’s
underwriting activities conducted in
accordance with this paragraph (a).
(2) Requirements. The underwriting
activities of a banking entity are
permitted under paragraph (a)(1) of this
section only if:
(i) The banking entity is acting as an
underwriter for a distribution of
securities and the trading desk’s
underwriting position is related to such
distribution;
(ii)(A) The amount and type of the
securities in the trading desk’s
underwriting position are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, taking into account the
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liquidity, maturity, and depth of the
market for the relevant types of
securities; and
(B) Reasonable efforts are made to sell
or otherwise reduce the underwriting
position within a reasonable period,
taking into account the liquidity,
maturity, and depth of the market for
the relevant types of securities;
(iii) In the case of a banking entity
with significant trading assets and
liabilities, the banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of this paragraph
(a), including reasonably designed
written policies and procedures,
internal controls, analysis and
independent testing identifying and
addressing:
(A) The products, instruments or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
(B) Limits for each trading desk, in
accordance with paragraph (a)(2)(ii)(A)
of this section;
(C) Written authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
and
(D) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits.
(iv) A banking entity with significant
trading assets and liabilities may satisfy
the requirements in paragraphs
(a)(2)(iii)(B) and (C) of this section by
complying with the requirements set
forth in paragraph (c) of this section;
(v) The compensation arrangements of
persons performing the activities
described in this paragraph (a) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in the activity
described in this paragraph (a) in
accordance with applicable law.
(3) Definition of distribution. For
purposes of this paragraph (a), a
distribution of securities means:
(i) An offering of securities, whether
or not subject to registration under the
Securities Act of 1933, that is
distinguished from ordinary trading
transactions by the presence of special
selling efforts and selling methods; or
(ii) An offering of securities made
pursuant to an effective registration
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62169
statement under the Securities Act of
1933.
(4) Definition of underwriter. For
purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an
issuer or selling security holder to:
(A) Purchase securities from the
issuer or selling security holder for
distribution;
(B) Engage in a distribution of
securities for or on behalf of the issuer
or selling security holder; or
(C) Manage a distribution of securities
for or on behalf of the issuer or selling
security holder; or
(ii) A person who has agreed to
participate or is participating in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.
(5) Definition of selling security
holder. For purposes of this paragraph
(a), selling security holder means any
person, other than an issuer, on whose
behalf a distribution is made.
(6) Definition of underwriting
position. For purposes of this section,
underwriting position means the long or
short positions in one or more securities
held by a banking entity or its affiliate,
and managed by a particular trading
desk, in connection with a particular
distribution of securities for which such
banking entity or affiliate is acting as an
underwriter.
(7) Definition of client, customer, and
counterparty. For purposes of this
paragraph (a), the terms client,
customer, and counterparty, on a
collective or individual basis, refer to
market participants that may transact
with the banking entity in connection
with a particular distribution for which
the banking entity is acting as
underwriter.
(b) Market making-related activities—
(1) Permitted market making-related
activities. The prohibition contained in
§ 351.3(a) does not apply to a banking
entity’s market making-related activities
conducted in accordance with this
paragraph (b).
(2) Requirements. The market makingrelated activities of a banking entity are
permitted under paragraph (b)(1) of this
section only if:
(i) The trading desk that establishes
and manages the financial exposure,
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure, and is willing and available to
quote, purchase and sell, or otherwise
enter into long and short positions in
those types of financial instruments for
its own account, in commercially
reasonable amounts and throughout
market cycles on a basis appropriate for
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the liquidity, maturity, and depth of the
market for the relevant types of financial
instruments;
(ii) The trading desk’s market-making
related activities are designed not to
exceed, on an ongoing basis, the
reasonably expected near term demands
of clients, customers, or counterparties,
taking into account the liquidity,
maturity, and depth of the market for
the relevant types of financial
instruments;
(iii) In the case of a banking entity
with significant trading assets and
liabilities, the banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (b)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The financial instruments each
trading desk stands ready to purchase
and sell in accordance with paragraph
(b)(2)(i) of this section;
(B) The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the limits
required under paragraph (b)(2)(iii)(C) of
this section; the products, instruments,
and exposures each trading desk may
use for risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and
positions; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
desk to mitigate these risks are and
continue to be effective;
(C) Limits for each trading desk, in
accordance with paragraph (b)(2)(ii) of
this section;
(D) Written authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
and
(E) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
(iv) A banking entity with significant
trading assets and liabilities may satisfy
the requirements in paragraphs
(b)(2)(iii)(C) and (D) of this section by
complying with the requirements set
forth in paragraph (c) of this section;
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(v) The compensation arrangements of
persons performing the activities
described in this paragraph (b) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in activity
described in this paragraph (b) in
accordance with applicable law.
(3) Definition of client, customer, and
counterparty. For purposes of paragraph
(b) of this section, the terms client,
customer, and counterparty, on a
collective or individual basis refer to
market participants that make use of the
banking entity’s market making-related
services by obtaining such services,
responding to quotations, or entering
into a continuing relationship with
respect to such services, provided that:
(i) A trading desk or other
organizational unit of another banking
entity is not a client, customer, or
counterparty of the trading desk if that
other entity has trading assets and
liabilities of $50 billion or more as
measured in accordance with the
methodology described in § 351.2(ee) of
this part, unless:
(A) The trading desk documents how
and why a particular trading desk or
other organizational unit of the entity
should be treated as a client, customer,
or counterparty of the trading desk for
purposes of paragraph (b)(2) of this
section; or
(B) The purchase or sale by the
trading desk is conducted anonymously
on an exchange or similar trading
facility that permits trading on behalf of
a broad range of market participants.
(ii) [Reserved]
(4) Definition of financial exposure.
For purposes of this section, financial
exposure means the aggregate risks of
one or more financial instruments and
any associated loans, commodities, or
foreign exchange or currency, held by a
banking entity or its affiliate and
managed by a particular trading desk as
part of the trading desk’s market
making-related activities.
(5) Definition of market-maker
positions. For the purposes of this
section, market-maker positions means
all of the positions in the financial
instruments for which the trading desk
stands ready to make a market in
accordance with paragraph (b)(2)(i) of
this section, that are managed by the
trading desk, including the trading
desk’s open positions or exposures
arising from open transactions.
(c) Rebuttable presumption of
compliance—(1) Internal limits. (i) A
banking entity shall be presumed to
meet the requirement in paragraph
(a)(2)(ii)(A) or (b)(2)(ii) of this section
with respect to the purchase or sale of
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a financial instrument if the banking
entity has established and implements,
maintains, and enforces the internal
limits for the relevant trading desk as
described in paragraph (c)(1)(ii) of this
section.
(ii)(A) With respect to underwriting
activities conducted pursuant to
paragraph (a) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall be available
to each trading desk that establishes,
implements, maintains, and enforces
internal limits that should take into
account the liquidity, maturity, and
depth of the market for the relevant
types of securities and are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, based on the nature and
amount of the trading desk’s
underwriting activities, on the:
(1) Amount, types, and risk of its
underwriting position;
(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held.
(B) With respect to market makingrelated activities conducted pursuant to
paragraph (b) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall be available
to each trading desk that establishes,
implements, maintains, and enforces
internal limits that should take into
account the liquidity, maturity, and
depth of the market for the relevant
types of financial instruments and are
designed not to exceed the reasonably
expected near term demands of clients,
customers, or counterparties, based on
the nature and amount of the trading
desk’s market-making related activities,
that address the:
(1) Amount, types, and risks of its
market-maker positions;
(2) Amount, types, and risks of the
products, instruments, and exposures
the trading desk may use for risk
management purposes;
(3) Level of exposures to relevant risk
factors arising from its financial
exposure; and
(4) Period of time a financial
instrument may be held.
(2) Supervisory review and oversight.
The limits described in paragraph (c)(1)
of this section shall be subject to
supervisory review and oversight by the
FDIC on an ongoing basis.
(3) Limit Breaches and Increases. (i)
With respect to any limit set pursuant
to paragraph (c)(1)(ii)(A) or (B) of this
section, a banking entity shall maintain
and make available to the FDIC upon
request records regarding:
(A) Any limit that is exceeded; and
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(B) Any temporary or permanent
increase to any limit(s), in each case in
the form and manner as directed by the
FDIC.
(ii) In the event of a breach or increase
of any limit set pursuant to paragraph
(c)(1)(ii)(A) or (B) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall continue to
be available only if the banking entity:
(A) Takes action as promptly as
possible after a breach to bring the
trading desk into compliance; and
(B) Follows established written
authorization procedures, including
escalation procedures that require
review and approval of any trade that
exceeds a trading desk’s limit(s),
demonstrable analysis of the basis for
any temporary or permanent increase to
a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval.
(4) Rebutting the presumption. The
presumption in paragraph (c)(1)(i) of
this section may be rebutted by the FDIC
if the FDIC determines, taking into
account the liquidity, maturity, and
depth of the market for the relevant
types of financial instruments and based
on all relevant facts and circumstances,
that a trading desk is engaging in
activity that is not based on the
reasonably expected near term demands
of clients, customers, or counterparties.
The FDIC’s rebuttal of the presumption
in paragraph (c)(1)(i) must be made in
accordance with the notice and
response procedures in subpart D of this
part.
■ 35. Section 351.5 is amended by
revising paragraphs (b) and (c)(1) and
adding paragraph (c)(4) to read as
follows:
§ 351.5 Permitted risk-mitigating hedging
activities.
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*
*
*
*
(b) * * *
(1) The risk-mitigating hedging
activities of a banking entity that has
significant trading assets and liabilities
are permitted under paragraph (a) of this
section only if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures regarding the
positions, techniques and strategies that
may be used for hedging, including
documentation indicating what
positions, contracts or other holdings a
particular trading desk may use in its
risk-mitigating hedging activities, as
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well as position and aging limits with
respect to such positions, contracts or
other holdings;
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(C) The conduct of analysis and
independent testing designed to ensure
that the positions, techniques and
strategies that may be used for hedging
may reasonably be expected to reduce or
otherwise significantly mitigate the
specific, identifiable risk(s) being
hedged;
(ii) The risk-mitigating hedging
activity:
(A) Is conducted in accordance with
the written policies, procedures, and
internal controls required under this
section;
(B) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks, including
market risk, counterparty or other credit
risk, currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section;
(D) Is subject to continuing review,
monitoring and management by the
banking entity that:
(1) Is consistent with the written
hedging policies and procedures
required under paragraph (b)(1)(i) of this
section;
(2) Is designed to reduce or otherwise
significantly mitigate the specific,
identifiable risks that develop over time
from the risk-mitigating hedging
activities undertaken under this section
and the underlying positions, contracts,
and other holdings of the banking
entity, based upon the facts and
circumstances of the underlying and
hedging positions, contracts and other
holdings of the banking entity and the
risks and liquidity thereof; and
(3) Requires ongoing recalibration of
the hedging activity by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(1)(ii) of this section and is
not prohibited proprietary trading; and
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62171
(iii) The compensation arrangements
of persons performing risk-mitigating
hedging activities are designed not to
reward or incentivize prohibited
proprietary trading.
(2) The risk-mitigating hedging
activities of a banking entity that does
not have significant trading assets and
liabilities are permitted under paragraph
(a) of this section only if the riskmitigating hedging activity:
(i) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks, including
market risk, counterparty or other credit
risk, currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to
ongoing recalibration by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(2) of this section and is
not prohibited proprietary trading.
(c) * * *
(1) A banking entity that has
significant trading assets and liabilities
must comply with the requirements of
paragraphs (c)(2) and (3) of this section,
unless the requirements of paragraph
(c)(4) of this section are met, with
respect to any purchase or sale of
financial instruments made in reliance
on this section for risk-mitigating
hedging purposes that is:
*
*
*
*
*
(4) The requirements of paragraphs
(c)(2) and (3) of this section do not
apply to the purchase or sale of a
financial instrument described in
paragraph (c)(1) of this section if:
(i) The financial instrument
purchased or sold is identified on a
written list of pre-approved financial
instruments that are commonly used by
the trading desk for the specific type of
hedging activity for which the financial
instrument is being purchased or sold;
and
(ii) At the time the financial
instrument is purchased or sold, the
hedging activity (including the purchase
or sale of the financial instrument)
complies with written, pre-approved
limits for the trading desk purchasing or
selling the financial instrument for
hedging activities undertaken for one or
more other trading desks. The limits
shall be appropriate for the:
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(A) Size, types, and risks of the
hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased
and sold for hedging activities by the
trading desk; and
(C) Levels and duration of the risk
exposures being hedged.
■ 36. Section 351.6 is amended by
revising paragraph (e)(3); removing
paragraphs (e)(4) and (6); and
redesignating paragraph (e)(5) as
paragraph (e)(4).
The revisions reads as follows:
§ 351.6 Other permitted proprietary trading
activities.
*
*
*
*
*
(e) * * *
(3) A purchase or sale by a banking
entity is permitted for purposes of this
paragraph (e) if:
(i) The banking entity engaging as
principal in the purchase or sale
(including relevant personnel) is not
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State; and
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State.
*
*
*
*
*
Subpart C—Covered Funds Activities
and Investments
37. Section 351.10 is amended by
revising paragraphs (c)(7)(ii) and
(c)(8)(i)(A) to read as follows:
■
38. Section 351.11 is amended by
revising paragraph (c) to read as follows:
■
§ 351.11 Permitted organizing and
offering, underwriting, and market making
with respect to a covered fund.
*
*
*
*
*
(c) Underwriting and market making
in ownership interests of a covered
fund. The prohibition contained in
§ 351.10(a) of this subpart does not
apply to a banking entity’s underwriting
activities or market making-related
activities involving a covered fund so
long as:
(1) Those activities are conducted in
accordance with the requirements of
§ 351.4(a) or (b) of subpart B,
respectively; and
(2) With respect to any banking entity
(or any affiliate thereof) that: Acts as a
sponsor, investment adviser or
commodity trading advisor to a
particular covered fund or otherwise
acquires and retains an ownership
interest in such covered fund in reliance
on paragraph (a) of this section; or
acquires and retains an ownership
interest in such covered fund and is
either a securitizer, as that term is used
in section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)), or is acquiring
and retaining an ownership interest in
such covered fund in compliance with
section 15G of that Act (15 U.S.C.78o–
11) and the implementing regulations
issued thereunder each as permitted by
paragraph (b) of this section, then in
each such case any ownership interests
acquired or retained by the banking
entity and its affiliates in connection
with underwriting and market making
related activities for that particular
covered fund are included in the
calculation of ownership interests
permitted to be held by the banking
entity and its affiliates under the
limitations of § 351.12(a)(2)(ii) and (iii)
and (d) of this subpart.
§ 351.12
[Amended]
39. Section 351.12 is amended by
redesignating the second instance of
paragraph (e)(2)(vi) as paragraph
(e)(2)(vii).
■ 40. Section 351.13 is amended by
revising paragraphs (a), (b)(3) and (4),
and (c) to read as follows:
■
§ 351.10 Prohibition on Acquiring or
Retaining an Ownership Interest in and
Having Certain Relationships with a
Covered Fund.
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*
*
*
*
*
(c) * * *
(7) * * *
(ii) Participates in the profits and
losses of the separate account other than
in compliance with applicable
requirements regarding bank owned life
insurance.
(8) * * *
(i) * * *
(A) Loans as defined in § 351.2(t) of
subpart A;
*
*
*
*
*
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§ 351.13 Other permitted covered fund
activities and investments.
(a) Permitted risk-mitigating hedging
activities. (1) The prohibition contained
in § 351.10(a) of this subpart does not
apply with respect to an ownership
interest in a covered fund acquired or
retained by a banking entity that is
designed to reduce or otherwise
significantly mitigate the specific,
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identifiable risks to the banking entity
in connection with:
(i) A compensation arrangement with
an employee of the banking entity or an
affiliate thereof that directly provides
investment advisory, commodity trading
advisory or other services to the covered
fund; or
(ii) A position taken by the banking
entity when acting as intermediary on
behalf of a customer that is not itself a
banking entity to facilitate the exposure
by the customer to the profits and losses
of the covered fund.
(2) The risk-mitigating hedging
activities of a banking entity are
permitted under this paragraph (a) only
if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program in
accordance with subpart D of this part
that is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures; and
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(ii) The acquisition or retention of the
ownership interest:
(A) Is made in accordance with the
written policies, procedures, and
internal controls required under this
section;
(B) At the inception of the hedge, is
designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks arising:
(1) Out of a transaction conducted
solely to accommodate a specific
customer request with respect to the
covered fund; or
(2) In connection with the
compensation arrangement with the
employee that directly provides
investment advisory, commodity trading
advisory, or other services to the
covered fund;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section; and
(D) Is subject to continuing review,
monitoring and management by the
banking entity.
(iii) With respect to risk-mitigating
hedging activity conducted pursuant to
paragraph (a)(1)(i) of this section, the
compensation arrangement relates
solely to the covered fund in which the
banking entity or any affiliate has
acquired an ownership interest pursuant
to paragraph (a)(1)(i) and such
compensation arrangement provides
that any losses incurred by the banking
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entity on such ownership interest will
be offset by corresponding decreases in
amounts payable under such
compensation arrangement.
(b) * * *
(3) An ownership interest in a covered
fund is not offered for sale or sold to a
resident of the United States for
purposes of paragraph (b)(1)(iii) of this
section only if it is not sold and has not
been sold pursuant to an offering that
targets residents of the United States in
which the banking entity or any affiliate
of the banking entity participates. If the
banking entity or an affiliate sponsors or
serves, directly or indirectly, as the
investment manager, investment
adviser, commodity pool operator or
commodity trading advisor to a covered
fund, then the banking entity or affiliate
will be deemed for purposes of this
paragraph (b)(3) to participate in any
offer or sale by the covered fund of
ownership interests in the covered fund.
(4) An activity or investment occurs
solely outside of the United States for
purposes of paragraph (b)(1)(iv) of this
section only if:
(i) The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
and is not controlled directly or
indirectly by, a banking entity that is
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
laws of the United States or of any State;
and
(iii) The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
as principal directly or indirectly on a
consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State.
*
*
*
*
*
(c) Permitted covered fund interests
and activities by a regulated insurance
company. The prohibition contained in
§ 351.10(a) of this subpart does not
apply to the acquisition or retention by
an insurance company, or an affiliate
thereof, of any ownership interest in, or
the sponsorship of, a covered fund only
if:
(1) The insurance company or its
affiliate acquires and retains the
ownership interest solely for the general
account of the insurance company or for
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one or more separate accounts
established by the insurance company;
(2) The acquisition and retention of
the ownership interest is conducted in
compliance with, and subject to, the
insurance company investment laws
and regulations of the State or
jurisdiction in which such insurance
company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law or
regulation described in paragraph (c)(2)
of this section is insufficient to protect
the safety and soundness of the banking
entity, or the financial stability of the
United States.
■ 41. Section 351.14 is amended by
revising paragraph (a)(2)(ii)(B) to read as
follows:
§ 351.14 Limitations on relationships with
a covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or
equivalent officer) of the banking entity
certifies in writing annually no later
than March 31 to the FDIC (with a duty
to update the certification if the
information in the certification
materially changes) that the banking
entity does not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests; and
*
*
*
*
*
Subpart D—Compliance Program
Requirement; Violations
42. Section 351.20 is amended by
revising paragraphs (a), (b) introductory
text, (c), (d), (e) introductory text, and
(f)(2) and adding paragraphs (g), (h), and
(i) to read as follows:
■
§ 351.20 Program for compliance;
reporting.
(a) Program requirement. Each
banking entity (other than a banking
entity with limited trading assets and
liabilities) shall develop and provide for
the continued administration of a
compliance program reasonably
designed to ensure and monitor
compliance with the prohibitions and
restrictions on proprietary trading and
covered fund activities and investments
set forth in section 13 of the BHC Act
and this part. The terms, scope, and
detail of the compliance program shall
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be appropriate for the types, size, scope,
and complexity of activities and
business structure of the banking entity.
(b) Banking entities with significant
trading assets and liabilities. With
respect to a banking entity with
significant trading assets and liabilities,
the compliance program required by
paragraph (a) of this section, at a
minimum, shall include:
*
*
*
*
*
(c) CEO attestation. The CEO of a
banking entity that has significant
trading assets and liabilities must, based
on a review by the CEO of the banking
entity, attest in writing to the FDIC, each
year no later than March 31, that the
banking entity has in place processes to
establish, maintain, enforce, review, test
and modify the compliance program
required by paragraph (b) of this section
in a manner reasonably designed to
achieve compliance with section 13 of
the BHC Act and this part. In the case
of a U.S. branch or agency of a foreign
banking entity, the attestation may be
provided for the entire U.S. operations
of the foreign banking entity by the
senior management officer of the U.S.
operations of the foreign banking entity
who is located in the United States.
(d) Reporting requirements under
appendix A to this part. (1) A banking
entity engaged in proprietary trading
activity permitted under subpart B shall
comply with the reporting requirements
described in appendix A to this part, if:
(i) The banking entity has significant
trading assets and liabilities; or
(ii) The FDIC notifies the banking
entity in writing that it must satisfy the
reporting requirements contained in
appendix A to this part.
(2) Frequency of reporting: Unless the
FDIC notifies the banking entity in
writing that it must report on a different
basis, a banking entity subject to
appendix A to this part shall report the
information required by appendix A for
each quarter within 30 days of the end
of the quarter.
(e) Additional documentation for
covered funds. A banking entity with
significant trading assets and liabilities
shall maintain records that include:
*
*
*
*
*
(f) * * *
(2) Banking entities with moderate
trading assets and liabilities. A banking
entity with moderate trading assets and
liabilities may satisfy the requirements
of this section by including in its
existing compliance policies and
procedures appropriate references to the
requirements of section 13 of the BHC
Act and this part and adjustments as
appropriate given the activities, size,
scope, and complexity of the banking
entity.
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(g) Rebuttable presumption of
compliance for banking entities with
limited trading assets and liabilities—
(1) Rebuttable presumption. Except as
otherwise provided in this paragraph, a
banking entity with limited trading
assets and liabilities shall be presumed
to be compliant with subpart B and
subpart C of this part and shall have no
obligation to demonstrate compliance
with this part on an ongoing basis.
(2) Rebuttal of presumption. If upon
examination or audit, the FDIC
determines that the banking entity has
engaged in proprietary trading or
covered fund activities that are
otherwise prohibited under subpart B or
subpart C of this part, the FDIC may
require the banking entity to be treated
under this part as if it did not have
limited trading assets and liabilities.
The FDIC’s rebuttal of the presumption
in this paragraph must be made in
accordance with the notice and
response procedures in paragraph (i) of
this section.
(h) Reservation of authority.
Notwithstanding any other provision of
this part, the FDIC retains its authority
to require a banking entity without
significant trading assets and liabilities
to apply any requirements of this part
that would otherwise apply if the
banking entity had significant or
moderate trading assets and liabilities if
the FDIC determines that the size or
complexity of the banking entity’s
trading or investment activities, or the
risk of evasion of subpart B or subpart
C of this part, does not warrant a
presumption of compliance under
paragraph (g) of this section or treatment
as a banking entity with moderate
trading assets and liabilities, as
applicable. The FDIC’s exercise of this
reservation of authority must be made in
accordance with the notice and
response procedures in paragraph (i) of
this section.
(i) Notice and response procedures—
(1) Notice. The FDIC will notify the
banking entity in writing of any
determination requiring notice under
this part and will provide an
explanation of the determination.
(2) Response. The banking entity may
respond to any or all items in the notice
described in paragraph (i)(1) of this
section. The response should include
any matters that the banking entity
would have the FDIC consider in
deciding whether to make the
determination. The response must be in
writing and delivered to the designated
FDIC official within 30 days after the
date on which the banking entity
received the notice. The FDIC may
shorten the time period when, in the
opinion of the FDIC, the activities or
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condition of the banking entity so
requires, provided that the banking
entity is informed of the time period at
the time of notice, or with the consent
of the banking entity. In its discretion,
the FDIC may extend the time period for
good cause.
(3) Waiver. Failure to respond within
30 days or such other time period as
may be specified by the FDIC shall
constitute a waiver of any objections to
the FDIC determination.
(4) Decision. The FDIC will notify the
banking entity of the decision in
writing. The notice will include an
explanation of the decision.
■ 43. Revise appendix A to part 351 to
read as follows:
Appendix A to Part 351—Reporting and
Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and
recordkeeping requirements that certain
banking entities must satisfy in connection
with the restrictions on proprietary trading
set forth in subpart B (‘‘proprietary trading
restrictions’’). Pursuant to § 351.20(d), this
appendix applies to a banking entity that,
together with its affiliates and subsidiaries,
has significant trading assets and liabilities.
These entities are required to (i) furnish
periodic reports to the FDIC regarding a
variety of quantitative measurements of their
covered trading activities, which vary
depending on the scope and size of covered
trading activities, and (ii) create and maintain
records documenting the preparation and
content of these reports. The requirements of
this appendix must be incorporated into the
banking entity’s internal compliance program
under § 351.20.
b. The purpose of this appendix is to assist
banking entities and the FDIC in:
(1) Better understanding and evaluating the
scope, type, and profile of the banking
entity’s covered trading activities;
(2) Monitoring the banking entity’s covered
trading activities;
(3) Identifying covered trading activities
that warrant further review or examination
by the banking entity to verify compliance
with the proprietary trading restrictions;
(4) Evaluating whether the covered trading
activities of trading desks engaged in market
making-related activities subject to § 351.4(b)
are consistent with the requirements
governing permitted market making-related
activities;
(5) Evaluating whether the covered trading
activities of trading desks that are engaged in
permitted trading activity subject to § 351.4,
§ 351.5, or § 351.6(a) and (b) (i.e.,
underwriting and market making-related
activity, risk-mitigating hedging, or trading in
certain government obligations) are
consistent with the requirement that such
activity not result, directly or indirectly, in
a material exposure to high-risk assets or
high-risk trading strategies;
(6) Identifying the profile of particular
covered trading activities of the banking
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entity, and the individual trading desks of
the banking entity, to help establish the
appropriate frequency and scope of
examination by the FDIC of such activities;
and
(7) Assessing and addressing the risks
associated with the banking entity’s covered
trading activities.
c. Information that must be furnished
pursuant to this appendix is not intended to
serve as a dispositive tool for the
identification of permissible or
impermissible activities.
d. In addition to the quantitative
measurements required in this appendix, a
banking entity may need to develop and
implement other quantitative measurements
in order to effectively monitor its covered
trading activities for compliance with section
13 of the BHC Act and this part and to have
an effective compliance program, as required
by § 351.20. The effectiveness of particular
quantitative measurements may differ based
on the profile of the banking entity’s
businesses in general and, more specifically,
of the particular trading desk, including
types of instruments traded, trading activities
and strategies, and history and experience
(e.g., whether the trading desk is an
established, successful market maker or a
new entrant to a competitive market). In all
cases, banking entities must ensure that they
have robust measures in place to identify and
monitor the risks taken in their trading
activities, to ensure that the activities are
within risk tolerances established by the
banking entity, and to monitor and examine
for compliance with the proprietary trading
restrictions in this part.
e. On an ongoing basis, banking entities
must carefully monitor, review, and evaluate
all furnished quantitative measurements, as
well as any others that they choose to utilize
in order to maintain compliance with section
13 of the BHC Act and this part. All
measurement results that indicate a
heightened risk of impermissible proprietary
trading, including with respect to otherwisepermitted activities under §§ 351.4 through
351.6(a) and (b), or that result in a material
exposure to high-risk assets or high-risk
trading strategies, must be escalated within
the banking entity for review, further
analysis, explanation to the FDIC, and
remediation, where appropriate. The
quantitative measurements discussed in this
appendix should be helpful to banking
entities in identifying and managing the risks
related to their covered trading activities.
II. Definitions
The terms used in this appendix have the
same meanings as set forth in §§ 351.2 and
351.3. In addition, for purposes of this
appendix, the following definitions apply:
Applicability identifies the trading desks
for which a banking entity is required to
calculate and report a particular quantitative
measurement based on the type of covered
trading activity conducted by the trading
desk.
Calculation period means the period of
time for which a particular quantitative
measurement must be calculated.
Comprehensive profit and loss means the
net profit or loss of a trading desk’s material
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sources of trading revenue over a specific
period of time, including, for example, any
increase or decrease in the market value of
a trading desk’s holdings, dividend income,
and interest income and expense.
Covered trading activity means trading
conducted by a trading desk under § 351.4,
§ 351.5, § 351.6(a), or § 351.6(b). A banking
entity may include in its covered trading
activity trading conducted under § 351.3(d),
§ 351.6(c), § 351.6(d) or § 351.6(e).
Measurement frequency means the
frequency with which a particular
quantitative metric must be calculated and
recorded.
Trading day means a calendar day on
which a trading desk is open for trading.
III. Reporting and Recordkeeping
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a. Scope of Required Reporting
1. Quantitative measurements. Each
banking entity made subject to this appendix
by § 351.20 must furnish the following
quantitative measurements, as applicable, for
each trading desk of the banking entity
engaged in covered trading activities and
calculate these quantitative measurements in
accordance with this appendix:
i. Internal Limits and Usage;
ii. Value-at-Risk;
iii. Comprehensive Profit and Loss
Attribution;
iv. Positions; and
v. Transaction Volumes.
2. Trading desk information. Each banking
entity made subject to this appendix by
§ 351.20 must provide certain descriptive
information, as further described in this
appendix, regarding each trading desk
engaged in covered trading activities.
3. Quantitative measurements identifying
information. Each banking entity made
subject to this appendix by § 351.20 must
provide certain identifying and descriptive
information, as further described in this
appendix, regarding its quantitative
measurements.
4. Narrative statement. Each banking entity
made subject to this appendix by § 351.20
may provide an optional narrative statement,
as further described in this appendix.
5. File identifying information. Each
banking entity made subject to this appendix
by § 351.20 must provide file identifying
information in each submission to the FDIC
pursuant to this appendix, including the
name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the
Board, and identification of the reporting
period and creation date and time.
b. Trading Desk Information
1. Each banking entity must provide
descriptive information regarding each
trading desk engaged in covered trading
activities, including:
i. Name of the trading desk used internally
by the banking entity and a unique
identification label for the trading desk;
ii. Identification of each type of covered
trading activity in which the trading desk is
engaged;
iii. Brief description of the general strategy
of the trading desk;
v. A list identifying each Agency receiving
the submission of the trading desk;
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2. Indication of whether each calendar date
is a trading day or not a trading day for the
trading desk; and
3. Currency reported and daily currency
conversion rate.
c. Quantitative Measurements Identifying
Information
Each banking entity must provide the
following information regarding the
quantitative measurements:
1. An Internal Limits Information Schedule
that provides identifying and descriptive
information for each limit reported pursuant
to the Internal Limits and Usage quantitative
measurement, including the name of the
limit, a unique identification label for the
limit, a description of the limit, the unit of
measurement for the limit, the type of limit,
and identification of the corresponding risk
factor attribution in the particular case that
the limit type is a limit on a risk factor
sensitivity and profit and loss attribution to
the same risk factor is reported; and
2. A Risk Factor Attribution Information
Schedule that provides identifying and
descriptive information for each risk factor
attribution reported pursuant to the
Comprehensive Profit and Loss Attribution
quantitative measurement, including the
name of the risk factor or other factor, a
unique identification label for the risk factor
or other factor, a description of the risk factor
or other factor, and the risk factor or other
factor’s change unit.
d. Narrative Statement
Each banking entity made subject to this
appendix by § 351.20 may submit in a
separate electronic document a Narrative
Statement to the FDIC with any information
the banking entity views as relevant for
assessing the information reported. The
Narrative Statement may include further
description of or changes to calculation
methods, identification of material events,
description of and reasons for changes in the
banking entity’s trading desk structure or
trading desk strategies, and when any such
changes occurred.
e. Frequency and Method of Required
Calculation and Reporting
A banking entity must calculate any
applicable quantitative measurement for each
trading day. A banking entity must report the
Trading Desk Information, the Quantitative
Measurements Identifying Information, and
each applicable quantitative measurement
electronically to the FDIC on the reporting
schedule established in § 351.20 unless
otherwise requested by the FDIC. A banking
entity must report the Trading Desk
Information, the Quantitative Measurements
Identifying Information, and each applicable
quantitative measurement to the FDIC in
accordance with the XML Schema specified
and published on the FDIC’s website.
f. Recordkeeping
A banking entity must, for any quantitative
measurement furnished to the FDIC pursuant
to this appendix and § 351.20(d), create and
maintain records documenting the
preparation and content of these reports, as
well as such information as is necessary to
permit the FDIC to verify the accuracy of
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62175
such reports, for a period of five years from
the end of the calendar year for which the
measurement was taken. A banking entity
must retain the Narrative Statement, the
Trading Desk Information, and the
Quantitative Measurements Identifying
Information for a period of five years from
the end of the calendar year for which the
information was reported to the FDIC.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Internal Limits and Usage
i. Description: For purposes of this
appendix, Internal Limits are the constraints
that define the amount of risk and the
positions that a trading desk is permitted to
take at a point in time, as defined by the
banking entity for a specific trading desk.
Usage represents the value of the trading
desk’s risk or positions that are accounted for
by the current activity of the desk. Internal
limits and their usage are key compliance
and risk management tools used to control
and monitor risk taking and include, but are
not limited to, the limits set out in §§ 351.4
and 351.5. A trading desk’s risk limits,
commonly including a limit on ‘‘Value-atRisk,’’ are useful in the broader context of the
trading desk’s overall activities, particularly
for the market making activities under
§ 351.4(b) and hedging activity under § 351.5.
Accordingly, the limits required under
§§ 351.4(b)(2)(iii)(C) and 351.5(b)(1)(i)(A)
must meet the applicable requirements under
§§ 351.4(b)(2)(iii)(C) and 351.5(b)(1)(i)(A) and
also must include appropriate metrics for the
trading desk limits including, at a minimum,
‘‘Value-at-Risk’’ except to the extent the
‘‘Value-at-Risk’’ metric is demonstrably
ineffective for measuring and monitoring the
risks of a trading desk based on the types of
positions traded by, and risk exposures of,
that desk.
A. A banking entity must provide the
following information for each limit reported
pursuant to this quantitative measurement:
The unique identification label for the limit
reported in the Internal Limits Information
Schedule, the limit size (distinguishing
between an upper and a lower limit), and the
value of usage of the limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
2. Value-at-Risk
i. Description: For purposes of this
appendix, Value-at-Risk (‘‘VaR’’) is the
measurement of the risk of future financial
loss in the value of a trading desk’s
aggregated positions at the ninety-nine
percent confidence level over a one-day
period, based on current market conditions.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this
appendix, Comprehensive Profit and Loss
Attribution is an analysis that attributes the
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daily fluctuation in the value of a trading
desk’s positions to various sources. First, the
daily profit and loss of the aggregated
positions is divided into two categories: (i)
Profit and loss attributable to a trading desk’s
existing positions that were also positions
held by the trading desk as of the end of the
prior day (‘‘existing positions’’); and (ii)
profit and loss attributable to new positions
resulting from the current day’s trading
activity (‘‘new positions’’).
A. The comprehensive profit and loss
associated with existing positions must
reflect changes in the value of these positions
on the applicable day. The comprehensive
profit and loss from existing positions must
be further attributed, as applicable, to (i)
changes in the specific risk factors and other
factors that are monitored and managed as
part of the trading desk’s overall risk
management policies and procedures; and (ii)
any other applicable elements, such as cash
flows, carry, changes in reserves, and the
correction, cancellation, or exercise of a
trade.
B. For the attribution of comprehensive
profit and loss from existing positions to
specific risk factors and other factors, a
banking entity must provide the following
information for the factors that explain the
preponderance of the profit or loss changes
due to risk factor changes: The unique
identification label for the risk factor or other
factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss
due to the risk factor or other factor change.
C. The comprehensive profit and loss
attributed to new positions must reflect
commissions and fee income or expense and
market gains or losses associated with
transactions executed on the applicable day.
New positions include purchases and sales of
financial instruments and other assets/
liabilities and negotiated amendments to
existing positions. The comprehensive profit
and loss from new positions may be reported
in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and
loss from existing positions that is not
attributed to changes in specific risk factors
and other factors must be allocated to a
residual category. Significant unexplained
profit and loss must be escalated for further
investigation and analysis.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
c. Positions and Transaction Volumes
Measurements
1. Positions
i. Description: For purposes of this
appendix, Positions is the value of securities
and derivatives positions managed by the
trading desk. For purposes of the Positions
quantitative measurement, do not include in
the Positions calculation for ‘‘securities’’
those securities that are also ‘‘derivatives,’’ as
those terms are defined under subpart A;
instead, report those securities that are also
derivatives as ‘‘derivatives.’’ 1225 A banking
1225 See
§ 351.2(h), (aa). For example, under this
part, a security-based swap is both a ‘‘security’’ and
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entity must separately report the trading
desk’s market value of long securities
positions, short securities positions,
derivatives receivables, and derivatives
payables.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely
on § 351.4(a) or § 351.4(b) to conduct
underwriting activity or market-makingrelated activity, respectively.
2. Transaction Volumes
i. Description: For purposes of this
appendix, Transaction Volumes measures
three exclusive categories of covered trading
activity conducted by a trading desk. A
banking entity is required to report the value
and number of security and derivative
transactions conducted by the trading desk
with: (i) Customers, excluding internal
transactions; (ii) non-customers, excluding
internal transactions; and (iii) trading desks
and other organizational units where the
transaction is booked into either the same
banking entity or an affiliated banking entity.
For securities, value means gross market
value. For derivatives, value means gross
notional value. For purposes of calculating
the Transaction Volumes quantitative
measurement, do not include in the
Transaction Volumes calculation for
‘‘securities’’ those securities that are also
‘‘derivatives,’’ as those terms are defined
under subpart A; instead, report those
securities that are also derivatives as
‘‘derivatives.’’ 1226 Further, for purposes of
the Transaction Volumes quantitative
measurement, a customer of a trading desk
that relies on § 351.4(a) to conduct
underwriting activity is a market participant
identified in § 351.4(a)(7), and a customer of
a trading desk that relies on § 351.4(b) to
conduct market making-related activity is a
market participant identified in § 351.4(b)(3).
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely
on § 351.4(a) or § 351.4(b) to conduct
underwriting activity or market-makingrelated activity, respectively.
Appendix B to Part 351 [Removed]
44. Appendix B to part 351 is
removed.
■
45. Effective January 1, 2020 until
December 31, 2020, appendix Z to part
351 is added to read as follows:
■
Appendix Z to Part 351—Proprietary
Trading and Certain Interests in and
Relationships With Covered Funds
(Alternative Compliance)
Note: The content of this appendix
reproduces the regulation implementing
Section 13 of the Bank Holding Company Act
as of November 13, 2019.
a ‘‘derivative.’’ For purposes of the Positions
quantitative measurement, security-based swaps are
reported as derivatives rather than securities.
1226 See § 351.2(h), (aa).
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Subpart A—Authority and Definitions
§ 351.1 Authority, purpose, scope, and
relationship to other authorities.
(a) Authority. This part is issued by
the FDIC under section 13 of the Bank
Holding Company Act of 1956, as
amended (12 U.S.C. 1851).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes
prohibitions and restrictions on
proprietary trading and investments in
or relationships with covered funds by
certain banking entities, including any
insured depository institution as
defined in section 3(c)(2) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)(2)) and certain subsidiaries
thereof for which the FDIC is the
appropriate Federal banking agency as
defined in section 3(q) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(q)). This part implements section
13 of the Bank Holding Company Act by
defining terms used in the statute and
related terms, establishing prohibitions
and restrictions on proprietary trading
and investments in or relationships with
covered funds, and explaining the
statute’s requirements.
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to insured
depository institutions for which the
FDIC is the appropriate Federal banking
agency, as defined in section 3(q) of the
Federal Deposit Insurance Act, and
certain subsidiaries of the foregoing, but
does not include such entities to the
extent they are not within the definition
of banking entity in § 351.2(c).
(d) Relationship to other authorities.
Except as otherwise provided in under
section 13 of the Bank Holding
Company Act, and notwithstanding any
other provision of law, the prohibitions
and restrictions under section 13 of
Bank Holding Company Act shall apply
to the activities and investments of a
banking entity, even if such activities
and investments are authorized for a
banking entity under other applicable
provisions of law.
(e) Preservation of authority. Nothing
in this part limits in any way the
authority of the FDIC to impose on a
banking entity identified in paragraph
(c) of this section additional
requirements or restrictions with respect
to any activity, investment, or
relationship covered under section 13 of
the Bank Holding Company Act or this
part, or additional penalties for
violation of this part provided under
any other applicable provision of law.
§ 351.2
Definitions.
Unless otherwise specified, for
purposes of this part:
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(a) Affiliate has the same meaning as
in section 2(k) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(k)).
(b) Bank holding company has the
same meaning as in section 2 of the
Bank Holding Company Act of 1956 (12
U.S.C. 1841).
(c) Banking entity. (1) Except as
provided in paragraph (c)(2) of this
section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an
insured depository institution;
(iii) Any company that is treated as a
bank holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any
entity described in paragraphs (c)(1)(i),
(ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a
banking entity under paragraphs
(c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under
the authority contained in section
4(k)(4)(H) or (I) of the BHC Act (12
U.S.C. 1843(k)(4)(H), (I)), or any
portfolio concern, as defined under 13
CFR 107.50, that is controlled by a small
business investment company, as
defined in section 103(3) of the Small
Business Investment Act of 1958 (15
U.S.C. 662), so long as the portfolio
company or portfolio concern is not
itself a banking entity under paragraphs
(c)(1)(i), (ii), or (iii) of this section; or
(iii) The FDIC acting in its corporate
capacity or as conservator or receiver
under the Federal Deposit Insurance Act
or Title II of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
(d) Board means the Board of
Governors of the Federal Reserve
System.
(e) CFTC means the Commodity
Futures Trading Commission.
(f) Dealer has the same meaning as in
section 3(a)(5) of the Exchange Act (15
U.S.C. 78c(a)(5)).
(g) Depository institution has the same
meaning as in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)).
(h) Derivative. (1) Except as provided
in paragraph (h)(2) of this section,
derivative means:
(i) Any swap, as that term is defined
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)), or
security-based swap, as that term is
defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68));
(ii) Any purchase or sale of a
commodity, that is not an excluded
commodity, for deferred shipment or
delivery that is intended to be
physically settled;
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(iii) Any foreign exchange forward (as
that term is defined in section 1a(24) of
the Commodity Exchange Act (7 U.S.C.
1a(24)) or foreign exchange swap (as
that term is defined in section 1a(25) of
the Commodity Exchange Act (7 U.S.C.
1a(25));
(iv) Any agreement, contract, or
transaction in foreign currency
described in section 2(c)(2)(C)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(C)(i));
(v) Any agreement, contract, or
transaction in a commodity other than
foreign currency described in section
2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under
section 19 of the Commodity Exchange
Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or
other agreement, contract, or transaction
that the CFTC and SEC have further
defined by joint regulation,
interpretation, guidance, or other action
as not within the definition of swap, as
that term is defined in section 1a(47) of
the Commodity Exchange Act (7 U.S.C.
1a(47)), or security-based swap, as that
term is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)); or
(ii) Any identified banking product, as
defined in section 402(b) of the Legal
Certainty for Bank Products Act of 2000
(7 U.S.C. 27(b)), that is subject to section
403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the
immediate family of the employee.
(j) Exchange Act means the Securities
Exchange Act of 1934 (15 U.S.C. 78a et
seq.).
(k) Excluded commodity has the same
meaning as in section 1a(19) of the
Commodity Exchange Act (7 U.S.C.
1a(19)).
(l) FDIC means the Federal Deposit
Insurance Corporation.
(m) Federal banking agencies means
the Board, the Office of the Comptroller
of the Currency, and the FDIC.
(n) Foreign banking organization has
the same meaning as in section
211.21(o) of the Board’s Regulation K
(12 CFR 211.21(o)), but does not include
a foreign bank, as defined in section
1(b)(7) of the International Banking Act
of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the
Commonwealth of Puerto Rico, Guam,
American Samoa, the United States
Virgin Islands, or the Commonwealth of
the Northern Mariana Islands.
(o) Foreign insurance regulator means
the insurance commissioner, or a
similar official or agency, of any country
other than the United States that is
engaged in the supervision of insurance
companies under foreign insurance law.
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(p) General account means all of the
assets of an insurance company except
those allocated to one or more separate
accounts.
(q) Insurance company means a
company that is organized as an
insurance company, primarily and
predominantly engaged in writing
insurance or reinsuring risks
underwritten by insurance companies,
subject to supervision as such by a state
insurance regulator or a foreign
insurance regulator, and not operated
for the purpose of evading the
provisions of section 13 of the BHC Act
(12 U.S.C. 1851).
(r) Insured depository institution,
unless otherwise indicated, has the
same meaning as in section 3(c) of the
Federal Deposit Insurance Act (12
U.S.C. 1813(c)), but does not include:
(1) An insured depository institution
that is described in section 2(c)(2)(D) of
the Bank Holding Company Act of 1956
(12 U.S.C. 1841(c)(2)(D)); or
(2) An insured depository institution
if it has, and if every company that
controls it has, total consolidated assets
of $10 billion or less and total trading
assets and trading liabilities, on a
consolidated basis, that are 5 percent or
less of total consolidated assets.
(s) Loan means any loan, lease,
extension of credit, or secured or
unsecured receivable that is not a
security or derivative.
(t) Primary financial regulatory
agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act (12 U.S.C. 5301(12)).
(u) Purchase includes any contract to
buy, purchase, or otherwise acquire. For
security futures products, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a commodity future, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a derivative, purchase
includes the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(v) Qualifying foreign banking
organization means a foreign banking
organization that qualifies as such under
section 211.23(a), (c) or (e) of the
Board’s Regulation K (12 CFR 211.23(a),
(c), or (e)).
(w) SEC means the Securities and
Exchange Commission.
(x) Sale and sell each include any
contract to sell or otherwise dispose of.
For security futures products, such
terms include any contract, agreement,
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or transaction for future delivery. With
respect to a commodity future, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a derivative, such terms
include the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(y) Security has the meaning specified
in section 3(a)(10) of the Exchange Act
(15 U.S.C. 78c(a)(10)).
(z) Security-based swap dealer has the
same meaning as in section 3(a)(71) of
the Exchange Act (15 U.S.C. 78c(a)(71)).
(aa) Security future has the meaning
specified in section 3(a)(55) of the
Exchange Act (15 U.S.C. 78c(a)(55)).
(bb) Separate account means an
account established and maintained by
an insurance company in connection
with one or more insurance contracts to
hold assets that are legally segregated
from the insurance company’s other
assets, under which income, gains, and
losses, whether or not realized, from
assets allocated to such account, are, in
accordance with the applicable contract,
credited to or charged against such
account without regard to other income,
gains, or losses of the insurance
company.
(cc) State means any State, the District
of Columbia, the Commonwealth of
Puerto Rico, Guam, American Samoa,
the United States Virgin Islands, and the
Commonwealth of the Northern Mariana
Islands.
(dd) Subsidiary has the same meaning
as in section 2(d) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(d)).
(ee) State insurance regulator means
the insurance commissioner, or a
similar official or agency, of a State that
is engaged in the supervision of
insurance companies under State
insurance law.
(ff) Swap dealer has the same meaning
as in section 1(a)(49) of the Commodity
Exchange Act (7 U.S.C. 1a(49)).
Subpart B—Proprietary Trading
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§ 351.3
Prohibition on proprietary trading.
(a) Prohibition. Except as otherwise
provided in this subpart, a banking
entity may not engage in proprietary
trading. Proprietary trading means
engaging as principal for the trading
account of the banking entity in any
purchase or sale of one or more
financial instruments.
(b) Definition of trading account. (1)
Trading account means any account that
is used by a banking entity to:
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(i) Purchase or sell one or more
financial instruments principally for the
purpose of:
(A) Short-term resale;
(B) Benefitting from actual or
expected short-term price movements;
(C) Realizing short-term arbitrage
profits; or
(D) Hedging one or more positions
resulting from the purchases or sales of
financial instruments described in
paragraphs (b)(1)(i)(A), (B), or (C) of this
section;
(ii) Purchase or sell one or more
financial instruments that are both
market risk capital rule covered
positions and trading positions (or
hedges of other market risk capital rule
covered positions), if the banking entity,
or any affiliate of the banking entity, is
an insured depository institution, bank
holding company, or savings and loan
holding company, and calculates riskbased capital ratios under the market
risk capital rule; or
(iii) Purchase or sell one or more
financial instruments for any purpose, if
the banking entity:
(A) Is licensed or registered, or is
required to be licensed or registered, to
engage in the business of a dealer, swap
dealer, or security-based swap dealer, to
the extent the instrument is purchased
or sold in connection with the activities
that require the banking entity to be
licensed or registered as such; or
(B) Is engaged in the business of a
dealer, swap dealer, or security-based
swap dealer outside of the United
States, to the extent the instrument is
purchased or sold in connection with
the activities of such business.
(2) Rebuttable presumption for certain
purchases and sales. The purchase (or
sale) of a financial instrument by a
banking entity shall be presumed to be
for the trading account of the banking
entity under paragraph (b)(1)(i) of this
section if the banking entity holds the
financial instrument for fewer than sixty
days or substantially transfers the risk of
the financial instrument within sixty
days of the purchase (or sale), unless the
banking entity can demonstrate, based
on all relevant facts and circumstances,
that the banking entity did not purchase
(or sell) the financial instrument
principally for any of the purposes
described in paragraph (b)(1)(i) of this
section.
(c) Financial instrument. (1) Financial
instrument means:
(i) A security, including an option on
a security;
(ii) A derivative, including an option
on a derivative; or
(iii) A contract of sale of a commodity
for future delivery, or option on a
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contract of sale of a commodity for
future delivery.
(2) A financial instrument does not
include:
(i) A loan;
(ii) A commodity that is not:
(A) An excluded commodity (other
than foreign exchange or currency);
(B) A derivative;
(C) A contract of sale of a commodity
for future delivery; or
(D) An option on a contract of sale of
a commodity for future delivery; or
(iii) Foreign exchange or currency.
(d) Proprietary trading. Proprietary
trading does not include:
(1) Any purchase or sale of one or
more financial instruments by a banking
entity that arises under a repurchase or
reverse repurchase agreement pursuant
to which the banking entity has
simultaneously agreed, in writing, to
both purchase and sell a stated asset, at
stated prices, and on stated dates or on
demand with the same counterparty;
(2) Any purchase or sale of one or
more financial instruments by a banking
entity that arises under a transaction in
which the banking entity lends or
borrows a security temporarily to or
from another party pursuant to a written
securities lending agreement under
which the lender retains the economic
interests of an owner of such security,
and has the right to terminate the
transaction and to recall the loaned
security on terms agreed by the parties;
(3) Any purchase or sale of a security
by a banking entity for the purpose of
liquidity management in accordance
with a documented liquidity
management plan of the banking entity
that:
(i) Specifically contemplates and
authorizes the particular securities to be
used for liquidity management
purposes, the amount, types, and risks
of these securities that are consistent
with liquidity management, and the
liquidity circumstances in which the
particular securities may or must be
used;
(ii) Requires that any purchase or sale
of securities contemplated and
authorized by the plan be principally for
the purpose of managing the liquidity of
the banking entity, and not for the
purpose of short-term resale, benefitting
from actual or expected short-term price
movements, realizing short-term
arbitrage profits, or hedging a position
taken for such short-term purposes;
(iii) Requires that any securities
purchased or sold for liquidity
management purposes be highly liquid
and limited to securities the market,
credit, and other risks of which the
banking entity does not reasonably
expect to give rise to appreciable profits
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or losses as a result of short-term price
movements;
(iv) Limits any securities purchased or
sold for liquidity management purposes,
together with any other instruments
purchased or sold for such purposes, to
an amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan;
(v) Includes written policies and
procedures, internal controls, analysis,
and independent testing to ensure that
the purchase and sale of securities that
are not permitted under §§ 351.6(a) or
(b) of this subpart are for the purpose of
liquidity management and in
accordance with the liquidity
management plan described in
paragraph (d)(3) of this section; and
(vi) Is consistent with the FDIC’s
supervisory requirements, guidance,
and expectations regarding liquidity
management;
(4) Any purchase or sale of one or
more financial instruments by a banking
entity that is a derivatives clearing
organization or a clearing agency in
connection with clearing financial
instruments;
(5) Any excluded clearing activities
by a banking entity that is a member of
a clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility;
(6) Any purchase or sale of one or
more financial instruments by a banking
entity, so long as:
(i) The purchase (or sale) satisfies an
existing delivery obligation of the
banking entity or its customers,
including to prevent or close out a
failure to deliver, in connection with
delivery, clearing, or settlement activity;
or
(ii) The purchase (or sale) satisfies an
obligation of the banking entity in
connection with a judicial,
administrative, self-regulatory
organization, or arbitration proceeding;
(7) Any purchase or sale of one or
more financial instruments by a banking
entity that is acting solely as agent,
broker, or custodian;
(8) Any purchase or sale of one or
more financial instruments by a banking
entity through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity that is
established and administered in
accordance with the law of the United
States or a foreign sovereign, if the
purchase or sale is made directly or
indirectly by the banking entity as
trustee for the benefit of persons who
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are or were employees of the banking
entity; or
(9) Any purchase or sale of one or
more financial instruments by a banking
entity in the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the financial instrument
as soon as practicable, and in no event
may the banking entity retain such
instrument for longer than such period
permitted by the FDIC.
(e) Definition of other terms related to
proprietary trading. For purposes of this
subpart:
(1) Anonymous means that each party
to a purchase or sale is unaware of the
identity of the other party(ies) to the
purchase or sale.
(2) Clearing agency has the same
meaning as in section 3(a)(23) of the
Exchange Act (15 U.S.C. 78c(a)(23)).
(3) Commodity has the same meaning
as in section 1a(9) of the Commodity
Exchange Act (7 U.S.C. 1a(9)), except
that a commodity does not include any
security;
(4) Contract of sale of a commodity
for future delivery means a contract of
sale (as that term is defined in section
1a(13) of the Commodity Exchange Act
(7 U.S.C. 1a(13)) for future delivery (as
that term is defined in section 1a(27) of
the Commodity Exchange Act (7 U.S.C.
1a(27))).
(5) Derivatives clearing organization
means:
(i) A derivatives clearing organization
registered under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1);
(ii) A derivatives clearing organization
that, pursuant to CFTC regulation, is
exempt from the registration
requirements under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1); or
(iii) A foreign derivatives clearing
organization that, pursuant to CFTC
regulation, is permitted to clear for a
foreign board of trade that is registered
with the CFTC.
(6) Exchange, unless the context
otherwise requires, means any
designated contract market, swap
execution facility, or foreign board of
trade registered with the CFTC, or, for
purposes of securities or security-based
swaps, an exchange, as defined under
section 3(a)(1) of the Exchange Act (15
U.S.C. 78c(a)(1)), or security-based swap
execution facility, as defined under
section 3(a)(77) of the Exchange Act (15
U.S.C. 78c(a)(77)).
(7) Excluded clearing activities means:
(i) With respect to customer
transactions cleared on a derivatives
clearing organization, a clearing agency,
or a designated financial market utility,
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any purchase or sale necessary to
correct trading errors made by or on
behalf of a customer provided that such
purchase or sale is conducted in
accordance with, for transactions
cleared on a derivatives clearing
organization, the Commodity Exchange
Act, CFTC regulations, and the rules or
procedures of the derivatives clearing
organization, or, for transactions cleared
on a clearing agency, the rules or
procedures of the clearing agency, or,
for transactions cleared on a designated
financial market utility that is neither a
derivatives clearing organization nor a
clearing agency, the rules or procedures
of the designated financial market
utility;
(ii) Any purchase or sale in
connection with and related to the
management of a default or threatened
imminent default of a customer
provided that such purchase or sale is
conducted in accordance with, for
transactions cleared on a derivatives
clearing organization, the Commodity
Exchange Act, CFTC regulations, and
the rules or procedures of the
derivatives clearing organization, or, for
transactions cleared on a clearing
agency, the rules or procedures of the
clearing agency, or, for transactions
cleared on a designated financial market
utility that is neither a derivatives
clearing organization nor a clearing
agency, the rules or procedures of the
designated financial market utility;
(iii) Any purchase or sale in
connection with and related to the
management of a default or threatened
imminent default of a member of a
clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility;
(iv) Any purchase or sale in
connection with and related to the
management of the default or threatened
default of a clearing agency, a
derivatives clearing organization, or a
designated financial market utility; and
(v) Any purchase or sale that is
required by the rules or procedures of a
clearing agency, a derivatives clearing
organization, or a designated financial
market utility to mitigate the risk to the
clearing agency, derivatives clearing
organization, or designated financial
market utility that would result from the
clearing by a member of security-based
swaps that reference the member or an
affiliate of the member.
(8) Designated financial market utility
has the same meaning as in section
803(4) of the Dodd-Frank Act (12 U.S.C.
5462(4)).
(9) Issuer has the same meaning as in
section 2(a)(4) of the Securities Act of
1933 (15 U.S.C. 77b(a)(4)).
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(10) Market risk capital rule covered
position and trading position means a
financial instrument that is both a
covered position and a trading position,
as those terms are respectively defined:
(i) In the case of a banking entity that
is a bank holding company, savings and
loan holding company, or insured
depository institution, under the market
risk capital rule that is applicable to the
banking entity; and
(ii) In the case of a banking entity that
is affiliated with a bank holding
company or savings and loan holding
company, other than a banking entity to
which a market risk capital rule is
applicable, under the market risk capital
rule that is applicable to the affiliated
bank holding company or savings and
loan holding company.
(11) Market risk capital rule means
the market risk capital rule that is
contained in subpart F of 12 CFR part
3, 12 CFR parts 208 and 225, or 12 CFR
part 324, as applicable.
(12) Municipal security means a
security that is a direct obligation of or
issued by, or an obligation guaranteed as
to principal or interest by, a State or any
political subdivision thereof, or any
agency or instrumentality of a State or
any political subdivision thereof, or any
municipal corporate instrumentality of
one or more States or political
subdivisions thereof.
(13) Trading desk means the smallest
discrete unit of organization of a
banking entity that purchases or sells
financial instruments for the trading
account of the banking entity or an
affiliate thereof.
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§ 351.4 Permitted underwriting and market
making-related activities.
(a) Underwriting activities—(1)
Permitted underwriting activities. The
prohibition contained in § 351.3(a) does
not apply to a banking entity’s
underwriting activities conducted in
accordance with this paragraph (a).
(2) Requirements. The underwriting
activities of a banking entity are
permitted under paragraph (a)(1) of this
section only if:
(i) The banking entity is acting as an
underwriter for a distribution of
securities and the trading desk’s
underwriting position is related to such
distribution;
(ii) The amount and type of the
securities in the trading desk’s
underwriting position are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, and reasonable efforts
are made to sell or otherwise reduce the
underwriting position within a
reasonable period, taking into account
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the liquidity, maturity, and depth of the
market for the relevant type of security;
(iii) The banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (a)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The products, instruments or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
(B) Limits for each trading desk, based
on the nature and amount of the trading
desk’s underwriting activities, including
the reasonably expected near term
demands of clients, customers, or
counterparties, on the:
(1) Amount, types, and risk of its
underwriting position;
(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held;
(C) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
(D) Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
(iv) The compensation arrangements
of persons performing the activities
described in this paragraph (a) are
designed not to reward or incentivize
prohibited proprietary trading; and
(v) The banking entity is licensed or
registered to engage in the activity
described in this paragraph (a) in
accordance with applicable law.
(3) Definition of distribution. For
purposes of this paragraph (a), a
distribution of securities means:
(i) An offering of securities, whether
or not subject to registration under the
Securities Act of 1933, that is
distinguished from ordinary trading
transactions by the presence of special
selling efforts and selling methods; or
(ii) An offering of securities made
pursuant to an effective registration
statement under the Securities Act of
1933.
(4) Definition of underwriter. For
purposes of this paragraph (a),
underwriter means:
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(i) A person who has agreed with an
issuer or selling security holder to:
(A) Purchase securities from the
issuer or selling security holder for
distribution;
(B) Engage in a distribution of
securities for or on behalf of the issuer
or selling security holder; or
(C) Manage a distribution of securities
for or on behalf of the issuer or selling
security holder; or
(ii) A person who has agreed to
participate or is participating in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.
(5) Definition of selling security
holder. For purposes of this paragraph
(a), selling security holder means any
person, other than an issuer, on whose
behalf a distribution is made.
(6) Definition of underwriting
position. For purposes of this paragraph
(a), underwriting position means the
long or short positions in one or more
securities held by a banking entity or its
affiliate, and managed by a particular
trading desk, in connection with a
particular distribution of securities for
which such banking entity or affiliate is
acting as an underwriter.
(7) Definition of client, customer, and
counterparty. For purposes of this
paragraph (a), the terms client,
customer, and counterparty, on a
collective or individual basis, refer to
market participants that may transact
with the banking entity in connection
with a particular distribution for which
the banking entity is acting as
underwriter.
(b) Market making-related activities—
(1) Permitted market making-related
activities. The prohibition contained in
§ 351.3(a) does not apply to a banking
entity’s market making-related activities
conducted in accordance with this
paragraph (b).
(2) Requirements. The market makingrelated activities of a banking entity are
permitted under paragraph (b)(1) of this
section only if:
(i) The trading desk that establishes
and manages the financial exposure
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure and is willing and available to
quote, purchase and sell, or otherwise
enter into long and short positions in
those types of financial instruments for
its own account, in commercially
reasonable amounts and throughout
market cycles on a basis appropriate for
the liquidity, maturity, and depth of the
market for the relevant types of financial
instruments;
(ii) The amount, types, and risks of
the financial instruments in the trading
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desk’s market-maker inventory are
designed not to exceed, on an ongoing
basis, the reasonably expected near term
demands of clients, customers, or
counterparties, based on:
(A) The liquidity, maturity, and depth
of the market for the relevant types of
financial instrument(s); and
(B) Demonstrable analysis of
historical customer demand, current
inventory of financial instruments, and
market and other factors regarding the
amount, types, and risks, of or
associated with financial instruments in
which the trading desk makes a market,
including through block trades;
(iii) The banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (b)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The financial instruments each
trading desk stands ready to purchase
and sell in accordance with paragraph
(b)(2)(i) of this section;
(B) The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the limits
required under paragraph (b)(2)(iii)(C) of
this section; the products, instruments,
and exposures each trading desk may
use for risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and
inventory; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
desk to mitigate these risks are and
continue to be effective;
(C) Limits for each trading desk, based
on the nature and amount of the trading
desk’s market making-related activities,
that address the factors prescribed by
paragraph (b)(2)(ii) of this section, on:
(1) The amount, types, and risks of its
market-maker inventory;
(2) The amount, types, and risks of the
products, instruments, and exposures
the trading desk may use for risk
management purposes;
(3) The level of exposures to relevant
risk factors arising from its financial
exposure; and
(4) The period of time a financial
instrument may be held;
(D) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
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(E) Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis that the
basis for any temporary or permanent
increase to a trading desk’s limit(s) is
consistent with the requirements of this
paragraph (b), and independent review
of such demonstrable analysis and
approval;
(iv) To the extent that any limit
identified pursuant to paragraph
(b)(2)(iii)(C) of this section is exceeded,
the trading desk takes action to bring the
trading desk into compliance with the
limits as promptly as possible after the
limit is exceeded;
(v) The compensation arrangements of
persons performing the activities
described in this paragraph (b) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in activity
described in this paragraph (b) in
accordance with applicable law.
(3) Definition of client, customer, and
counterparty. For purposes of paragraph
(b) of this section, the terms client,
customer, and counterparty, on a
collective or individual basis refer to
market participants that make use of the
banking entity’s market making-related
services by obtaining such services,
responding to quotations, or entering
into a continuing relationship with
respect to such services, provided that:
(i) A trading desk or other
organizational unit of another banking
entity is not a client, customer, or
counterparty of the trading desk if that
other entity has trading assets and
liabilities of $50 billion or more as
measured in accordance with
§ 351.20(d)(1) of subpart D, unless:
(A) The trading desk documents how
and why a particular trading desk or
other organizational unit of the entity
should be treated as a client, customer,
or counterparty of the trading desk for
purposes of paragraph (b)(2) of this
section; or
(B) The purchase or sale by the
trading desk is conducted anonymously
on an exchange or similar trading
facility that permits trading on behalf of
a broad range of market participants.
(4) Definition of financial exposure.
For purposes of this paragraph (b),
financial exposure means the aggregate
risks of one or more financial
instruments and any associated loans,
commodities, or foreign exchange or
currency, held by a banking entity or its
affiliate and managed by a particular
trading desk as part of the trading desk’s
market making-related activities.
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(5) Definition of market-maker
inventory. For the purposes of this
paragraph (b), market-maker inventory
means all of the positions in the
financial instruments for which the
trading desk stands ready to make a
market in accordance with paragraph
(b)(2)(i) of this section, that are managed
by the trading desk, including the
trading desk’s open positions or
exposures arising from open
transactions.
§ 351.5 Permitted risk-mitigating hedging
activities.
(a) Permitted risk-mitigating hedging
activities. The prohibition contained in
§ 351.3(a) does not apply to the riskmitigating hedging activities of a
banking entity in connection with and
related to individual or aggregated
positions, contracts, or other holdings of
the banking entity and designed to
reduce the specific risks to the banking
entity in connection with and related to
such positions, contracts, or other
holdings.
(b) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under paragraph (a) of this
section only if:
(1) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(i) Reasonably designed written
policies and procedures regarding the
positions, techniques and strategies that
may be used for hedging, including
documentation indicating what
positions, contracts or other holdings a
particular trading desk may use in its
risk-mitigating hedging activities, as
well as position and aging limits with
respect to such positions, contracts or
other holdings;
(ii) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(iii) The conduct of analysis,
including correlation analysis, and
independent testing designed to ensure
that the positions, techniques and
strategies that may be used for hedging
may reasonably be expected to
demonstrably reduce or otherwise
significantly mitigate the specific,
identifiable risk(s) being hedged, and
such correlation analysis demonstrates
that the hedging activity demonstrably
reduces or otherwise significantly
mitigates the specific, identifiable risk(s)
being hedged;
(2) The risk-mitigating hedging
activity:
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(i) Is conducted in accordance with
the written policies, procedures, and
internal controls required under this
section;
(ii) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks, including market risk,
counterparty or other credit risk,
currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof;
(iii) Does not give rise, at the
inception of the hedge, to any
significant new or additional risk that is
not itself hedged contemporaneously in
accordance with this section;
(iv) Is subject to continuing review,
monitoring and management by the
banking entity that:
(A) Is consistent with the written
hedging policies and procedures
required under paragraph (b)(1) of this
section;
(B) Is designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates the specific, identifiable risks
that develop over time from the riskmitigating hedging activities undertaken
under this section and the underlying
positions, contracts, and other holdings
of the banking entity, based upon the
facts and circumstances of the
underlying and hedging positions,
contracts and other holdings of the
banking entity and the risks and
liquidity thereof; and
(C) Requires ongoing recalibration of
the hedging activity by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(2) of this section and is
not prohibited proprietary trading; and
(3) The compensation arrangements of
persons performing risk-mitigating
hedging activities are designed not to
reward or incentivize prohibited
proprietary trading.
(c) Documentation requirement—(1) A
banking entity must comply with the
requirements of paragraphs (c)(2) and
(3) of this section with respect to any
purchase or sale of financial
instruments made in reliance on this
section for risk-mitigating hedging
purposes that is:
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(i) Not established by the specific
trading desk establishing or responsible
for the underlying positions, contracts,
or other holdings the risks of which the
hedging activity is designed to reduce;
(ii) Established by the specific trading
desk establishing or responsible for the
underlying positions, contracts, or other
holdings the risks of which the
purchases or sales are designed to
reduce, but that is effected through a
financial instrument, exposure,
technique, or strategy that is not
specifically identified in the trading
desk’s written policies and procedures
established under paragraph (b)(1) of
this section or under § 351.4(b)(2)(iii)(B)
of this subpart as a product, instrument,
exposure, technique, or strategy such
trading desk may use for hedging; or
(iii) Established to hedge aggregated
positions across two or more trading
desks.
(2) In connection with any purchase
or sale identified in paragraph (c)(1) of
this section, a banking entity must, at a
minimum, and contemporaneously with
the purchase or sale, document:
(i) The specific, identifiable risk(s) of
the identified positions, contracts, or
other holdings of the banking entity that
the purchase or sale is designed to
reduce;
(ii) The specific risk-mitigating
strategy that the purchase or sale is
designed to fulfill; and
(iii) The trading desk or other
business unit that is establishing and
responsible for the hedge.
(3) A banking entity must create and
retain records sufficient to demonstrate
compliance with the requirements of
this paragraph (c) for a period that is no
less than five years in a form that allows
the banking entity to promptly produce
such records to the FDIC on request, or
such longer period as required under
other law or this part.
§ 351.6 Other permitted proprietary trading
activities.
(a) Permitted trading in domestic
government obligations. The prohibition
contained in § 351.3(a) does not apply to
the purchase or sale by a banking entity
of a financial instrument that is:
(1) An obligation of, or issued or
guaranteed by, the United States;
(2) An obligation, participation, or
other instrument of, or issued or
guaranteed by, an agency of the United
States, the Government National
Mortgage Association, the Federal
National Mortgage Association, the
Federal Home Loan Mortgage
Corporation, a Federal Home Loan
Bank, the Federal Agricultural Mortgage
Corporation or a Farm Credit System
institution chartered under and subject
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to the provisions of the Farm Credit Act
of 1971 (12 U.S.C. 2001 et seq.);
(3) An obligation of any State or any
political subdivision thereof, including
any municipal security; or
(4) An obligation of the FDIC, or any
entity formed by or on behalf of the
FDIC for purpose of facilitating the
disposal of assets acquired or held by
the FDIC in its corporate capacity or as
conservator or receiver under the
Federal Deposit Insurance Act or Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
(b) Permitted trading in foreign
government obligations—(1) Affiliates of
foreign banking entities in the United
States. The prohibition contained in
§ 351.3(a) does not apply to the
purchase or sale of a financial
instrument that is an obligation of, or
issued or guaranteed by, a foreign
sovereign (including any multinational
central bank of which the foreign
sovereign is a member), or any agency
or political subdivision of such foreign
sovereign, by a banking entity, so long
as:
(i) The banking entity is organized
under or is directly or indirectly
controlled by a banking entity that is
organized under the laws of a foreign
sovereign and is not directly or
indirectly controlled by a top-tier
banking entity that is organized under
the laws of the United States;
(ii) The financial instrument is an
obligation of, or issued or guaranteed
by, the foreign sovereign under the laws
of which the foreign banking entity
referred to in paragraph (b)(1)(i) of this
section is organized (including any
multinational central bank of which the
foreign sovereign is a member), or any
agency or political subdivision of that
foreign sovereign; and
(iii) The purchase or sale as principal
is not made by an insured depository
institution.
(2) Foreign affiliates of a U.S. banking
entity. The prohibition contained in
§ 351.3(a) does not apply to the
purchase or sale of a financial
instrument that is an obligation of, or
issued or guaranteed by, a foreign
sovereign (including any multinational
central bank of which the foreign
sovereign is a member), or any agency
or political subdivision of that foreign
sovereign, by a foreign entity that is
owned or controlled by a banking entity
organized or established under the laws
of the United States or any State, so long
as:
(i) The foreign entity is a foreign bank,
as defined in section 211.2(j) of the
Board’s Regulation K (12 CFR 211.2(j)),
or is regulated by the foreign sovereign
as a securities dealer;
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(ii) The financial instrument is an
obligation of, or issued or guaranteed
by, the foreign sovereign under the laws
of which the foreign entity is organized
(including any multinational central
bank of which the foreign sovereign is
a member), or any agency or political
subdivision of that foreign sovereign;
and
(iii) The financial instrument is
owned by the foreign entity and is not
financed by an affiliate that is located in
the United States or organized under the
laws of the United States or of any State.
(c) Permitted trading on behalf of
customers—(1) Fiduciary transactions.
The prohibition contained in § 351.3(a)
does not apply to the purchase or sale
of financial instruments by a banking
entity acting as trustee or in a similar
fiduciary capacity, so long as:
(i) The transaction is conducted for
the account of, or on behalf of, a
customer; and
(ii) The banking entity does not have
or retain beneficial ownership of the
financial instruments.
(2) Riskless principal transactions.
The prohibition contained in § 351.3(a)
does not apply to the purchase or sale
of financial instruments by a banking
entity acting as riskless principal in a
transaction in which the banking entity,
after receiving an order to purchase (or
sell) a financial instrument from a
customer, purchases (or sells) the
financial instrument for its own account
to offset a contemporaneous sale to (or
purchase from) the customer.
(d) Permitted trading by a regulated
insurance company. The prohibition
contained in § 351.3(a) does not apply to
the purchase or sale of financial
instruments by a banking entity that is
an insurance company or an affiliate of
an insurance company if:
(1) The insurance company or its
affiliate purchases or sells the financial
instruments solely for:
(i) The general account of the
insurance company; or
(ii) A separate account established by
the insurance company;
(2) The purchase or sale is conducted
in compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (d)(2) of this
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section is insufficient to protect the
safety and soundness of the covered
banking entity, or the financial stability
of the United States.
(e) Permitted trading activities of
foreign banking entities. (1) The
prohibition contained in § 351.3(a) does
not apply to the purchase or sale of
financial instruments by a banking
entity if:
(i) The banking entity is not organized
or directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of any
State;
(ii) The purchase or sale by the
banking entity is made pursuant to
paragraph (9) or (13) of section 4(c) of
the BHC Act; and
(iii) The purchase or sale meets the
requirements of paragraph (e)(3) of this
section.
(2) A purchase or sale of financial
instruments by a banking entity is made
pursuant to paragraph (9) or (13) of
section 4(c) of the BHC Act for purposes
of paragraph (e)(1)(ii) of this section
only if:
(i) The purchase or sale is conducted
in accordance with the requirements of
paragraph (e) of this section; and
(ii)(A) With respect to a banking
entity that is a foreign banking
organization, the banking entity meets
the qualifying foreign banking
organization requirements of section
211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c) or
(e)), as applicable; or
(B) With respect to a banking entity
that is not a foreign banking
organization, the banking entity is not
organized under the laws of the United
States or of any State and the banking
entity, on a fully-consolidated basis,
meets at least two of the following
requirements:
(1) Total assets of the banking entity
held outside of the United States exceed
total assets of the banking entity held in
the United States;
(2) Total revenues derived from the
business of the banking entity outside of
the United States exceed total revenues
derived from the business of the
banking entity in the United States; or
(3) Total net income derived from the
business of the banking entity outside of
the United States exceeds total net
income derived from the business of the
banking entity in the United States.
(3) A purchase or sale by a banking
entity is permitted for purposes of this
paragraph (e) if:
(i) The banking entity engaging as
principal in the purchase or sale
(including any personnel of the banking
entity or its affiliate that arrange,
negotiate or execute such purchase or
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62183
sale) is not located in the United States
or organized under the laws of the
United States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State;
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State;
(iv) No financing for the banking
entity’s purchases or sales is provided,
directly or indirectly, by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
(v) The purchase or sale is not
conducted with or through any U.S.
entity, other than:
(A) A purchase or sale with the
foreign operations of a U.S. entity if no
personnel of such U.S. entity that are
located in the United States are
involved in the arrangement,
negotiation, or execution of such
purchase or sale;
(B) A purchase or sale with an
unaffiliated market intermediary acting
as principal, provided the purchase or
sale is promptly cleared and settled
through a clearing agency or derivatives
clearing organization acting as a central
counterparty; or
(C) A purchase or sale through an
unaffiliated market intermediary acting
as agent, provided the purchase or sale
is conducted anonymously on an
exchange or similar trading facility and
is promptly cleared and settled through
a clearing agency or derivatives clearing
organization acting as a central
counterparty.
(4) For purposes of this paragraph (e),
a U.S. entity is any entity that is, or is
controlled by, or is acting on behalf of,
or at the direction of, any other entity
that is, located in the United States or
organized under the laws of the United
States or of any State.
(5) For purposes of this paragraph (e),
a U.S. branch, agency, or subsidiary of
a foreign banking entity is considered to
be located in the United States;
however, the foreign bank that operates
or controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(6) For purposes of this paragraph (e),
unaffiliated market intermediary means
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an unaffiliated entity, acting as an
intermediary, that is:
(i) A broker or dealer registered with
the SEC under section 15 of the
Exchange Act or exempt from
registration or excluded from regulation
as such;
(ii) A swap dealer registered with the
CFTC under section 4s of the
Commodity Exchange Act or exempt
from registration or excluded from
regulation as such;
(iii) A security-based swap dealer
registered with the SEC under section
15F of the Exchange Act or exempt from
registration or excluded from regulation
as such; or
(iv) A futures commission merchant
registered with the CFTC under section
4f of the Commodity Exchange Act or
exempt from registration or excluded
from regulation as such.
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§ 351.7 Limitations on permitted
proprietary trading activities.
(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ 351.4 through
351.6 if the transaction, class of
transactions, or activity would:
(1) Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
(2) Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
(3) Pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.
(b) Definition of material conflict of
interest. (1) For purposes of this section,
a material conflict of interest between a
banking entity and its clients,
customers, or counterparties exists if the
banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the banking entity’s interests being
materially adverse to the interests of its
client, customer, or counterparty with
respect to such transaction, class of
transactions, or activity, and the
banking entity has not taken at least one
of the actions in paragraph (b)(2) of this
section.
(2) Prior to effecting the specific
transaction or class or type of
transactions, or engaging in the specific
activity, the banking entity:
(i) Timely and effective disclosure. (A)
Has made clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
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counterparty to meaningfully
understand the conflict of interest; and
(B) Such disclosure is made in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
mitigate, any materially adverse effect
on the client, customer, or counterparty
created by the conflict of interest; or
(ii) Information barriers. Has
established, maintained, and enforced
information barriers that are
memorialized in written policies and
procedures, such as physical separation
of personnel, or functions, or limitations
on types of activity, that are reasonably
designed, taking into consideration the
nature of the banking entity’s business,
to prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A banking entity may not
rely on such information barriers if, in
the case of any specific transaction,
class or type of transactions or activity,
the banking entity knows or should
reasonably know that, notwithstanding
the banking entity’s establishment of
information barriers, the conflict of
interest may involve or result in a
materially adverse effect on a client,
customer, or counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
§§ 351.8–351.9
[Reserved]
Subpart C—Covered Funds Activities
and Investments
§ 351.10 Prohibition on acquiring or
retaining an ownership interest in and
having certain relationships with a covered
fund.
(a) Prohibition. (1) Except as
otherwise provided in this subpart, a
banking entity may not, as principal,
directly or indirectly, acquire or retain
any ownership interest in or sponsor a
covered fund.
(2) Paragraph (a)(1) of this section
does not include acquiring or retaining
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an ownership interest in a covered fund
by a banking entity:
(i) Acting solely as agent, broker, or
custodian, so long as;
(A) The activity is conducted for the
account of, or on behalf of, a customer;
and
(B) The banking entity and its
affiliates do not have or retain beneficial
ownership of such ownership interest;
(ii) Through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity (or an affiliate
thereof) that is established and
administered in accordance with the
law of the United States or a foreign
sovereign, if the ownership interest is
held or controlled directly or indirectly
by the banking entity as trustee for the
benefit of persons who are or were
employees of the banking entity (or an
affiliate thereof);
(iii) In the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the ownership interest as
soon as practicable, and in no event may
the banking entity retain such
ownership interest for longer than such
period permitted by the FDIC; or
(iv) On behalf of customers as trustee
or in a similar fiduciary capacity for a
customer that is not a covered fund, so
long as:
(A) The activity is conducted for the
account of, or on behalf of, the
customer; and
(B) The banking entity and its
affiliates do not have or retain beneficial
ownership of such ownership interest.
(b) Definition of covered fund. (1)
Except as provided in paragraph (c) of
this section, covered fund means:
(i) An issuer that would be an
investment company, as defined in the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.), but for section
3(c)(1) or 3(c)(7) of that Act (15 U.S.C.
80a–3(c)(1) or (7));
(ii) Any commodity pool under
section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10)) for
which:
(A) The commodity pool operator has
claimed an exemption under 17 CFR
4.7; or
(B)(1) A commodity pool operator is
registered with the CFTC as a
commodity pool operator in connection
with the operation of the commodity
pool;
(2) Substantially all participation
units of the commodity pool are owned
by qualified eligible persons under 17
CFR 4.7(a)(2) and (3); and
(3) Participation units of the
commodity pool have not been publicly
offered to persons who are not qualified
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eligible persons under 17 CFR 4.7(a)(2)
and (3); or
(iii) For any banking entity that is, or
is controlled directly or indirectly by a
banking entity that is, located in or
organized under the laws of the United
States or of any State, an entity that:
(A) Is organized or established outside
the United States and the ownership
interests of which are offered and sold
solely outside the United States;
(B) Is, or holds itself out as being, an
entity or arrangement that raises money
from investors primarily for the purpose
of investing in securities for resale or
other disposition or otherwise trading in
securities; and
(C)(1) Has as its sponsor that banking
entity (or an affiliate thereof); or
(2) Has issued an ownership interest
that is owned directly or indirectly by
that banking entity (or an affiliate
thereof).
(2) An issuer shall not be deemed to
be a covered fund under paragraph
(b)(1)(iii) of this section if, were the
issuer subject to U.S. securities laws, the
issuer could rely on an exclusion or
exemption from the definition of
‘‘investment company’’ under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) other than the
exclusions contained in section 3(c)(1)
and 3(c)(7) of that Act.
(3) For purposes of paragraph
(b)(1)(iii) of this section, a U.S. branch,
agency, or subsidiary of a foreign
banking entity is located in the United
States; however, the foreign bank that
operates or controls that branch, agency,
or subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(c) Notwithstanding paragraph (b) of
this section, unless the appropriate
Federal banking agencies, the SEC, and
the CFTC jointly determine otherwise, a
covered fund does not include:
(1) Foreign public funds. (i) Subject to
paragraphs (ii) and (iii) below, an issuer
that:
(A) Is organized or established outside
of the United States;
(B) Is authorized to offer and sell
ownership interests to retail investors in
the issuer’s home jurisdiction; and
(C) Sells ownership interests
predominantly through one or more
public offerings outside of the United
States.
(ii) With respect to a banking entity
that is, or is controlled directly or
indirectly by a banking entity that is,
located in or organized under the laws
of the United States or of any State and
any issuer for which such banking
entity acts as sponsor, the sponsoring
banking entity may not rely on the
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exemption in paragraph (c)(1)(i) of this
section for such issuer unless ownership
interests in the issuer are sold
predominantly to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring
banking entity or such issuer; and
(D) Directors and employees of such
entities.
(iii) For purposes of paragraph
(c)(1)(i)(C) of this section, the term
‘‘public offering’’ means a distribution
(as defined in § 351.4(a)(3) of subpart B)
of securities in any jurisdiction outside
the United States to investors, including
retail investors, provided that:
(A) The distribution complies with all
applicable requirements in the
jurisdiction in which such distribution
is being made;
(B) The distribution does not restrict
availability to investors having a
minimum level of net worth or net
investment assets; and
(C) The issuer has filed or submitted,
with the appropriate regulatory
authority in such jurisdiction, offering
disclosure documents that are publicly
available.
(2) Wholly-owned subsidiaries. An
entity, all of the outstanding ownership
interests of which are owned directly or
indirectly by the banking entity (or an
affiliate thereof), except that:
(i) Up to five percent of the entity’s
outstanding ownership interests, less
any amounts outstanding under
paragraph (c)(2)(ii) of this section, may
be held by employees or directors of the
banking entity or such affiliate
(including former employees or
directors if their ownership interest was
acquired while employed by or in the
service of the banking entity); and
(ii) Up to 0.5 percent of the entity’s
outstanding ownership interests may be
held by a third party if the ownership
interest is acquired or retained by the
third party for the purpose of
establishing corporate separateness or
addressing bankruptcy, insolvency, or
similar concerns.
(3) Joint ventures. A joint venture
between a banking entity or any of its
affiliates and one or more unaffiliated
persons, provided that the joint venture:
(i) Is comprised of no more than 10
unaffiliated co-venturers;
(ii) Is in the business of engaging in
activities that are permissible for the
banking entity or affiliate, other than
investing in securities for resale or other
disposition; and
(iii) Is not, and does not hold itself out
as being, an entity or arrangement that
raises money from investors primarily
for the purpose of investing in securities
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62185
for resale or other disposition or
otherwise trading in securities.
(4) Acquisition vehicles. An issuer:
(i) Formed solely for the purpose of
engaging in a bona fide merger or
acquisition transaction; and
(ii) That exists only for such period as
necessary to effectuate the transaction.
(5) Foreign pension or retirement
funds. A plan, fund, or program
providing pension, retirement, or
similar benefits that is:
(i) Organized and administered
outside the United States;
(ii) A broad-based plan for employees
or citizens that is subject to regulation
as a pension, retirement, or similar plan
under the laws of the jurisdiction in
which the plan, fund, or program is
organized and administered; and
(iii) Established for the benefit of
citizens or residents of one or more
foreign sovereigns or any political
subdivision thereof.
(6) Insurance company separate
accounts. A separate account, provided
that no banking entity other than the
insurance company participates in the
account’s profits and losses.
(7) Bank owned life insurance. A
separate account that is used solely for
the purpose of allowing one or more
banking entities to purchase a life
insurance policy for which the banking
entity or entities is beneficiary,
provided that no banking entity that
purchases the policy:
(i) Controls the investment decisions
regarding the underlying assets or
holdings of the separate account; or
(ii) Participates in the profits and
losses of the separate account other than
in compliance with applicable
supervisory guidance regarding bank
owned life insurance.
(8) Loan securitizations. (i) Scope. An
issuing entity for asset-backed securities
that satisfies all the conditions of this
paragraph (c)(8) and the assets or
holdings of which are comprised solely
of:
(A) Loans as defined in § 351.2(s) of
subpart A;
(B) Rights or other assets designed to
assure the servicing or timely
distribution of proceeds to holders of
such securities and rights or other assets
that are related or incidental to
purchasing or otherwise acquiring and
holding the loans, provided that each
asset meets the requirements of
paragraph (c)(8)(iii) of this section;
(C) Interest rate or foreign exchange
derivatives that meet the requirements
of paragraph (c)(8)(iv) of this section;
and
(D) Special units of beneficial interest
and collateral certificates that meet the
requirements of paragraph (c)(8)(v) of
this section.
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(ii) Impermissible assets. For purposes
of this paragraph (c)(8), the assets or
holdings of the issuing entity shall not
include any of the following:
(A) A security, including an assetbacked security, or an interest in an
equity or debt security other than as
permitted in paragraph (c)(8)(iii) of this
section;
(B) A derivative, other than a
derivative that meets the requirements
of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities.
Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may
hold securities if those securities are:
(A) Cash equivalents for purposes of
the rights and assets in paragraph
(c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts
previously contracted with respect to
the loans supporting the asset-backed
securities.
(iv) Derivatives. The holdings of
derivatives by the issuing entity shall be
limited to interest rate or foreign
exchange derivatives that satisfy all of
the following conditions:
(A) The written terms of the
derivative directly relate to the loans,
the asset-backed securities, or the
contractual rights of other assets
described in paragraph (c)(8)(i)(B) of
this section; and
(B) The derivatives reduce the interest
rate and/or foreign exchange risks
related to the loans, the asset-backed
securities, or the contractual rights or
other assets described in paragraph
(c)(8)(i)(B) of this section.
(v) Special units of beneficial interest
and collateral certificates. The assets or
holdings of the issuing entity may
include collateral certificates and
special units of beneficial interest
issued by a special purpose vehicle,
provided that:
(A) The special purpose vehicle that
issues the special unit of beneficial
interest or collateral certificate meets
the requirements in this paragraph
(c)(8);
(B) The special unit of beneficial
interest or collateral certificate is used
for the sole purpose of transferring to
the issuing entity for the loan
securitization the economic risks and
benefits of the assets that are
permissible for loan securitizations
under this paragraph (c)(8) and does not
directly or indirectly transfer any
interest in any other economic or
financial exposure;
(C) The special unit of beneficial
interest or collateral certificate is
created solely to satisfy legal
requirements or otherwise facilitate the
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structuring of the loan securitization;
and
(D) The special purpose vehicle that
issues the special unit of beneficial
interest or collateral certificate and the
issuing entity are established under the
direction of the same entity that
initiated the loan securitization.
(9) Qualifying asset-backed
commercial paper conduits. (i) An
issuing entity for asset-backed
commercial paper that satisfies all of the
following requirements:
(A) The asset-backed commercial
paper conduit holds only:
(1) Loans and other assets permissible
for a loan securitization under
paragraph (c)(8)(i) of this section; and
(2) Asset-backed securities supported
solely by assets that are permissible for
loan securitizations under paragraph
(c)(8)(i) of this section and acquired by
the asset-backed commercial paper
conduit as part of an initial issuance
either directly from the issuing entity of
the asset-backed securities or directly
from an underwriter in the distribution
of the asset-backed securities;
(B) The asset-backed commercial
paper conduit issues only asset-backed
securities, comprised of a residual
interest and securities with a legal
maturity of 397 days or less; and
(C) A regulated liquidity provider has
entered into a legally binding
commitment to provide full and
unconditional liquidity coverage with
respect to all of the outstanding assetbacked securities issued by the assetbacked commercial paper conduit (other
than any residual interest) in the event
that funds are required to redeem
maturing asset-backed securities.
(ii) For purposes of this paragraph
(c)(9), a regulated liquidity provider
means:
(A) A depository institution, as
defined in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c));
(B) A bank holding company, as
defined in section 2(a) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1841(a)), or a subsidiary thereof;
(C) A savings and loan holding
company, as defined in section 10a of
the Home Owners’ Loan Act (12 U.S.C.
1467a), provided all or substantially all
of the holding company’s activities are
permissible for a financial holding
company under section 4(k) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1843(k)), or a subsidiary thereof;
(D) A foreign bank whose home
country supervisor, as defined in
§ 211.21(q) of the Board’s Regulation K
(12 CFR 211.21(q)), has adopted capital
standards consistent with the Capital
Accord for the Basel Committee on
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banking Supervision, as amended, and
that is subject to such standards, or a
subsidiary thereof; or
(E) The United States or a foreign
sovereign.
(10) Qualifying covered bonds—(i)
Scope. An entity owning or holding a
dynamic or fixed pool of loans or other
assets as provided in paragraph (c)(8) of
this section for the benefit of the holders
of covered bonds, provided that the
assets in the pool are comprised solely
of assets that meet the conditions in
paragraph (c)(8)(i) of this section.
(ii) Covered bond. For purposes of this
paragraph (c)(10), a covered bond
means:
(A) A debt obligation issued by an
entity that meets the definition of
foreign banking organization, the
payment obligations of which are fully
and unconditionally guaranteed by an
entity that meets the conditions set forth
in paragraph (c)(10)(i) of this section; or
(B) A debt obligation of an entity that
meets the conditions set forth in
paragraph (c)(10)(i) of this section,
provided that the payment obligations
are fully and unconditionally
guaranteed by an entity that meets the
definition of foreign banking
organization and the entity is a whollyowned subsidiary, as defined in
paragraph (c)(2) of this section, of such
foreign banking organization.
(11) SBICs and public welfare
investment funds. An issuer:
(i) That is a small business investment
company, as defined in section 103(3) of
the Small Business Investment Act of
1958 (15 U.S.C. 662), or that has
received from the Small Business
Administration notice to proceed to
qualify for a license as a small business
investment company, which notice or
license has not been revoked; or
(ii) The business of which is to make
investments that are:
(A) Designed primarily to promote the
public welfare, of the type permitted
under paragraph (11) of section 5136 of
the Revised Statutes of the United States
(12 U.S.C. 24), including the welfare of
low- and moderate-income communities
or families (such as providing housing,
services, or jobs); or
(B) Qualified rehabilitation
expenditures with respect to a qualified
rehabilitated building or certified
historic structure, as such terms are
defined in section 47 of the Internal
Revenue Code of 1986 or a similar State
historic tax credit program.
(12) Registered investment companies
and excluded entities. An issuer:
(i) That is registered as an investment
company under section 8 of the
Investment Company Act of 1940 (15
U.S.C. 80a–8), or that is formed and
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operated pursuant to a written plan to
become a registered investment
company as described in § 351.20(e)(3)
of subpart D and that complies with the
requirements of section 18 of the
Investment Company Act of 1940 (15
U.S.C. 80a–18);
(ii) That may rely on an exclusion or
exemption from the definition of
‘‘investment company’’ under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) other than the
exclusions contained in section 3(c)(1)
and 3(c)(7) of that Act; or
(iii) That has elected to be regulated
as a business development company
pursuant to section 54(a) of that Act (15
U.S.C. 80a–53) and has not withdrawn
its election, or that is formed and
operated pursuant to a written plan to
become a business development
company as described in § 351.20(e)(3)
of subpart D and that complies with the
requirements of section 61 of the
Investment Company Act of 1940 (15
U.S.C. 80a–60).
(13) Issuers in conjunction with the
FDIC’s receivership or conservatorship
operations. An issuer that is an entity
formed by or on behalf of the FDIC for
the purpose of facilitating the disposal
of assets acquired in the FDIC’s capacity
as conservator or receiver under the
Federal Deposit Insurance Act or Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
(14) Other excluded issuers. (i) Any
issuer that the appropriate Federal
banking agencies, the SEC, and the
CFTC jointly determine the exclusion of
which is consistent with the purposes of
section 13 of the BHC Act.
(ii) A determination made under
paragraph (c)(14)(i) of this section will
be promptly made public.
(d) Definition of other terms related to
covered funds. For purposes of this
subpart:
(1) Applicable accounting standards
means U.S. generally accepted
accounting principles, or such other
accounting standards applicable to a
banking entity that the FDIC determines
are appropriate and that the banking
entity uses in the ordinary course of its
business in preparing its consolidated
financial statements.
(2) Asset-backed security has the
meaning specified in Section 3(a)(79) of
the Exchange Act (15 U.S.C. 78c(a)(79)).
(3) Director has the same meaning as
provided in section 215.2(d)(1) of the
Board’s Regulation O (12 CFR
215.2(d)(1)).
(4) Issuer has the same meaning as in
section 2(a)(22) of the Investment
Company Act of 1940 (15 U.S.C. 80a–
2(a)(22)).
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(5) Issuing entity means with respect
to asset-backed securities the special
purpose vehicle that owns or holds the
pool assets underlying asset-backed
securities and in whose name the assetbacked securities supported or serviced
by the pool assets are issued.
(6) Ownership interest—(i) Ownership
interest means any equity, partnership,
or other similar interest. An ‘‘other
similar interest’’ means an interest that:
(A) Has the right to participate in the
selection or removal of a general
partner, managing member, member of
the board of directors or trustees,
investment manager, investment
adviser, or commodity trading advisor
of the covered fund (excluding the
rights of a creditor to exercise remedies
upon the occurrence of an event of
default or an acceleration event);
(B) Has the right under the terms of
the interest to receive a share of the
income, gains or profits of the covered
fund;
(C) Has the right to receive the
underlying assets of the covered fund
after all other interests have been
redeemed and/or paid in full (excluding
the rights of a creditor to exercise
remedies upon the occurrence of an
event of default or an acceleration
event);
(D) Has the right to receive all or a
portion of excess spread (the positive
difference, if any, between the aggregate
interest payments received from the
underlying assets of the covered fund
and the aggregate interest paid to the
holders of other outstanding interests);
(E) Provides under the terms of the
interest that the amounts payable by the
covered fund with respect to the interest
could be reduced based on losses arising
from the underlying assets of the
covered fund, such as allocation of
losses, write-downs or charge-offs of the
outstanding principal balance, or
reductions in the amount of interest due
and payable on the interest;
(F) Receives income on a pass-through
basis from the covered fund, or has a
rate of return that is determined by
reference to the performance of the
underlying assets of the covered fund;
or
(G) Any synthetic right to have,
receive, or be allocated any of the rights
in paragraphs (d)(6)(i)(A) through (F) of
this section.
(ii) Ownership interest does not
include: Restricted profit interest. An
interest held by an entity (or an
employee or former employee thereof)
in a covered fund for which the entity
(or employee thereof) serves as
investment manager, investment
adviser, commodity trading advisor, or
other service provider so long as:
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(A) The sole purpose and effect of the
interest is to allow the entity (or
employee or former employee thereof)
to share in the profits of the covered
fund as performance compensation for
the investment management, investment
advisory, commodity trading advisory,
or other services provided to the
covered fund by the entity (or employee
or former employee thereof), provided
that the entity (or employee or former
employee thereof) may be obligated
under the terms of such interest to
return profits previously received;
(B) All such profit, once allocated, is
distributed to the entity (or employee or
former employee thereof) promptly after
being earned or, if not so distributed, is
retained by the covered fund for the sole
purpose of establishing a reserve
amount to satisfy contractual obligations
with respect to subsequent losses of the
covered fund and such undistributed
profit of the entity (or employee or
former employee thereof) does not share
in the subsequent investment gains of
the covered fund;
(C) Any amounts invested in the
covered fund, including any amounts
paid by the entity (or employee or
former employee thereof) in connection
with obtaining the restricted profit
interest, are within the limits of § 351.12
of this subpart; and
(D) The interest is not transferable by
the entity (or employee or former
employee thereof) except to an affiliate
thereof (or an employee of the banking
entity or affiliate), to immediate family
members, or through the intestacy, of
the employee or former employee, or in
connection with a sale of the business
that gave rise to the restricted profit
interest by the entity (or employee or
former employee thereof) to an
unaffiliated party that provides
investment management, investment
advisory, commodity trading advisory,
or other services to the fund.
(7) Prime brokerage transaction means
any transaction that would be a covered
transaction, as defined in section
23A(b)(7) of the Federal Reserve Act (12
U.S.C. 371c(b)(7)), that is provided in
connection with custody, clearance and
settlement, securities borrowing or
lending services, trade execution,
financing, or data, operational, and
administrative support.
(8) Resident of the United States
means a person that is a ‘‘U.S. person’’
as defined in rule 902(k) of the SEC’s
Regulation S (17 CFR 230.902(k)).
(9) Sponsor means, with respect to a
covered fund:
(i) To serve as a general partner,
managing member, or trustee of a
covered fund, or to serve as a
commodity pool operator with respect
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to a covered fund as defined in (b)(1)(ii)
of this section;
(ii) In any manner to select or to
control (or to have employees, officers,
or directors, or agents who constitute) a
majority of the directors, trustees, or
management of a covered fund; or
(iii) To share with a covered fund, for
corporate, marketing, promotional, or
other purposes, the same name or a
variation of the same name, except as
permitted under § 351.11(a)(6).
(10) Trustee. (i) For purposes of
paragraph (d)(9) of this section and
§ 351.11 of subpart C, a trustee does not
include:
(A) A trustee that does not exercise
investment discretion with respect to a
covered fund, including a trustee that is
subject to the direction of an
unaffiliated named fiduciary who is not
a trustee pursuant to section 403(a)(1) of
the Employee’s Retirement Income
Security Act (29 U.S.C. 1103(a)(1)); or
(B) A trustee that is subject to
fiduciary standards imposed under
foreign law that are substantially
equivalent to those described in
paragraph (d)(10)(i)(A) of this section;
(ii) Any entity that directs a person
described in paragraph (d)(10)(i) of this
section, or that possesses authority and
discretion to manage and control the
investment decisions of a covered fund
for which such person serves as trustee,
shall be considered to be a trustee of
such covered fund.
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§ 351.11 Permitted organizing and
offering, underwriting, and market making
with respect to a covered fund.
(a) Organizing and offering a covered
fund in general. Notwithstanding
§ 351.10(a) of this subpart, a banking
entity is not prohibited from acquiring
or retaining an ownership interest in, or
acting as sponsor to, a covered fund in
connection with, directly or indirectly,
organizing and offering a covered fund,
including serving as a general partner,
managing member, trustee, or
commodity pool operator of the covered
fund and in any manner selecting or
controlling (or having employees,
officers, directors, or agents who
constitute) a majority of the directors,
trustees, or management of the covered
fund, including any necessary expenses
for the foregoing, only if:
(1) The banking entity (or an affiliate
thereof) provides bona fide trust,
fiduciary, investment advisory, or
commodity trading advisory services;
(2) The covered fund is organized and
offered only in connection with the
provision of bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services and only to
persons that are customers of such
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services of the banking entity (or an
affiliate thereof), pursuant to a written
plan or similar documentation outlining
how the banking entity or such affiliate
intends to provide advisory or similar
services to its customers through
organizing and offering such fund;
(3) The banking entity and its
affiliates do not acquire or retain an
ownership interest in the covered fund
except as permitted under § 351.12 of
this subpart;
(4) The banking entity and its
affiliates comply with the requirements
of § 351.14 of this subpart;
(5) The banking entity and its
affiliates do not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests;
(6) The covered fund, for corporate,
marketing, promotional, or other
purposes:
(i) Does not share the same name or
a variation of the same name with the
banking entity (or an affiliate thereof),
except that a covered fund may share
the same name or a variation of the
same name with a banking entity that is
an investment adviser to the covered
fund if:
(A) The investment adviser is not an
insured depository institution, a
company that controls an insured
depository institution, or a company
that is treated as a bank holding
company for purposes of section 8 of the
International Banking Act of 1978 (12
U.S.C. 3106); and
(B) The investment adviser does not
share the same name or a variation of
the same name as an insured depository
institution, a company that controls an
insured depository institution, or a
company that is treated as a bank
holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(ii) Does not use the word ‘‘bank’’ in
its name;
(7) No director or employee of the
banking entity (or an affiliate thereof)
takes or retains an ownership interest in
the covered fund, except for any
director or employee of the banking
entity or such affiliate who is directly
engaged in providing investment
advisory, commodity trading advisory,
or other services to the covered fund at
the time the director or employee takes
the ownership interest; and
(8) The banking entity:
(i) Clearly and conspicuously
discloses, in writing, to any prospective
and actual investor in the covered fund
(such as through disclosure in the
covered fund’s offering documents):
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(A) That ‘‘any losses in [such covered
fund] will be borne solely by investors
in [the covered fund] and not by [the
banking entity] or its affiliates;
therefore, [the banking entity’s] losses in
[such covered fund] will be limited to
losses attributable to the ownership
interests in the covered fund held by
[the banking entity] and any affiliate in
its capacity as investor in the [covered
fund] or as beneficiary of a restricted
profit interest held by [the banking
entity] or any affiliate’’;
(B) That such investor should read the
fund offering documents before
investing in the covered fund;
(C) That the ‘‘ownership interests in
the covered fund are not insured by the
FDIC, and are not deposits, obligations
of, or endorsed or guaranteed in any
way, by any banking entity’’ (unless that
happens to be the case); and
(D) The role of the banking entity and
its affiliates and employees in
sponsoring or providing any services to
the covered fund; and
(ii) Complies with any additional
rules of the appropriate Federal banking
agencies, the SEC, or the CFTC, as
provided in section 13(b)(2) of the BHC
Act, designed to ensure that losses in
such covered fund are borne solely by
investors in the covered fund and not by
the covered banking entity and its
affiliates.
(b) Organizing and offering an issuing
entity of asset-backed securities. (1)
Notwithstanding § 351.10(a) of this
subpart, a banking entity is not
prohibited from acquiring or retaining
an ownership interest in, or acting as
sponsor to, a covered fund that is an
issuing entity of asset-backed securities
in connection with, directly or
indirectly, organizing and offering that
issuing entity, so long as the banking
entity and its affiliates comply with all
of the requirements of paragraph (a)(3)
through (8) of this section.
(2) For purposes of this paragraph (b),
organizing and offering a covered fund
that is an issuing entity of asset-backed
securities means acting as the
securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)) of the issuing
entity, or acquiring or retaining an
ownership interest in the issuing entity
as required by section 15G of that Act
(15 U.S.C. 78o–11) and the
implementing regulations issued
thereunder.
(c) Underwriting and market making
in ownership interests of a covered
fund. The prohibition contained in
§ 351.10(a) of this subpart does not
apply to a banking entity’s underwriting
activities or market making-related
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activities involving a covered fund so
long as:
(1) Those activities are conducted in
accordance with the requirements of
§ 351.4(a) or § 351.4(b) of subpart B,
respectively;
(2) With respect to any banking entity
(or any affiliate thereof) that: Acts as a
sponsor, investment adviser or
commodity trading advisor to a
particular covered fund or otherwise
acquires and retains an ownership
interest in such covered fund in reliance
on paragraph (a) of this section; acquires
and retains an ownership interest in
such covered fund and is either a
securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)), or is acquiring
and retaining an ownership interest in
such covered fund in compliance with
section 15G of that Act (15 U.S.C. 78o–
11) and the implementing regulations
issued thereunder each as permitted by
paragraph (b) of this section; or, directly
or indirectly, guarantees, assumes, or
otherwise insures the obligations or
performance of the covered fund or of
any covered fund in which such fund
invests, then in each such case any
ownership interests acquired or retained
by the banking entity and its affiliates in
connection with underwriting and
market making related activities for that
particular covered fund are included in
the calculation of ownership interests
permitted to be held by the banking
entity and its affiliates under the
limitations of § 351.12(a)(2)(ii) and
§ 351.12(d) of this subpart; and
(3) With respect to any banking entity,
the aggregate value of all ownership
interests of the banking entity and its
affiliates in all covered funds acquired
and retained under § 351.11 of this
subpart, including all covered funds in
which the banking entity holds an
ownership interest in connection with
underwriting and market making related
activities permitted under this
paragraph (c), are included in the
calculation of all ownership interests
under § 351.12(a)(2)(iii) and § 351.12(d)
of this subpart.
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§ 351.12 Permitted investment in a
covered fund.
(a) Authority and limitations on
permitted investments in covered funds.
(1) Notwithstanding the prohibition
contained in § 351.10(a) of this subpart,
a banking entity may acquire and retain
an ownership interest in a covered fund
that the banking entity or an affiliate
thereof organizes and offers pursuant to
§ 351.11, for the purposes of:
(i) Establishment. Establishing the
fund and providing the fund with
sufficient initial equity for investment to
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permit the fund to attract unaffiliated
investors, subject to the limits contained
in paragraphs (a)(2)(i) and (iii) of this
section; or
(ii) De minimis investment. Making
and retaining an investment in the
covered fund subject to the limits
contained in paragraphs (a)(2)(ii) and
(iii) of this section.
(2) Investment limits—(i) Seeding
period. With respect to an investment in
any covered fund made or held
pursuant to paragraph (a)(1)(i) of this
section, the banking entity and its
affiliates:
(A) Must actively seek unaffiliated
investors to reduce, through
redemption, sale, dilution, or other
methods, the aggregate amount of all
ownership interests of the banking
entity in the covered fund to the amount
permitted in paragraph (a)(2)(i)(B) of
this section; and
(B) Must, no later than 1 year after the
date of establishment of the fund (or
such longer period as may be provided
by the Board pursuant to paragraph (e)
of this section), conform its ownership
interest in the covered fund to the limits
in paragraph (a)(2)(ii) of this section;
(ii) Per-fund limits. (A) Except as
provided in paragraph (a)(2)(ii)(B) of
this section, an investment by a banking
entity and its affiliates in any covered
fund made or held pursuant to
paragraph (a)(1)(ii) of this section may
not exceed 3 percent of the total number
or value of the outstanding ownership
interests of the fund.
(B) An investment by a banking entity
and its affiliates in a covered fund that
is an issuing entity of asset-backed
securities may not exceed 3 percent of
the total fair market value of the
ownership interests of the fund
measured in accordance with paragraph
(b)(3) of this section, unless a greater
percentage is retained by the banking
entity and its affiliates in compliance
with the requirements of section 15G of
the Exchange Act (15 U.S.C. 78o–11)
and the implementing regulations
issued thereunder, in which case the
investment by the banking entity and its
affiliates in the covered fund may not
exceed the amount, number, or value of
ownership interests of the fund required
under section 15G of the Exchange Act
and the implementing regulations
issued thereunder.
(iii) Aggregate limit. The aggregate
value of all ownership interests of the
banking entity and its affiliates in all
covered funds acquired or retained
under this section may not exceed 3
percent of the tier 1 capital of the
banking entity, as provided under
paragraph (c) of this section, and shall
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be calculated as of the last day of each
calendar quarter.
(iv) Date of establishment. For
purposes of this section, the date of
establishment of a covered fund shall
be:
(A) In general. The date on which the
investment adviser or similar entity to
the covered fund begins making
investments pursuant to the written
investment strategy for the fund;
(B) Issuing entities of asset-backed
securities. In the case of an issuing
entity of asset-backed securities, the
date on which the assets are initially
transferred into the issuing entity of
asset-backed securities.
(b) Rules of construction—(1)
Attribution of ownership interests to a
covered banking entity. (i) For purposes
of paragraph (a)(2) of this section, the
amount and value of a banking entity’s
permitted investment in any single
covered fund shall include any
ownership interest held under § 351.12
directly by the banking entity, including
any affiliate of the banking entity.
(ii) Treatment of registered investment
companies, SEC-regulated business
development companies and foreign
public funds. For purposes of paragraph
(b)(1)(i) of this section, a registered
investment company, SEC-regulated
business development companies or
foreign public fund as described in
§ 351.10(c)(1) of this subpart will not be
considered to be an affiliate of the
banking entity so long as the banking
entity:
(A) Does not own, control, or hold
with the power to vote 25 percent or
more of the voting shares of the
company or fund; and
(B) Provides investment advisory,
commodity trading advisory,
administrative, and other services to the
company or fund in compliance with
the limitations under applicable
regulation, order, or other authority.
(iii) Covered funds. For purposes of
paragraph (b)(1)(i) of this section, a
covered fund will not be considered to
be an affiliate of a banking entity so long
as the covered fund is held in
compliance with the requirements of
this subpart.
(iv) Treatment of employee and
director investments financed by the
banking entity. For purposes of
paragraph (b)(1)(i) of this section, an
investment by a director or employee of
a banking entity who acquires an
ownership interest in his or her
personal capacity in a covered fund
sponsored by the banking entity will be
attributed to the banking entity if the
banking entity, directly or indirectly,
extends financing for the purpose of
enabling the director or employee to
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acquire the ownership interest in the
fund and the financing is used to
acquire such ownership interest in the
covered fund.
(2) Calculation of permitted
ownership interests in a single covered
fund. Except as provided in paragraph
(b)(3) or (4), for purposes of determining
whether an investment in a single
covered fund complies with the
restrictions on ownership interests
under paragraphs (a)(2)(i)(B) and
(a)(2)(ii)(A) of this section:
(i) The aggregate number of the
outstanding ownership interests held by
the banking entity shall be the total
number of ownership interests held
under this section by the banking entity
in a covered fund divided by the total
number of ownership interests held by
all entities in that covered fund, as of
the last day of each calendar quarter
(both measured without regard to
committed funds not yet called for
investment);
(ii) The aggregate value of the
outstanding ownership interests held by
the banking entity shall be the aggregate
fair market value of all investments in
and capital contributions made to the
covered fund by the banking entity,
divided by the value of all investments
in and capital contributions made to
that covered fund by all entities, as of
the last day of each calendar quarter (all
measured without regard to committed
funds not yet called for investment). If
fair market value cannot be determined,
then the value shall be the historical
cost basis of all investments in and
contributions made by the banking
entity to the covered fund;
(iii) For purposes of the calculation
under paragraph (b)(2)(ii) of this section,
once a valuation methodology is chosen,
the banking entity must calculate the
value of its investment and the
investments of all others in the covered
fund in the same manner and according
to the same standards.
(3) Issuing entities of asset-backed
securities. In the case of an ownership
interest in an issuing entity of assetbacked securities, for purposes of
determining whether an investment in a
single covered fund complies with the
restrictions on ownership interests
under paragraphs (a)(2)(i)(B) and
(a)(2)(ii)(B) of this section:
(i) For securitizations subject to the
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11), the
calculations shall be made as of the date
and according to the valuation
methodology applicable pursuant to the
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11) and
the implementing regulations issued
thereunder; or
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(ii) For securitization transactions
completed prior to the compliance date
of such implementing regulations (or as
to which such implementing regulations
do not apply), the calculations shall be
made as of the date of establishment as
defined in paragraph (a)(2)(iv)(B) of this
section or such earlier date on which
the transferred assets have been valued
for purposes of transfer to the covered
fund, and thereafter only upon the date
on which additional securities of the
issuing entity of asset-backed securities
are priced for purposes of the sales of
ownership interests to unaffiliated
investors.
(iii) For securitization transactions
completed prior to the compliance date
of such implementing regulations (or as
to which such implementing regulations
do not apply), the aggregate value of the
outstanding ownership interests in the
covered fund shall be the fair market
value of the assets transferred to the
issuing entity of the securitization and
any other assets otherwise held by the
issuing entity at such time, determined
in a manner that is consistent with its
determination of the fair market value of
those assets for financial statement
purposes.
(iv) For purposes of the calculation
under paragraph (b)(3)(iii) of this
section, the valuation methodology used
to calculate the fair market value of the
ownership interests must be the same
for both the ownership interests held by
a banking entity and the ownership
interests held by all others in the
covered fund in the same manner and
according to the same standards.
(4) Multi-tier fund investments—(i)
Master-feeder fund investments. If the
principal investment strategy of a
covered fund (the ‘‘feeder fund’’) is to
invest substantially all of its assets in
another single covered fund (the
‘‘master fund’’), then for purposes of the
investment limitations in paragraphs
(a)(2)(i)(B) and (a)(2)(ii) of this section,
the banking entity’s permitted
investment in such funds shall be
measured only by reference to the value
of the master fund. The banking entity’s
permitted investment in the master fund
shall include any investment by the
banking entity in the master fund, as
well as the banking entity’s pro-rata
share of any ownership interest of the
master fund that is held through the
feeder fund; and
(ii) Fund-of-funds investments. If a
banking entity organizes and offers a
covered fund pursuant to § 351.11 of
this subpart for the purpose of investing
in other covered funds (a ‘‘fund of
funds’’) and that fund of funds itself
invests in another covered fund that the
banking entity is permitted to own, then
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the banking entity’s permitted
investment in that other fund shall
include any investment by the banking
entity in that other fund, as well as the
banking entity’s pro-rata share of any
ownership interest of the fund that is
held through the fund of funds. The
investment of the banking entity may
not represent more than 3 percent of the
amount or value of any single covered
fund.
(c) Aggregate permitted investments
in all covered funds. (1) For purposes of
paragraph (a)(2)(iii) of this section, the
aggregate value of all ownership
interests held by a banking entity shall
be the sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest in covered funds
(together with any amounts paid by the
entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § 351.10(d)(6)(ii) of
this subpart), on a historical cost basis.
(2) Calculation of tier 1 capital. For
purposes of paragraph (a)(2)(iii) of this
section:
(i) Entities that are required to hold
and report tier 1 capital. If a banking
entity is required to calculate and report
tier 1 capital, the banking entity’s tier 1
capital shall be equal to the amount of
tier 1 capital of the banking entity as of
the last day of the most recent calendar
quarter, as reported to its primary
financial regulatory agency; and
(ii) If a banking entity is not required
to calculate and report tier 1 capital, the
banking entity’s tier 1 capital shall be
determined to be equal to:
(A) In the case of a banking entity that
is controlled, directly or indirectly, by a
depository institution that calculates
and reports tier 1 capital, be equal to the
amount of tier 1 capital reported by
such controlling depository institution
in the manner described in paragraph
(c)(2)(i) of this section;
(B) In the case of a banking entity that
is not controlled, directly or indirectly,
by a depository institution that
calculates and reports tier 1 capital:
(1) Bank holding company
subsidiaries. If the banking entity is a
subsidiary of a bank holding company
or company that is treated as a bank
holding company, be equal to the
amount of tier 1 capital reported by the
top-tier affiliate of such covered banking
entity that calculates and reports tier 1
capital in the manner described in
paragraph (c)(2)(i) of this section; and
(2) Other holding companies and any
subsidiary or affiliate thereof. If the
banking entity is not a subsidiary of a
bank holding company or a company
that is treated as a bank holding
company, be equal to the total amount
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of shareholders’ equity of the top-tier
affiliate within such organization as of
the last day of the most recent calendar
quarter that has ended, as determined
under applicable accounting standards.
(iii) Treatment of foreign banking
entities—(A) Foreign banking entities.
Except as provided in paragraph
(c)(2)(iii)(B) of this section, with respect
to a banking entity that is not itself, and
is not controlled directly or indirectly
by, a banking entity that is located or
organized under the laws of the United
States or of any State, the tier 1 capital
of the banking entity shall be the
consolidated tier 1 capital of the entity
as calculated under applicable home
country standards.
(B) U.S. affiliates of foreign banking
entities. With respect to a banking entity
that is located or organized under the
laws of the United States or of any State
and is controlled by a foreign banking
entity identified under paragraph
(c)(2)(iii)(A) of this section, the banking
entity’s tier 1 capital shall be as
calculated under paragraphs (c)(2)(i) or
(ii) of this section.
(d) Capital treatment for a permitted
investment in a covered fund. For
purposes of calculating compliance with
the applicable regulatory capital
requirements, a banking entity shall
deduct from the banking entity’s tier 1
capital (as determined under paragraph
(c)(2) of this section) the greater of:
(1) The sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest (together with any
amounts paid by the entity (or employee
thereof) in connection with obtaining a
restricted profit interest under
§ 351.10(d)(6)(ii) of subpart C), on a
historical cost basis, plus any earnings
received; and
(2) The fair market value of the
banking entity’s ownership interests in
the covered fund as determined under
paragraph (b)(2)(ii) or (b)(3) of this
section (together with any amounts paid
by the entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § 351.10(d)(6)(ii) of
subpart C), if the banking entity
accounts for the profits (or losses) of the
fund investment in its financial
statements.
(e) Extension of time to divest an
ownership interest. (1) Upon application
by a banking entity, the Board may
extend the period under paragraph
(a)(2)(i) of this section for up to 2
additional years if the Board finds that
an extension would be consistent with
safety and soundness and not
detrimental to the public interest. An
application for extension must:
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(i) Be submitted to the Board at least
90 days prior to the expiration of the
applicable time period;
(ii) Provide the reasons for
application, including information that
addresses the factors in paragraph (e)(2)
of this section; and
(iii) Explain the banking entity’s plan
for reducing the permitted investment
in a covered fund through redemption,
sale, dilution or other methods as
required in paragraph (a)(2) of this
section.
(2) Factors governing Board
determinations. In reviewing any
application under paragraph (e)(1) of
this section, the Board may consider all
the facts and circumstances related to
the permitted investment in a covered
fund, including:
(i) Whether the investment would
result, directly or indirectly, in a
material exposure by the banking entity
to high-risk assets or high-risk trading
strategies;
(ii) The contractual terms governing
the banking entity’s interest in the
covered fund;
(iii) The date on which the covered
fund is expected to have attracted
sufficient investments from investors
unaffiliated with the banking entity to
enable the banking entity to comply
with the limitations in paragraph
(a)(2)(i) of this section;
(iv) The total exposure of the covered
banking entity to the investment and the
risks that disposing of, or maintaining,
the investment in the covered fund may
pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of
divesting or disposing of the investment
within the applicable period;
(vi) Whether the investment or the
divestiture or conformance of the
investment would involve or result in a
material conflict of interest between the
banking entity and unaffiliated parties,
including clients, customers or
counterparties to which it owes a duty;
(vi) The banking entity’s prior efforts
to reduce through redemption, sale,
dilution, or other methods its ownership
interests in the covered fund, including
activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board
believes appropriate.
(3) Authority to impose restrictions on
activities or investment during any
extension period. The Board may
impose such conditions on any
extension approved under paragraph
(e)(1) of this section as the Board
determines are necessary or appropriate
to protect the safety and soundness of
the banking entity or the financial
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62191
stability of the United States, address
material conflicts of interest or other
unsound banking practices, or otherwise
further the purposes of section 13 of the
BHC Act and this part.
(4) Consultation. In the case of a
banking entity that is primarily
regulated by another Federal banking
agency, the SEC, or the CFTC, the Board
will consult with such agency prior to
acting on an application by the banking
entity for an extension under paragraph
(e)(1) of this section.
§ 351.13 Other permitted covered fund
activities and investments.
(a) Permitted risk-mitigating hedging
activities. (1) The prohibition contained
in § 351.10(a) of this subpart does not
apply with respect to an ownership
interest in a covered fund acquired or
retained by a banking entity that is
designed to demonstrably reduce or
otherwise significantly mitigate the
specific, identifiable risks to the banking
entity in connection with a
compensation arrangement with an
employee of the banking entity or an
affiliate thereof that directly provides
investment advisory, commodity trading
advisory or other services to the covered
fund.
(2) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under this paragraph (a) only
if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures; and
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(ii) The acquisition or retention of the
ownership interest:
(A) Is made in accordance with the
written policies, procedures and
internal controls required under this
section;
(B) At the inception of the hedge, is
designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks arising in connection
with the compensation arrangement
with the employee that directly
provides investment advisory,
commodity trading advisory, or other
services to the covered fund;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
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contemporaneously in accordance with
this section; and
(D) Is subject to continuing review,
monitoring and management by the
banking entity.
(iii) The compensation arrangement
relates solely to the covered fund in
which the banking entity or any affiliate
has acquired an ownership interest
pursuant to this paragraph and such
compensation arrangement provides
that any losses incurred by the banking
entity on such ownership interest will
be offset by corresponding decreases in
amounts payable under such
compensation arrangement.
(b) Certain permitted covered fund
activities and investments outside of the
United States. (1) The prohibition
contained in § 351.10(a) of this subpart
does not apply to the acquisition or
retention of any ownership interest in,
or the sponsorship of, a covered fund by
a banking entity only if:
(i) The banking entity is not organized
or directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of one
or more States;
(ii) The activity or investment by the
banking entity is pursuant to paragraph
(9) or (13) of section 4(c) of the BHC Act;
(iii) No ownership interest in the
covered fund is offered for sale or sold
to a resident of the United States; and
(iv) The activity or investment occurs
solely outside of the United States.
(2) An activity or investment by the
banking entity is pursuant to paragraph
(9) or (13) of section 4(c) of the BHC Act
for purposes of paragraph (b)(1)(ii) of
this section only if:
(i) The activity or investment is
conducted in accordance with the
requirements of this section; and
(ii)(A) With respect to a banking
entity that is a foreign banking
organization, the banking entity meets
the qualifying foreign banking
organization requirements of section
211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c) or
(e)), as applicable; or
(B) With respect to a banking entity
that is not a foreign banking
organization, the banking entity is not
organized under the laws of the United
States or of one or more States and the
banking entity, on a fully-consolidated
basis, meets at least two of the following
requirements:
(1) Total assets of the banking entity
held outside of the United States exceed
total assets of the banking entity held in
the United States;
(2) Total revenues derived from the
business of the banking entity outside of
the United States exceed total revenues
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derived from the business of the
banking entity in the United States; or
(3) Total net income derived from the
business of the banking entity outside of
the United States exceeds total net
income derived from the business of the
banking entity in the United States.
(3) An ownership interest in a covered
fund is not offered for sale or sold to a
resident of the United States for
purposes of paragraph (b)(1)(iii) of this
section only if it is sold or has been sold
pursuant to an offering that does not
target residents of the United States.
(4) An activity or investment occurs
solely outside of the United States for
purposes of paragraph (b)(1)(iv) of this
section only if:
(i) The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
and is not controlled directly or
indirectly by, a banking entity that is
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
laws of the United States or of any State;
(iii) The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
as principal directly or indirectly on a
consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
(iv) No financing for the banking
entity’s ownership or sponsorship is
provided, directly or indirectly, by any
branch or affiliate that is located in the
United States or organized under the
laws of the United States or of any State.
(5) For purposes of this section, a U.S.
branch, agency, or subsidiary of a
foreign bank, or any subsidiary thereof,
is located in the United States; however,
a foreign bank of which that branch,
agency, or subsidiary is a part is not
considered to be located in the United
States solely by virtue of operation of
the U.S. branch, agency, or subsidiary.
(c) Permitted covered fund interests
and activities by a regulated insurance
company. The prohibition contained in
§ 351.10(a) of this subpart does not
apply to the acquisition or retention by
an insurance company, or an affiliate
thereof, of any ownership interest in, or
the sponsorship of, a covered fund only
if:
(1) The insurance company or its
affiliate acquires and retains the
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ownership interest solely for the general
account of the insurance company or for
one or more separate accounts
established by the insurance company;
(2) The acquisition and retention of
the ownership interest is conducted in
compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (c)(2) of this
section is insufficient to protect the
safety and soundness of the banking
entity, or the financial stability of the
United States.
§ 351.14 Limitations on relationships with
a covered fund.
(a) Relationships with a covered fund.
(1) Except as provided for in paragraph
(a)(2) of this section, no banking entity
that serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, that
organizes and offers a covered fund
pursuant to § 351.11 of this subpart, or
that continues to hold an ownership
interest in accordance with § 351.11(b)
of this subpart, and no affiliate of such
entity, may enter into a transaction with
the covered fund, or with any other
covered fund that is controlled by such
covered fund, that would be a covered
transaction as defined in section 23A of
the Federal Reserve Act (12 U.S.C.
371c(b)(7)), as if such banking entity
and the affiliate thereof were a member
bank and the covered fund were an
affiliate thereof.
(2) Notwithstanding paragraph (a)(1)
of this section, a banking entity may:
(i) Acquire and retain any ownership
interest in a covered fund in accordance
with the requirements of § 351.11,
§ 351.12, or § 351.13 of this subpart; and
(ii) Enter into any prime brokerage
transaction with any covered fund in
which a covered fund managed,
sponsored, or advised by such banking
entity (or an affiliate thereof) has taken
an ownership interest, if:
(A) The banking entity is in
compliance with each of the limitations
set forth in § 351.11 of this subpart with
respect to a covered fund organized and
offered by such banking entity (or an
affiliate thereof);
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(B) The chief executive officer (or
equivalent officer) of the banking entity
certifies in writing annually to the FDIC
(with a duty to update the certification
if the information in the certification
materially changes) that the banking
entity does not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests; and
(C) The Board has not determined that
such transaction is inconsistent with the
safe and sound operation and condition
of the banking entity.
(b) Restrictions on transactions with
covered funds. A banking entity that
serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, or that
organizes and offers a covered fund
pursuant to § 351.11 of this subpart, or
that continues to hold an ownership
interest in accordance with § 351.11(b)
of this subpart, shall be subject to
section 23B of the Federal Reserve Act
(12 U.S.C. 371c–1), as if such banking
entity were a member bank and such
covered fund were an affiliate thereof.
(c) Restrictions on prime brokerage
transactions. A prime brokerage
transaction permitted under paragraph
(a)(2)(ii) of this section shall be subject
to section 23B of the Federal Reserve
Act (12 U.S.C. 371c–1) as if the
counterparty were an affiliate of the
banking entity.
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§ 351.15 Other limitations on permitted
covered fund activities.
(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ 351.11 through
351.13 of this subpart if the transaction,
class of transactions, or activity would:
(1) Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
(2) Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
(3) Pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.
(b) Definition of material conflict of
interest. (1) For purposes of this section,
a material conflict of interest between a
banking entity and its clients,
customers, or counterparties exists if the
banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the banking entity’s interests being
materially adverse to the interests of its
client, customer, or counterparty with
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respect to such transaction, class of
transactions, or activity, and the
banking entity has not taken at least one
of the actions in paragraph (b)(2) of this
section.
(2) Prior to effecting the specific
transaction or class or type of
transactions, or engaging in the specific
activity, the banking entity:
(i) Timely and effective disclosure. (A)
Has made clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest; and
(B) Such disclosure is made in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
mitigate, any materially adverse effect
on the client, customer, or counterparty
created by the conflict of interest; or
(ii) Information barriers. Has
established, maintained, and enforced
information barriers that are
memorialized in written policies and
procedures, such as physical separation
of personnel, or functions, or limitations
on types of activity, that are reasonably
designed, taking into consideration the
nature of the banking entity’s business,
to prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A banking entity may not
rely on such information barriers if, in
the case of any specific transaction,
class or type of transactions or activity,
the banking entity knows or should
reasonably know that, notwithstanding
the banking entity’s establishment of
information barriers, the conflict of
interest may involve or result in a
materially adverse effect on a client,
customer, or counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
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§ 351.16 Ownership of Interests in and
Sponsorship of Issuers of Certain
Collateralized Debt Obligations Backed by
Trust-Preferred Securities.
(a) The prohibition contained in
§ 351.10(a)(1) does not apply to the
ownership by a banking entity of an
interest in, or sponsorship of, any issuer
if:
(1) The issuer was established, and
the interest was issued, before May 19,
2010;
(2) The banking entity reasonably
believes that the offering proceeds
received by the issuer were invested
primarily in Qualifying TruPS
Collateral; and
(3) The banking entity acquired such
interest on or before December 10, 2013
(or acquired such interest in connection
with a merger with or acquisition of a
banking entity that acquired the interest
on or before December 10, 2013).
(b) For purposes of this § 351.16,
Qualifying TruPS Collateral shall mean
any trust preferred security or
subordinated debt instrument issued
prior to May 19, 2010 by a depository
institution holding company that, as of
the end of any reporting period within
12 months immediately preceding the
issuance of such trust preferred security
or subordinated debt instrument, had
total consolidated assets of less than
$15,000,000,000 or issued prior to May
19, 2010 by a mutual holding company.
(c) Notwithstanding paragraph (a)(3)
of this section, a banking entity may act
as a market maker with respect to the
interests of an issuer described in
paragraph (a) of this section in
accordance with the applicable
provisions of §§ 351.4 and 351.11.
(d) Without limiting the applicability
of paragraph (a) of this section, the
Board, the FDIC and the OCC will make
public a non-exclusive list of issuers
that meet the requirements of paragraph
(a). A banking entity may rely on the list
published by the Board, the FDIC and
the OCC.
§§ 351.17–351.19
[Reserved]
Subpart D—Compliance Program
Requirement; Violations
§ 351.20 Program for compliance;
reporting.
(a) Program requirement. Each
banking entity shall develop and
provide for the continued
administration of a compliance program
reasonably designed to ensure and
monitor compliance with the
prohibitions and restrictions on
proprietary trading and covered fund
activities and investments set forth in
section 13 of the BHC Act and this part.
The terms, scope and detail of the
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compliance program shall be
appropriate for the types, size, scope
and complexity of activities and
business structure of the banking entity.
(b) Contents of compliance program.
Except as provided in paragraph (f) of
this section, the compliance program
required by paragraph (a) of this section,
at a minimum, shall include:
(1) Written policies and procedures
reasonably designed to document,
describe, monitor and limit trading
activities subject to subpart B (including
those permitted under §§ 351.3 to 351.6
of subpart B), including setting,
monitoring and managing required
limits set out in § 351.4 and § 351.5, and
activities and investments with respect
to a covered fund subject to subpart C
(including those permitted under
§§ 351.11 through 351.14 of subpart C)
conducted by the banking entity to
ensure that all activities and
investments conducted by the banking
entity that are subject to section 13 of
the BHC Act and this part comply with
section 13 of the BHC Act and this part;
(2) A system of internal controls
reasonably designed to monitor
compliance with section 13 of the BHC
Act and this part and to prevent the
occurrence of activities or investments
that are prohibited by section 13 of the
BHC Act and this part;
(3) A management framework that
clearly delineates responsibility and
accountability for compliance with
section 13 of the BHC Act and this part
and includes appropriate management
review of trading limits, strategies,
hedging activities, investments,
incentive compensation and other
matters identified in this part or by
management as requiring attention;
(4) Independent testing and audit of
the effectiveness of the compliance
program conducted periodically by
qualified personnel of the banking
entity or by a qualified outside party;
(5) Training for trading personnel and
managers, as well as other appropriate
personnel, to effectively implement and
enforce the compliance program; and
(6) Records sufficient to demonstrate
compliance with section 13 of the BHC
Act and this part, which a banking
entity must promptly provide to the
FDIC upon request and retain for a
period of no less than 5 years or such
longer period as required by the FDIC.
(c) Additional standards. In addition
to the requirements in paragraph (b) of
this section, the compliance program of
a banking entity must satisfy the
requirements and other standards
contained in Appendix B, if:
(1) The banking entity engages in
proprietary trading permitted under
subpart B and is required to comply
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with the reporting requirements of
paragraph (d) of this section;
(2) The banking entity has reported
total consolidated assets as of the
previous calendar year end of $50
billion or more or, in the case of a
foreign banking entity, has total U.S.
assets as of the previous calendar year
end of $50 billion or more (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity
operating, located or organized in the
United States); or
(3) The FDIC notifies the banking
entity in writing that it must satisfy the
requirements and other standards
contained in Appendix B to this part.
(d) Reporting requirements under
Appendix A to this part. (1) A banking
entity engaged in proprietary trading
activity permitted under subpart B shall
comply with the reporting requirements
described in Appendix A, if:
(i) The banking entity (other than a
foreign banking entity as provided in
paragraph (d)(1)(ii) of this section) has,
together with its affiliates and
subsidiaries, trading assets and
liabilities (excluding trading assets and
liabilities involving obligations of or
guaranteed by the United States or any
agency of the United States) the average
gross sum of which (on a worldwide
consolidated basis) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the threshold established in
paragraph (d)(2) of this section;
(ii) In the case of a foreign banking
entity, the average gross sum of the
trading assets and liabilities of the
combined U.S. operations of the foreign
banking entity (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity
operating, located or organized in the
United States and excluding trading
assets and liabilities involving
obligations of or guaranteed by the
United States or any agency of the
United States) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the threshold established in
paragraph (d)(2) of this section; or
(iii) The FDIC notifies the banking
entity in writing that it must satisfy the
reporting requirements contained in
Appendix A.
(2) The threshold for reporting under
paragraph (d)(1) of this section shall be
$50 billion beginning on June 30, 2014;
$25 billion beginning on April 30, 2016;
and $10 billion beginning on December
31, 2016.
(3) Frequency of reporting: Unless the
FDIC notifies the banking entity in
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writing that it must report on a different
basis, a banking entity with $50 billion
or more in trading assets and liabilities
(as calculated in accordance with
paragraph (d)(1) of this section) shall
report the information required by
Appendix A for each calendar month
within 30 days of the end of the relevant
calendar month; beginning with
information for the month of January
2015, such information shall be reported
within 10 days of the end of each
calendar month. Any other banking
entity subject to Appendix A shall
report the information required by
Appendix A for each calendar quarter
within 30 days of the end of that
calendar quarter unless the FDIC
notifies the banking entity in writing
that it must report on a different basis.
(e) Additional documentation for
covered funds. Any banking entity that
has more than $10 billion in total
consolidated assets as reported on
December 31 of the previous two
calendar years shall maintain records
that include:
(1) Documentation of the exclusions
or exemptions other than sections
3(c)(1) and 3(c)(7) of the Investment
Company Act of 1940 relied on by each
fund sponsored by the banking entity
(including all subsidiaries and affiliates)
in determining that such fund is not a
covered fund;
(2) For each fund sponsored by the
banking entity (including all
subsidiaries and affiliates) for which the
banking entity relies on one or more of
the exclusions from the definition of
covered fund provided by
§§ 351.10(c)(1), 351.10(c)(5),
351.10(c)(8), 351.10(c)(9), or
351.10(c)(10) of subpart C,
documentation supporting the banking
entity’s determination that the fund is
not a covered fund pursuant to one or
more of those exclusions;
(3) For each seeding vehicle described
in § 351.10(c)(12)(i) or (iii) of subpart C
that will become a registered investment
company or SEC-regulated business
development company, a written plan
documenting the banking entity’s
determination that the seeding vehicle
will become a registered investment
company or SEC-regulated business
development company; the period of
time during which the vehicle will
operate as a seeding vehicle; and the
banking entity’s plan to market the
vehicle to third-party investors and
convert it into a registered investment
company or SEC-regulated business
development company within the time
period specified in § 351.12(a)(2)(i)(B) of
subpart C;
(4) For any banking entity that is, or
is controlled directly or indirectly by a
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banking entity that is, located in or
organized under the laws of the United
States or of any State, if the aggregate
amount of ownership interests in
foreign public funds that are described
in § 351.10(c)(1) of subpart C owned by
such banking entity (including
ownership interests owned by any
affiliate that is controlled directly or
indirectly by a banking entity that is
located in or organized under the laws
of the United States or of any State)
exceeds $50 million at the end of two
or more consecutive calendar quarters,
beginning with the next succeeding
calendar quarter, documentation of the
value of the ownership interests owned
by the banking entity (and such
affiliates) in each foreign public fund
and each jurisdiction in which any such
foreign public fund is organized,
calculated as of the end of each calendar
quarter, which documentation must
continue until the banking entity’s
aggregate amount of ownership interests
in foreign public funds is below $50
million for two consecutive calendar
quarters; and
(5) For purposes of paragraph (e)(4) of
this section, a U.S. branch, agency, or
subsidiary of a foreign banking entity is
located in the United States; however,
the foreign bank that operates or
controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(f) Simplified programs for less active
banking entities—(1) Banking entities
with no covered activities. A banking
entity that does not engage in activities
or investments pursuant to subpart B or
subpart C (other than trading activities
permitted pursuant to § 351.6(a) of
subpart B) may satisfy the requirements
of this section by establishing the
required compliance program prior to
becoming engaged in such activities or
making such investments (other than
trading activities permitted pursuant to
§ 351.6(a) of subpart B).
(2) Banking entities with modest
activities. A banking entity with total
consolidated assets of $10 billion or less
as reported on December 31 of the
previous two calendar years that
engages in activities or investments
pursuant to subpart B or subpart C
(other than trading activities permitted
under § 351.6(a) of subpart B) may
satisfy the requirements of this section
by including in its existing compliance
policies and procedures appropriate
references to the requirements of section
13 of the BHC Act and this part and
adjustments as appropriate given the
activities, size, scope and complexity of
the banking entity.
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§ 351.21 Termination of activities or
investments; penalties for violations.
(a) Any banking entity that engages in
an activity or makes an investment in
violation of section 13 of the BHC Act
or this part, or acts in a manner that
functions as an evasion of the
requirements of section 13 of the BHC
Act or this part, including through an
abuse of any activity or investment
permitted under subparts B or C, or
otherwise violates the restrictions and
requirements of section 13 of the BHC
Act or this part, shall, upon discovery,
promptly terminate the activity and, as
relevant, dispose of the investment.
(b) Whenever the FDIC finds
reasonable cause to believe any banking
entity has engaged in an activity or
made an investment in violation of
section 13 of the BHC Act or this part,
or engaged in any activity or made any
investment that functions as an evasion
of the requirements of section 13 of the
BHC Act or this part, the FDIC may take
any action permitted by law to enforce
compliance with section 13 of the BHC
Act and this part, including directing
the banking entity to restrict, limit, or
terminate any or all activities under this
part and dispose of any investment.
Appendix A to Part 351—Reporting and
Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and
recordkeeping requirements that certain
banking entities must satisfy in connection
with the restrictions on proprietary trading
set forth in subpart B (‘‘proprietary trading
restrictions’’). Pursuant to § 351.20(d), this
appendix generally applies to a banking
entity that, together with its affiliates and
subsidiaries, has significant trading assets
and liabilities. These entities are required to
(i) furnish periodic reports to the FDIC
regarding a variety of quantitative
measurements of their covered trading
activities, which vary depending on the
scope and size of covered trading activities,
and (ii) create and maintain records
documenting the preparation and content of
these reports. The requirements of this
appendix must be incorporated into the
banking entity’s internal compliance program
under § 351.20 and Appendix B.
b. The purpose of this appendix is to assist
banking entities and the FDIC in:
(i) Better understanding and evaluating the
scope, type, and profile of the banking
entity’s covered trading activities;
(ii) Monitoring the banking entity’s covered
trading activities;
(iii) Identifying covered trading activities
that warrant further review or examination
by the banking entity to verify compliance
with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading
activities of trading desks engaged in market
making-related activities subject to § 351.4(b)
are consistent with the requirements
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governing permitted market making-related
activities;
(v) Evaluating whether the covered trading
activities of trading desks that are engaged in
permitted trading activity subject to §§ 351.4,
351.5, or 351.6(a)–(b) (i.e., underwriting and
market making-related related activity, riskmitigating hedging, or trading in certain
government obligations) are consistent with
the requirement that such activity not result,
directly or indirectly, in a material exposure
to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular
covered trading activities of the banking
entity, and the individual trading desks of
the banking entity, to help establish the
appropriate frequency and scope of
examination by the FDIC of such activities;
and
(vii) Assessing and addressing the risks
associated with the banking entity’s covered
trading activities.
c. The quantitative measurements that
must be furnished pursuant to this appendix
are not intended to serve as a dispositive tool
for the identification of permissible or
impermissible activities.
d. In order to allow banking entities and
the Agencies to evaluate the effectiveness of
these metrics, banking entities must collect
and report these metrics for all trading desks
beginning on the dates established in
§ 351.20 of the final rule. The Agencies will
review the data collected and revise this
collection requirement as appropriate based
on a review of the data collected prior to
September 30, 2015.
e. In addition to the quantitative
measurements required in this appendix, a
banking entity may need to develop and
implement other quantitative measurements
in order to effectively monitor its covered
trading activities for compliance with section
13 of the BHC Act and this part and to have
an effective compliance program, as required
by § 351.20 and Appendix B to this part. The
effectiveness of particular quantitative
measurements may differ based on the profile
of the banking entity’s businesses in general
and, more specifically, of the particular
trading desk, including types of instruments
traded, trading activities and strategies, and
history and experience (e.g., whether the
trading desk is an established, successful
market maker or a new entrant to a
competitive market). In all cases, banking
entities must ensure that they have robust
measures in place to identify and monitor the
risks taken in their trading activities, to
ensure that the activities are within risk
tolerances established by the banking entity,
and to monitor and examine for compliance
with the proprietary trading restrictions in
this part.
f. On an ongoing basis, banking entities
must carefully monitor, review, and evaluate
all furnished quantitative measurements, as
well as any others that they choose to utilize
in order to maintain compliance with section
13 of the BHC Act and this part. All
measurement results that indicate a
heightened risk of impermissible proprietary
trading, including with respect to otherwisepermitted activities under §§ 351.4 through
351.6(a) and (b), or that result in a material
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exposure to high-risk assets or high-risk
trading strategies, must be escalated within
the banking entity for review, further
analysis, explanation to the FDIC, and
remediation, where appropriate. The
quantitative measurements discussed in this
appendix should be helpful to banking
entities in identifying and managing the risks
related to their covered trading activities.
II. Definitions
The terms used in this appendix have the
same meanings as set forth in §§ 351.2 and
351.3. In addition, for purposes of this
appendix, the following definitions apply:
Calculation period means the period of
time for which a particular quantitative
measurement must be calculated.
Comprehensive profit and loss means the
net profit or loss of a trading desk’s material
sources of trading revenue over a specific
period of time, including, for example, any
increase or decrease in the market value of
a trading desk’s holdings, dividend income,
and interest income and expense.
Covered trading activity means trading
conducted by a trading desk under §§ 351.4,
351.5, 351.6(a), or 351.6(b). A banking entity
may include trading under §§ 351.3(d),
351.6(c), 351.6(d) or 351.6(e).
Measurement frequency means the
frequency with which a particular
quantitative metric must be calculated and
recorded.
Trading desk means the smallest discrete
unit of organization of a banking entity that
purchases or sells financial instruments for
the trading account of the banking entity or
an affiliate thereof.
III. Reporting and Recordkeeping of
Quantitative Measurements
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a. Scope of Required Reporting
General scope. Each banking entity made
subject to this part by § 351.20 must furnish
the following quantitative measurements for
each trading desk of the banking entity,
calculated in accordance with this appendix:
• Risk and Position Limits and Usage;
• Risk Factor Sensitivities;
• Value-at-Risk and Stress VaR;
• Comprehensive Profit and Loss
Attribution;
• Inventory Turnover;
• Inventory Aging; and
• Customer-Facing Trade Ratio
b. Frequency of Required Calculation and
Reporting
A banking entity must calculate any
applicable quantitative measurement for each
trading day. A banking entity must report
each applicable quantitative measurement to
the FDIC on the reporting schedule
established in § 351.20 unless otherwise
requested by the FDIC. All quantitative
measurements for any calendar month must
be reported within the time period required
by § 351.20.
c. Recordkeeping
A banking entity must, for any quantitative
measurement furnished to the FDIC pursuant
to this appendix and § 351.20(d), create and
maintain records documenting the
preparation and content of these reports, as
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well as such information as is necessary to
permit the FDIC to verify the accuracy of
such reports, for a period of 5 years from the
end of the calendar year for which the
measurement was taken.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Risk and Position Limits and Usage
i. Description: For purposes of this
appendix, Risk and Position Limits are the
constraints that define the amount of risk that
a trading desk is permitted to take at a point
in time, as defined by the banking entity for
a specific trading desk. Usage represents the
portion of the trading desk’s limits that are
accounted for by the current activity of the
desk. Risk and position limits and their usage
are key risk management tools used to
control and monitor risk taking and include,
but are not limited, to the limits set out in
§ 351.4 and § 351.5. A number of the metrics
that are described below, including ‘‘Risk
Factor Sensitivities’’ and ‘‘Value-at-Risk and
Stress Value-at-Risk,’’ relate to a trading
desk’s risk and position limits and are useful
in evaluating and setting these limits in the
broader context of the trading desk’s overall
activities, particularly for the market making
activities under § 351.4(b) and hedging
activity under § 351.5. Accordingly, the
limits required under § 351.4(b)(2)(iii) and
§ 351.5(b)(1)(i) must meet the applicable
requirements under § 351.4(b)(2)(iii) and
§ 351.5(b)(1)(i) and also must include
appropriate metrics for the trading desk
limits including, at a minimum, the ‘‘Risk
Factor Sensitivities’’ and ‘‘Value-at-Risk and
Stress Value-at-Risk’’ metrics except to the
extent any of the ‘‘Risk Factor Sensitivities’’
or ‘‘Value-at-Risk and Stress Value-at-Risk’’
metrics are demonstrably ineffective for
measuring and monitoring the risks of a
trading desk based on the types of positions
traded by, and risk exposures of, that desk.
ii. General Calculation Guidance: Risk and
Position Limits must be reported in the
format used by the banking entity for the
purposes of risk management of each trading
desk. Risk and Position Limits are often
expressed in terms of risk measures, such as
VaR and Risk Factor Sensitivities, but may
also be expressed in terms of other
observable criteria, such as net open
positions. When criteria other than VaR or
Risk Factor Sensitivities are used to define
the Risk and Position Limits, both the value
of the Risk and Position Limits and the value
of the variables used to assess whether these
limits have been reached must be reported.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
2. Risk Factor Sensitivities
i. Description: For purposes of this
appendix, Risk Factor Sensitivities are
changes in a trading desk’s Comprehensive
Profit and Loss that are expected to occur in
the event of a change in one or more
underlying variables that are significant
sources of the trading desk’s profitability and
risk.
ii. General Calculation Guidance: A
banking entity must report the Risk Factor
Sensitivities that are monitored and managed
as part of the trading desk’s overall risk
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management policy. The underlying data and
methods used to compute a trading desk’s
Risk Factor Sensitivities will depend on the
specific function of the trading desk and the
internal risk management models employed.
The number and type of Risk Factor
Sensitivities that are monitored and managed
by a trading desk, and furnished to the FDIC,
will depend on the explicit risks assumed by
the trading desk. In general, however,
reported Risk Factor Sensitivities must be
sufficiently granular to account for a
preponderance of the expected price
variation in the trading desk’s holdings.
A. Trading desks must take into account
any relevant factors in calculating Risk Factor
Sensitivities, including, for example, the
following with respect to particular asset
classes:
• Commodity derivative positions: Risk
factors with respect to the related
commodities set out in 17 CFR 20.2, the
maturity of the positions, volatility and/or
correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), and the maturity profile of
the positions;
• Credit positions: Risk factors with
respect to credit spreads that are sufficiently
granular to account for specific credit sectors
and market segments, the maturity profile of
the positions, and risk factors with respect to
interest rates of all relevant maturities;
• Credit-related derivative positions: Risk
factor sensitivities, for example credit
spreads, shifts (parallel and non-parallel) in
credit spreads—volatility, and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
and the maturity profile of the positions;
• Equity derivative positions: Risk factor
sensitivities such as equity positions,
volatility, and/or correlation sensitivities
(expressed in a manner that demonstrates
any significant non-linearities), and the
maturity profile of the positions;
• Equity positions: Risk factors for equity
prices and risk factors that differentiate
between important equity market sectors and
segments, such as a small capitalization
equities and international equities;
• Foreign exchange derivative positions:
Risk factors with respect to major currency
pairs and maturities, exposure to interest
rates at relevant maturities, volatility, and/or
correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), as well as the maturity
profile of the positions; and
• Interest rate positions, including interest
rate derivative positions: Risk factors with
respect to major interest rate categories and
maturities and volatility and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
and shifts (parallel and non-parallel) in the
interest rate curve, as well as the maturity
profile of the positions.
B. The methods used by a banking entity
to calculate sensitivities to a common factor
shared by multiple trading desks, such as an
equity price factor, must be applied
consistently across its trading desks so that
the sensitivities can be compared from one
trading desk to another.
iii. Calculation Period: One trading day.
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iv. Measurement Frequency: Daily.
3. Value-at-Risk and Stress Value-at-Risk
i. Description: For purposes of this
appendix, Value-at-Risk (‘‘VaR’’) is the
commonly used percentile measurement of
the risk of future financial loss in the value
of a given set of aggregated positions over a
specified period of time, based on current
market conditions. For purposes of this
appendix, Stress Value-at-Risk (‘‘Stress VaR’’)
is the percentile measurement of the risk of
future financial loss in the value of a given
set of aggregated positions over a specified
period of time, based on market conditions
during a period of significant financial stress.
ii. General Calculation Guidance: Banking
entities must compute and report VaR and
Stress VaR by employing generally accepted
standards and methods of calculation. VaR
should reflect a loss in a trading desk that is
expected to be exceeded less than one
percent of the time over a one-day period.
For those banking entities that are subject to
regulatory capital requirements imposed by a
Federal banking agency, VaR and Stress VaR
must be computed and reported in a manner
that is consistent with such regulatory capital
requirements. In cases where a trading desk
does not have a standalone VaR or Stress VaR
calculation but is part of a larger aggregation
of positions for which a VaR or Stress VaR
calculation is performed, a VaR or Stress VaR
calculation that includes only the trading
desk’s holdings must be performed consistent
with the VaR or Stress VaR model and
methodology used for the larger aggregation
of positions.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this
appendix, Comprehensive Profit and Loss
Attribution is an analysis that attributes the
daily fluctuation in the value of a trading
desk’s positions to various sources. First, the
daily profit and loss of the aggregated
positions is divided into three categories: (i)
Profit and loss attributable to a trading desk’s
existing positions that were also positions
held by the trading desk as of the end of the
prior day (‘‘existing positions’’); (ii) profit
and loss attributable to new positions
resulting from the current day’s trading
activity (‘‘new positions’’); and (iii) residual
profit and loss that cannot be specifically
attributed to existing positions or new
positions. The sum of (i), (ii), and (iii) must
equal the trading desk’s comprehensive profit
and loss at each point in time. In addition,
profit and loss measurements must calculate
volatility of comprehensive profit and loss
(i.e., the standard deviation of the trading
desk’s one-day profit and loss, in dollar
terms) for the reporting period for at least a
30-, 60- and 90-day lag period, from the end
of the reporting period, and any other period
that the banking entity deems necessary to
meet the requirements of the rule.
A. The comprehensive profit and loss
associated with existing positions must
reflect changes in the value of these positions
on the applicable day. The comprehensive
profit and loss from existing positions must
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be further attributed, as applicable, to
changes in (i) the specific Risk Factors and
other factors that are monitored and managed
as part of the trading desk’s overall risk
management policies and procedures; and (ii)
any other applicable elements, such as cash
flows, carry, changes in reserves, and the
correction, cancellation, or exercise of a
trade.
B. The comprehensive profit and loss
attributed to new positions must reflect
commissions and fee income or expense and
market gains or losses associated with
transactions executed on the applicable day.
New positions include purchases and sales of
financial instruments and other assets/
liabilities and negotiated amendments to
existing positions. The comprehensive profit
and loss from new positions may be reported
in the aggregate and does not need to be
further attributed to specific sources.
C. The portion of comprehensive profit and
loss that cannot be specifically attributed to
known sources must be allocated to a
residual category identified as an
unexplained portion of the comprehensive
profit and loss. Significant unexplained
profit and loss must be escalated for further
investigation and analysis.
ii. General Calculation Guidance: The
specific categories used by a trading desk in
the attribution analysis and amount of detail
for the analysis should be tailored to the type
and amount of trading activities undertaken
by the trading desk. The new position
attribution must be computed by calculating
the difference between the prices at which
instruments were bought and/or sold and the
prices at which those instruments are marked
to market at the close of business on that day
multiplied by the notional or principal
amount of each purchase or sale. Any fees,
commissions, or other payments received
(paid) that are associated with transactions
executed on that day must be added
(subtracted) from such difference. These
factors must be measured consistently over
time to facilitate historical comparisons.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
c. Customer-Facing Activity Measurements
1. Inventory Turnover
i. Description: For purposes of this
appendix, Inventory Turnover is a ratio that
measures the turnover of a trading desk’s
inventory. The numerator of the ratio is the
absolute value of all transactions over the
reporting period. The denominator of the
ratio is the value of the trading desk’s
inventory at the beginning of the reporting
period.
ii. General Calculation Guidance: For
purposes of this appendix, for derivatives,
other than options and interest rate
derivatives, value means gross notional
value, for options, value means delta
adjusted notional value, and for interest rate
derivatives, value means 10-year bond
equivalent value.
iii. Calculation Period: 30 days, 60 days,
and 90 days.
iv. Measurement Frequency: Daily.
2. Inventory Aging
i. Description: For purposes of this
appendix, Inventory Aging generally
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62197
describes a schedule of the trading desk’s
aggregate assets and liabilities and the
amount of time that those assets and
liabilities have been held. Inventory Aging
should measure the age profile of the trading
desk’s assets and liabilities.
ii. General Calculation Guidance: In
general, Inventory Aging must be computed
using a trading desk’s trading activity data
and must identify the value of a trading
desk’s aggregate assets and liabilities.
Inventory Aging must include two schedules,
an asset-aging schedule and a liability-aging
schedule. Each schedule must record the
value of assets or liabilities held over all
holding periods. For derivatives, other than
options, and interest rate derivatives, value
means gross notional value, for options,
value means delta adjusted notional value
and, for interest rate derivatives, value means
10-year bond equivalent value.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Customer-Facing Trade Ratio—Trade
Count Based and Value Based
i. Description: For purposes of this
appendix, the Customer-Facing Trade Ratio
is a ratio comparing (i) the transactions
involving a counterparty that is a customer
of the trading desk to (ii) the transactions
involving a counterparty that is not a
customer of the trading desk. A trade count
based ratio must be computed that records
the number of transactions involving a
counterparty that is a customer of the trading
desk and the number of transactions
involving a counterparty that is not a
customer of the trading desk. A value based
ratio must be computed that records the
value of transactions involving a
counterparty that is a customer of the trading
desk and the value of transactions involving
a counterparty that is not a customer of the
trading desk.
ii. General Calculation Guidance: For
purposes of calculating the Customer-Facing
Trade Ratio, a counterparty is considered to
be a customer of the trading desk if the
counterparty is a market participant that
makes use of the banking entity’s market
making-related services by obtaining such
services, responding to quotations, or
entering into a continuing relationship with
respect to such services. However, a trading
desk or other organizational unit of another
banking entity would not be a client,
customer, or counterparty of the trading desk
if the other entity has trading assets and
liabilities of $50 billion or more as measured
in accordance with § 351.20(d)(1) unless the
trading desk documents how and why a
particular trading desk or other
organizational unit of the entity should be
treated as a client, customer, or counterparty
of the trading desk. Transactions conducted
anonymously on an exchange or similar
trading facility that permits trading on behalf
of a broad range of market participants would
be considered transactions with customers of
the trading desk. For derivatives, other than
options, and interest rate derivatives, value
means gross notional value, for options,
value means delta adjusted notional value,
and for interest rate derivatives, value means
10-year bond equivalent value.
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iii. Calculation Period: 30 days, 60 days,
and 90 days.
iv. Measurement Frequency: Daily.
Appendix B to Part 351—Enhanced
Minimum Standards for Compliance
Programs
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I. Overview
Section 351.20(c) requires certain banking
entities to establish, maintain, and enforce an
enhanced compliance program that includes
the requirements and standards in this
Appendix as well as the minimum written
policies and procedures, internal controls,
management framework, independent
testing, training, and recordkeeping
provisions outlined in § 351.20. This
Appendix sets forth additional minimum
standards with respect to the establishment,
oversight, maintenance, and enforcement by
these banking entities of an enhanced
internal compliance program for ensuring
and monitoring compliance with the
prohibitions and restrictions on proprietary
trading and covered fund activities and
investments set forth in section 13 of the
BHC Act and this part.
a. This compliance program must:
1. Be reasonably designed to identify,
document, monitor, and report the permitted
trading and covered fund activities and
investments of the banking entity; identify,
monitor and promptly address the risks of
these covered activities and investments and
potential areas of noncompliance; and
prevent activities or investments prohibited
by, or that do not comply with, section 13 of
the BHC Act and this part;
2. Establish and enforce appropriate limits
on the covered activities and investments of
the banking entity, including limits on the
size, scope, complexity, and risks of the
individual activities or investments
consistent with the requirements of section
13 of the BHC Act and this part;
3. Subject the effectiveness of the
compliance program to periodic independent
review and testing, and ensure that the
entity’s internal audit, corporate compliance
and internal control functions involved in
review and testing are effective and
independent;
4. Make senior management, and others as
appropriate, accountable for the effective
implementation of the compliance program,
and ensure that the board of directors and
chief executive officer (or equivalent) of the
banking entity review the effectiveness of the
compliance program; and
5. Facilitate supervision and examination
by the Agencies of the banking entity’s
permitted trading and covered fund activities
and investments.
II. Enhanced Compliance Program
a. Proprietary Trading Activities. A
banking entity must establish, maintain and
enforce a compliance program that includes
written policies and procedures that are
appropriate for the types, size, and
complexity of, and risks associated with, its
permitted trading activities. The compliance
program may be tailored to the types of
trading activities conducted by the banking
entity, and must include a detailed
description of controls established by the
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banking entity to reasonably ensure that its
trading activities are conducted in
accordance with the requirements and
limitations applicable to those trading
activities under section 13 of the BHC Act
and this part, and provide for appropriate
revision of the compliance program before
expansion of the trading activities of the
banking entity. A banking entity must devote
adequate resources and use knowledgeable
personnel in conducting, supervising and
managing its trading activities, and promote
consistency, independence and rigor in
implementing its risk controls and
compliance efforts. The compliance program
must be updated with a frequency sufficient
to account for changes in the activities of the
banking entity, results of independent testing
of the program, identification of weaknesses
in the program, and changes in legal,
regulatory or other requirements.
1. Trading Desks: The banking entity must
have written policies and procedures
governing each trading desk that include a
description of:
i. The process for identifying, authorizing
and documenting financial instruments each
trading desk may purchase or sell, with
separate documentation for market makingrelated activities conducted in reliance on
§ 351.4(b) and for hedging activity conducted
in reliance on § 351.5;
ii. A mapping for each trading desk to the
division, business line, or other
organizational structure that is responsible
for managing and overseeing the trading
desk’s activities;
iii. The mission (i.e., the type of trading
activity, such as market-making, trading in
sovereign debt, etc.) and strategy (i.e.,
methods for conducting authorized trading
activities) of each trading desk;
iv. The activities that the trading desk is
authorized to conduct, including (i)
authorized instruments and products, and (ii)
authorized hedging strategies, techniques and
instruments;
v. The types and amount of risks allocated
by the banking entity to each trading desk to
implement the mission and strategy of the
trading desk, including an enumeration of
material risks resulting from the activities in
which the trading desk is authorized to
engage (including but not limited to price
risks, such as basis, volatility and correlation
risks, as well as counterparty credit risk).
Risk assessments must take into account both
the risks inherent in the trading activity and
the strength and effectiveness of controls
designed to mitigate those risks;
vi. How the risks allocated to each trading
desk will be measured;
vii. Why the allocated risks levels are
appropriate to the activities authorized for
the trading desk;
viii. The limits on the holding period of,
and the risk associated with, financial
instruments under the responsibility of the
trading desk;
ix. The process for setting new or revised
limits, as well as escalation procedures for
granting exceptions to any limits or to any
policies or procedures governing the desk,
the analysis that will be required to support
revising limits or granting exceptions, and
the process for independently reviewing and
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documenting those exceptions and the
underlying analysis;
x. The process for identifying,
documenting and approving new products,
trading strategies, and hedging strategies;
xi. The types of clients, customers, and
counterparties with whom the trading desk
may trade; and
xii. The compensation arrangements,
including incentive arrangements, for
employees associated with the trading desk,
which may not be designed to reward or
incentivize prohibited proprietary trading or
excessive or imprudent risk-taking.
2. Description of risks and risk
management processes: The compliance
program for the banking entity must include
a comprehensive description of the risk
management program for the trading activity
of the banking entity. The compliance
program must also include a description of
the governance, approval, reporting,
escalation, review and other processes the
banking entity will use to reasonably ensure
that trading activity is conducted in
compliance with section 13 of the BHC Act
and this part. Trading activity in similar
financial instruments should be subject to
similar governance, limits, testing, controls,
and review, unless the banking entity
specifically determines to establish different
limits or processes and documents those
differences. Descriptions must include, at a
minimum, the following elements:
i. A description of the supervisory and risk
management structure governing all trading
activity, including a description of processes
for initial and senior-level review of new
products and new strategies;
ii. A description of the process for
developing, documenting, testing, approving
and reviewing all models used for valuing,
identifying and monitoring the risks of
trading activity and related positions,
including the process for periodic
independent testing of the reliability and
accuracy of those models;
iii. A description of the process for
developing, documenting, testing, approving
and reviewing the limits established for each
trading desk;
iv. A description of the process by which
a security may be purchased or sold pursuant
to the liquidity management plan, including
the process for authorizing and monitoring
such activity to ensure compliance with the
banking entity’s liquidity management plan
and the restrictions on liquidity management
activities in this part;
v. A description of the management review
process, including escalation procedures, for
approving any temporary exceptions or
permanent adjustments to limits on the
activities, positions, strategies, or risks
associated with each trading desk; and
vi. The role of the audit, compliance, risk
management and other relevant units for
conducting independent testing of trading
and hedging activities, techniques and
strategies.
3. Authorized risks, instruments, and
products. The banking entity must
implement and enforce limits and internal
controls for each trading desk that are
reasonably designed to ensure that trading
activity is conducted in conformance with
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section 13 of the BHC Act and this part and
with the banking entity’s written policies and
procedures. The banking entity must
establish and enforce risk limits appropriate
for the activity of each trading desk. These
limits should be based on probabilistic and
non-probabilistic measures of potential loss
(e.g., Value-at-Risk and notional exposure,
respectively), and measured under normal
and stress market conditions. At a minimum,
these internal controls must monitor,
establish and enforce limits on:
i. The financial instruments (including, at
a minimum, by type and exposure) that the
trading desk may trade;
ii. The types and levels of risks that may
be taken by each trading desk; and
iii. The types of hedging instruments used,
hedging strategies employed, and the amount
of risk effectively hedged.
4. Hedging policies and procedures. The
banking entity must establish, maintain, and
enforce written policies and procedures
regarding the use of risk-mitigating hedging
instruments and strategies that, at a
minimum, describe:
i. The positions, techniques and strategies
that each trading desk may use to hedge the
risk of its positions;
ii. The manner in which the banking entity
will identify the risks arising in connection
with and related to the individual or
aggregated positions, contracts or other
holdings of the banking entity that are to be
hedged and determine that those risks have
been properly and effectively hedged;
iii. The level of the organization at which
hedging activity and management will occur;
iv. The manner in which hedging strategies
will be monitored and the personnel
responsible for such monitoring;
v. The risk management processes used to
control unhedged or residual risks; and
vi. The process for developing,
documenting, testing, approving and
reviewing all hedging positions, techniques
and strategies permitted for each trading desk
and for the banking entity in reliance on
§ 351.5.
5. Analysis and quantitative
measurements. The banking entity must
perform robust analysis and quantitative
measurement of its trading activities that is
reasonably designed to ensure that the
trading activity of each trading desk is
consistent with the banking entity’s
compliance program; monitor and assist in
the identification of potential and actual
prohibited proprietary trading activity; and
prevent the occurrence of prohibited
proprietary trading. Analysis and models
used to determine, measure and limit risk
must be rigorously tested and be reviewed by
management responsible for trading activity
to ensure that trading activities, limits,
strategies, and hedging activities do not
understate the risk and exposure to the
banking entity or allow prohibited
proprietary trading. This review should
include periodic and independent backtesting and revision of activities, limits,
strategies and hedging as appropriate to
contain risk and ensure compliance. In
addition to the quantitative measurements
reported by any banking entity subject to
Appendix A to this part, each banking entity
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must develop and implement, to the extent
appropriate to facilitate compliance with this
part, additional quantitative measurements
specifically tailored to the particular risks,
practices, and strategies of its trading desks.
The banking entity’s analysis and
quantitative measurements must incorporate
the quantitative measurements reported by
the banking entity pursuant to Appendix A
(if applicable) and include, at a minimum,
the following:
i. Internal controls and written policies and
procedures reasonably designed to ensure the
accuracy and integrity of quantitative
measurements;
ii. Ongoing, timely monitoring and review
of calculated quantitative measurements;
iii. The establishment of numerical
thresholds and appropriate trading measures
for each trading desk and heightened review
of trading activity not consistent with those
thresholds to ensure compliance with section
13 of the BHC Act and this part, including
analysis of the measurement results or other
information, appropriate escalation
procedures, and documentation related to the
review; and
iv. Immediate review and compliance
investigation of the trading desk’s activities,
escalation to senior management with
oversight responsibilities for the applicable
trading desk, timely notification to the FDIC,
appropriate remedial action (e.g., divesting of
impermissible positions, cessation of
impermissible activity, disciplinary actions),
and documentation of the investigation
findings and remedial action taken when
quantitative measurements or other
information, considered together with the
facts and circumstances, or findings of
internal audit, independent testing or other
review suggest a reasonable likelihood that
the trading desk has violated any part of
section 13 of the BHC Act or this part.
6. Other Compliance Matters. In addition
to the requirements specified above, the
banking entity’s compliance program must:
i. Identify activities of each trading desk
that will be conducted in reliance on
exemptions contained in §§ 351.4 through
351.6, including an explanation of:
A. How and where in the organization the
activity occurs; and
B. Which exemption is being relied on and
how the activity meets the specific
requirements for reliance on the applicable
exemption;
ii. Include an explanation of the process for
documenting, approving and reviewing
actions taken pursuant to the liquidity
management plan, where in the organization
this activity occurs, the securities permissible
for liquidity management, the process for
ensuring that liquidity management activities
are not conducted for the purpose of
prohibited proprietary trading, and the
process for ensuring that securities
purchased as part of the liquidity
management plan are highly liquid and
conform to the requirements of this part;
iii. Describe how the banking entity
monitors for and prohibits potential or actual
material exposure to high-risk assets or highrisk trading strategies presented by each
trading desk that relies on the exemptions
contained in §§ 351.3(d)(3), and 351.4
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62199
through 351.6, which must take into account
potential or actual exposure to:
A. Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
B. Assets whose changes in value cannot
be adequately mitigated by effective hedging;
C. New products with rapid growth,
including those that do not have a market
history;
D. Assets or strategies that include
significant embedded leverage;
E. Assets or strategies that have
demonstrated significant historical volatility;
F. Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
G. Assets or strategies that result in large
and significant concentrations to sectors, risk
factors, or counterparties;
iv. Establish responsibility for compliance
with the reporting and recordkeeping
requirements of subpart B and § 351.20; and
v. Establish policies for monitoring and
prohibiting potential or actual material
conflicts of interest between the banking
entity and its clients, customers, or
counterparties.
7. Remediation of violations. The banking
entity’s compliance program must be
reasonably designed and established to
effectively monitor and identify for further
analysis any trading activity that may
indicate potential violations of section 13 of
the BHC Act and this part and to prevent
actual violations of section 13 of the BHC Act
and this part. The compliance program must
describe procedures for identifying and
remedying violations of section 13 of the
BHC Act and this part, and must include, at
a minimum, a requirement to promptly
document, address and remedy any violation
of section 13 of the BHC Act or this part, and
document all proposed and actual
remediation efforts. The compliance program
must include specific written policies and
procedures that are reasonably designed to
assess the extent to which any activity
indicates that modification to the banking
entity’s compliance program is warranted
and to ensure that appropriate modifications
are implemented. The written policies and
procedures must provide for prompt
notification to appropriate management,
including senior management and the board
of directors, of any material weakness or
significant deficiencies in the design or
implementation of the compliance program
of the banking entity.
b. Covered Fund Activities or Investments.
A banking entity must establish, maintain
and enforce a compliance program that
includes written policies and procedures that
are appropriate for the types, size,
complexity and risks of the covered fund and
related activities conducted and investments
made, by the banking entity.
1. Identification of covered funds. The
banking entity’s compliance program must
provide a process, which must include
appropriate management review and
independent testing, for identifying and
documenting covered funds that each unit
within the banking entity’s organization
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sponsors or organizes and offers, and covered
funds in which each such unit invests. In
addition to the documentation requirements
for covered funds, as specified under
§ 351.20(e), the documentation must include
information that identifies all pools that the
banking entity sponsors or has an interest in
and the type of exemption from the
Commodity Exchange Act (whether or not
the pool relies on section 4.7 of the
regulations under the Commodity Exchange
Act), and the amount of ownership interest
the banking entity has in those pools.
2. Identification of covered fund activities
and investments. The banking entity’s
compliance program must identify,
document and map each unit within the
organization that is permitted to acquire or
hold an interest in any covered fund or
sponsor any covered fund and map each unit
to the division, business line, or other
organizational structure that will be
responsible for managing and overseeing that
unit’s activities and investments.
3. Explanation of compliance. The banking
entity’s compliance program must explain
how:
i. The banking entity monitors for and
prohibits potential or actual material
conflicts of interest between the banking
entity and its clients, customers, or
counterparties related to its covered fund
activities and investments;
ii. The banking entity monitors for and
prohibits potential or actual transactions or
activities that may threaten the safety and
soundness of the banking entity related to its
covered fund activities and investments; and
iii. The banking entity monitors for and
prohibits potential or actual material
exposure to high-risk assets or high-risk
trading strategies presented by its covered
fund activities and investments, taking into
account potential or actual exposure to:
A. Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
B. Assets whose changes in values cannot
be adequately mitigated by effective hedging;
C. New products with rapid growth,
including those that do not have a market
history;
D. Assets or strategies that include
significant embedded leverage;
E. Assets or strategies that have
demonstrated significant historical volatility;
F. Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
G. Assets or strategies that expose the
banking entity to large and significant
concentrations with respect to sectors, risk
factors, or counterparties;
4. Description and documentation of
covered fund activities and investments. For
each organizational unit engaged in covered
fund activities and investments, the banking
entity’s compliance program must document:
i. The covered fund activities and
investments that the unit is authorized to
conduct;
ii. The banking entity’s plan for actively
seeking unaffiliated investors to ensure that
any investment by the banking entity
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conforms to the limits contained in § 351.12
or registered in compliance with the
securities laws and thereby exempt from
those limits within the time periods allotted
in § 351.12; and
iii. How it complies with the requirements
of subpart C.
5. Internal Controls. A banking entity must
establish, maintain, and enforce internal
controls that are reasonably designed to
ensure that its covered fund activities or
investments comply with the requirements of
section 13 of the BHC Act and this part and
are appropriate given the limits on risk
established by the banking entity. These
written internal controls must be reasonably
designed and established to effectively
monitor and identify for further analysis any
covered fund activity or investment that may
indicate potential violations of section 13 of
the BHC Act or this part. The internal
controls must, at a minimum require:
i. Monitoring and limiting the banking
entity’s individual and aggregate investments
in covered funds;
ii. Monitoring the amount and timing of
seed capital investments for compliance with
the limitations under subpart C (including
but not limited to the redemption, sale or
disposition requirements) of § 351.12, and
the effectiveness of efforts to seek unaffiliated
investors to ensure compliance with those
limits;
iii. Calculating the individual and
aggregate levels of ownership interests in one
or more covered fund required by § 351.12;
iv. Attributing the appropriate instruments
to the individual and aggregate ownership
interest calculations above;
v. Making disclosures to prospective and
actual investors in any covered fund
organized and offered or sponsored by the
banking entity, as provided under
§ 351.11(a)(8);
vi. Monitoring for and preventing any
relationship or transaction between the
banking entity and a covered fund that is
prohibited under § 351.14, including where
the banking entity has been designated as the
sponsor, investment manager, investment
adviser, or commodity trading advisor to a
covered fund by another banking entity; and
vii. Appropriate management review and
supervision across legal entities of the
banking entity to ensure that services and
products provided by all affiliated entities
comply with the limitation on services and
products contained in § 351.14.
6. Remediation of violations. The banking
entity’s compliance program must be
reasonably designed and established to
effectively monitor and identify for further
analysis any covered fund activity or
investment that may indicate potential
violations of section 13 of the BHC Act or
this part and to prevent actual violations of
section 13 of the BHC Act and this part. The
banking entity’s compliance program must
describe procedures for identifying and
remedying violations of section 13 of the
BHC Act and this part, and must include, at
a minimum, a requirement to promptly
document, address and remedy any violation
of section 13 of the BHC Act or this part,
including § 351.21, and document all
proposed and actual remediation efforts. The
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compliance program must include specific
written policies and procedures that are
reasonably designed to assess the extent to
which any activity or investment indicates
that modification to the banking entity’s
compliance program is warranted and to
ensure that appropriate modifications are
implemented. The written policies and
procedures must provide for prompt
notification to appropriate management,
including senior management and the board
of directors, of any material weakness or
significant deficiencies in the design or
implementation of the compliance program
of the banking entity.
III. Responsibility and Accountability for the
Compliance Program
a. A banking entity must establish,
maintain, and enforce a governance and
management framework to manage its
business and employees with a view to
preventing violations of section 13 of the
BHC Act and this part. A banking entity must
have an appropriate management framework
reasonably designed to ensure that:
Appropriate personnel are responsible and
accountable for the effective implementation
and enforcement of the compliance program;
a clear reporting line with a chain of
responsibility is delineated; and the
compliance program is reviewed periodically
by senior management. The board of
directors (or equivalent governance body)
and senior management should have the
appropriate authority and access to personnel
and information within the organizations as
well as appropriate resources to conduct
their oversight activities effectively.
1. Corporate governance. The banking
entity must adopt a written compliance
program approved by the board of directors,
an appropriate committee of the board, or
equivalent governance body, and senior
management.
2. Management procedures. The banking
entity must establish, maintain, and enforce
a governance framework that is reasonably
designed to achieve compliance with section
13 of the BHC Act and this part, which, at
a minimum, provides for:
i. The designation of appropriate senior
management or committee of senior
management with authority to carry out the
management responsibilities of the banking
entity for each trading desk and for each
organizational unit engaged in covered fund
activities;
ii. Written procedures addressing the
management of the activities of the banking
entity that are reasonably designed to achieve
compliance with section 13 of the BHC Act
and this part, including:
A. A description of the management
system, including the titles, qualifications,
and locations of managers and the specific
responsibilities of each person with respect
to the banking entity’s activities governed by
section 13 of the BHC Act and this part; and
B. Procedures for determining
compensation arrangements for traders
engaged in underwriting or market makingrelated activities under § 351.4 or riskmitigating hedging activities under § 351.5 so
that such compensation arrangements are
designed not to reward or incentivize
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prohibited proprietary trading and
appropriately balance risk and financial
results in a manner that does not encourage
employees to expose the banking entity to
excessive or imprudent risk.
3. Business line managers. Managers with
responsibility for one or more trading desks
of the banking entity are accountable for the
effective implementation and enforcement of
the compliance program with respect to the
applicable trading desk(s).
4. Board of directors, or similar corporate
body, and senior management. The board of
directors, or similar corporate body, and
senior management are responsible for
setting and communicating an appropriate
culture of compliance with section 13 of the
BHC Act and this part and ensuring that
appropriate policies regarding the
management of trading activities and covered
fund activities or investments are adopted to
comply with section 13 of the BHC Act and
this part. The board of directors or similar
corporate body (such as a designated
committee of the board or an equivalent
governance body) must ensure that senior
management is fully capable, qualified, and
properly motivated to manage compliance
with this part in light of the organization’s
business activities and the expectations of
the board of directors. The board of directors
or similar corporate body must also ensure
that senior management has established
appropriate incentives and adequate
resources to support compliance with this
part, including the implementation of a
compliance program meeting the
requirements of this appendix into
management goals and compensation
structures across the banking entity.
5. Senior management. Senior management
is responsible for implementing and
enforcing the approved compliance program.
Senior management must also ensure that
effective corrective action is taken when
failures in compliance with section 13 of the
BHC Act and this part are identified. Senior
management and control personnel charged
with overseeing compliance with section 13
of the BHC Act and this part should review
the compliance program for the banking
entity periodically and report to the board, or
an appropriate committee thereof, on the
effectiveness of the compliance program and
compliance matters with a frequency
appropriate to the size, scope, and risk
profile of the banking entity’s trading
activities and covered fund activities or
investments, which shall be at least annually.
6. CEO attestation. Based on a review by
the CEO of the banking entity, the CEO of the
banking entity must, annually, attest in
writing to the FDIC that the banking entity
has in place processes to establish, maintain,
enforce, review, test and modify the
compliance program established under this
Appendix and § 351.20 of this part in a
manner reasonably designed to achieve
compliance with section 13 of the BHC Act
and this part. In the case of a U.S. branch or
agency of a foreign banking entity, the
attestation may be provided for the entire
U.S. operations of the foreign banking entity
by the senior management officer of the
United States operations of the foreign
banking entity who is located in the United
States.
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IV. Independent Testing
a. Independent testing must occur with a
frequency appropriate to the size, scope, and
risk profile of the banking entity’s trading
and covered fund activities or investments,
which shall be at least annually. This
independent testing must include an
evaluation of:
1. The overall adequacy and effectiveness
of the banking entity’s compliance program,
including an analysis of the extent to which
the program contains all the required
elements of this appendix;
2. The effectiveness of the banking entity’s
internal controls, including an analysis and
documentation of instances in which such
internal controls have been breached, and
how such breaches were addressed and
resolved; and
3. The effectiveness of the banking entity’s
management procedures.
b. A banking entity must ensure that
independent testing regarding the
effectiveness of the banking entity’s
compliance program is conducted by a
qualified independent party, such as the
banking entity’s internal audit department,
compliance personnel or risk managers
independent of the organizational unit being
tested, outside auditors, consultants, or other
qualified independent parties. A banking
entity must promptly take appropriate action
to remedy any significant deficiencies or
material weaknesses in its compliance
program and to terminate any violations of
section 13 of the BHC Act or this part.
V. Training
Banking entities must provide adequate
training to personnel and managers of the
banking entity engaged in activities or
investments governed by section 13 of the
BHC Act or this part, as well as other
appropriate supervisory, risk, independent
testing, and audit personnel, in order to
effectively implement and enforce the
compliance program. This training should
occur with a frequency appropriate to the
size and the risk profile of the banking
entity’s trading activities and covered fund
activities or investments.
VI. Recordkeeping
Banking entities must create and retain
records sufficient to demonstrate compliance
and support the operations and effectiveness
of the compliance program. A banking entity
must retain these records for a period that is
no less than 5 years or such longer period as
required by the FDIC in a form that allows
it to promptly produce such records to the
FDIC on request.
COMMODITY FUTURES TRADING
COMMISSION
17 CFR Chapter I
Authority and Issuance
For the reasons stated in the Common
Preamble, the Commodity Futures
Trading Commission amends part 75 to
chapter I of Title 17 Code of Federal
Regulations as follows:
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62201
PART 75—PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS
46. The authority citation for part 75
continues to read as follows:
■
Authority: 12 U.S.C. 1851.
Subpart A—Authority and Definitions
47. Section 75.2 is revised to read as
follows:
■
§ 75.2
Definitions.
Unless otherwise specified, for
purposes of this part:
(a) Affiliate has the same meaning as
in section 2(k) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(k)).
(b) Bank holding company has the
same meaning as in section 2 of the
Bank Holding Company Act of 1956 (12
U.S.C. 1841).
(c) Banking entity. (1) Except as
provided in paragraph (c)(2) of this
section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an
insured depository institution;
(iii) Any company that is treated as a
bank holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any
entity described in paragraph (c)(1)(i),
(ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a
banking entity under paragraph (c)(1)(i),
(ii), or (iii) of this section;
(ii) A portfolio company held under
the authority contained in section
4(k)(4)(H) or (I) of the BHC Act (12
U.S.C. 1843(k)(4)(H), (I)), or any
portfolio concern, as defined under 13
CFR 107.50, that is controlled by a small
business investment company, as
defined in section 103(3) of the Small
Business Investment Act of 1958 (15
U.S.C. 662), so long as the portfolio
company or portfolio concern is not
itself a banking entity under paragraph
(c)(1)(i), (ii), or (iii) of this section; or
(iii) The FDIC acting in its corporate
capacity or as conservator or receiver
under the Federal Deposit Insurance Act
or Title II of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
(d) Board means the Board of
Governors of the Federal Reserve
System.
(e) CFTC means the Commodity
Futures Trading Commission.
(f) Dealer has the same meaning as in
section 3(a)(5) of the Exchange Act (15
U.S.C. 78c(a)(5)).
(g) Depository institution has the same
meaning as in section 3(c) of the Federal
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Deposit Insurance Act (12 U.S.C.
1813(c)).
(h) Derivative. (1) Except as provided
in paragraph (h)(2) of this section,
derivative means:
(i) Any swap, as that term is defined
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)), or
security-based swap, as that term is
defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68));
(ii) Any purchase or sale of a
commodity, that is not an excluded
commodity, for deferred shipment or
delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as
that term is defined in section 1a(24) of
the Commodity Exchange Act (7 U.S.C.
1a(24)) or foreign exchange swap (as
that term is defined in section 1a(25) of
the Commodity Exchange Act (7 U.S.C.
1a(25));
(iv) Any agreement, contract, or
transaction in foreign currency
described in section 2(c)(2)(C)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(C)(i));
(v) Any agreement, contract, or
transaction in a commodity other than
foreign currency described in section
2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under
section 19 of the Commodity Exchange
Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or
other agreement, contract, or transaction
that the CFTC and SEC have further
defined by joint regulation,
interpretation, or other action as not
within the definition of swap, as that
term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C.
1a(47)), or security-based swap, as that
term is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)); or
(ii) Any identified banking product, as
defined in section 402(b) of the Legal
Certainty for Bank Products Act of 2000
(7 U.S.C. 27(b)), that is subject to section
403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the
immediate family of the employee.
(j) Exchange Act means the Securities
Exchange Act of 1934 (15 U.S.C. 78a et
seq.).
(k) Excluded commodity has the same
meaning as in section 1a(19) of the
Commodity Exchange Act (7 U.S.C.
1a(19)).
(l) FDIC means the Federal Deposit
Insurance Corporation.
(m) Federal banking agencies means
the Board, the Office of the Comptroller
of the Currency, and the FDIC.
(n) Foreign banking organization has
the same meaning as in § 211.21(o) of
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the Board’s Regulation K (12 CFR
211.21(o)), but does not include a
foreign bank, as defined in section
1(b)(7) of the International Banking Act
of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the
Commonwealth of Puerto Rico, Guam,
American Samoa, the United States
Virgin Islands, or the Commonwealth of
the Northern Mariana Islands.
(o) Foreign insurance regulator means
the insurance commissioner, or a
similar official or agency, of any country
other than the United States that is
engaged in the supervision of insurance
companies under foreign insurance law.
(p) General account means all of the
assets of an insurance company except
those allocated to one or more separate
accounts.
(q) Insurance company means a
company that is organized as an
insurance company, primarily and
predominantly engaged in writing
insurance or reinsuring risks
underwritten by insurance companies,
subject to supervision as such by a state
insurance regulator or a foreign
insurance regulator, and not operated
for the purpose of evading the
provisions of section 13 of the BHC Act
(12 U.S.C. 1851).
(r) Insured depository institution has
the same meaning as in section 3(c) of
the Federal Deposit Insurance Act (12
U.S.C. 1813(c)), but does not include: (1)
An insured depository institution that is
described in section 2(c)(2)(D) of the
BHC Act (12 U.S.C. 1841(c)(2)(D)); or (2)
An insured depository institution if it
has, and if every company that controls
it has, total consolidated assets of $10
billion or less and total trading assets
and trading liabilities, on a consolidated
basis, that are 5 percent or less of total
consolidated assets.
(s) Limited trading assets and
liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together
with its affiliates and subsidiaries,
trading assets and liabilities (excluding
trading assets and liabilities attributable
to trading activities permitted pursuant
to § 75.6(a)(1) and (2) of subpart B) the
average gross sum of which over the
previous consecutive four quarters, as
measured as of the last day of each of
the four previous calendar quarters, is
less than $1 billion; and
(ii) The CFTC has not determined
pursuant to § 75.20(g) or (h) of this part
that the banking entity should not be
treated as having limited trading assets
and liabilities.
(2) With respect to a banking entity
other than a banking entity described in
paragraph (s)(3) of this section, trading
assets and liabilities for purposes of this
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paragraph (s) means trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 75.6(a)(1) and (2) of subpart B) on a
worldwide consolidated basis.
(3)(i) With respect to a banking entity
that is a foreign banking organization or
a subsidiary of a foreign banking
organization, trading assets and
liabilities for purposes of this paragraph
(s) means the trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 75.6(a)(1) and (2) of subpart B) of the
combined U.S. operations of the top-tier
foreign banking organization (including
all subsidiaries, affiliates, branches, and
agencies of the foreign banking
organization operating, located, or
organized in the United States).
(ii) For purposes of paragraph (s)(3)(i)
of this section, a U.S. branch, agency, or
subsidiary of a banking entity is located
in the United States; however, the
foreign bank that operates or controls
that branch, agency, or subsidiary is not
considered to be located in the United
States solely by virtue of operating or
controlling the U.S. branch, agency, or
subsidiary. For purposes of paragraph
(s)(3)(i) of this section, all foreign
operations of a U.S. agency, branch, or
subsidiary of a foreign banking
organization are considered to be
located in the United States, including
branches outside the United States that
are managed or controlled by a U.S.
branch or agency of the foreign banking
organization, for purposes of calculating
the banking entity’s U.S. trading assets
and liabilities.
(t) Loan means any loan, lease,
extension of credit, or secured or
unsecured receivable that is not a
security or derivative.
(u) Moderate trading assets and
liabilities means, with respect to a
banking entity, that the banking entity
does not have significant trading assets
and liabilities or limited trading assets
and liabilities.
(v) Primary financial regulatory
agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act (12 U.S.C. 5301(12)).
(w) Purchase includes any contract to
buy, purchase, or otherwise acquire. For
security futures products, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a commodity future, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a derivative, purchase
includes the execution, termination
(prior to its scheduled maturity date),
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assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(x) Qualifying foreign banking
organization means a foreign banking
organization that qualifies as such under
§ 211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c), or
(e)).
(y) SEC means the Securities and
Exchange Commission.
(z) Sale and sell each include any
contract to sell or otherwise dispose of.
For security futures products, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a commodity future, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a derivative, such terms
include the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(aa) Security has the meaning
specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(bb) Security-based swap dealer has
the same meaning as in section 3(a)(71)
of the Exchange Act (15 U.S.C.
78c(a)(71)).
(cc) Security future has the meaning
specified in section 3(a)(55) of the
Exchange Act (15 U.S.C. 78c(a)(55)).
(dd) Separate account means an
account established and maintained by
an insurance company in connection
with one or more insurance contracts to
hold assets that are legally segregated
from the insurance company’s other
assets, under which income, gains, and
losses, whether or not realized, from
assets allocated to such account, are, in
accordance with the applicable contract,
credited to or charged against such
account without regard to other income,
gains, or losses of the insurance
company.
(ee) Significant trading assets and
liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together
with its affiliates and subsidiaries,
trading assets and liabilities the average
gross sum of which over the previous
consecutive four quarters, as measured
as of the last day of each of the four
previous calendar quarters, equals or
exceeds $20 billion; or
(ii) The CFTC has determined
pursuant to § 75.20(h) of this part that
the banking entity should be treated as
having significant trading assets and
liabilities.
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(2) With respect to a banking entity,
other than a banking entity described in
paragraph (ee)(3) of this section, trading
assets and liabilities for purposes of this
paragraph (ee) means trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 75.6(a)(1) and (2) of subpart B) on a
worldwide consolidated basis.
(3)(i) With respect to a banking entity
that is a foreign banking organization or
a subsidiary of a foreign banking
organization, trading assets and
liabilities for purposes of this paragraph
(ee) means the trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 75.6(a)(1) and (2) of subpart B) of the
combined U.S. operations of the top-tier
foreign banking organization (including
all subsidiaries, affiliates, branches, and
agencies of the foreign banking
organization operating, located, or
organized in the United States as well
as branches outside the United States
that are managed or controlled by a
branch or agency of the foreign banking
entity operating, located or organized in
the United States).
(ii) For purposes of paragraph
(ee)(3)(i) of this section, a U.S. branch,
agency, or subsidiary of a banking entity
is located in the United States; however,
the foreign bank that operates or
controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary. For
purposes of paragraph (ee)(3)(i) of this
section, all foreign operations of a U.S.
agency, branch, or subsidiary of a
foreign banking organization are
considered to be located in the United
States for purposes of calculating the
banking entity’s U.S. trading assets and
liabilities.
(ff) State means any State, the District
of Columbia, the Commonwealth of
Puerto Rico, Guam, American Samoa,
the United States Virgin Islands, and the
Commonwealth of the Northern Mariana
Islands.
(gg) Subsidiary has the same meaning
as in section 2(d) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(d)).
(hh) State insurance regulator means
the insurance commissioner, or a
similar official or agency, of a State that
is engaged in the supervision of
insurance companies under State
insurance law.
(ii) Swap dealer has the same meaning
as in section 1(a)(49) of the Commodity
Exchange Act (7 U.S.C. 1a(49)).
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62203
Subpart B—Proprietary Trading
48. Section 75.3 is amended by:
a. Revising paragraphs (b), and (d)(3),
(8), and (9);
■ b. Adding paragraphs (d)(10) through
(13);
■ c. Redesignating paragraphs (e)(5)
through (13) as paragraphs (e)(6)
through (14);
■ d. Adding new paragraph (e)(5); and
■ e. Revising paragraph (e)(11), (12), and
(14).
The revisions and additions read as
follows:
■
■
§ 75.3
Prohibition on proprietary trading.
*
*
*
*
*
(b) Definition of trading account. (1)
Trading account. Trading account
means:
(i) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments principally
for the purpose of short-term resale,
benefitting from actual or expected
short-term price movements, realizing
short-term arbitrage profits, or hedging
one or more of the positions resulting
from the purchases or sales of financial
instruments described in this paragraph;
(ii) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments that are both
market risk capital rule covered
positions and trading positions (or
hedges of other market risk capital rule
covered positions), if the banking entity,
or any affiliate with which the banking
entity is consolidated for regulatory
reporting purposes, calculates riskbased capital ratios under the market
risk capital rule; or
(iii) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments, if the
banking entity:
(A) Is licensed or registered, or is
required to be licensed or registered, to
engage in the business of a dealer, swap
dealer, or security-based swap dealer, to
the extent the instrument is purchased
or sold in connection with the activities
that require the banking entity to be
licensed or registered as such; or
(B) Is engaged in the business of a
dealer, swap dealer, or security-based
swap dealer outside of the United
States, to the extent the instrument is
purchased or sold in connection with
the activities of such business.
(2) Trading account application for
certain banking entities. (i) A banking
entity that is subject to paragraph
(b)(1)(ii) of this section in determining
the scope of its trading account is not
subject to paragraph (b)(1)(i) of this
section.
(ii) A banking entity that does not
calculate risk-based capital ratios under
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the market risk capital rule and is not
a consolidated affiliate for regulatory
reporting purposes of a banking entity
that calculates risk based capital ratios
under the market risk capital rule may
elect to apply paragraph (b)(1)(ii) of this
section in determining the scope of its
trading account as if it were subject to
that paragraph. A banking entity that
elects under this subsection to apply
paragraph (b)(1)(ii) of this section in
determining the scope of its trading
account as if it were subject to that
paragraph is not required to apply
paragraph (b)(1)(i) of this section.
(3) Consistency of account election for
certain banking entities. (i) Any election
or change to an election under
paragraph (b)(2)(ii) of this section must
apply to the electing banking entity and
all of its wholly owned subsidiaries.
The primary financial regulatory agency
of a banking entity that is affiliated with
but is not a wholly owned subsidiary of
such electing banking entity may
require that the banking entity be
subject to this uniform application
requirement if the primary financial
regulatory agency determines that it is
necessary to prevent evasion of the
requirements of this part after notice
and opportunity for response as
provided in subpart D of this part.
(ii) A banking entity that does not
elect under paragraph (b)(2)(ii) of this
section to be subject to the trading
account definition in (b)(1)(ii) may
continue to apply the trading account
definition in paragraph (b)(1)(i) of this
section for one year from the date on
which it becomes, or becomes a
consolidated affiliate for regulatory
reporting purposes with, a banking
entity that calculates risk-based capital
ratios under the market risk capital rule.
(4) Rebuttable presumption for certain
purchases and sales. The purchase (or
sale) of a financial instrument by a
banking entity shall be presumed not to
be for the trading account of the banking
entity under paragraph (b)(1)(i) of this
section if the banking entity holds the
financial instrument for sixty days or
longer and does not transfer
substantially all of the risk of the
financial instrument within sixty days
of the purchase (or sale).
*
*
*
*
*
(d) * * *
(3) Any purchase or sale of a security,
foreign exchange forward (as that term
is defined in section 1a(24) of the
Commodity Exchange Act (7 U.S.C.
1a(24)), foreign exchange swap (as that
term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C.
1a(25)), or cross-currency swap by a
banking entity for the purpose of
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liquidity management in accordance
with a documented liquidity
management plan of the banking entity
that:
(i) Specifically contemplates and
authorizes the particular financial
instruments to be used for liquidity
management purposes, the amount,
types, and risks of these financial
instruments that are consistent with
liquidity management, and the liquidity
circumstances in which the particular
financial instruments may or must be
used;
(ii) Requires that any purchase or sale
of financial instruments contemplated
and authorized by the plan be
principally for the purpose of managing
the liquidity of the banking entity, and
not for the purpose of short-term resale,
benefitting from actual or expected
short-term price movements, realizing
short-term arbitrage profits, or hedging a
position taken for such short-term
purposes;
(iii) Requires that any financial
instruments purchased or sold for
liquidity management purposes be
highly liquid and limited to financial
instruments the market, credit, and
other risks of which the banking entity
does not reasonably expect to give rise
to appreciable profits or losses as a
result of short-term price movements;
(iv) Limits any financial instruments
purchased or sold for liquidity
management purposes, together with
any other financial instruments
purchased or sold for such purposes, to
an amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan;
(v) Includes written policies and
procedures, internal controls, analysis,
and independent testing to ensure that
the purchase and sale of financial
instruments that are not permitted
under § 75.6(a) or (b) of this subpart are
for the purpose of liquidity management
and in accordance with the liquidity
management plan described in this
paragraph (d)(3); and
(vi) Is consistent with the CFTC’s
regulatory requirements regarding
liquidity management;
*
*
*
*
*
(8) Any purchase or sale of one or
more financial instruments by a banking
entity through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity that is
established and administered in
accordance with the law of the United
States or a foreign sovereign, if the
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purchase or sale is made directly or
indirectly by the banking entity as
trustee for the benefit of persons who
are or were employees of the banking
entity;
(9) Any purchase or sale of one or
more financial instruments by a banking
entity in the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the financial instrument
as soon as practicable, and in no event
may the banking entity retain such
instrument for longer than such period
permitted by the OCC;
(10) Any purchase or sale of one or
more financial instruments that was
made in error by a banking entity in the
course of conducting a permitted or
excluded activity or is a subsequent
transaction to correct such an error;
(11) Contemporaneously entering into
a customer-driven swap or customerdriven security-based swap and a
matched swap or security-based swap if:
(i) The banking entity retains no more
than minimal price risk; and
(ii) The banking entity is not a
registered dealer, swap dealer, or
security-based swap dealer;
(12) Any purchase or sale of one or
more financial instruments that the
banking entity uses to hedge mortgage
servicing rights or mortgage servicing
assets in accordance with a documented
hedging strategy; or
(13) Any purchase or sale of a
financial instrument that does not meet
the definition of trading asset or trading
liability under the applicable reporting
form for a banking entity as of January
1, 2020.
(e) * * *
(5) Cross-currency swap means a swap
in which one party exchanges with
another party principal and interest rate
payments in one currency for principal
and interest rate payments in another
currency, and the exchange of principal
occurs on the date the swap is entered
into, with a reversal of the exchange of
principal at a later date that is agreed
upon when the swap is entered into.
*
*
*
*
*
(11) Market risk capital rule covered
position and trading position means a
financial instrument that meets the
criteria to be a covered position and a
trading position, as those terms are
respectively defined, without regard to
whether the financial instrument is
reported as a covered position or trading
position on any applicable regulatory
reporting forms:
(i) In the case of a banking entity that
is a bank holding company, savings and
loan holding company, or insured
depository institution, under the market
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risk capital rule that is applicable to the
banking entity; and
(ii) In the case of a banking entity that
is affiliated with a bank holding
company or savings and loan holding
company, other than a banking entity to
which a market risk capital rule is
applicable, under the market risk capital
rule that is applicable to the affiliated
bank holding company or savings and
loan holding company.
(12) Market risk capital rule means
the market risk capital rule that is
contained in 12 CFR part 3, subpart F,
with respect to a banking entity for
which the OCC is the primary financial
regulatory agency, 12 CFR part 217 with
respect to a banking entity for which the
Board is the primary financial
regulatory agency, or 12 CFR part 324
with respect to a banking entity for
which the FDIC is the primary financial
regulatory agency.
*
*
*
*
*
(14) Trading desk means a unit of
organization of a banking entity that
purchases or sells financial instruments
for the trading account of the banking
entity or an affiliate thereof that is:
(i)(A) Structured by the banking entity
to implement a well-defined business
strategy;
(B) Organized to ensure appropriate
setting, monitoring, and management
review of the desk’s trading and hedging
limits, current and potential future loss
exposures, and strategies; and
(C) Characterized by a clearly defined
unit that:
(1) Engages in coordinated trading
activity with a unified approach to its
key elements;
(2) Operates subject to a common and
calibrated set of risk metrics, risk levels,
and joint trading limits;
(3) Submits compliance reports and
other information as a unit for
monitoring by management; and
(4) Books its trades together; or
(ii) For a banking entity that
calculates risk-based capital ratios
under the market risk capital rule, or a
consolidated affiliate for regulatory
reporting purposes of a banking entity
that calculates risk-based capital ratios
under the market risk capital rule,
established by the banking entity or its
affiliate for purposes of market risk
capital calculations under the market
risk capital rule.
■ 49. Section 75.4 is revised to read as
follows:
§ 75.4 Permitted underwriting and market
making-related activities.
(a) Underwriting activities—(1)
Permitted underwriting activities. The
prohibition contained in § 75.3(a) does
not apply to a banking entity’s
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underwriting activities conducted in
accordance with this paragraph (a).
(2) Requirements. The underwriting
activities of a banking entity are
permitted under paragraph (a)(1) of this
section only if:
(i) The banking entity is acting as an
underwriter for a distribution of
securities and the trading desk’s
underwriting position is related to such
distribution;
(ii)(A) The amount and type of the
securities in the trading desk’s
underwriting position are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, taking into account the
liquidity, maturity, and depth of the
market for the relevant types of
securities; and
(B) Reasonable efforts are made to sell
or otherwise reduce the underwriting
position within a reasonable period,
taking into account the liquidity,
maturity, and depth of the market for
the relevant types of securities;
(iii) In the case of a banking entity
with significant trading assets and
liabilities, the banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (a)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The products, instruments or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
(B) Limits for each trading desk, in
accordance with paragraph (a)(2)(ii)(A)
of this section;
(C) Written authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
and
(D) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits.
(iv) A banking entity with significant
trading assets and liabilities may satisfy
the requirements in paragraphs
(a)(2))iii)(B) and (C) of this section by
complying with the requirements set
forth below in paragraph (c) of this
section;
(v) The compensation arrangements of
persons performing the activities
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62205
described in this paragraph (a) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in the activity
described in this paragraph (a) in
accordance with applicable law.
(3) Definition of distribution. For
purposes of this paragraph (a), a
distribution of securities means:
(i) An offering of securities, whether
or not subject to registration under the
Securities Act of 1933, that is
distinguished from ordinary trading
transactions by the presence of special
selling efforts and selling methods; or
(ii) An offering of securities made
pursuant to an effective registration
statement under the Securities Act of
1933.
(4) Definition of underwriter. For
purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an
issuer or selling security holder to:
(A) Purchase securities from the
issuer or selling security holder for
distribution;
(B) Engage in a distribution of
securities for or on behalf of the issuer
or selling security holder; or
(C) Manage a distribution of securities
for or on behalf of the issuer or selling
security holder; or
(ii) A person who has agreed to
participate or is participating in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.
(5) Definition of selling security
holder. For purposes of this paragraph
(a), selling security holder means any
person, other than an issuer, on whose
behalf a distribution is made.
(6) Definition of underwriting
position. For purposes of this section,
underwriting position means the long or
short positions in one or more securities
held by a banking entity or its affiliate,
and managed by a particular trading
desk, in connection with a particular
distribution of securities for which such
banking entity or affiliate is acting as an
underwriter.
(7) Definition of client, customer, and
counterparty. For purposes of this
paragraph (a), the terms client,
customer, and counterparty, on a
collective or individual basis, refer to
market participants that may transact
with the banking entity in connection
with a particular distribution for which
the banking entity is acting as
underwriter.
(b) Market making-related activities—
(1) Permitted market making-related
activities. The prohibition contained in
§ 75.3(a) does not apply to a banking
entity’s market making-related activities
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conducted in accordance with this
paragraph (b).
(2) Requirements. The market makingrelated activities of a banking entity are
permitted under paragraph (b)(1) of this
section only if:
(i) The trading desk that establishes
and manages the financial exposure,
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure, and is willing and available to
quote, purchase and sell, or otherwise
enter into long and short positions in
those types of financial instruments for
its own account, in commercially
reasonable amounts and throughout
market cycles on a basis appropriate for
the liquidity, maturity, and depth of the
market for the relevant types of financial
instruments;
(ii) The trading desk’s market-making
related activities are designed not to
exceed, on an ongoing basis, the
reasonably expected near term demands
of clients, customers, or counterparties,
taking into account the liquidity,
maturity, and depth of the market for
the relevant types of financial
instruments;
(iii) In the case of a banking entity
with significant trading assets and
liabilities, the banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (b)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The financial instruments each
trading desk stands ready to purchase
and sell in accordance with paragraph
(b)(2)(i) of this section;
(B) The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the limits
required under paragraph (b)(2)(iii)(C) of
this section; the products, instruments,
and exposures each trading desk may
use for risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and
positions; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
desk to mitigate these risks are and
continue to be effective;
(C) Limits for each trading desk, in
accordance with paragraph (b)(2)(ii) of
this section;
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(D) Written authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
and
(E) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits.
(iv) A banking entity with significant
trading assets and liabilities may satisfy
the requirements in paragraphs
(b)(2)(iii)(C) and (D) of this section by
complying with the requirements set
forth below in paragraph (c) of this
section;
(v) The compensation arrangements of
persons performing the activities
described in this paragraph (b) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in activity
described in this paragraph (b) in
accordance with applicable law.
(3) Definition of client, customer, and
counterparty. For purposes of paragraph
(b) of this section, the terms client,
customer, and counterparty, on a
collective or individual basis refer to
market participants that make use of the
banking entity’s market making-related
services by obtaining such services,
responding to quotations, or entering
into a continuing relationship with
respect to such services, provided that:
(i) A trading desk or other
organizational unit of another banking
entity is not a client, customer, or
counterparty of the trading desk if that
other entity has trading assets and
liabilities of $50 billion or more as
measured in accordance with the
methodology described in § 75.2(ee) of
this part, unless:
(A) The trading desk documents how
and why a particular trading desk or
other organizational unit of the entity
should be treated as a client, customer,
or counterparty of the trading desk for
purposes of paragraph (b)(2) of this
section; or
(B) The purchase or sale by the
trading desk is conducted anonymously
on an exchange or similar trading
facility that permits trading on behalf of
a broad range of market participants.
(ii) [Reserved]
(4) Definition of financial exposure.
For purposes of this section, financial
exposure means the aggregate risks of
one or more financial instruments and
any associated loans, commodities, or
foreign exchange or currency, held by a
banking entity or its affiliate and
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managed by a particular trading desk as
part of the trading desk’s market
making-related activities.
(5) Definition of market-maker
positions. For the purposes of this
section, market-maker positions means
all of the positions in the financial
instruments for which the trading desk
stands ready to make a market in
accordance with paragraph (b)(2)(i) of
this section, that are managed by the
trading desk, including the trading
desk’s open positions or exposures
arising from open transactions.
(c) Rebuttable presumption of
compliance—(1) Internal limits. (i) A
banking entity shall be presumed to
meet the requirement in paragraph
(a)(2)(ii)(A) or (b)(2)(ii) of this section
with respect to the purchase or sale of
a financial instrument if the banking
entity has established and implements,
maintains, and enforces the internal
limits for the relevant trading desk as
described in paragraph (c)(1)(ii) of this
section.
(ii)(A) With respect to underwriting
activities conducted pursuant to
paragraph (a) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall be available
to each trading desk that establishes,
implements, maintains, and enforces
internal limits that should take into
account the liquidity, maturity, and
depth of the market for the relevant
types of securities and are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, based on the nature and
amount of the trading desk’s
underwriting activities, on the:
(1) Amount, types, and risk of its
underwriting position;
(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held.
(B) With respect to market makingrelated activities conducted pursuant to
paragraph (b) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall be available
to each trading desk that establishes,
implements, maintains, and enforces
internal limits that should take into
account the liquidity, maturity, and
depth of the market for the relevant
types of financial instruments and are
designed not to exceed the reasonably
expected near term demands of clients,
customers, or counterparties, based on
the nature and amount of the trading
desk’s market-making related activities,
that address the:
(1) Amount, types, and risks of its
market-maker positions;
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(2) Amount, types, and risks of the
products, instruments, and exposures
the trading desk may use for risk
management purposes;
(3) Level of exposures to relevant risk
factors arising from its financial
exposure; and
(4) Period of time a financial
instrument may be held.
(2) Supervisory review and oversight.
The limits described in paragraph (c)(1)
of this section shall be subject to
supervisory review and oversight by the
CFTC on an ongoing basis.
(3) Limit Breaches and Increases. (i)
With respect to any limit set pursuant
to paragraph (c)(1)(ii)(A) or (B) of this
section, a banking entity shall maintain
and make available to the CFTC upon
request records regarding:
(A) Any limit that is exceeded; and
(B) Any temporary or permanent
increase to any limit(s), in each case in
the form and manner as directed by the
CFTC.
(ii) In the event of a breach or increase
of any limit set pursuant to paragraph
(c)(1)(ii)(A) or (B) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall continue to
be available only if the banking entity:
(A) Takes action as promptly as
possible after a breach to bring the
trading desk into compliance; and
(B) Follows established written
authorization procedures, including
escalation procedures that require
review and approval of any trade that
exceeds a trading desk’s limit(s),
demonstrable analysis of the basis for
any temporary or permanent increase to
a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval.
(4) Rebutting the presumption. The
presumption in paragraph (c)(1)(i) of
this section may be rebutted by the
CFTC if the CFTC determines, taking
into account the liquidity, maturity, and
depth of the market for the relevant
types of financial instruments and based
on all relevant facts and circumstances,
that a trading desk is engaging in
activity that is not based on the
reasonably expected near term demands
of clients, customers, or counterparties.
The CFTC’s rebuttal of the presumption
in paragraph (c)(1)(i) of this section
must be made in accordance with the
notice and response procedures in
subpart D of this part.
■ 50. Section 75.5 is amended by
revising paragraphs (b) and (c)(1)
introductory text and adding paragraph
(c)(4) to read as follows:
§ 75.5 Permitted risk-mitigating hedging
activities.
*
*
*
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*
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(b) Requirements. (1) The riskmitigating hedging activities of a
banking entity that has significant
trading assets and liabilities are
permitted under paragraph (a) of this
section only if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures regarding the
positions, techniques and strategies that
may be used for hedging, including
documentation indicating what
positions, contracts or other holdings a
particular trading desk may use in its
risk-mitigating hedging activities, as
well as position and aging limits with
respect to such positions, contracts or
other holdings;
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(C) The conduct of analysis and
independent testing designed to ensure
that the positions, techniques and
strategies that may be used for hedging
may reasonably be expected to reduce or
otherwise significantly mitigate the
specific, identifiable risk(s) being
hedged;
(ii) The risk-mitigating hedging
activity:
(A) Is conducted in accordance with
the written policies, procedures, and
internal controls required under this
section;
(B) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks, including
market risk, counterparty or other credit
risk, currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section;
(D) Is subject to continuing review,
monitoring and management by the
banking entity that:
(1) Is consistent with the written
hedging policies and procedures
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required under paragraph (b)(1)(i) of this
section;
(2) Is designed to reduce or otherwise
significantly mitigate the specific,
identifiable risks that develop over time
from the risk-mitigating hedging
activities undertaken under this section
and the underlying positions, contracts,
and other holdings of the banking
entity, based upon the facts and
circumstances of the underlying and
hedging positions, contracts and other
holdings of the banking entity and the
risks and liquidity thereof; and
(3) Requires ongoing recalibration of
the hedging activity by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(1)(ii) of this section and is
not prohibited proprietary trading; and
(iii) The compensation arrangements
of persons performing risk-mitigating
hedging activities are designed not to
reward or incentivize prohibited
proprietary trading.
(2) The risk-mitigating hedging
activities of a banking entity that does
not have significant trading assets and
liabilities are permitted under paragraph
(a) of this section only if the riskmitigating hedging activity:
(i) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks, including
market risk, counterparty or other credit
risk, currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to
ongoing recalibration by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(2) of this section and is
not prohibited proprietary trading.
(c) * * *
(1) A banking entity that has
significant trading assets and liabilities
must comply with the requirements of
paragraphs (c)(2) and (3) of this section,
unless the requirements of paragraph
(c)(4) of this section are met, with
respect to any purchase or sale of
financial instruments made in reliance
on this section for risk-mitigating
hedging purposes that is:
*
*
*
*
*
(4) The requirements of paragraphs
(c)(2) and (3) of this section do not
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apply to the purchase or sale of a
financial instrument described in
paragraph (c)(1) of this section if:
(i) The financial instrument
purchased or sold is identified on a
written list of pre-approved financial
instruments that are commonly used by
the trading desk for the specific type of
hedging activity for which the financial
instrument is being purchased or sold;
and
(ii) At the time the financial
instrument is purchased or sold, the
hedging activity (including the purchase
or sale of the financial instrument)
complies with written, pre-approved
limits for the trading desk purchasing or
selling the financial instrument for
hedging activities undertaken for one or
more other trading desks. The limits
shall be appropriate for the:
(A) Size, types, and risks of the
hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased
and sold for hedging activities by the
trading desk; and
(C) Levels and duration of the risk
exposures being hedged.
51. Section 75.6 is amended by
revising paragraph (e)(3); removing
paragraphs (e)(4) and (6); and
redesignating paragraph (e)(5) as
paragraph (e)(4).
The revision reads as follows:
■
§ 75.6 Other permitted proprietary trading
activities.
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*
*
*
*
*
(e) * * *
(3) A purchase or sale by a banking
entity is permitted for purposes of this
paragraph (e) if:
(i) The banking entity engaging as
principal in the purchase or sale
(including relevant personnel) is not
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State; and
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State.
*
*
*
*
*
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Subpart C—Covered Funds Activities
and Investments
52. Section 75.10 is amended by
revising paragraphs (c)(7)(ii) and
(c)(8)(i)(A) to read as follows:
■
§ 75.10 Prohibition on Acquiring or
Retaining an Ownership Interest in and
Having Certain Relationships with a
Covered Fund
*
*
*
*
*
(c) * * *
(7) * * *
(ii) Participates in the profits and
losses of the separate account other than
in compliance with applicable
requirements regarding bank owned life
insurance.
(8) * * *
(i) * * *
(A) Loans as defined in § 75.2(t) of
subpart A;
*
*
*
*
*
■ 53. Section 75.11 is amended by
revising paragraph (c) to read as follows:
§ 75.11 Permitted organizing and offering,
underwriting, and market making with
respect to a covered fund.
*
*
*
*
*
(c) Underwriting and market making
in ownership interests of a covered
fund. The prohibition contained in
§ 75.10(a) of this subpart does not apply
to a banking entity’s underwriting
activities or market making-related
activities involving a covered fund so
long as:
(1) Those activities are conducted in
accordance with the requirements of
§ 75.4(a) or (b) of subpart B,
respectively; and
(2) With respect to any banking entity
(or any affiliate thereof) that: Acts as a
sponsor, investment adviser or
commodity trading advisor to a
particular covered fund or otherwise
acquires and retains an ownership
interest in such covered fund in reliance
on paragraph (a) of this section; or
acquires and retains an ownership
interest in such covered fund and is
either a securitizer, as that term is used
in section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)), or is acquiring
and retaining an ownership interest in
such covered fund in compliance with
section 15G of that Act (15 U.S.C. 78o–
11) and the implementing regulations
issued thereunder each as permitted by
paragraph (b) of this section, then in
each such case any ownership interests
acquired or retained by the banking
entity and its affiliates in connection
with underwriting and market making
related activities for that particular
covered fund are included in the
calculation of ownership interests
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permitted to be held by the banking
entity and its affiliates under the
limitations of § 75.12(a)(2)(ii);
§ 75.12(a)(2)(iii), and § 75.12(d) of this
subpart.
■ 54. Section 75.13 is amended by
revising paragraphs (a), (b)(3) and (4),
and (c) to read as follows:
§ 75.13 Other permitted covered fund
activities and investments.
(a) Permitted risk-mitigating hedging
activities. (1) The prohibition contained
in § 75.10(a) of this subpart does not
apply with respect to an ownership
interest in a covered fund acquired or
retained by a banking entity that is
designed to reduce or otherwise
significantly mitigate the specific,
identifiable risks to the banking entity
in connection with:
(i) A compensation arrangement with
an employee of the banking entity or an
affiliate thereof that directly provides
investment advisory, commodity trading
advisory or other services to the covered
fund; or
(ii) A position taken by the banking
entity when acting as intermediary on
behalf of a customer that is not itself a
banking entity to facilitate the exposure
by the customer to the profits and losses
of the covered fund.
(2) The risk-mitigating hedging
activities of a banking entity are
permitted under this paragraph (a) only
if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program in
accordance with subpart D of this part
that is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures; and
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(ii) The acquisition or retention of the
ownership interest:
(A) Is made in accordance with the
written policies, procedures, and
internal controls required under this
section;
(B) At the inception of the hedge, is
designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks arising:
(1) Out of a transaction conducted
solely to accommodate a specific
customer request with respect to the
covered fund; or
(2) In connection with the
compensation arrangement with the
employee that directly provides
investment advisory, commodity trading
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advisory, or other services to the
covered fund;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section; and
(D) Is subject to continuing review,
monitoring and management by the
banking entity.
(iii) With respect to risk-mitigating
hedging activity conducted pursuant to
paragraph (a)(1)(i) of this section, the
compensation arrangement relates
solely to the covered fund in which the
banking entity or any affiliate has
acquired an ownership interest pursuant
to paragraph (a)(1)(i) and such
compensation arrangement provides
that any losses incurred by the banking
entity on such ownership interest will
be offset by corresponding decreases in
amounts payable under such
compensation arrangement.
(b) * * *
(3) An ownership interest in a covered
fund is not offered for sale or sold to a
resident of the United States for
purposes of paragraph (b)(1)(iii) of this
section only if it is not sold and has not
been sold pursuant to an offering that
targets residents of the United States in
which the banking entity or any affiliate
of the banking entity participates. If the
banking entity or an affiliate sponsors or
serves, directly or indirectly, as the
investment manager, investment
adviser, commodity pool operator or
commodity trading advisor to a covered
fund, then the banking entity or affiliate
will be deemed for purposes of this
paragraph (b)(3) to participate in any
offer or sale by the covered fund of
ownership interests in the covered fund.
(4) An activity or investment occurs
solely outside of the United States for
purposes of paragraph (b)(1)(iv) of this
section only if:
(i) The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
and is not controlled directly or
indirectly by, a banking entity that is
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
laws of the United States or of any State;
and
(iii) The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
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18:12 Nov 13, 2019
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as principal directly or indirectly on a
consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State.
*
*
*
*
*
(c) Permitted covered fund interests
and activities by a regulated insurance
company. The prohibition contained in
§ 75.10(a) of this subpart does not apply
to the acquisition or retention by an
insurance company, or an affiliate
thereof, of any ownership interest in, or
the sponsorship of, a covered fund only
if:
(1) The insurance company or its
affiliate acquires and retains the
ownership interest solely for the general
account of the insurance company or for
one or more separate accounts
established by the insurance company;
(2) The acquisition and retention of
the ownership interest is conducted in
compliance with, and subject to, the
insurance company investment laws
and regulations of the State or
jurisdiction in which such insurance
company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law or
regulation described in paragraph (c)(2)
of this section is insufficient to protect
the safety and soundness of the banking
entity, or the financial stability of the
United States.
■ 55. Section 75.14 is amended by
revising paragraph (a)(2)(ii)(B) to read as
follows:
§ 75.14 Limitations on relationships with a
covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or
equivalent officer) of the banking entity
certifies in writing annually no later
than March 31 to the CFTC (with a duty
to update the certification if the
information in the certification
materially changes) that the banking
entity does not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests; and
*
*
*
*
*
Subpart D—Compliance Program
Requirement; Violations
56. Section 75.20 is amended by
revising paragraphs (a), (b) introductory
■
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62209
text, (c), (d), (e) introductory text, and
(f)(2) and adding paragraphs (g), (h), and
(i) to read as follows:
§ 75.20
Program for compliance; reporting.
(a) Program requirement. Each
banking entity (other than a banking
entity with limited trading assets and
liabilities) shall develop and provide for
the continued administration of a
compliance program reasonably
designed to ensure and monitor
compliance with the prohibitions and
restrictions on proprietary trading and
covered fund activities and investments
set forth in section 13 of the BHC Act
and this part. The terms, scope, and
detail of the compliance program shall
be appropriate for the types, size, scope,
and complexity of activities and
business structure of the banking entity.
(b) Banking entities with significant
trading assets and liabilities. With
respect to a banking entity with
significant trading assets and liabilities,
the compliance program required by
paragraph (a) of this section, at a
minimum, shall include:
*
*
*
*
*
(c) CEO attestation. The CEO of a
banking entity that has significant
trading assets and liabilities must, based
on a review by the CEO of the banking
entity, attest in writing to the CFTC,
each year no later than March 31, that
the banking entity has in place
processes to establish, maintain,
enforce, review, test and modify the
compliance program required by
paragraph (b) of this section in a manner
reasonably designed to achieve
compliance with section 13 of the BHC
Act and this part. In the case of a U.S.
branch or agency of a foreign banking
entity, the attestation may be provided
for the entire U.S. operations of the
foreign banking entity by the senior
management officer of the U.S.
operations of the foreign banking entity
who is located in the United States.
(d) Reporting requirements under
appendix A to this part. (1) A banking
entity engaged in proprietary trading
activity permitted under subpart B of
this part shall comply with the reporting
requirements described in appendix A
to this part, if:
(i) The banking entity has significant
trading assets and liabilities; or
(ii) The CFTC notifies the banking
entity in writing that it must satisfy the
reporting requirements contained in
appendix A to this part.
(2) Frequency of reporting: Unless the
CFTC notifies the banking entity in
writing that it must report on a different
basis, a banking entity subject to
appendix A to this part shall report the
information required by appendix A for
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each quarter within 30 days of the end
of the quarter.
(e) Additional documentation for
covered funds. A banking entity with
significant trading assets and liabilities
shall maintain records that include:
*
*
*
*
*
(f) * * *
(2) Banking entities with moderate
trading assets and liabilities. A banking
entity with moderate trading assets and
liabilities may satisfy the requirements
of this section by including in its
existing compliance policies and
procedures appropriate references to the
requirements of section 13 of the BHC
Act and this part and adjustments as
appropriate given the activities, size,
scope, and complexity of the banking
entity.
(g) Rebuttable presumption of
compliance for banking entities with
limited trading assets and liabilities—
(1) Rebuttable presumption. Except as
otherwise provided in this paragraph, a
banking entity with limited trading
assets and liabilities shall be presumed
to be compliant with subpart B and
subpart C of this part and shall have no
obligation to demonstrate compliance
with this part on an ongoing basis.
(2) Rebuttal of presumption. If upon
examination or audit, the CFTC
determines that the banking entity has
engaged in proprietary trading or
covered fund activities that are
otherwise prohibited under subpart B or
subpart C of this part, the CFTC may
require the banking entity to be treated
under this part as if it did not have
limited trading assets and liabilities.
The CFTC’s rebuttal of the presumption
in this paragraph must be made in
accordance with the notice and
response procedures in paragraph (i) of
this section.
(h) Reservation of authority.
Notwithstanding any other provision of
this part, the CFTC retains its authority
to require a banking entity without
significant trading assets and liabilities
to apply any requirements of this part
that would otherwise apply if the
banking entity had significant or
moderate trading assets and liabilities if
the CFTC determines that the size or
complexity of the banking entity’s
trading or investment activities, or the
risk of evasion of subpart B or subpart
C, of this part does not warrant a
presumption of compliance under
paragraph (g) of this section or treatment
as a banking entity with moderate
trading assets and liabilities, as
applicable. The CFTC’s exercise of this
reservation of authority must be made in
accordance with the notice and
response procedures in paragraph (i) of
this section.
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(i) Notice and response procedures—
(1) Notice. The CFTC will notify the
banking entity in writing of any
determination requiring notice under
this part and will provide an
explanation of the determination.
(2) Response. The banking entity may
respond to any or all items in the notice
described in paragraph (i)(1) of this
section. The response should include
any matters that the banking entity
would have the CFTC consider in
deciding whether to make the
determination. The response must be in
writing and delivered to the designated
CFTC official within 30 days after the
date on which the banking entity
received the notice. The CFTC may
shorten the time period when, in the
opinion of the CFTC, the activities or
condition of the banking entity so
requires, provided that the banking
entity is informed of the time period at
the time of notice, or with the consent
of the banking entity. In its discretion,
the CFTC may extend the time period
for good cause.
(3) Waiver. Failure to respond within
30 days or such other time period as
may be specified by the CFTC shall
constitute a waiver of any objections to
the CFTC’s determination.
(4) Decision. The CFTC will notify the
banking entity of the decision in
writing. The notice will include an
explanation of the decision.
■ 57. Revise appendix A to part 75 to
read as follows:
Appendix A to Part 75—Reporting and
Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and
recordkeeping requirements that certain
banking entities must satisfy in connection
with the restrictions on proprietary trading
set forth in subpart B (‘‘proprietary trading
restrictions’’). Pursuant to § 75.20(d), this
appendix applies to a banking entity that,
together with its affiliates and subsidiaries,
has significant trading assets and liabilities.
These entities are required to (i) furnish
periodic reports to the CFTC regarding a
variety of quantitative measurements of their
covered trading activities, which vary
depending on the scope and size of covered
trading activities, and (ii) create and maintain
records documenting the preparation and
content of these reports. The requirements of
this appendix must be incorporated into the
banking entity’s internal compliance program
under § 75.20.
b. The purpose of this appendix is to assist
banking entities and the CFTC in:
(1) Better understanding and evaluating the
scope, type, and profile of the banking
entity’s covered trading activities;
(2) Monitoring the banking entity’s covered
trading activities;
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(3) Identifying covered trading activities
that warrant further review or examination
by the banking entity to verify compliance
with the proprietary trading restrictions;
(4) Evaluating whether the covered trading
activities of trading desks engaged in market
making-related activities subject to § 75.4(b)
are consistent with the requirements
governing permitted market making-related
activities;
(5) Evaluating whether the covered trading
activities of trading desks that are engaged in
permitted trading activity subject to § 75.4,
75.5, or 75.6(a) and (b) (i.e., underwriting and
market making-related activity, riskmitigating hedging, or trading in certain
government obligations) are consistent with
the requirement that such activity not result,
directly or indirectly, in a material exposure
to high-risk assets or high-risk trading
strategies;
(6) Identifying the profile of particular
covered trading activities of the banking
entity, and the individual trading desks of
the banking entity, to help establish the
appropriate frequency and scope of
examination by CFTC of such activities; and
(7) Assessing and addressing the risks
associated with the banking entity’s covered
trading activities.
c. Information that must be furnished
pursuant to this appendix is not intended to
serve as a dispositive tool for the
identification of permissible or
impermissible activities.
d. In addition to the quantitative
measurements required in this appendix, a
banking entity may need to develop and
implement other quantitative measurements
in order to effectively monitor its covered
trading activities for compliance with section
13 of the BHC Act and this part and to have
an effective compliance program, as required
by § 75.20. The effectiveness of particular
quantitative measurements may differ based
on the profile of the banking entity’s
businesses in general and, more specifically,
of the particular trading desk, including
types of instruments traded, trading activities
and strategies, and history and experience
(e.g., whether the trading desk is an
established, successful market maker or a
new entrant to a competitive market). In all
cases, banking entities must ensure that they
have robust measures in place to identify and
monitor the risks taken in their trading
activities, to ensure that the activities are
within risk tolerances established by the
banking entity, and to monitor and examine
for compliance with the proprietary trading
restrictions in this part.
e. On an ongoing basis, banking entities
must carefully monitor, review, and evaluate
all furnished quantitative measurements, as
well as any others that they choose to utilize
in order to maintain compliance with section
13 of the BHC Act and this part. All
measurement results that indicate a
heightened risk of impermissible proprietary
trading, including with respect to otherwisepermitted activities under §§ 75.4 through
75.6(a) and (b), or that result in a material
exposure to high-risk assets or high-risk
trading strategies, must be escalated within
the banking entity for review, further
analysis, explanation to CFTC, and
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remediation, where appropriate. The
quantitative measurements discussed in this
appendix should be helpful to banking
entities in identifying and managing the risks
related to their covered trading activities.
II. Definitions
The terms used in this appendix have the
same meanings as set forth in §§ 75.2 and
75.3. In addition, for purposes of this
appendix, the following definitions apply:
Applicability identifies the trading desks
for which a banking entity is required to
calculate and report a particular quantitative
measurement based on the type of covered
trading activity conducted by the trading
desk.
Calculation period means the period of
time for which a particular quantitative
measurement must be calculated.
Comprehensive profit and loss means the
net profit or loss of a trading desk’s material
sources of trading revenue over a specific
period of time, including, for example, any
increase or decrease in the market value of
a trading desk’s holdings, dividend income,
and interest income and expense.
Covered trading activity means trading
conducted by a trading desk under § 75.4,
§ 75.5, § 75.6(a), or § 75.6(b). A banking entity
may include in its covered trading activity
trading conducted under § 75.3(d), § 75.6(c),
§ 75.6(d) or § 75.6(e).
Measurement frequency means the
frequency with which a particular
quantitative metric must be calculated and
recorded.
Trading day means a calendar day on
which a trading desk is open for trading.
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III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each
banking entity made subject to this appendix
by § 75.20 must furnish the following
quantitative measurements, as applicable, for
each trading desk of the banking entity
engaged in covered trading activities and
calculate these quantitative measurements in
accordance with this appendix:
i. Internal Limits and Usage;
ii. Value-at-Risk;
iii. Comprehensive Profit and Loss
Attribution;
iv. Positions; and
v. Transaction Volumes.
2. Trading desk information. Each banking
entity made subject to this appendix by
§ 75.20 must provide certain descriptive
information, as further described in this
appendix, regarding each trading desk
engaged in covered trading activities.
3. Quantitative measurements identifying
information. Each banking entity made
subject to this appendix by § 75.20 must
provide certain identifying and descriptive
information, as further described in this
appendix, regarding its quantitative
measurements.
4. Narrative statement. Each banking entity
made subject to this appendix by § 75.20 may
provide an optional narrative statement, as
further described in this appendix.
5. File identifying information. Each
banking entity made subject to this appendix
by § 75.20 must provide file identifying
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information in each submission to the CFTC
pursuant to this appendix, including the
name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the
Board, and identification of the reporting
period and creation date and time.
b. Trading Desk Information
1. Each banking entity must provide
descriptive information regarding each
trading desk engaged in covered trading
activities, including:
i. Name of the trading desk used internally
by the banking entity and a unique
identification label for the trading desk;
ii. Identification of each type of covered
trading activity in which the trading desk is
engaged;
iii. Brief description of the general strategy
of the trading desk;
v. A list identifying each Agency receiving
the submission of the trading desk;
2. Indication of whether each calendar date
is a trading day or not a trading day for the
trading desk; and
3. Currency reported and daily currency
conversion rate.
c. Quantitative Measurements Identifying
Information
Each banking entity must provide the
following information regarding the
quantitative measurements:
1. An Internal Limits Information Schedule
that provides identifying and descriptive
information for each limit reported pursuant
to the Internal Limits and Usage quantitative
measurement, including the name of the
limit, a unique identification label for the
limit, a description of the limit, the unit of
measurement for the limit, the type of limit,
and identification of the corresponding risk
factor attribution in the particular case that
the limit type is a limit on a risk factor
sensitivity and profit and loss attribution to
the same risk factor is reported; and
2. A Risk Factor Attribution Information
Schedule that provides identifying and
descriptive information for each risk factor
attribution reported pursuant to the
Comprehensive Profit and Loss Attribution
quantitative measurement, including the
name of the risk factor or other factor, a
unique identification label for the risk factor
or other factor, a description of the risk factor
or other factor, and the risk factor or other
factor’s change unit.
d. Narrative Statement
Each banking entity made subject to this
appendix by § 75.20 may submit in a separate
electronic document a Narrative Statement to
the CFTC with any information the banking
entity views as relevant for assessing the
information reported. The Narrative
Statement may include further description of
or changes to calculation methods,
identification of material events, description
of and reasons for changes in the banking
entity’s trading desk structure or trading desk
strategies, and when any such changes
occurred.
e. Frequency and Method of Required
Calculation and Reporting
A banking entity must calculate any
applicable quantitative measurement for each
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trading day. A banking entity must report the
Trading Desk Information, the Quantitative
Measurements Identifying Information, and
each applicable quantitative measurement
electronically to the CFTC on the reporting
schedule established in § 75.20 unless
otherwise requested by the CFTC. A banking
entity must report the Trading Desk
Information, the Quantitative Measurements
Identifying Information, and each applicable
quantitative measurement to the CFTC in
accordance with the XML Schema specified
and published on the CFTC’s website.
f. Recordkeeping
A banking entity must, for any quantitative
measurement furnished to the CFTC
pursuant to this appendix and § 75.20(d),
create and maintain records documenting the
preparation and content of these reports, as
well as such information as is necessary to
permit the CFTC to verify the accuracy of
such reports, for a period of five years from
the end of the calendar year for which the
measurement was taken. A banking entity
must retain the Narrative Statement, the
Trading Desk Information, and the
Quantitative Measurements Identifying
Information for a period of five years from
the end of the calendar year for which the
information was reported to the CFTC.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Internal Limits and Usage
i. Description: For purposes of this
appendix, Internal Limits are the constraints
that define the amount of risk and the
positions that a trading desk is permitted to
take at a point in time, as defined by the
banking entity for a specific trading desk.
Usage represents the value of the trading
desk’s risk or positions that are accounted for
by the current activity of the desk. Internal
limits and their usage are key compliance
and risk management tools used to control
and monitor risk taking and include, but are
not limited to, the limits set out in §§ 75.4
and 75.5. A trading desk’s risk limits,
commonly including a limit on ‘‘Value-atRisk,’’ are useful in the broader context of the
trading desk’s overall activities, particularly
for the market making activities under
§ 75.4(b) and hedging activity under § 75.5.
Accordingly, the limits required under
§§ 75.4(b)(2)(iii)(C) and 75.5(b)(1)(i)(A) must
meet the applicable requirements under
§§ 75.4(b)(2)(iii)(C) and 75.5(b)(1)(i)(A) and
also must include appropriate metrics for the
trading desk limits including, at a minimum,
‘‘Value-at-Risk’’ except to the extent the
‘‘Value-at-Risk’’ metric is demonstrably
ineffective for measuring and monitoring the
risks of a trading desk based on the types of
positions traded by, and risk exposures of,
that desk.
A. A banking entity must provide the
following information for each limit reported
pursuant to this quantitative measurement:
The unique identification label for the limit
reported in the Internal Limits Information
Schedule, the limit size (distinguishing
between an upper and a lower limit), and the
value of usage of the limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
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iv. Applicability: All trading desks engaged
in covered trading activities.
2. Value-at-Risk
i. Description: For purposes of this
appendix, Value-at-Risk (‘‘VaR’’) is the
measurement of the risk of future financial
loss in the value of a trading desk’s
aggregated positions at the ninety-nine
percent confidence level over a one-day
period, based on current market conditions.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this
appendix, Comprehensive Profit and Loss
Attribution is an analysis that attributes the
daily fluctuation in the value of a trading
desk’s positions to various sources. First, the
daily profit and loss of the aggregated
positions is divided into two categories: (i)
Profit and loss attributable to a trading desk’s
existing positions that were also positions
held by the trading desk as of the end of the
prior day (‘‘existing positions’’); and (ii)
profit and loss attributable to new positions
resulting from the current day’s trading
activity (‘‘new positions’’).
A. The comprehensive profit and loss
associated with existing positions must
reflect changes in the value of these positions
on the applicable day. The comprehensive
profit and loss from existing positions must
be further attributed, as applicable, to (i)
changes in the specific risk factors and other
factors that are monitored and managed as
part of the trading desk’s overall risk
management policies and procedures; and (ii)
any other applicable elements, such as cash
flows, carry, changes in reserves, and the
correction, cancellation, or exercise of a
trade.
B. For the attribution of comprehensive
profit and loss from existing positions to
specific risk factors and other factors, a
banking entity must provide the following
information for the factors that explain the
preponderance of the profit or loss changes
due to risk factor changes: The unique
identification label for the risk factor or other
factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss
due to the risk factor or other factor change.
C. The comprehensive profit and loss
attributed to new positions must reflect
commissions and fee income or expense and
market gains or losses associated with
transactions executed on the applicable day.
New positions include purchases and sales of
financial instruments and other assets/
liabilities and negotiated amendments to
existing positions. The comprehensive profit
and loss from new positions may be reported
in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and
loss from existing positions that is not
attributed to changes in specific risk factors
and other factors must be allocated to a
residual category. Significant unexplained
profit and loss must be escalated for further
investigation and analysis.
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ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
c. Positions and Transaction Volumes
Measurements
1. Positions
i. Description: For purposes of this
appendix, Positions is the value of securities
and derivatives positions managed by the
trading desk. For purposes of the Positions
quantitative measurement, do not include in
the Positions calculation for ‘‘securities’’
those securities that are also ‘‘derivatives,’’ as
those terms are defined under subpart A;
instead, report those securities that are also
derivatives as ‘‘derivatives.’’ 1227 A banking
entity must separately report the trading
desk’s market value of long securities
positions, short securities positions,
derivatives receivables, and derivatives
payables.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely
on § 75.4(a) or (b) to conduct underwriting
activity or market-making-related activity,
respectively.
2. Transaction Volumes
i. Description: For purposes of this
appendix, Transaction Volumes measures
three exclusive categories of covered trading
activity conducted by a trading desk. A
banking entity is required to report the value
and number of security and derivative
transactions conducted by the trading desk
with: (i) Customers, excluding internal
transactions; (ii) non-customers, excluding
internal transactions; and (iii) trading desks
and other organizational units where the
transaction is booked into either the same
banking entity or an affiliated banking entity.
For securities, value means gross market
value. For derivatives, value means gross
notional value. For purposes of calculating
the Transaction Volumes quantitative
measurement, do not include in the
Transaction Volumes calculation for
‘‘securities’’ those securities that are also
‘‘derivatives,’’ as those terms are defined
under subpart A; instead, report those
securities that are also derivatives as
‘‘derivatives.’’ 1228 Further, for purposes of
the Transaction Volumes quantitative
measurement, a customer of a trading desk
that relies on § 75.4(a) to conduct
underwriting activity is a market participant
identified in § 75.4(a)(7), and a customer of
a trading desk that relies on § 75.4(b) to
conduct market making-related activity is a
market participant identified in § 75.4(b)(3).
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely
on § 75.4(a) or (b) to conduct underwriting
activity or market-making-related activity,
respectively.
1227 See § 75.2(h), (aa). For example, under this
part, a security-based swap is both a ‘‘security’’ and
a ‘‘derivative.’’ For purposes of the Positions
quantitative measurement, security-based swaps are
reported as derivatives rather than securities.
1228 See § 75.2(h), (aa).
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Appendix B to Part 75 [Removed]
58. Appendix B to part 75 is removed.
59. Effective January 1, 2020, until
December 31, 2020, appendix Z to part
75 is added to read as follows:
■
■
Appendix Z to Part 75—Proprietary
Trading and Certain Interests in and
Relationships with Covered Funds
(Alternative Compliance)
Note: The content of this appendix
reproduces the regulation implementing
Section 13 of the Bank Holding Company Act
as of November 13, 2019.
Subpart A—Authority and Definitions
§ 75.1 Authority, purpose, scope, and
relationship to other authorities.
(a) Authority. This part is issued by
the Commission under section 13 of the
Bank Holding Company Act of 1956, as
amended (12 U.S.C. 1851).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes
prohibitions and restrictions on
proprietary trading by, and investments
in or relationships with covered funds
by, certain banking entities. This part
implements section 13 of the Bank
Holding Company Act by defining terms
used in the statute and related terms,
establishing prohibitions and
restrictions on proprietary trading and
investments in or relationships with
covered funds, and further explaining
the statute’s requirements.
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to banking
entities for which the CFTC is the
primary financial regulatory agency, as
defined in section 2(12) of the DoddFrank Act, but does not include such
entities to the extent they are not within
the definition of banking entity in
§ 75.2(c).
(d) Relationship to other authorities.
Except as otherwise provided under
section 13 of the BHC Act, and
notwithstanding any other provision of
law, the prohibitions and restrictions
under section 13 of the BHC Act shall
apply to the activities of an applicable
banking entity, even if such activities
are authorized for the applicable
banking entity under other applicable
provisions of law.
§ 75.2
Definitions.
Unless otherwise specified, for
purposes of this part:
(a) Affiliate has the same meaning as
in section 2(k) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(k)).
(b) Bank holding company has the
same meaning as in section 2 of the
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Bank Holding Company Act of 1956 (12
U.S.C. 1841).
(c) Banking entity. (1) Except as
provided in paragraph (c)(2) of this
section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an
insured depository institution;
(iii) Any company that is treated as a
bank holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any
entity described in paragraphs (c)(1)(i),
(ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a
banking entity under paragraphs
(c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under
the authority contained in section
4(k)(4)(H) or (I) of the BHC Act (12
U.S.C. 1843(k)(4)(H), (I)), or any
portfolio concern, as defined under 13
CFR 107.50, that is controlled by a small
business investment company, as
defined in section 103(3) of the Small
Business Investment Act of 1958 (15
U.S.C. 662), so long as the portfolio
company or portfolio concern is not
itself a banking entity under paragraphs
(c)(1)(i), (ii), or (iii) of this section; or
(iii) The FDIC acting in its corporate
capacity or as conservator or receiver
under the Federal Deposit Insurance Act
or Title II of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
(d) Board means the Board of
Governors of the Federal Reserve
System.
(e) CFTC or Commission means the
Commodity Futures Trading
Commission.
(f) Dealer has the same meaning as in
section 3(a)(5) of the Exchange Act (15
U.S.C. 78c(a)(5)).
(g) Depository institution has the same
meaning as in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)).
(h) Derivative. (1) Except as provided
in paragraph (h)(2) of this section,
derivative means:
(i) Any swap, as that term is defined
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)), or
security-based swap, as that term is
defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68));
(ii) Any purchase or sale of a
commodity, that is not an excluded
commodity, for deferred shipment or
delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as
that term is defined in section 1a(24) of
the Commodity Exchange Act (7 U.S.C.
1a(24)) or foreign exchange swap (as
that term is defined in section 1a(25) of
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the Commodity Exchange Act (7 U.S.C.
1a(25));
(iv) Any agreement, contract, or
transaction in foreign currency
described in section 2(c)(2)(C)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(C)(i));
(v) Any agreement, contract, or
transaction in a commodity other than
foreign currency described in section
2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under
section 19 of the Commodity Exchange
Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or
other agreement, contract, or transaction
that the CFTC and SEC have further
defined by joint regulation,
interpretation, guidance, or other action
as not within the definition of swap, as
that term is defined in section 1a(47) of
the Commodity Exchange Act (7 U.S.C.
1a(47)), or security-based swap, as that
term is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)); or
(ii) Any identified banking product, as
defined in section 402(b) of the Legal
Certainty for Bank Products Act of 2000
(7 U.S.C. 27(b)), that is subject to section
403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the
immediate family of the employee.
(j) Exchange Act means the Securities
Exchange Act of 1934 (15 U.S.C. 78a et
seq.).
(k) Excluded commodity has the same
meaning as in section 1a(19) of the
Commodity Exchange Act (7 U.S.C.
1a(19)).
(l) FDIC means the Federal Deposit
Insurance Corporation.
(m) Federal banking agencies means
the Board, the Office of the Comptroller
of the Currency, and the FDIC.
(n) Foreign banking organization has
the same meaning as in section
211.21(o) of the Board’s Regulation K
(12 CFR 211.21(o)), but does not include
a foreign bank, as defined in section
1(b)(7) of the International Banking Act
of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the
Commonwealth of Puerto Rico, Guam,
American Samoa, the United States
Virgin Islands, or the Commonwealth of
the Northern Mariana Islands.
(o) Foreign insurance regulator means
the insurance commissioner, or a
similar official or agency, of any country
other than the United States that is
engaged in the supervision of insurance
companies under foreign insurance law.
(p) General account means all of the
assets of an insurance company except
those allocated to one or more separate
accounts.
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(q) Insurance company means a
company that is organized as an
insurance company, primarily and
predominantly engaged in writing
insurance or reinsuring risks
underwritten by insurance companies,
subject to supervision as such by a state
insurance regulator or a foreign
insurance regulator, and not operated
for the purpose of evading the
provisions of section 13 of the BHC Act
(12 U.S.C. 1851).
(r) Insured depository institution,
unless otherwise indicated, has the
same meaning as in section 3(c) of the
Federal Deposit Insurance Act (12
U.S.C. 1813(c)), but does not include:
(1) An insured depository institution
that is described in section 2(c)(2)(D) of
the Bank Holding Company Act of 1956
(12 U.S.C. 1841(c)(2)(D)); or
(2) An insured depository institution
if it has, and if every company that
controls it has, total consolidated assets
of $10 billion or less and total trading
assets and trading liabilities, on a
consolidated basis, that are 5 percent or
less of total consolidated assets.
(s) Loan means any loan, lease,
extension of credit, or secured or
unsecured receivable that is not a
security or derivative.
(t) Primary financial regulatory
agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act (12 U.S.C. 5301(12)).
(u) Purchase includes any contract to
buy, purchase, or otherwise acquire. For
security futures products, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a commodity future, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a derivative, purchase
includes the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(v) Qualifying foreign banking
organization means a foreign banking
organization that qualifies as such under
§ 211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c), or
(e)).
(w) SEC means the Securities and
Exchange Commission.
(x) Sale and sell each include any
contract to sell or otherwise dispose of.
For security futures products, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a commodity future, such
terms include any contract, agreement,
or transaction for future delivery. With
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respect to a derivative, such terms
include the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(y) Security has the meaning specified
in section 3(a)(10) of the Exchange Act
(15 U.S.C. 78c(a)(10)).
(z) Security-based swap dealer has the
same meaning as in section 3(a)(71) of
the Exchange Act (15 U.S.C. 78c(a)(71)).
(aa) Security future has the meaning
specified in section 3(a)(55) of the
Exchange Act (15 U.S.C. 78c(a)(55)).
(bb) Separate account means an
account established and maintained by
an insurance company in connection
with one or more insurance contracts to
hold assets that are legally segregated
from the insurance company’s other
assets, under which income, gains, and
losses, whether or not realized, from
assets allocated to such account, are, in
accordance with the applicable contract,
credited to or charged against such
account without regard to other income,
gains, or losses of the insurance
company.
(cc) State means any State, the District
of Columbia, the Commonwealth of
Puerto Rico, Guam, American Samoa,
the United States Virgin Islands, and the
Commonwealth of the Northern Mariana
Islands.
(dd) Subsidiary has the same meaning
as in section 2(d) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(d)).
(ee) State insurance regulator means
the insurance commissioner, or a
similar official or agency, of a State that
is engaged in the supervision of
insurance companies under State
insurance law.
(ff) Swap dealer has the same meaning
as in section 1(a)(49) of the Commodity
Exchange Act (7 U.S.C. 1a(49)).
Subpart B—Proprietary Trading
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§ 75.3
Prohibition on proprietary trading.
(a) Prohibition. Except as otherwise
provided in this subpart, a banking
entity may not engage in proprietary
trading. Proprietary trading means
engaging as principal for the trading
account of the banking entity in any
purchase or sale of one or more
financial instruments.
(b) Definition of trading account. (1)
Trading account means any account that
is used by a banking entity to:
(i) Purchase or sell one or more
financial instruments principally for the
purpose of:
(A) Short-term resale;
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(B) Benefitting from actual or
expected short-term price movements;
(C) Realizing short-term arbitrage
profits; or
(D) Hedging one or more positions
resulting from the purchases or sales of
financial instruments described in
paragraphs (b)(1)(i)(A), (B), or (C) of this
section;
(ii) Purchase or sell one or more
financial instruments that are both
market risk capital rule covered
positions and trading positions (or
hedges of other market risk capital rule
covered positions), if the banking entity,
or any affiliate of the banking entity, is
an insured depository institution, bank
holding company, or savings and loan
holding company, and calculates riskbased capital ratios under the market
risk capital rule; or
(iii) Purchase or sell one or more
financial instruments for any purpose, if
the banking entity:
(A) Is licensed or registered, or is
required to be licensed or registered, to
engage in the business of a dealer, swap
dealer, or security-based swap dealer, to
the extent the instrument is purchased
or sold in connection with the activities
that require the banking entity to be
licensed or registered as such; or
(B) Is engaged in the business of a
dealer, swap dealer, or security-based
swap dealer outside of the United
States, to the extent the instrument is
purchased or sold in connection with
the activities of such business.
(2) Rebuttable presumption for certain
purchases and sales. The purchase (or
sale) of a financial instrument by a
banking entity shall be presumed to be
for the trading account of the banking
entity under paragraph (b)(1)(i) of this
section if the banking entity holds the
financial instrument for fewer than sixty
days or substantially transfers the risk of
the financial instrument within sixty
days of the purchase (or sale), unless the
banking entity can demonstrate, based
on all relevant facts and circumstances,
that the banking entity did not purchase
(or sell) the financial instrument
principally for any of the purposes
described in paragraph (b)(1)(i) of this
section.
(c) Financial instrument—(1)
Financial instrument means:
(i) A security, including an option on
a security;
(ii) A derivative, including an option
on a derivative; or
(iii) A contract of sale of a commodity
for future delivery, or option on a
contract of sale of a commodity for
future delivery.
(2) A financial instrument does not
include:
(i) A loan;
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(ii) A commodity that is not:
(A) An excluded commodity (other
than foreign exchange or currency);
(B) A derivative;
(C) A contract of sale of a commodity
for future delivery; or
(D) An option on a contract of sale of
a commodity for future delivery; or
(iii) Foreign exchange or currency.
(d) Proprietary trading does not
include:—(1) Any purchase or sale of
one or more financial instruments by a
banking entity that arises under a
repurchase or reverse repurchase
agreement pursuant to which the
banking entity has simultaneously
agreed, in writing, to both purchase and
sell a stated asset, at stated prices, and
on stated dates or on demand with the
same counterparty;
(2) Any purchase or sale of one or
more financial instruments by a banking
entity that arises under a transaction in
which the banking entity lends or
borrows a security temporarily to or
from another party pursuant to a written
securities lending agreement under
which the lender retains the economic
interests of an owner of such security,
and has the right to terminate the
transaction and to recall the loaned
security on terms agreed by the parties;
(3) Any purchase or sale of a security
by a banking entity for the purpose of
liquidity management in accordance
with a documented liquidity
management plan of the banking entity
that:
(i) Specifically contemplates and
authorizes the particular securities to be
used for liquidity management
purposes, the amount, types, and risks
of these securities that are consistent
with liquidity management, and the
liquidity circumstances in which the
particular securities may or must be
used;
(ii) Requires that any purchase or sale
of securities contemplated and
authorized by the plan be principally for
the purpose of managing the liquidity of
the banking entity, and not for the
purpose of short-term resale, benefitting
from actual or expected short-term price
movements, realizing short-term
arbitrage profits, or hedging a position
taken for such short-term purposes;
(iii) Requires that any securities
purchased or sold for liquidity
management purposes be highly liquid
and limited to securities the market,
credit, and other risks of which the
banking entity does not reasonably
expect to give rise to appreciable profits
or losses as a result of short-term price
movements;
(iv) Limits any securities purchased or
sold for liquidity management purposes,
together with any other instruments
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purchased or sold for such purposes, to
an amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan;
(v) Includes written policies and
procedures, internal controls, analysis,
and independent testing to ensure that
the purchase and sale of securities that
are not permitted under § 75.6(a) or (b)
are for the purpose of liquidity
management and in accordance with the
liquidity management plan described in
paragraph (d)(3) of this section; and
(vi) Is consistent with the
Commission’s supervisory
requirements, guidance, and
expectations regarding liquidity
management;
(4) Any purchase or sale of one or
more financial instruments by a banking
entity that is a derivatives clearing
organization or a clearing agency in
connection with clearing financial
instruments;
(5) Any excluded clearing activities
by a banking entity that is a member of
a clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility;
(6) Any purchase or sale of one or
more financial instruments by a banking
entity, so long as:
(i) The purchase (or sale) satisfies an
existing delivery obligation of the
banking entity or its customers,
including to prevent or close out a
failure to deliver, in connection with
delivery, clearing, or settlement activity;
or
(ii) The purchase (or sale) satisfies an
obligation of the banking entity in
connection with a judicial,
administrative, self-regulatory
organization, or arbitration proceeding;
(7) Any purchase or sale of one or
more financial instruments by a banking
entity that is acting solely as agent,
broker, or custodian;
(8) Any purchase or sale of one or
more financial instruments by a banking
entity through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity that is
established and administered in
accordance with the law of the United
States or a foreign sovereign, if the
purchase or sale is made directly or
indirectly by the banking entity as
trustee for the benefit of persons who
are or were employees of the banking
entity; or
(9) Any purchase or sale of one or
more financial instruments by a banking
entity in the ordinary course of
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collecting a debt previously contracted
in good faith, provided that the banking
entity divests the financial instrument
as soon as practicable, and in no event
may the banking entity retain such
instrument for longer than such period
permitted by the Commission.
(e) Definition of other terms related to
proprietary trading. For purposes of this
subpart:
(1) Anonymous means that each party
to a purchase or sale is unaware of the
identity of the other party(ies) to the
purchase or sale.
(2) Clearing agency has the same
meaning as in section 3(a)(23) of the
Exchange Act (15 U.S.C. 78c(a)(23)).
(3) Commodity has the same meaning
as in section 1a(9) of the Commodity
Exchange Act (7 U.S.C. 1a(9)), except
that a commodity does not include any
security;
(4) Contract of sale of a commodity
for future delivery means a contract of
sale (as that term is defined in section
1a(13) of the Commodity Exchange Act
(7 U.S.C. 1a(13)) for future delivery (as
that term is defined in section 1a(27) of
the Commodity Exchange Act (7 U.S.C.
1a(27))).
(5) Derivatives clearing organization
means:
(i) A derivatives clearing organization
registered under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1);
(ii) A derivatives clearing organization
that, pursuant to CFTC regulation, is
exempt from the registration
requirements under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1); or
(iii) A foreign derivatives clearing
organization that, pursuant to CFTC
regulation, is permitted to clear for a
foreign board of trade that is registered
with the CFTC.
(6) Exchange, unless the context
otherwise requires, means any
designated contract market, swap
execution facility, or foreign board of
trade registered with the CFTC, or, for
purposes of securities or security-based
swaps, an exchange, as defined under
section 3(a)(1) of the Exchange Act (15
U.S.C. 78c(a)(1)), or security-based swap
execution facility, as defined under
section 3(a)(77) of the Exchange Act (15
U.S.C. 78c(a)(77)).
(7) Excluded clearing activities means:
(i) With respect to customer
transactions cleared on a derivatives
clearing organization, a clearing agency,
or a designated financial market utility,
any purchase or sale necessary to
correct trading errors made by or on
behalf of a customer provided that such
purchase or sale is conducted in
accordance with, for transactions
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cleared on a derivatives clearing
organization, the Commodity Exchange
Act, CFTC regulations, and the rules or
procedures of the derivatives clearing
organization, or, for transactions cleared
on a clearing agency, the rules or
procedures of the clearing agency, or,
for transactions cleared on a designated
financial market utility that is neither a
derivatives clearing organization nor a
clearing agency, the rules or procedures
of the designated financial market
utility;
(ii) Any purchase or sale in
connection with and related to the
management of a default or threatened
imminent default of a customer
provided that such purchase or sale is
conducted in accordance with, for
transactions cleared on a derivatives
clearing organization, the Commodity
Exchange Act, CFTC regulations, and
the rules or procedures of the
derivatives clearing organization, or, for
transactions cleared on a clearing
agency, the rules or procedures of the
clearing agency, or, for transactions
cleared on a designated financial market
utility that is neither a derivatives
clearing organization nor a clearing
agency, the rules or procedures of the
designated financial market utility;
(iii) Any purchase or sale in
connection with and related to the
management of a default or threatened
imminent default of a member of a
clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility;
(iv) Any purchase or sale in
connection with and related to the
management of the default or threatened
default of a clearing agency, a
derivatives clearing organization, or a
designated financial market utility; and
(v) Any purchase or sale that is
required by the rules or procedures of a
clearing agency, a derivatives clearing
organization, or a designated financial
market utility to mitigate the risk to the
clearing agency, derivatives clearing
organization, or designated financial
market utility that would result from the
clearing by a member of security-based
swaps that reference the member or an
affiliate of the member.
(8) Designated financial market utility
has the same meaning as in section
803(4) of the Dodd-Frank Act (12 U.S.C.
5462(4)).
(9) Issuer has the same meaning as in
section 2(a)(4) of the Securities Act of
1933 (15 U.S.C. 77b(a)(4)).
(10) Market risk capital rule covered
position and trading position means a
financial instrument that is both a
covered position and a trading position,
as those terms are respectively defined:
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(i) In the case of a banking entity that
is a bank holding company, savings and
loan holding company, or insured
depository institution, under the market
risk capital rule that is applicable to the
banking entity; and
(ii) In the case of a banking entity that
is affiliated with a bank holding
company or savings and loan holding
company, other than a banking entity to
which a market risk capital rule is
applicable, under the market risk capital
rule that is applicable to the affiliated
bank holding company or savings and
loan holding company.
(11) Market risk capital rule means
the market risk capital rule that is
contained in subpart F of 12 CFR part
3, 12 CFR parts 208 and 225, or 12 CFR
part 324, as applicable.
(12) Municipal security means a
security that is a direct obligation of or
issued by, or an obligation guaranteed as
to principal or interest by, a State or any
political subdivision thereof, or any
agency or instrumentality of a State or
any political subdivision thereof, or any
municipal corporate instrumentality of
one or more States or political
subdivisions thereof.
(13) Trading desk means the smallest
discrete unit of organization of a
banking entity that purchases or sells
financial instruments for the trading
account of the banking entity or an
affiliate thereof.
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§ 75.4 Permitted underwriting and market
making-related activities.
(a) Underwriting activities—(1)
Permitted underwriting activities. The
prohibition contained in § 75.3(a) does
not apply to a banking entity’s
underwriting activities conducted in
accordance with paragraph (a) of this
section.
(2) Requirements. The underwriting
activities of a banking entity are
permitted under paragraph (a)(1) of this
section only if:
(i) The banking entity is acting as an
underwriter for a distribution of
securities and the trading desk’s
underwriting position is related to such
distribution;
(ii) The amount and type of the
securities in the trading desk’s
underwriting position are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, and reasonable efforts
are made to sell or otherwise reduce the
underwriting position within a
reasonable period, taking into account
the liquidity, maturity, and depth of the
market for the relevant type of security;
(iii) The banking entity has
established and implements, maintains,
and enforces an internal compliance
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program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (a)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The products, instruments or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
(B) Limits for each trading desk, based
on the nature and amount of the trading
desk’s underwriting activities, including
the reasonably expected near term
demands of clients, customers, or
counterparties, on the:
(1) Amount, types, and risk of its
underwriting position;
(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held;
(C) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
(D) Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
(iv) The compensation arrangements
of persons performing the activities
described in paragraph (a) of this
section are designed not to reward or
incentivize prohibited proprietary
trading; and
(v) The banking entity is licensed or
registered to engage in the activity
described in paragraph (a) of this
section in accordance with applicable
law.
(3) Definition of distribution. For
purposes of paragraph (a) of this section,
a distribution of securities means:
(i) An offering of securities, whether
or not subject to registration under the
Securities Act of 1933, that is
distinguished from ordinary trading
transactions by the presence of special
selling efforts and selling methods; or
(ii) An offering of securities made
pursuant to an effective registration
statement under the Securities Act of
1933.
(4) Definition of underwriter. For
purposes of paragraph (a) of this section,
underwriter means:
(i) A person who has agreed with an
issuer or selling security holder to:
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(A) Purchase securities from the
issuer or selling security holder for
distribution;
(B) Engage in a distribution of
securities for or on behalf of the issuer
or selling security holder; or
(C) Manage a distribution of securities
for or on behalf of the issuer or selling
security holder; or
(ii) A person who has agreed to
participate or is participating in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.
(5) Definition of selling security
holder. For purposes of paragraph (a) of
this section, selling security holder
means any person, other than an issuer,
on whose behalf a distribution is made.
(6) Definition of underwriting
position. For purposes of paragraph (a)
of this section, underwriting position
means the long or short positions in one
or more securities held by a banking
entity or its affiliate, and managed by a
particular trading desk, in connection
with a particular distribution of
securities for which such banking entity
or affiliate is acting as an underwriter.
(7) Definition of client, customer, and
counterparty. For purposes of paragraph
(a) of this section, the terms client,
customer, and counterparty, on a
collective or individual basis, refer to
market participants that may transact
with the banking entity in connection
with a particular distribution for which
the banking entity is acting as
underwriter.
(b) Market making-related activities—
(1) Permitted market making-related
activities. The prohibition contained in
§ 75.3(a) does not apply to a banking
entity’s market making-related activities
conducted in accordance with
paragraph (b) of this section.
(2) Requirements. The market makingrelated activities of a banking entity are
permitted under paragraph (b)(1) of this
section only if:
(i) The trading desk that establishes
and manages the financial exposure
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure and is willing and available to
quote, purchase and sell, or otherwise
enter into long and short positions in
those types of financial instruments for
its own account, in commercially
reasonable amounts and throughout
market cycles on a basis appropriate for
the liquidity, maturity, and depth of the
market for the relevant types of financial
instruments;
(ii) The amount, types, and risks of
the financial instruments in the trading
desk’s market-maker inventory are
designed not to exceed, on an ongoing
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basis, the reasonably expected near term
demands of clients, customers, or
counterparties, based on:
(A) The liquidity, maturity, and depth
of the market for the relevant types of
financial instrument(s); and
(B) Demonstrable analysis of
historical customer demand, current
inventory of financial instruments, and
market and other factors regarding the
amount, types, and risks, of or
associated with financial instruments in
which the trading desk makes a market,
including through block trades;
(iii) The banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (b)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The financial instruments each
trading desk stands ready to purchase
and sell in accordance with paragraph
(b)(2)(i) of this section;
(B) The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the limits
required under paragraph (b)(2)(iii)(C) of
this section; the products, instruments,
and exposures each trading desk may
use for risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and
inventory; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
desk to mitigate these risks are and
continue to be effective;
(C) Limits for each trading desk, based
on the nature and amount of the trading
desk’s market making-related activities,
that address the factors prescribed by
paragraph (b)(2)(ii) of this section, on:
(1) The amount, types, and risks of its
market-maker inventory;
(2) The amount, types, and risks of the
products, instruments, and exposures
the trading desk may use for risk
management purposes;
(3) The level of exposures to relevant
risk factors arising from its financial
exposure; and
(4) The period of time a financial
instrument may be held;
(D) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
(E) Authorization procedures,
including escalation procedures that
require review and approval of any
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trade that would exceed a trading desk’s
limit(s), demonstrable analysis that the
basis for any temporary or permanent
increase to a trading desk’s limit(s) is
consistent with the requirements of
paragraph (b) of this section, and
independent review of such
demonstrable analysis and approval;
(iv) To the extent that any limit
identified pursuant to paragraph
(b)(2)(iii)(C) of this section is exceeded,
the trading desk takes action to bring the
trading desk into compliance with the
limits as promptly as possible after the
limit is exceeded;
(v) The compensation arrangements of
persons performing the activities
described in paragraph (b) of this
section are designed not to reward or
incentivize prohibited proprietary
trading; and
(vi) The banking entity is licensed or
registered to engage in activity
described in paragraph (b) of this
section in accordance with applicable
law.
(3) Definition of client, customer, and
counterparty. For purposes of paragraph
(b) of this section, the terms client,
customer, and counterparty, on a
collective or individual basis refer to
market participants that make use of the
banking entity’s market making-related
services by obtaining such services,
responding to quotations, or entering
into a continuing relationship with
respect to such services, provided that:
(i) A trading desk or other
organizational unit of another banking
entity is not a client, customer, or
counterparty of the trading desk if that
other entity has trading assets and
liabilities of $50 billion or more as
measured in accordance with
§ 75.20(d)(1), unless:
(A) The trading desk documents how
and why a particular trading desk or
other organizational unit of the entity
should be treated as a client, customer,
or counterparty of the trading desk for
purposes of paragraph (b)(2) of this
section; or
(B) The purchase or sale by the
trading desk is conducted anonymously
on an exchange or similar trading
facility that permits trading on behalf of
a broad range of market participants.
(ii) [Reserved]
(4) Definition of financial exposure.
For purposes of paragraph (b) of this
section, financial exposure means the
aggregate risks of one or more financial
instruments and any associated loans,
commodities, or foreign exchange or
currency, held by a banking entity or its
affiliate and managed by a particular
trading desk as part of the trading desk’s
market making-related activities.
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(5) Definition of market-maker
inventory. For the purposes of paragraph
(b) of this section, market-maker
inventory means all of the positions in
the financial instruments for which the
trading desk stands ready to make a
market in accordance with paragraph
(b)(2)(i) of this section that are managed
by the trading desk, including the
trading desk’s open positions or
exposures arising from open
transactions.
§ 75.5 Permitted risk-mitigating hedging
activities.
(a) Permitted risk-mitigating hedging
activities. The prohibition contained in
§ 75.3(a) does not apply to the riskmitigating hedging activities of a
banking entity in connection with and
related to individual or aggregated
positions, contracts, or other holdings of
the banking entity and designed to
reduce the specific risks to the banking
entity in connection with and related to
such positions, contracts, or other
holdings.
(b) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under paragraph (a) of this
section only if:
(1) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(i) Reasonably designed written
policies and procedures regarding the
positions, techniques and strategies that
may be used for hedging, including
documentation indicating what
positions, contracts or other holdings a
particular trading desk may use in its
risk-mitigating hedging activities, as
well as position and aging limits with
respect to such positions, contracts or
other holdings;
(ii) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(iii) The conduct of analysis,
including correlation analysis, and
independent testing designed to ensure
that the positions, techniques and
strategies that may be used for hedging
may reasonably be expected to
demonstrably reduce or otherwise
significantly mitigate the specific,
identifiable risk(s) being hedged, and
such correlation analysis demonstrates
that the hedging activity demonstrably
reduces or otherwise significantly
mitigates the specific, identifiable risk(s)
being hedged;
(2) The risk-mitigating hedging
activity:
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(i) Is conducted in accordance with
the written policies, procedures, and
internal controls required under this
section;
(ii) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks, including market risk,
counterparty or other credit risk,
currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof;
(iii) Does not give rise, at the
inception of the hedge, to any
significant new or additional risk that is
not itself hedged contemporaneously in
accordance with this section;
(iv) Is subject to continuing review,
monitoring and management by the
banking entity that:
(A) Is consistent with the written
hedging policies and procedures
required under paragraph (b)(1) of this
section;
(B) Is designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates the specific, identifiable risks
that develop over time from the riskmitigating hedging activities undertaken
under this section and the underlying
positions, contracts, and other holdings
of the banking entity, based upon the
facts and circumstances of the
underlying and hedging positions,
contracts and other holdings of the
banking entity and the risks and
liquidity thereof; and
(C) Requires ongoing recalibration of
the hedging activity by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(2) of this section and is
not prohibited proprietary trading; and
(3) The compensation arrangements of
persons performing risk-mitigating
hedging activities are designed not to
reward or incentivize prohibited
proprietary trading.
(c) Documentation requirement. (1) A
banking entity must comply with the
requirements of paragraphs (c)(2) and
(c)(3) of this section with respect to any
purchase or sale of financial
instruments made in reliance on this
section for risk-mitigating hedging
purposes that is:
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(i) Not established by the specific
trading desk establishing or responsible
for the underlying positions, contracts,
or other holdings the risks of which the
hedging activity is designed to reduce;
(ii) Established by the specific trading
desk establishing or responsible for the
underlying positions, contracts, or other
holdings the risks of which the
purchases or sales are designed to
reduce, but that is effected through a
financial instrument, exposure,
technique, or strategy that is not
specifically identified in the trading
desk’s written policies and procedures
established under paragraph (b)(1) of
this section or under § 75.4(b)(2)(iii)(B)
as a product, instrument, exposure,
technique, or strategy such trading desk
may use for hedging; or
(iii) Established to hedge aggregated
positions across two or more trading
desks.
(2) In connection with any purchase
or sale identified in paragraph (c)(1) of
this section, a banking entity must, at a
minimum, and contemporaneously with
the purchase or sale, document:
(i) The specific, identifiable risk(s) of
the identified positions, contracts, or
other holdings of the banking entity that
the purchase or sale is designed to
reduce;
(ii) The specific risk-mitigating
strategy that the purchase or sale is
designed to fulfill; and
(iii) The trading desk or other
business unit that is establishing and
responsible for the hedge.
(3) A banking entity must create and
retain records sufficient to demonstrate
compliance with the requirements of
paragraph (c) of this section for a period
that is no less than five years in a form
that allows the banking entity to
promptly produce such records to the
Commission on request, or such longer
period as required under other law or
this part.
§ 75.6 Other permitted proprietary trading
activities.
(a) Permitted trading in domestic
government obligations. The prohibition
contained in § 75.3(a) does not apply to
the purchase or sale by a banking entity
of a financial instrument that is:
(1) An obligation of, or issued or
guaranteed by, the United States;
(2) An obligation, participation, or
other instrument of, or issued or
guaranteed by, an agency of the United
States, the Government National
Mortgage Association, the Federal
National Mortgage Association, the
Federal Home Loan Mortgage
Corporation, a Federal Home Loan
Bank, the Federal Agricultural Mortgage
Corporation or a Farm Credit System
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institution chartered under and subject
to the provisions of the Farm Credit Act
of 1971 (12 U.S.C. 2001 et seq.);
(3) An obligation of any State or any
political subdivision thereof, including
any municipal security; or
(4) An obligation of the FDIC, or any
entity formed by or on behalf of the
FDIC for purpose of facilitating the
disposal of assets acquired or held by
the FDIC in its corporate capacity or as
conservator or receiver under the
Federal Deposit Insurance Act or Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
(b) Permitted trading in foreign
government obligations—(1) Affiliates of
foreign banking entities in the United
States. The prohibition contained in
§ 75.3(a) does not apply to the purchase
or sale of a financial instrument that is
an obligation of, or issued or guaranteed
by, a foreign sovereign (including any
multinational central bank of which the
foreign sovereign is a member), or any
agency or political subdivision of such
foreign sovereign, by a banking entity,
so long as:
(i) The banking entity is organized
under or is directly or indirectly
controlled by a banking entity that is
organized under the laws of a foreign
sovereign and is not directly or
indirectly controlled by a top-tier
banking entity that is organized under
the laws of the United States;
(ii) The financial instrument is an
obligation of, or issued or guaranteed
by, the foreign sovereign under the laws
of which the foreign banking entity
referred to in paragraph (b)(1)(i) of this
section is organized (including any
multinational central bank of which the
foreign sovereign is a member), or any
agency or political subdivision of that
foreign sovereign; and
(iii) The purchase or sale as principal
is not made by an insured depository
institution.
(2) Foreign affiliates of a U.S. banking
entity. The prohibition contained in
§ 75.3(a) does not apply to the purchase
or sale of a financial instrument that is
an obligation of, or issued or guaranteed
by, a foreign sovereign (including any
multinational central bank of which the
foreign sovereign is a member), or any
agency or political subdivision of that
foreign sovereign, by a foreign entity
that is owned or controlled by a banking
entity organized or established under
the laws of the United States or any
State, so long as:
(i) The foreign entity is a foreign bank,
as defined in § 211.2(j) of the Board’s
Regulation K (12 CFR 211.2(j)), or is
regulated by the foreign sovereign as a
securities dealer;
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(ii) The financial instrument is an
obligation of, or issued or guaranteed
by, the foreign sovereign under the laws
of which the foreign entity is organized
(including any multinational central
bank of which the foreign sovereign is
a member), or any agency or political
subdivision of that foreign sovereign;
and
(iii) The financial instrument is
owned by the foreign entity and is not
financed by an affiliate that is located in
the United States or organized under the
laws of the United States or of any State.
(c) Permitted trading on behalf of
customers—(1) Fiduciary transactions.
The prohibition contained in § 75.3(a)
does not apply to the purchase or sale
of financial instruments by a banking
entity acting as trustee or in a similar
fiduciary capacity, so long as:
(i) The transaction is conducted for
the account of, or on behalf of, a
customer; and
(ii) The banking entity does not have
or retain beneficial ownership of the
financial instruments.
(2) Riskless principal transactions.
The prohibition contained in § 75.3(a)
does not apply to the purchase or sale
of financial instruments by a banking
entity acting as riskless principal in a
transaction in which the banking entity,
after receiving an order to purchase (or
sell) a financial instrument from a
customer, purchases (or sells) the
financial instrument for its own account
to offset a contemporaneous sale to (or
purchase from) the customer.
(d) Permitted trading by a regulated
insurance company. The prohibition
contained in § 75.3(a) does not apply to
the purchase or sale of financial
instruments by a banking entity that is
an insurance company or an affiliate of
an insurance company if:
(1) The insurance company or its
affiliate purchases or sells the financial
instruments solely for:
(i) The general account of the
insurance company; or
(ii) A separate account established by
the insurance company;
(2) The purchase or sale is conducted
in compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (d)(2) of this
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section is insufficient to protect the
safety and soundness of the covered
banking entity, or the financial stability
of the United States.
(e) Permitted trading activities of
foreign banking entities. (1) The
prohibition contained in § 75.3(a) does
not apply to the purchase or sale of
financial instruments by a banking
entity if:
(i) The banking entity is not organized
or directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of any
State;
(ii) The purchase or sale by the
banking entity is made pursuant to
paragraph (9) or (13) of section 4(c) of
the BHC Act; and
(iii) The purchase or sale meets the
requirements of paragraph (e)(3) of this
section.
(2) A purchase or sale of financial
instruments by a banking entity is made
pursuant to paragraph (9) or (13) of
section 4(c) of the BHC Act for purposes
of paragraph (e)(1)(ii) of this section
only if:
(i) The purchase or sale is conducted
in accordance with the requirements of
paragraph (e) of this section; and
(ii)(A) With respect to a banking
entity that is a foreign banking
organization, the banking entity meets
the qualifying foreign banking
organization requirements of
§ 211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c) or
(e)), as applicable; or
(B) With respect to a banking entity
that is not a foreign banking
organization, the banking entity is not
organized under the laws of the United
States or of any State and the banking
entity, on a fully-consolidated basis,
meets at least two of the following
requirements:
(1) Total assets of the banking entity
held outside of the United States exceed
total assets of the banking entity held in
the United States;
(2) Total revenues derived from the
business of the banking entity outside of
the United States exceed total revenues
derived from the business of the
banking entity in the United States; or
(3) Total net income derived from the
business of the banking entity outside of
the United States exceeds total net
income derived from the business of the
banking entity in the United States.
(3) A purchase or sale by a banking
entity is permitted for purposes of
paragraph (e) of this section only if:
(i) The banking entity engaging as
principal in the purchase or sale
(including any personnel of the banking
entity or its affiliate that arrange,
negotiate or execute such purchase or
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sale) is not located in the United States
or organized under the laws of the
United States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State;
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State;
(iv) No financing for the banking
entity’s purchases or sales is provided,
directly or indirectly, by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
(v) The purchase or sale is not
conducted with or through any U.S.
entity, other than:
(A) A purchase or sale with the
foreign operations of a U.S. entity if no
personnel of such U.S. entity that are
located in the United States are
involved in the arrangement,
negotiation, or execution of such
purchase or sale;
(B) A purchase or sale with an
unaffiliated market intermediary acting
as principal, provided the purchase or
sale is promptly cleared and settled
through a clearing agency or derivatives
clearing organization acting as a central
counterparty; or
(C) A purchase or sale through an
unaffiliated market intermediary acting
as agent, provided the purchase or sale
is conducted anonymously on an
exchange or similar trading facility and
is promptly cleared and settled through
a clearing agency or derivatives clearing
organization acting as a central
counterparty,
(4) For purposes of paragraph (e) of
this section, a U.S. entity is any entity
that is, or is controlled by, or is acting
on behalf of, or at the direction of, any
other entity that is, located in the
United States or organized under the
laws of the United States or of any State.
(5) For purposes of paragraph (e) of
this section, a U.S. branch, agency, or
subsidiary of a foreign banking entity is
considered to be located in the United
States; however, the foreign bank that
operates or controls that branch, agency,
or subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(6) For purposes of paragraph (e) of
this section, unaffiliated market
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intermediary means an unaffiliated
entity, acting as an intermediary, that is:
(i) A broker or dealer registered with
the SEC under section 15 of the
Exchange Act or exempt from
registration or excluded from regulation
as such;
(ii) A swap dealer registered with the
CFTC under section 4s of the
Commodity Exchange Act or exempt
from registration or excluded from
regulation as such;
(iii) A security-based swap dealer
registered with the SEC under section
15F of the Exchange Act or exempt from
registration or excluded from regulation
as such; or
(iv) A futures commission merchant
registered with the CFTC under section
4f of the Commodity Exchange Act or
exempt from registration or excluded
from regulation as such.
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§ 75.7 Limitations on permitted proprietary
trading activities.
(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ 75.4 through 75.6
if the transaction, class of transactions,
or activity would:
(1) Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
(2) Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
(3) Pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.
(b) Definition of material conflict of
interest. (1) For purposes of this section,
a material conflict of interest between a
banking entity and its clients,
customers, or counterparties exists if the
banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the banking entity’s interests being
materially adverse to the interests of its
client, customer, or counterparty with
respect to such transaction, class of
transactions, or activity, and the
banking entity has not taken at least one
of the actions in paragraph (b)(2) of this
section.
(2) Prior to effecting the specific
transaction or class or type of
transactions, or engaging in the specific
activity, the banking entity:
(i) Timely and effective disclosure. (A)
Has made clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
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counterparty to meaningfully
understand the conflict of interest; and
(B) Such disclosure is made in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
mitigate, any materially adverse effect
on the client, customer, or counterparty
created by the conflict of interest; or
(ii) Information barriers. Has
established, maintained, and enforced
information barriers that are
memorialized in written policies and
procedures, such as physical separation
of personnel, or functions, or limitations
on types of activity, that are reasonably
designed, taking into consideration the
nature of the banking entity’s business,
to prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A banking entity may not
rely on such information barriers if, in
the case of any specific transaction,
class or type of transactions or activity,
the banking entity knows or should
reasonably know that, notwithstanding
the banking entity’s establishment of
information barriers, the conflict of
interest may involve or result in a
materially adverse effect on a client,
customer, or counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
§§ 75.8–75.9
[Reserved]
Subpart C—Covered Fund Activities
and Investments
§ 75.10 Prohibition on acquiring or
retaining an ownership interest in and
having certain relationships with a covered
fund.
(a) Prohibition. (1) Except as
otherwise provided in this subpart, a
banking entity may not, as principal,
directly or indirectly, acquire or retain
any ownership interest in or sponsor a
covered fund.
(2) Paragraph (a)(1) of this section
does not include acquiring or retaining
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an ownership interest in a covered fund
by a banking entity:
(i) Acting solely as agent, broker, or
custodian, so long as;
(A) The activity is conducted for the
account of, or on behalf of, a customer;
and
(B) The banking entity and its
affiliates do not have or retain beneficial
ownership of such ownership interest;
(ii) Through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity (or an affiliate
thereof) that is established and
administered in accordance with the
law of the United States or a foreign
sovereign, if the ownership interest is
held or controlled directly or indirectly
by the banking entity as trustee for the
benefit of persons who are or were
employees of the banking entity (or an
affiliate thereof);
(iii) In the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the ownership interest as
soon as practicable, and in no event may
the banking entity retain such
ownership interest for longer than such
period permitted by the Commission; or
(iv) On behalf of customers as trustee
or in a similar fiduciary capacity for a
customer that is not a covered fund, so
long as:
(A) The activity is conducted for the
account of, or on behalf of, the
customer; and
(B) The banking entity and its
affiliates do not have or retain beneficial
ownership of such ownership interest.
(b) Definition of covered fund. (1)
Except as provided in paragraph (c) of
this section, covered fund means:
(i) An issuer that would be an
investment company, as defined in the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.), but for section
3(c)(1) or 3(c)(7) of that Act (15 U.S.C.
80a–3(c)(1) or (7));
(ii) Any commodity pool under
section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10)) for
which:
(A) The commodity pool operator has
claimed an exemption under § 4.7 of
this chapter; or
(B)(1) A commodity pool operator is
registered with the CFTC as a
commodity pool operator in connection
with the operation of the commodity
pool;
(2) Substantially all participation
units of the commodity pool are owned
by qualified eligible persons under
§ 4.7(a)(2) and (3) of this chapter; and
(3) Participation units of the
commodity pool have not been publicly
offered to persons who are not qualified
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eligible persons under § 4.7(a)(2) and (3)
of this chapter; or
(iii) For any banking entity that is, or
is controlled directly or indirectly by a
banking entity that is, located in or
organized under the laws of the United
States or of any State, an entity that:
(A) Is organized or established outside
the United States and the ownership
interests of which are offered and sold
solely outside the United States;
(B) Is, or holds itself out as being, an
entity or arrangement that raises money
from investors primarily for the purpose
of investing in securities for resale or
other disposition or otherwise trading in
securities; and
(C)(1) Has as its sponsor that banking
entity (or an affiliate thereof); or
(2) Has issued an ownership interest
that is owned directly or indirectly by
that banking entity (or an affiliate
thereof).
(2) An issuer shall not be deemed to
be a covered fund under paragraph
(b)(1)(iii) of this section if, were the
issuer subject to U.S. securities laws, the
issuer could rely on an exclusion or
exemption from the definition of
‘‘investment company’’ under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) other than the
exclusions contained in section 3(c)(1)
and 3(c)(7) of that Act.
(3) For purposes of paragraph
(b)(1)(iii) of this section, a U.S. branch,
agency, or subsidiary of a foreign
banking entity is located in the United
States; however, the foreign bank that
operates or controls that branch, agency,
or subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(c) Notwithstanding paragraph (b) of
this section, unless the appropriate
Federal banking agencies, the SEC, and
the CFTC jointly determine otherwise, a
covered fund does not include:
(1) Foreign public funds. (i) Subject to
paragraphs (c)(1)(ii) and (iii) of this
section, an issuer that:
(A) Is organized or established outside
of the United States;
(B) Is authorized to offer and sell
ownership interests to retail investors in
the issuer’s home jurisdiction; and
(C) Sells ownership interests
predominantly through one or more
public offerings outside of the United
States.
(ii) With respect to a banking entity
that is, or is controlled directly or
indirectly by a banking entity that is,
located in or organized under the laws
of the United States or of any State and
any issuer for which such banking
entity acts as sponsor, the sponsoring
banking entity may not rely on the
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exemption in paragraph (c)(1)(i) of this
section for such issuer unless ownership
interests in the issuer are sold
predominantly to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring
banking entity or such issuer; and
(D) Directors and employees of such
entities.
(iii) For purposes of paragraph
(c)(1)(i)(C) of this section, the term
public offering means a distribution (as
defined in § 75.4(a)(3)) of securities in
any jurisdiction outside the United
States to investors, including retail
investors, provided that:
(A) The distribution complies with all
applicable requirements in the
jurisdiction in which such distribution
is being made;
(B) The distribution does not restrict
availability to investors having a
minimum level of net worth or net
investment assets; and
(C) The issuer has filed or submitted,
with the appropriate regulatory
authority in such jurisdiction, offering
disclosure documents that are publicly
available.
(2) Wholly-owned subsidiaries. An
entity, all of the outstanding ownership
interests of which are owned directly or
indirectly by the banking entity (or an
affiliate thereof), except that:
(i) Up to five percent of the entity’s
outstanding ownership interests, less
any amounts outstanding under
paragraph (c)(2)(ii) of this section, may
be held by employees or directors of the
banking entity or such affiliate
(including former employees or
directors if their ownership interest was
acquired while employed by or in the
service of the banking entity); and
(ii) Up to 0.5 percent of the entity’s
outstanding ownership interests may be
held by a third party if the ownership
interest is acquired or retained by the
third party for the purpose of
establishing corporate separateness or
addressing bankruptcy, insolvency, or
similar concerns.
(3) Joint ventures. A joint venture
between a banking entity or any of its
affiliates and one or more unaffiliated
persons, provided that the joint venture:
(i) Is comprised of no more than 10
unaffiliated co-venturers;
(ii) Is in the business of engaging in
activities that are permissible for the
banking entity or affiliate, other than
investing in securities for resale or other
disposition; and
(iii) Is not, and does not hold itself out
as being, an entity or arrangement that
raises money from investors primarily
for the purpose of investing in securities
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for resale or other disposition or
otherwise trading in securities.
(4) Acquisition vehicles. An issuer:
(i) Formed solely for the purpose of
engaging in a bona fide merger or
acquisition transaction; and
(ii) That exists only for such period as
necessary to effectuate the transaction.
(5) Foreign pension or retirement
funds. A plan, fund, or program
providing pension, retirement, or
similar benefits that is:
(i) Organized and administered
outside the United States;
(ii) A broad-based plan for employees
or citizens that is subject to regulation
as a pension, retirement, or similar plan
under the laws of the jurisdiction in
which the plan, fund, or program is
organized and administered; and
(iii) Established for the benefit of
citizens or residents of one or more
foreign sovereigns or any political
subdivision thereof.
(6) Insurance company separate
accounts. A separate account, provided
that no banking entity other than the
insurance company participates in the
account’s profits and losses.
(7) Bank owned life insurance. A
separate account that is used solely for
the purpose of allowing one or more
banking entities to purchase a life
insurance policy for which the banking
entity or entities is beneficiary,
provided that no banking entity that
purchases the policy:
(i) Controls the investment decisions
regarding the underlying assets or
holdings of the separate account; or
(ii) Participates in the profits and
losses of the separate account other than
in compliance with applicable
supervisory guidance regarding bank
owned life insurance.
(8) Loan securitizations—(i) Scope.
An issuing entity for asset-backed
securities that satisfies all the
conditions of paragraph (c)(8) of this
section and the assets or holdings of
which are comprised solely of:
(A) Loans as defined in § 75.2(s);
(B) Rights or other assets designed to
assure the servicing or timely
distribution of proceeds to holders of
such securities and rights or other assets
that are related or incidental to
purchasing or otherwise acquiring and
holding the loans, provided that each
asset meets the requirements of
paragraph (c)(8)(iii) of this section;
(C) Interest rate or foreign exchange
derivatives that meet the requirements
of paragraph (c)(8)(iv) of this section;
and
(D) Special units of beneficial interest
and collateral certificates that meet the
requirements of paragraph (c)(8)(v) of
this section.
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(ii) Impermissible assets. For purposes
of paragraph (c)(8) of this section, the
assets or holdings of the issuing entity
shall not include any of the following:
(A) A security, including an assetbacked security, or an interest in an
equity or debt security other than as
permitted in paragraph (c)(8)(iii) of this
section;
(B) A derivative, other than a
derivative that meets the requirements
of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities.
Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may
hold securities if those securities are:
(A) Cash equivalents for purposes of
the rights and assets in paragraph
(c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts
previously contracted with respect to
the loans supporting the asset-backed
securities.
(iv) Derivatives. The holdings of
derivatives by the issuing entity shall be
limited to interest rate or foreign
exchange derivatives that satisfy all of
the following conditions:
(A) The written terms of the
derivative directly relate to the loans,
the asset-backed securities, or the
contractual rights of other assets
described in paragraph (c)(8)(i)(B) of
this section; and
(B) The derivatives reduce the interest
rate and/or foreign exchange risks
related to the loans, the asset-backed
securities, or the contractual rights or
other assets described in paragraph
(c)(8)(i)(B) of this section.
(v) Special units of beneficial interest
and collateral certificates. The assets or
holdings of the issuing entity may
include collateral certificates and
special units of beneficial interest
issued by a special purpose vehicle,
provided that:
(A) The special purpose vehicle that
issues the special unit of beneficial
interest or collateral certificate meets
the requirements in paragraph (c)(8) of
this section;
(B) The special unit of beneficial
interest or collateral certificate is used
for the sole purpose of transferring to
the issuing entity for the loan
securitization the economic risks and
benefits of the assets that are
permissible for loan securitizations
under paragraph (c)(8) of this section
and does not directly or indirectly
transfer any interest in any other
economic or financial exposure;
(C) The special unit of beneficial
interest or collateral certificate is
created solely to satisfy legal
requirements or otherwise facilitate the
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structuring of the loan securitization;
and
(D) The special purpose vehicle that
issues the special unit of beneficial
interest or collateral certificate and the
issuing entity are established under the
direction of the same entity that
initiated the loan securitization.
(9) Qualifying asset-backed
commercial paper conduits. (i) An
issuing entity for asset-backed
commercial paper that satisfies all of the
following requirements:
(A) The asset-backed commercial
paper conduit holds only:
(1) Loans and other assets permissible
for a loan securitization under
paragraph (c)(8)(i) of this section; and
(2) Asset-backed securities supported
solely by assets that are permissible for
loan securitizations under paragraph
(c)(8)(i) of this section and acquired by
the asset-backed commercial paper
conduit as part of an initial issuance
either directly from the issuing entity of
the asset-backed securities or directly
from an underwriter in the distribution
of the asset-backed securities;
(B) The asset-backed commercial
paper conduit issues only asset-backed
securities, comprised of a residual
interest and securities with a legal
maturity of 397 days or less; and
(C) A regulated liquidity provider has
entered into a legally binding
commitment to provide full and
unconditional liquidity coverage with
respect to all of the outstanding assetbacked securities issued by the assetbacked commercial paper conduit (other
than any residual interest) in the event
that funds are required to redeem
maturing asset-backed securities.
(ii) For purposes of this paragraph
(c)(9) of this section, a regulated
liquidity provider means:
(A) A depository institution, as
defined in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c));
(B) A bank holding company, as
defined in section 2(a) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1841(a)), or a subsidiary thereof;
(C) A savings and loan holding
company, as defined in section 10a of
the Home Owners’ Loan Act (12 U.S.C.
1467a), provided all or substantially all
of the holding company’s activities are
permissible for a financial holding
company under section 4(k) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1843(k)), or a subsidiary thereof;
(D) A foreign bank whose home
country supervisor, as defined in
§ 211.21(q) of the Board’s Regulation K
(12 CFR 211.21(q)), has adopted capital
standards consistent with the Capital
Accord for the Basel Committee on
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Banking Supervision, as amended, and
that is subject to such standards, or a
subsidiary thereof; or
(E) The United States or a foreign
sovereign.
(10) Qualifying covered bonds—(i)
Scope. An entity owning or holding a
dynamic or fixed pool of loans or other
assets as provided in paragraph (c)(8) of
this section for the benefit of the holders
of covered bonds, provided that the
assets in the pool are comprised solely
of assets that meet the conditions in
paragraph (c)(8)(i) of this section.
(ii) Covered bond. For purposes of
paragraph (c)(10) of this section, a
covered bond means:
(A) A debt obligation issued by an
entity that meets the definition of
foreign banking organization, the
payment obligations of which are fully
and unconditionally guaranteed by an
entity that meets the conditions set forth
in paragraph (c)(10)(i) of this section; or
(B) A debt obligation of an entity that
meets the conditions set forth in
paragraph (c)(10)(i) of this section,
provided that the payment obligations
are fully and unconditionally
guaranteed by an entity that meets the
definition of foreign banking
organization and the entity is a whollyowned subsidiary, as defined in
paragraph (c)(2) of this section, of such
foreign banking organization.
(11) SBICs and public welfare
investment funds. An issuer:
(i) That is a small business investment
company, as defined in section 103(3) of
the Small Business Investment Act of
1958 (15 U.S.C. 662), or that has
received from the Small Business
Administration notice to proceed to
qualify for a license as a small business
investment company, which notice or
license has not been revoked; or
(ii) The business of which is to make
investments that are:
(A) Designed primarily to promote the
public welfare, of the type permitted
under paragraph (11) of section 5136 of
the Revised Statutes of the United States
(12 U.S.C. 24), including the welfare of
low- and moderate-income communities
or families (such as providing housing,
services, or jobs); or
(B) Qualified rehabilitation
expenditures with respect to a qualified
rehabilitated building or certified
historic structure, as such terms are
defined in section 47 of the Internal
Revenue Code of 1986 or a similar State
historic tax credit program.
(12) Registered investment companies
and excluded entities. An issuer:
(i) That is registered as an investment
company under section 8 of the
Investment Company Act of 1940 (15
U.S.C. 80a–8), or that is formed and
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operated pursuant to a written plan to
become a registered investment
company as described in § 75.20(e)(3)
and that complies with the requirements
of section 18 of the Investment
Company Act of 1940 (15 U.S.C. 80a–
18);
(ii) That may rely on an exclusion or
exemption from the definition of
‘‘investment company’’ under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) other than the
exclusions contained in section 3(c)(1)
and 3(c)(7) of that Act; or
(iii) That has elected to be regulated
as a business development company
pursuant to section 54(a) of that Act (15
U.S.C. 80a–53) and has not withdrawn
its election, or that is formed and
operated pursuant to a written plan to
become a business development
company as described in § 75.20(e)(3)
and that complies with the requirements
of section 61 of the Investment
Company Act of 1940 (15 U.S.C. 80a–
60).
(13) Issuers in conjunction with the
FDIC’s receivership or conservatorship
operations. An issuer that is an entity
formed by or on behalf of the FDIC for
the purpose of facilitating the disposal
of assets acquired in the FDIC’s capacity
as conservator or receiver under the
Federal Deposit Insurance Act or Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
(14) Other excluded issuers. (i) Any
issuer that the appropriate Federal
banking agencies, the SEC, and the
CFTC jointly determine the exclusion of
which is consistent with the purposes of
section 13 of the BHC Act.
(ii) A determination made under
paragraph (c)(14)(i) of this section will
be promptly made public.
(d) Definition of other terms related to
covered funds. For purposes of this
subpart:
(1) Applicable accounting standards
means U.S. generally accepted
accounting principles, or such other
accounting standards applicable to a
banking entity that the Commission
determines are appropriate and that the
banking entity uses in the ordinary
course of its business in preparing its
consolidated financial statements.
(2) Asset-backed security has the
meaning specified in section 3(a)(79) of
the Exchange Act (15 U.S.C. 78c(a)(79)).
(3) Director has the same meaning as
provided in § 215.2(d)(1) of the Board’s
Regulation O (12 CFR 215.2(d)(1)).
(4) Issuer has the same meaning as in
section 2(a)(22) of the Investment
Company Act of 1940 (15 U.S.C. 80a–
2(a)(22)).
(5) Issuing entity means with respect
to asset-backed securities the special
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purpose vehicle that owns or holds the
pool assets underlying asset-backed
securities and in whose name the assetbacked securities supported or serviced
by the pool assets are issued.
(6) Ownership interest—(i) Ownership
interest means any equity, partnership,
or other similar interest. An ‘‘other
similar interest’’ means an interest that:
(A) Has the right to participate in the
selection or removal of a general
partner, managing member, member of
the board of directors or trustees,
investment manager, investment
adviser, or commodity trading advisor
of the covered fund (excluding the
rights of a creditor to exercise remedies
upon the occurrence of an event of
default or an acceleration event);
(B) Has the right under the terms of
the interest to receive a share of the
income, gains or profits of the covered
fund;
(C) Has the right to receive the
underlying assets of the covered fund
after all other interests have been
redeemed and/or paid in full (excluding
the rights of a creditor to exercise
remedies upon the occurrence of an
event of default or an acceleration
event);
(D) Has the right to receive all or a
portion of excess spread (the positive
difference, if any, between the aggregate
interest payments received from the
underlying assets of the covered fund
and the aggregate interest paid to the
holders of other outstanding interests);
(E) Provides under the terms of the
interest that the amounts payable by the
covered fund with respect to the interest
could be reduced based on losses arising
from the underlying assets of the
covered fund, such as allocation of
losses, write-downs or charge-offs of the
outstanding principal balance, or
reductions in the amount of interest due
and payable on the interest;
(F) Receives income on a pass-through
basis from the covered fund, or has a
rate of return that is determined by
reference to the performance of the
underlying assets of the covered fund;
or
(G) Any synthetic right to have,
receive, or be allocated any of the rights
in paragraphs (d)(6)(i)(A) through
(d)(6)(i)(F) of this section.
(ii) Ownership interest does not
include restricted profit interest, which
is an interest held by an entity (or an
employee or former employee thereof)
in a covered fund for which the entity
(or employee thereof) serves as
investment manager, investment
adviser, commodity trading advisor, or
other service provider so long as:
(A) The sole purpose and effect of the
interest is to allow the entity (or
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62223
employee or former employee thereof)
to share in the profits of the covered
fund as performance compensation for
the investment management, investment
advisory, commodity trading advisory,
or other services provided to the
covered fund by the entity (or employee
or former employee thereof), provided
that the entity (or employee or former
employee thereof) may be obligated
under the terms of such interest to
return profits previously received;
(B) All such profit, once allocated, is
distributed to the entity (or employee or
former employee thereof) promptly after
being earned or, if not so distributed, is
retained by the covered fund for the sole
purpose of establishing a reserve
amount to satisfy contractual obligations
with respect to subsequent losses of the
covered fund and such undistributed
profit of the entity (or employee or
former employee thereof) does not share
in the subsequent investment gains of
the covered fund;
(C) Any amounts invested in the
covered fund, including any amounts
paid by the entity (or employee or
former employee thereof) in connection
with obtaining the restricted profit
interest, are within the limits of § 75.12;
and
(D) The interest is not transferable by
the entity (or employee or former
employee thereof) except to an affiliate
thereof (or an employee of the banking
entity or affiliate), to immediate family
members, or through the intestacy, of
the employee or former employee, or in
connection with a sale of the business
that gave rise to the restricted profit
interest by the entity (or employee or
former employee thereof) to an
unaffiliated party that provides
investment management, investment
advisory, commodity trading advisory,
or other services to the fund.
(7) Prime brokerage transaction means
any transaction that would be a covered
transaction, as defined in section
23A(b)(7) of the Federal Reserve Act (12
U.S.C. 371c(b)(7)), that is provided in
connection with custody, clearance and
settlement, securities borrowing or
lending services, trade execution,
financing, or data, operational, and
administrative support.
(8) Resident of the United States
means a person that is a ‘‘U.S. person’’
as defined in rule 902(k) of the SEC’s
Regulation S (17 CFR 230.902(k)).
(9) Sponsor means, with respect to a
covered fund:
(i) To serve as a general partner,
managing member, or trustee of a
covered fund, or to serve as a
commodity pool operator with respect
to a covered fund as defined in (b)(1)(ii)
of this section;
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(ii) In any manner to select or to
control (or to have employees, officers,
or directors, or agents who constitute) a
majority of the directors, trustees, or
management of a covered fund; or
(iii) To share with a covered fund, for
corporate, marketing, promotional, or
other purposes, the same name or a
variation of the same name, except as
permitted under § 75.11(a)(6).
(10) Trustee. (i) For purposes of
paragraph (d)(9) of this section and
§ 75.11, a trustee does not include:
(A) A trustee that does not exercise
investment discretion with respect to a
covered fund, including a trustee that is
subject to the direction of an
unaffiliated named fiduciary who is not
a trustee pursuant to section 403(a)(1) of
the Employee’s Retirement Income
Security Act (29 U.S.C. 1103(a)(1)); or
(B) A trustee that is subject to
fiduciary standards imposed under
foreign law that are substantially
equivalent to those described in
paragraph (d)(10)(i)(A) of this section;
(ii) Any entity that directs a person
described in paragraph (d)(10)(i) of this
section, or that possesses authority and
discretion to manage and control the
investment decisions of a covered fund
for which such person serves as trustee,
shall be considered to be a trustee of
such covered fund.
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§ 75.11 Permitted organizing and offering,
underwriting, and market making with
respect to a covered fund.
(a) Organizing and offering a covered
fund in general. Notwithstanding
§ 75.10(a), a banking entity is not
prohibited from acquiring or retaining
an ownership interest in, or acting as
sponsor to, a covered fund in
connection with, directly or indirectly,
organizing and offering a covered fund,
including serving as a general partner,
managing member, trustee, or
commodity pool operator of the covered
fund and in any manner selecting or
controlling (or having employees,
officers, directors, or agents who
constitute) a majority of the directors,
trustees, or management of the covered
fund, including any necessary expenses
for the foregoing, only if:
(1) The banking entity (or an affiliate
thereof) provides bona fide trust,
fiduciary, investment advisory, or
commodity trading advisory services;
(2) The covered fund is organized and
offered only in connection with the
provision of bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services and only to
persons that are customers of such
services of the banking entity (or an
affiliate thereof), pursuant to a written
plan or similar documentation outlining
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how the banking entity or such affiliate
intends to provide advisory or similar
services to its customers through
organizing and offering such fund;
(3) The banking entity and its
affiliates do not acquire or retain an
ownership interest in the covered fund
except as permitted under § 75.12;
(4) The banking entity and its
affiliates comply with the requirements
of § 75.14;
(5) The banking entity and its
affiliates do not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests;
(6) The covered fund, for corporate,
marketing, promotional, or other
purposes:
(i) Does not share the same name or
a variation of the same name with the
banking entity (or an affiliate thereof),
except that a covered fund may share
the same name or a variation of the
same name with a banking entity that is
an investment adviser to the covered
fund if:
(A) The investment adviser is not an
insured depository institution, a
company that controls an insured
depository institution, or a company
that is treated as a bank holding
company for purposes of section 8 of the
International Banking Act of 1978 (12
U.S.C. 3106); and
(B) The investment adviser does not
share the same name or a variation of
the same name as an insured depository
institution, a company that controls an
insured depository institution, or a
company that is treated as a bank
holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(ii) Does not use the word ‘‘bank’’ in
its name;
(7) No director or employee of the
banking entity (or an affiliate thereof)
takes or retains an ownership interest in
the covered fund, except for any
director or employee of the banking
entity or such affiliate who is directly
engaged in providing investment
advisory, commodity trading advisory,
or other services to the covered fund at
the time the director or employee takes
the ownership interest; and
(8) The banking entity:
(i) Clearly and conspicuously
discloses, in writing, to any prospective
and actual investor in the covered fund
(such as through disclosure in the
covered fund’s offering documents):
(A) That ‘‘any losses in [such covered
fund] will be borne solely by investors
in [the covered fund] and not by [the
banking entity] or its affiliates;
therefore, [the banking entity’s] losses in
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[such covered fund] will be limited to
losses attributable to the ownership
interests in the covered fund held by
[the banking entity] and any affiliate in
its capacity as investor in the [covered
fund] or as beneficiary of a restricted
profit interest held by [the banking
entity] or any affiliate’’;
(B) That such investor should read the
fund offering documents before
investing in the covered fund;
(C) That the ‘‘ownership interests in
the covered fund are not insured by the
FDIC, and are not deposits, obligations
of, or endorsed or guaranteed in any
way, by any banking entity’’ (unless that
happens to be the case); and
(D) The role of the banking entity and
its affiliates and employees in
sponsoring or providing any services to
the covered fund; and
(ii) Complies with any additional
rules of the appropriate Federal banking
agencies, the SEC, or the CFTC, as
provided in section 13(b)(2) of the BHC
Act, designed to ensure that losses in
such covered fund are borne solely by
investors in the covered fund and not by
the covered banking entity and its
affiliates.
(b) Organizing and offering an issuing
entity of asset-backed securities. (1)
Notwithstanding § 75.10(a), a banking
entity is not prohibited from acquiring
or retaining an ownership interest in, or
acting as sponsor to, a covered fund that
is an issuing entity of asset-backed
securities in connection with, directly
or indirectly, organizing and offering
that issuing entity, so long as the
banking entity and its affiliates comply
with all of the requirements of
paragraphs (a)(3) through (a)(8) of this
section.
(2) For purposes of paragraph (b) of
this section, organizing and offering a
covered fund that is an issuing entity of
asset-backed securities means acting as
the securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)) of the issuing
entity, or acquiring or retaining an
ownership interest in the issuing entity
as required by section 15G of that Act
(15 U.S.C. 78o–11) and the
implementing regulations issued
thereunder.
(c) Underwriting and market making
in ownership interests of a covered
fund. The prohibition contained in
§ 75.10(a) does not apply to a banking
entity’s underwriting activities or
market making-related activities
involving a covered fund so long as:
(1) Those activities are conducted in
accordance with the requirements of
§ 75.4(a) or (b), respectively;
(2) With respect to any banking entity
(or any affiliate thereof) that acts as a
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sponsor, investment adviser or
commodity trading advisor to a
particular covered fund or otherwise
acquires and retains an ownership
interest in such covered fund in reliance
on paragraph (a) of this section; acquires
and retains an ownership interest in
such covered fund and is either a
securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)), or is acquiring
and retaining an ownership interest in
such covered fund in compliance with
section 15G of that Act (15 U.S.C. 78o–
11) and the implementing regulations
issued thereunder each as permitted by
paragraph (b) of this section; or, directly
or indirectly, guarantees, assumes, or
otherwise insures the obligations or
performance of the covered fund or of
any covered fund in which such fund
invests, then in each such case any
ownership interests acquired or retained
by the banking entity and its affiliates in
connection with underwriting and
market making related activities for that
particular covered fund are included in
the calculation of ownership interests
permitted to be held by the banking
entity and its affiliates under the
limitations of § 75.12(a)(2)(ii) and (d);
and
(3) With respect to any banking entity,
the aggregate value of all ownership
interests of the banking entity and its
affiliates in all covered funds acquired
and retained under § 75.11, including
all covered funds in which the banking
entity holds an ownership interest in
connection with underwriting and
market making related activities
permitted under paragraph (c) of this
section, are included in the calculation
of all ownership interests under
§ 75.12(a)(2)(iii) and (d).
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§ 75.12
fund.
Permitted investment in a covered
(a) Authority and limitations on
permitted investments in covered funds.
(1) Notwithstanding the prohibition
contained in § 75.10(a), a banking entity
may acquire and retain an ownership
interest in a covered fund that the
banking entity or an affiliate thereof
organizes and offers pursuant to § 75.11,
for the purposes of:
(i) Establishment. Establishing the
fund and providing the fund with
sufficient initial equity for investment to
permit the fund to attract unaffiliated
investors, subject to the limits contained
in paragraphs (a)(2)(i) and (a)(2)(iii) of
this section; or
(ii) De minimis investment. Making
and retaining an investment in the
covered fund subject to the limits
contained in paragraphs (a)(2)(ii) and
(a)(2)(iii) of this section.
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(2) Investment limits—(i) Seeding
period. With respect to an investment in
any covered fund made or held
pursuant to paragraph (a)(1)(i) of this
section, the banking entity and its
affiliates:
(A) Must actively seek unaffiliated
investors to reduce, through
redemption, sale, dilution, or other
methods, the aggregate amount of all
ownership interests of the banking
entity in the covered fund to the amount
permitted in paragraph (a)(2)(i)(B) of
this section; and
(B) Must, no later than 1 year after the
date of establishment of the fund (or
such longer period as may be provided
by the Board pursuant to paragraph (e)
of this section), conform its ownership
interest in the covered fund to the limits
in paragraph (a)(2)(ii) of this section;
(ii) Per-fund limits. (A) Except as
provided in paragraph (a)(2)(ii)(B) of
this section, an investment by a banking
entity and its affiliates in any covered
fund made or held pursuant to
paragraph (a)(1)(ii) of this section may
not exceed 3 percent of the total number
or value of the outstanding ownership
interests of the fund.
(B) An investment by a banking entity
and its affiliates in a covered fund that
is an issuing entity of asset-backed
securities may not exceed 3 percent of
the total fair market value of the
ownership interests of the fund
measured in accordance with paragraph
(b)(3) of this section, unless a greater
percentage is retained by the banking
entity and its affiliates in compliance
with the requirements of section 15G of
the Exchange Act (15 U.S.C. 78o–11)
and the implementing regulations
issued thereunder, in which case the
investment by the banking entity and its
affiliates in the covered fund may not
exceed the amount, number, or value of
ownership interests of the fund required
under section 15G of the Exchange Act
and the implementing regulations
issued thereunder.
(iii) Aggregate limit. The aggregate
value of all ownership interests of the
banking entity and its affiliates in all
covered funds acquired or retained
under this section may not exceed 3
percent of the tier 1 capital of the
banking entity, as provided under
paragraph (c) of this section, and shall
be calculated as of the last day of each
calendar quarter.
(iv) Date of establishment. For
purposes of this section, the date of
establishment of a covered fund shall
be:
(A) In general. The date on which the
investment adviser or similar entity to
the covered fund begins making
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62225
investments pursuant to the written
investment strategy for the fund;
(B) Issuing entities of asset-backed
securities. In the case of an issuing
entity of asset-backed securities, the
date on which the assets are initially
transferred into the issuing entity of
asset-backed securities.
(b) Rules of construction—(1)
Attribution of ownership interests to a
covered banking entity. (i) For purposes
of paragraph (a)(2) of this section, the
amount and value of a banking entity’s
permitted investment in any single
covered fund shall include any
ownership interest held under § 75.12
directly by the banking entity, including
any affiliate of the banking entity.
(ii) Treatment of registered investment
companies, SEC-regulated business
development companies and foreign
public funds. For purposes of paragraph
(b)(1)(i) of this section, a registered
investment company, SEC-regulated
business development companies or
foreign public fund as described in
§ 75.10(c)(1) will not be considered to be
an affiliate of the banking entity so long
as the banking entity:
(A) Does not own, control, or hold
with the power to vote 25 percent or
more of the voting shares of the
company or fund; and
(B) Provides investment advisory,
commodity trading advisory,
administrative, and other services to the
company or fund in compliance with
the limitations under applicable
regulation, order, or other authority.
(iii) Covered funds. For purposes of
paragraph (b)(1)(i) of this section, a
covered fund will not be considered to
be an affiliate of a banking entity so long
as the covered fund is held in
compliance with the requirements of
this subpart.
(iv) Treatment of employee and
director investments financed by the
banking entity. For purposes of
paragraph (b)(1)(i) of this section, an
investment by a director or employee of
a banking entity who acquires an
ownership interest in his or her
personal capacity in a covered fund
sponsored by the banking entity will be
attributed to the banking entity if the
banking entity, directly or indirectly,
extends financing for the purpose of
enabling the director or employee to
acquire the ownership interest in the
fund and the financing is used to
acquire such ownership interest in the
covered fund.
(2) Calculation of permitted
ownership interests in a single covered
fund. Except as provided in paragraphs
(b)(3) or (4) of this section, for purposes
of determining whether an investment
in a single covered fund complies with
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the restrictions on ownership interests
under paragraphs (a)(2)(i)(B) and (ii)(A)
of this section:
(i) The aggregate number of the
outstanding ownership interests held by
the banking entity shall be the total
number of ownership interests held
under this section by the banking entity
in a covered fund divided by the total
number of ownership interests held by
all entities in that covered fund, as of
the last day of each calendar quarter
(both measured without regard to
committed funds not yet called for
investment);
(ii) The aggregate value of the
outstanding ownership interests held by
the banking entity shall be the aggregate
fair market value of all investments in
and capital contributions made to the
covered fund by the banking entity,
divided by the value of all investments
in and capital contributions made to
that covered fund by all entities, as of
the last day of each calendar quarter (all
measured without regard to committed
funds not yet called for investment). If
fair market value cannot be determined,
then the value shall be the historical
cost basis of all investments in and
contributions made by the banking
entity to the covered fund;
(iii) For purposes of the calculation
under paragraph (b)(2)(ii) of this section,
once a valuation methodology is chosen,
the banking entity must calculate the
value of its investment and the
investments of all others in the covered
fund in the same manner and according
to the same standards.
(3) Issuing entities of asset-backed
securities. In the case of an ownership
interest in an issuing entity of assetbacked securities, for purposes of
determining whether an investment in a
single covered fund complies with the
restrictions on ownership interests
under paragraphs (a)(2)(i)(B) and
(a)(2)(ii)(B) of this section:
(i) For securitizations subject to the
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11), the
calculations shall be made as of the date
and according to the valuation
methodology applicable pursuant to the
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11) and
the implementing regulations issued
thereunder; or
(ii) For securitization transactions
completed prior to the compliance date
of such implementing regulations (or as
to which such implementing regulations
do not apply), the calculations shall be
made as of the date of establishment as
defined in paragraph (a)(2)(iv)(B) of this
section or such earlier date on which
the transferred assets have been valued
for purposes of transfer to the covered
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fund, and thereafter only upon the date
on which additional securities of the
issuing entity of asset-backed securities
are priced for purposes of the sales of
ownership interests to unaffiliated
investors.
(iii) For securitization transactions
completed prior to the compliance date
of such implementing regulations (or as
to which such implementing regulations
do not apply), the aggregate value of the
outstanding ownership interests in the
covered fund shall be the fair market
value of the assets transferred to the
issuing entity of the securitization and
any other assets otherwise held by the
issuing entity at such time, determined
in a manner that is consistent with its
determination of the fair market value of
those assets for financial statement
purposes.
(iv) For purposes of the calculation
under paragraph (b)(3)(iii) of this
section, the valuation methodology used
to calculate the fair market value of the
ownership interests must be the same
for both the ownership interests held by
a banking entity and the ownership
interests held by all others in the
covered fund in the same manner and
according to the same standards.
(4) Multi-tier fund investments—(i)
Master-feeder fund investments. If the
principal investment strategy of a
covered fund (the ‘‘feeder fund’’) is to
invest substantially all of its assets in
another single covered fund (the
‘‘master fund’’), then for purposes of the
investment limitations in paragraphs
(a)(2)(i)(B) and (a)(2)(ii) of this section,
the banking entity’s permitted
investment in such funds shall be
measured only by reference to the value
of the master fund. The banking entity’s
permitted investment in the master fund
shall include any investment by the
banking entity in the master fund, as
well as the banking entity’s pro-rata
share of any ownership interest of the
master fund that is held through the
feeder fund; and
(ii) Fund-of-funds investments. If a
banking entity organizes and offers a
covered fund pursuant to § 75.11 for the
purpose of investing in other covered
funds (a ‘‘fund of funds’’) and that fund
of funds itself invests in another
covered fund that the banking entity is
permitted to own, then the banking
entity’s permitted investment in that
other fund shall include any investment
by the banking entity in that other fund,
as well as the banking entity’s pro-rata
share of any ownership interest of the
fund that is held through the fund of
funds. The investment of the banking
entity may not represent more than 3
percent of the amount or value of any
single covered fund.
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(c) Aggregate permitted investments
in all covered funds. (1) For purposes of
paragraph (a)(2)(iii) of this section, the
aggregate value of all ownership
interests held by a banking entity shall
be the sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest in covered funds
(together with any amounts paid by the
entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § 75.10(d)(6)(ii)), on
a historical cost basis.
(2) Calculation of tier 1 capital. For
purposes of paragraph (a)(2)(iii) of this
section:
(i) Entities that are required to hold
and report tier 1 capital. If a banking
entity is required to calculate and report
tier 1 capital, the banking entity’s tier 1
capital shall be equal to the amount of
tier 1 capital of the banking entity as of
the last day of the most recent calendar
quarter, as reported to its primary
financial regulatory agency; and
(ii) If a banking entity is not required
to calculate and report tier 1 capital, the
banking entity’s tier 1 capital shall be
determined to be equal to:
(A) In the case of a banking entity that
is controlled, directly or indirectly, by a
depository institution that calculates
and reports tier 1 capital, be equal to the
amount of tier 1 capital reported by
such controlling depository institution
in the manner described in paragraph
(c)(2)(i) of this section;
(B) In the case of a banking entity that
is not controlled, directly or indirectly,
by a depository institution that
calculates and reports tier 1 capital:
(1) Bank holding company
subsidiaries. If the banking entity is a
subsidiary of a bank holding company
or company that is treated as a bank
holding company, be equal to the
amount of tier 1 capital reported by the
top-tier affiliate of such covered banking
entity that calculates and reports tier 1
capital in the manner described in
paragraph (c)(2)(i) of this section; and
(2) Other holding companies and any
subsidiary or affiliate thereof. If the
banking entity is not a subsidiary of a
bank holding company or a company
that is treated as a bank holding
company, be equal to the total amount
of shareholders’ equity of the top-tier
affiliate within such organization as of
the last day of the most recent calendar
quarter that has ended, as determined
under applicable accounting standards.
(iii) Treatment of foreign banking
entities—(A) Foreign banking entities.
Except as provided in paragraph
(c)(2)(iii)(B) of this section, with respect
to a banking entity that is not itself, and
is not controlled directly or indirectly
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by, a banking entity that is located or
organized under the laws of the United
States or of any State, the tier 1 capital
of the banking entity shall be the
consolidated tier 1 capital of the entity
as calculated under applicable home
country standards.
(B) U.S. affiliates of foreign banking
entities. With respect to a banking entity
that is located or organized under the
laws of the United States or of any State
and is controlled by a foreign banking
entity identified under paragraph
(c)(2)(iii)(A) of this section, the banking
entity’s tier 1 capital shall be as
calculated under paragraphs (c)(2)(i) or
(ii) of this section.
(d) Capital treatment for a permitted
investment in a covered fund. For
purposes of calculating compliance with
the applicable regulatory capital
requirements, a banking entity shall
deduct from the banking entity’s tier 1
capital (as determined under paragraph
(c)(2) of this section) the greater of:
(1) The sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest (together with any
amounts paid by the entity (or employee
thereof) in connection with obtaining a
restricted profit interest under
§ 75.10(d)(6)(ii)), on a historical cost
basis, plus any earnings received; and
(2) The fair market value of the
banking entity’s ownership interests in
the covered fund as determined under
paragraph (b)(2)(ii) or (3) of this section
(together with any amounts paid by the
entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § 75.10(d)(6)(ii)), if
the banking entity accounts for the
profits (or losses) of the fund investment
in its financial statements.
(e) Extension of time to divest an
ownership interest. (1) Upon application
by a banking entity, the Board may
extend the period under paragraph
(a)(2)(i) of this section for up to 2
additional years if the Board finds that
an extension would be consistent with
safety and soundness and not
detrimental to the public interest. An
application for extension must:
(i) Be submitted to the Board at least
90 days prior to the expiration of the
applicable time period;
(ii) Provide the reasons for
application, including information that
addresses the factors in paragraph (e)(2)
of this section; and
(iii) Explain the banking entity’s plan
for reducing the permitted investment
in a covered fund through redemption,
sale, dilution or other methods as
required in paragraph (a)(2) of this
section.
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(2) Factors governing Board
determinations. In reviewing any
application under paragraph (e)(1) of
this section, the Board may consider all
the facts and circumstances related to
the permitted investment in a covered
fund, including:
(i) Whether the investment would
result, directly or indirectly, in a
material exposure by the banking entity
to high-risk assets or high-risk trading
strategies;
(ii) The contractual terms governing
the banking entity’s interest in the
covered fund;
(iii) The date on which the covered
fund is expected to have attracted
sufficient investments from investors
unaffiliated with the banking entity to
enable the banking entity to comply
with the limitations in paragraph
(a)(2)(i) of this section;
(iv) The total exposure of the covered
banking entity to the investment and the
risks that disposing of, or maintaining,
the investment in the covered fund may
pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of
divesting or disposing of the investment
within the applicable period;
(vi) Whether the investment or the
divestiture or conformance of the
investment would involve or result in a
material conflict of interest between the
banking entity and unaffiliated parties,
including clients, customers or
counterparties to which it owes a duty;
(vii) The banking entity’s prior efforts
to reduce through redemption, sale,
dilution, or other methods its ownership
interests in the covered fund, including
activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board
believes appropriate.
(3) Authority to impose restrictions on
activities or investment during any
extension period. The Board may
impose such conditions on any
extension approved under paragraph
(e)(1) of this section as the Board
determines are necessary or appropriate
to protect the safety and soundness of
the banking entity or the financial
stability of the United States, address
material conflicts of interest or other
unsound banking practices, or otherwise
further the purposes of section 13 of the
BHC Act and this part.
(4) Consultation. In the case of a
banking entity that is primarily
regulated by another Federal banking
agency, the SEC, or the CFTC, the Board
will consult with such agency prior to
acting on an application by the banking
entity for an extension under paragraph
(e)(1) of this section.
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62227
§ 75.13 Other permitted covered fund
activities and investments.
(a) Permitted risk-mitigating hedging
activities. (1) The prohibition contained
in § 75.10(a) does not apply with respect
to an ownership interest in a covered
fund acquired or retained by a banking
entity that is designed to demonstrably
reduce or otherwise significantly
mitigate the specific, identifiable risks
to the banking entity in connection with
a compensation arrangement with an
employee of the banking entity or an
affiliate thereof that directly provides
investment advisory, commodity trading
advisory or other services to the covered
fund.
(2) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under paragraph (a) of this
section only if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures; and
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(ii) The acquisition or retention of the
ownership interest:
(A) Is made in accordance with the
written policies, procedures and
internal controls required under this
section;
(B) At the inception of the hedge, is
designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks arising in connection
with the compensation arrangement
with the employee that directly
provides investment advisory,
commodity trading advisory, or other
services to the covered fund;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section; and
(D) Is subject to continuing review,
monitoring and management by the
banking entity.
(iii) The compensation arrangement
relates solely to the covered fund in
which the banking entity or any affiliate
has acquired an ownership interest
pursuant to this paragraph and such
compensation arrangement provides
that any losses incurred by the banking
entity on such ownership interest will
be offset by corresponding decreases in
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amounts payable under such
compensation arrangement.
(b) Certain permitted covered fund
activities and investments outside of the
United States. (1) The prohibition
contained in § 75.10(a) does not apply to
the acquisition or retention of any
ownership interest in, or the
sponsorship of, a covered fund by a
banking entity only if:
(i) The banking entity is not organized
or directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of one
or more States;
(ii) The activity or investment by the
banking entity is pursuant to paragraph
(9) or (13) of section 4(c) of the BHC Act;
(iii) No ownership interest in the
covered fund is offered for sale or sold
to a resident of the United States; and
(iv) The activity or investment occurs
solely outside of the United States.
(2) An activity or investment by the
banking entity is pursuant to paragraph
(9) or (13) of section 4(c) of the BHC Act
for purposes of paragraph (b)(1)(ii) of
this section only if:
(i) The activity or investment is
conducted in accordance with the
requirements of this section; and
(ii)(A) With respect to a banking
entity that is a foreign banking
organization, the banking entity meets
the qualifying foreign banking
organization requirements of
§ 211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c) or
(e)), as applicable; or
(B) With respect to a banking entity
that is not a foreign banking
organization, the banking entity is not
organized under the laws of the United
States or of one or more States and the
banking entity, on a fully-consolidated
basis, meets at least two of the following
requirements:
(1) Total assets of the banking entity
held outside of the United States exceed
total assets of the banking entity held in
the United States;
(2) Total revenues derived from the
business of the banking entity outside of
the United States exceed total revenues
derived from the business of the
banking entity in the United States; or
(3) Total net income derived from the
business of the banking entity outside of
the United States exceeds total net
income derived from the business of the
banking entity in the United States.
(3) An ownership interest in a covered
fund is not offered for sale or sold to a
resident of the United States for
purposes of paragraph (b)(1)(iii) of this
section only if it is sold or has been sold
pursuant to an offering that does not
target residents of the United States.
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(4) An activity or investment occurs
solely outside of the United States for
purposes of paragraph (b)(1)(iv) of this
section only if:
(i) The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
and is not controlled directly or
indirectly by, a banking entity that is
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
laws of the United States or of any State;
(iii) The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
as principal directly or indirectly on a
consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
(iv) No financing for the banking
entity’s ownership or sponsorship is
provided, directly or indirectly, by any
branch or affiliate that is located in the
United States or organized under the
laws of the United States or of any State.
(5) For purposes of this section, a U.S.
branch, agency, or subsidiary of a
foreign bank, or any subsidiary thereof,
is located in the United States; however,
a foreign bank of which that branch,
agency, or subsidiary is a part is not
considered to be located in the United
States solely by virtue of operation of
the U.S. branch, agency, or subsidiary.
(c) Permitted covered fund interests
and activities by a regulated insurance
company. The prohibition contained in
§ 75.10(a) does not apply to the
acquisition or retention by an insurance
company, or an affiliate thereof, of any
ownership interest in, or the
sponsorship of, a covered fund only if:
(1) The insurance company or its
affiliate acquires and retains the
ownership interest solely for the general
account of the insurance company or for
one or more separate accounts
established by the insurance company;
(2) The acquisition and retention of
the ownership interest is conducted in
compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
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commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (c)(2) of this
section is insufficient to protect the
safety and soundness of the banking
entity, or the financial stability of the
United States.
§ 75.14 Limitations on relationships with a
covered fund.
(a) Relationships with a covered fund.
(1) Except as provided for in paragraph
(a)(2) of this section, no banking entity
that serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, that
organizes and offers a covered fund
pursuant to § 75.11, or that continues to
hold an ownership interest in
accordance with § 75.11(b), and no
affiliate of such entity, may enter into a
transaction with the covered fund, or
with any other covered fund that is
controlled by such covered fund, that
would be a covered transaction as
defined in section 23A of the Federal
Reserve Act (12 U.S.C. 371c(b)(7)), as if
such banking entity and the affiliate
thereof were a member bank and the
covered fund were an affiliate thereof.
(2) Notwithstanding paragraph (a)(1)
of this section, a banking entity may:
(i) Acquire and retain any ownership
interest in a covered fund in accordance
with the requirements of § 75.11,
§ 75.12, or § 75.13; and
(ii) Enter into any prime brokerage
transaction with any covered fund in
which a covered fund managed,
sponsored, or advised by such banking
entity (or an affiliate thereof) has taken
an ownership interest, if:
(A) The banking entity is in
compliance with each of the limitations
set forth in § 75.11 with respect to a
covered fund organized and offered by
such banking entity (or an affiliate
thereof);
(B) The chief executive officer (or
equivalent officer) of the banking entity
certifies in writing annually to the
Commission (with a duty to update the
certification if the information in the
certification materially changes) that the
banking entity does not, directly or
indirectly, guarantee, assume, or
otherwise insure the obligations or
performance of the covered fund or of
any covered fund in which such
covered fund invests; and
(C) The Board has not determined that
such transaction is inconsistent with the
safe and sound operation and condition
of the banking entity.
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(b) Restrictions on transactions with
covered funds. A banking entity that
serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, or that
organizes and offers a covered fund
pursuant to § 75.11, or that continues to
hold an ownership interest in
accordance with § 75.11(b), shall be
subject to section 23B of the Federal
Reserve Act (12 U.S.C. 371c–1), as if
such banking entity were a member
bank and such covered fund were an
affiliate thereof.
(c) Restrictions on prime brokerage
transactions. A prime brokerage
transaction permitted under paragraph
(a)(2)(ii) of this section shall be subject
to section 23B of the Federal Reserve
Act (12 U.S.C. 371c–1) as if the
counterparty were an affiliate of the
banking entity.
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§ 75.15 Other limitations on permitted
covered fund activities.
(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ 75.11 through
75.13 if the transaction, class of
transactions, or activity would:
(1) Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
(2) Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
(3) Pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.
(b) Definition of material conflict of
interest. (1) For purposes of this section,
a material conflict of interest between a
banking entity and its clients,
customers, or counterparties exists if the
banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the banking entity’s interests being
materially adverse to the interests of its
client, customer, or counterparty with
respect to such transaction, class of
transactions, or activity, and the
banking entity has not taken at least one
of the actions in paragraph (b)(2) of this
section.
(2) Prior to effecting the specific
transaction or class or type of
transactions, or engaging in the specific
activity, the banking entity:
(i) Timely and effective disclosure. (A)
Has made clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
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reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest; and
(B) Such disclosure is made in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
mitigate, any materially adverse effect
on the client, customer, or counterparty
created by the conflict of interest; or
(ii) Information barriers. Has
established, maintained, and enforced
information barriers that are
memorialized in written policies and
procedures, such as physical separation
of personnel, or functions, or limitations
on types of activity, that are reasonably
designed, taking into consideration the
nature of the banking entity’s business,
to prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A banking entity may not
rely on such information barriers if, in
the case of any specific transaction,
class or type of transactions or activity,
the banking entity knows or should
reasonably know that, notwithstanding
the banking entity’s establishment of
information barriers, the conflict of
interest may involve or result in a
materially adverse effect on a client,
customer, or counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
§ 75.16 Ownership of interests in and
sponsorship of issuers of certain
collateralized debt obligations backed by
trust-preferred securities.
(a) The prohibition contained in
§ 75.10(a)(1) does not apply to the
ownership by a banking entity of an
interest in, or sponsorship of, any issuer
if:
(1) The issuer was established, and
the interest was issued, before May 19,
2010;
(2) The banking entity reasonably
believes that the offering proceeds
received by the issuer were invested
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primarily in Qualifying TruPS
Collateral; and
(3) The banking entity acquired such
interest on or before December 10, 2013
(or acquired such interest in connection
with a merger with or acquisition of a
banking entity that acquired the interest
on or before December 10, 2013).
(b) For purposes of this § 75.16,
Qualifying TruPS Collateral shall mean
any trust preferred security or
subordinated debt instrument issued
prior to May 19, 2010 by a depository
institution holding company that, as of
the end of any reporting period within
12 months immediately preceding the
issuance of such trust preferred security
or subordinated debt instrument, had
total consolidated assets of less than
$15,000,000,000 or issued prior to May
19, 2010 by a mutual holding company.
(c) Notwithstanding paragraph (a)(3)
of this section, a banking entity may act
as a market maker with respect to the
interests of an issuer described in
paragraph (a) of this section in
accordance with the applicable
provisions of §§ 75.4 and 75.11.
(d) Without limiting the applicability
of paragraph (a) of this section, the
Board, the FDIC and the OCC will make
public a non-exclusive list of issuers
that meet the requirements of paragraph
(a). A banking entity may rely on the list
published by the Board, the FDIC and
the OCC.
§§ 75.17–75.19
[Reserved]
Subpart D—Compliance Program
Requirement; Violations
§ 75.20
Program for compliance; reporting.
(a) Program requirement. Each
banking entity shall develop and
provide for the continued
administration of a compliance program
reasonably designed to ensure and
monitor compliance with the
prohibitions and restrictions on
proprietary trading and covered fund
activities and investments set forth in
section 13 of the BHC Act and this part.
The terms, scope and detail of the
compliance program shall be
appropriate for the types, size, scope
and complexity of activities and
business structure of the banking entity.
(b) Contents of compliance program.
Except as provided in paragraph (f) of
this section, the compliance program
required by paragraph (a) of this section,
at a minimum, shall include:
(1) Written policies and procedures
reasonably designed to document,
describe, monitor and limit trading
activities subject to subpart B of this
part (including those permitted under
§§ 75.3 to 75.6), including setting,
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monitoring and managing required
limits set out in §§ 75.4 and 75.5, and
activities and investments with respect
to a covered fund subject to subpart C
of this part (including those permitted
under §§ 75.11 through 75.14)
conducted by the banking entity to
ensure that all activities and
investments conducted by the banking
entity that are subject to section 13 of
the BHC Act and this part comply with
section 13 of the BHC Act and this part;
(2) A system of internal controls
reasonably designed to monitor
compliance with section 13 of the BHC
Act and this part and to prevent the
occurrence of activities or investments
that are prohibited by section 13 of the
BHC Act and this part;
(3) A management framework that
clearly delineates responsibility and
accountability for compliance with
section 13 of the BHC Act and this part
and includes appropriate management
review of trading limits, strategies,
hedging activities, investments,
incentive compensation and other
matters identified in this part or by
management as requiring attention;
(4) Independent testing and audit of
the effectiveness of the compliance
program conducted periodically by
qualified personnel of the banking
entity or by a qualified outside party;
(5) Training for trading personnel and
managers, as well as other appropriate
personnel, to effectively implement and
enforce the compliance program; and
(6) Records sufficient to demonstrate
compliance with section 13 of the BHC
Act and this part, which a banking
entity must promptly provide to the
Commission upon request and retain for
a period of no less than 5 years or such
longer period as required by the
Commission.
(c) Additional standards. In addition
to the requirements in paragraph (b) of
this section, the compliance program of
a banking entity must satisfy the
requirements and other standards
contained in appendix B of this part, if:
(1) The banking entity engages in
proprietary trading permitted under
subpart B of this part and is required to
comply with the reporting requirements
of paragraph (d) of this section;
(2) The banking entity has reported
total consolidated assets as of the
previous calendar year end of $50
billion or more or, in the case of a
foreign banking entity, has total U.S.
assets as of the previous calendar year
end of $50 billion or more (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity
operating, located or organized in the
United States); or
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(3) The Commission notifies the
banking entity in writing that it must
satisfy the requirements and other
standards contained in appendix B of
this part.
(d) Reporting requirements under
appendix A of this part. (1) A banking
entity engaged in proprietary trading
activity permitted under subpart B of
this part shall comply with the reporting
requirements described in appendix A
of this part, if:
(i) The banking entity (other than a
foreign banking entity as provided in
paragraph (d)(1)(ii) of this section) has,
together with its affiliates and
subsidiaries, trading assets and
liabilities (excluding trading assets and
liabilities involving obligations of or
guaranteed by the United States or any
agency of the United States) the average
gross sum of which (on a worldwide
consolidated basis) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the threshold established in
paragraph (d)(2) of this section;
(ii) In the case of a foreign banking
entity, the average gross sum of the
trading assets and liabilities of the
combined U.S. operations of the foreign
banking entity (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity
operating, located or organized in the
United States and excluding trading
assets and liabilities involving
obligations of or guaranteed by the
United States or any agency of the
United States) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the threshold established in
paragraph (d)(2) of this section; or
(iii) The Commission notifies the
banking entity in writing that it must
satisfy the reporting requirements
contained in appendix A of this part.
(2) The threshold for reporting under
paragraph (d)(1) of this section shall be
$50 billion beginning on June 30, 2014;
$25 billion beginning on April 30, 2016;
and $10 billion beginning on December
31, 2016.
(3) Frequency of reporting. Unless the
Commission notifies the banking entity
in writing that it must report on a
different basis, a banking entity with
$50 billion or more in trading assets and
liabilities (as calculated in accordance
with paragraph (d)(1) of this section)
shall report the information required by
appendix A of this part for each
calendar month within 30 days of the
end of the relevant calendar month;
beginning with information for the
month of January 2015, such
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information shall be reported within 10
days of the end of each calendar month.
Any other banking entity subject to
appendix A of this part shall report the
information required by appendix A of
this part for each calendar quarter
within 30 days of the end of that
calendar quarter unless the Commission
notifies the banking entity in writing
that it must report on a different basis.
(e) Additional documentation for
covered funds. Any banking entity that
has more than $10 billion in total
consolidated assets as reported on
December 31 of the previous two
calendar years shall maintain records
that include:
(1) Documentation of the exclusions
or exemptions other than sections
3(c)(1) and 3(c)(7) of the Investment
Company Act of 1940 relied on by each
fund sponsored by the banking entity
(including all subsidiaries and affiliates)
in determining that such fund is not a
covered fund;
(2) For each fund sponsored by the
banking entity (including all
subsidiaries and affiliates) for which the
banking entity relies on one or more of
the exclusions from the definition of
covered fund provided by § 75.10(c)(1),
(5), (8), (9), or (10), documentation
supporting the banking entity’s
determination that the fund is not a
covered fund pursuant to one or more
of those exclusions;
(3) For each seeding vehicle described
in § 75.10(c)(12)(i) or (iii) that will
become a registered investment
company or SEC-regulated business
development company, a written plan
documenting the banking entity’s
determination that the seeding vehicle
will become a registered investment
company or SEC-regulated business
development company; the period of
time during which the vehicle will
operate as a seeding vehicle; and the
banking entity’s plan to market the
vehicle to third-party investors and
convert it into a registered investment
company or SEC-regulated business
development company within the time
period specified in § 75.12(a)(2)(i)(B);
(4) For any banking entity that is, or
is controlled directly or indirectly by a
banking entity that is, located in or
organized under the laws of the United
States or of any State, if the aggregate
amount of ownership interests in
foreign public funds that are described
in § 75.10(c)(1) owned by such banking
entity (including ownership interests
owned by any affiliate that is controlled
directly or indirectly by a banking entity
that is located in or organized under the
laws of the United States or of any State)
exceeds $50 million at the end of two
or more consecutive calendar quarters,
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beginning with the next succeeding
calendar quarter, documentation of the
value of the ownership interests owned
by the banking entity (and such
affiliates) in each foreign public fund
and each jurisdiction in which any such
foreign public fund is organized,
calculated as of the end of each calendar
quarter, which documentation must
continue until the banking entity’s
aggregate amount of ownership interests
in foreign public funds is below $50
million for two consecutive calendar
quarters; and
(5) For purposes of paragraph (e)(4) of
this section, a U.S. branch, agency, or
subsidiary of a foreign banking entity is
located in the United States; however,
the foreign bank that operates or
controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(f) Simplified programs for less active
banking entities—(1) Banking entities
with no covered activities. A banking
entity that does not engage in activities
or investments pursuant to subpart B or
subpart C of this part (other than trading
activities permitted pursuant to
§ 75.6(a)) may satisfy the requirements
of this section by establishing the
required compliance program prior to
becoming engaged in such activities or
making such investments (other than
trading activities permitted pursuant to
§ 75.6(a)).
(2) Banking entities with modest
activities. A banking entity with total
consolidated assets of $10 billion or less
as reported on December 31 of the
previous two calendar years that
engages in activities or investments
pursuant to subpart B or subpart C of
this part (other than trading activities
permitted under § 75.6(a)) may satisfy
the requirements of this section by
including in its existing compliance
policies and procedures appropriate
references to the requirements of section
13 of the BHC Act and this part and
adjustments as appropriate given the
activities, size, scope and complexity of
the banking entity.
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§ 75.21 Termination of activities or
investments; penalties for violations.
(a) Any banking entity that engages in
an activity or makes an investment in
violation of section 13 of the BHC Act
or this part, or acts in a manner that
functions as an evasion of the
requirements of section 13 of the BHC
Act or this part, including through an
abuse of any activity or investment
permitted under subparts B or C of this
part, or otherwise violates the
restrictions and requirements of section
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13 of the BHC Act or this part, shall,
upon discovery, promptly terminate the
activity and, as relevant, dispose of the
investment.
(b) Whenever the Commission finds
reasonable cause to believe any banking
entity has engaged in an activity or
made an investment in violation of
section 13 of the BHC Act or this part,
or engaged in any activity or made any
investment that functions as an evasion
of the requirements of section 13 of the
BHC Act or this part, the Commission
may take any action permitted by law to
enforce compliance with section 13 of
the BHC Act and this part, including
directing the banking entity to restrict,
limit, or terminate any or all activities
under this part and dispose of any
investment.
Appendix A to Part 75—Reporting and
Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and
recordkeeping requirements that certain
banking entities must satisfy in connection
with the restrictions on proprietary trading
set forth in subpart B of this part
(‘‘proprietary trading restrictions’’). Pursuant
to § 75.20(d), this appendix generally applies
to a banking entity that, together with its
affiliates and subsidiaries, has significant
trading assets and liabilities. These entities
are required to (i) furnish periodic reports to
the Commission regarding a variety of
quantitative measurements of their covered
trading activities, which vary depending on
the scope and size of covered trading
activities, and (ii) create and maintain
records documenting the preparation and
content of these reports. The requirements of
this appendix must be incorporated into the
banking entity’s internal compliance program
under § 75.20 and Appendix B of this part.
b. The purpose of this appendix is to assist
banking entities and the Commission in:
(i) Better understanding and evaluating the
scope, type, and profile of the banking
entity’s covered trading activities;
(ii) Monitoring the banking entity’s covered
trading activities;
(iii) Identifying covered trading activities
that warrant further review or examination
by the banking entity to verify compliance
with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading
activities of trading desks engaged in market
making-related activities subject to § 75.4(b)
are consistent with the requirements
governing permitted market making-related
activities;
(v) Evaluating whether the covered trading
activities of trading desks that are engaged in
permitted trading activity subject to § 75.4,
75.5, or 75.6(a) and (b) (i.e., underwriting and
market making-related related activity, riskmitigating hedging, or trading in certain
government obligations) are consistent with
the requirement that such activity not result,
directly or indirectly, in a material exposure
to high-risk assets or high-risk trading
strategies;
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(vi) Identifying the profile of particular
covered trading activities of the banking
entity, and the individual trading desks of
the banking entity, to help establish the
appropriate frequency and scope of
examination by the Commission of such
activities; and
(vii) Assessing and addressing the risks
associated with the banking entity’s covered
trading activities.
c. The quantitative measurements that
must be furnished pursuant to this appendix
are not intended to serve as a dispositive tool
for the identification of permissible or
impermissible activities.
d. In order to allow banking entities and
the Agencies to evaluate the effectiveness of
these metrics, banking entities must collect
and report these metrics for all trading desks
beginning on the dates established in § 75.20.
The Agencies will review the data collected
and revise this collection requirement as
appropriate based on a review of the data
collected prior to September 30, 2015.
e. In addition to the quantitative
measurements required in this appendix, a
banking entity may need to develop and
implement other quantitative measurements
in order to effectively monitor its covered
trading activities for compliance with section
13 of the BHC Act and this part and to have
an effective compliance program, as required
by § 75.20 and Appendix B of this part. The
effectiveness of particular quantitative
measurements may differ based on the profile
of the banking entity’s businesses in general
and, more specifically, of the particular
trading desk, including types of instruments
traded, trading activities and strategies, and
history and experience (e.g., whether the
trading desk is an established, successful
market maker or a new entrant to a
competitive market). In all cases, banking
entities must ensure that they have robust
measures in place to identify and monitor the
risks taken in their trading activities, to
ensure that the activities are within risk
tolerances established by the banking entity,
and to monitor and examine for compliance
with the proprietary trading restrictions in
this part.
f. On an ongoing basis, banking entities
must carefully monitor, review, and evaluate
all furnished quantitative measurements, as
well as any others that they choose to utilize
in order to maintain compliance with section
13 of the BHC Act and this part. All
measurement results that indicate a
heightened risk of impermissible proprietary
trading, including with respect to otherwisepermitted activities under §§ 75.4 through
75.6(a) and (b), or that result in a material
exposure to high-risk assets or high-risk
trading strategies, must be escalated within
the banking entity for review, further
analysis, explanation to the Commission, and
remediation, where appropriate. The
quantitative measurements discussed in this
appendix should be helpful to banking
entities in identifying and managing the risks
related to their covered trading activities.
II. Definitions
The terms used in this appendix have the
same meanings as set forth in §§ 75.2 and
75.3. In addition, for purposes of this
appendix, the following definitions apply:
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Calculation period means the period of
time for which a particular quantitative
measurement must be calculated.
Comprehensive profit and loss means the
net profit or loss of a trading desk’s material
sources of trading revenue over a specific
period of time, including, for example, any
increase or decrease in the market value of
a trading desk’s holdings, dividend income,
and interest income and expense.
Covered trading activity means trading
conducted by a trading desk under § 75.4,
75.5, or 75.6(a) or (b). A banking entity may
include trading under § 75.3(d) or 75.6(c), (d)
or (e).
Measurement frequency means the
frequency with which a particular
quantitative metric must be calculated and
recorded.
Trading desk means the smallest discrete
unit of organization of a banking entity that
purchases or sells financial instruments for
the trading account of the banking entity or
an affiliate thereof.
III. Reporting and Recordkeeping of
Quantitative Measurements
a. Scope of Required Reporting
General scope. Each banking entity made
subject to this part by § 75.20 must furnish
the following quantitative measurements for
each trading desk of the banking entity,
calculated in accordance with this appendix:
• Risk and Position Limits and Usage;
• Risk Factor Sensitivities;
• Value-at-Risk and Stress VaR;
• Comprehensive Profit and Loss
Attribution;
• Inventory Turnover;
• Inventory Aging; and
• Customer Facing Trade Ratio
b. Frequency of Required Calculation and
Reporting
A banking entity must calculate any
applicable quantitative measurement for each
trading day. A banking entity must report
each applicable quantitative measurement to
the Commission on the reporting schedule
established in § 75.20 unless otherwise
requested by the Commission. All
quantitative measurements for any calendar
month must be reported within the time
period required by § 75.20.
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c. Recordkeeping
A banking entity must, for any quantitative
measurement furnished to the Commission
pursuant to this appendix and § 75.20(d),
create and maintain records documenting the
preparation and content of these reports, as
well as such information as is necessary to
permit the Commission to verify the accuracy
of such reports, for a period of 5 years from
the end of the calendar year for which the
measurement was taken.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Risk and Position Limits and Usage
i. Description: For purposes of this
appendix, Risk and Position Limits are the
constraints that define the amount of risk that
a trading desk is permitted to take at a point
in time, as defined by the banking entity for
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a specific trading desk. Usage represents the
portion of the trading desk’s limits that are
accounted for by the current activity of the
desk. Risk and position limits and their usage
are key risk management tools used to
control and monitor risk taking and include,
but are not limited, to the limits set out in
§§ 75.4 and 75.5. A number of the metrics
that are described below, including ‘‘Risk
Factor Sensitivities’’ and ‘‘Value-at-Risk and
Stress Value-at-Risk,’’ relate to a trading
desk’s risk and position limits and are useful
in evaluating and setting these limits in the
broader context of the trading desk’s overall
activities, particularly for the market making
activities under § 75.4(b) and hedging activity
under § 75.5. Accordingly, the limits required
under §§ 75.4(b)(2)(iii) and 75.5(b)(1)(i) must
meet the applicable requirements under
§§ 75.4(b)(2)(iii) and 75.5(b)(1)(i) and also
must include appropriate metrics for the
trading desk limits including, at a minimum,
the ‘‘Risk Factor Sensitivities’’ and ‘‘Value-atRisk and Stress Value-at-Risk’’ metrics except
to the extent any of the ‘‘Risk Factor
Sensitivities’’ or ‘‘Value-at-Risk and Stress
Value-at-Risk’’ metrics are demonstrably
ineffective for measuring and monitoring the
risks of a trading desk based on the types of
positions traded by, and risk exposures of,
that desk.
ii. General Calculation Guidance: Risk and
Position Limits must be reported in the
format used by the banking entity for the
purposes of risk management of each trading
desk. Risk and Position Limits are often
expressed in terms of risk measures, such as
VaR and Risk Factor Sensitivities, but may
also be expressed in terms of other
observable criteria, such as net open
positions. When criteria other than VaR or
Risk Factor Sensitivities are used to define
the Risk and Position Limits, both the value
of the Risk and Position Limits and the value
of the variables used to assess whether these
limits have been reached must be reported.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
2. Risk Factor Sensitivities
i. Description: For purposes of this
appendix, Risk Factor Sensitivities are
changes in a trading desk’s Comprehensive
Profit and Loss that are expected to occur in
the event of a change in one or more
underlying variables that are significant
sources of the trading desk’s profitability and
risk.
ii. General Calculation Guidance: A
banking entity must report the Risk Factor
Sensitivities that are monitored and managed
as part of the trading desk’s overall risk
management policy. The underlying data and
methods used to compute a trading desk’s
Risk Factor Sensitivities will depend on the
specific function of the trading desk and the
internal risk management models employed.
The number and type of Risk Factor
Sensitivities that are monitored and managed
by a trading desk, and furnished to the
Commission, will depend on the explicit
risks assumed by the trading desk. In general,
however, reported Risk Factor Sensitivities
must be sufficiently granular to account for
a preponderance of the expected price
variation in the trading desk’s holdings.
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A. Trading desks must take into account
any relevant factors in calculating Risk Factor
Sensitivities, including, for example, the
following with respect to particular asset
classes:
• Commodity derivative positions: Risk
factors with respect to the related
commodities set out in § 20.2 of this chapter,
the maturity of the positions, volatility and/
or correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), and the maturity profile of
the positions;
• Credit positions: Risk factors with
respect to credit spreads that are sufficiently
granular to account for specific credit sectors
and market segments, the maturity profile of
the positions, and risk factors with respect to
interest rates of all relevant maturities;
• Credit-related derivative positions: Risk
factor sensitivities, for example credit
spreads, shifts (parallel and non-parallel) in
credit spreads—volatility, and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
and the maturity profile of the positions;
• Equity derivative positions: Risk factor
sensitivities such as equity positions,
volatility, and/or correlation sensitivities
(expressed in a manner that demonstrates
any significant non-linearities), and the
maturity profile of the positions;
• Equity positions: Risk factors for equity
prices and risk factors that differentiate
between important equity market sectors and
segments, such as a small capitalization
equities and international equities;
• Foreign exchange derivative positions:
Risk factors with respect to major currency
pairs and maturities, exposure to interest
rates at relevant maturities, volatility, and/or
correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), as well as the maturity
profile of the positions; and
• Interest rate positions, including interest
rate derivative positions: Risk factors with
respect to major interest rate categories and
maturities and volatility and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
and shifts (parallel and non-parallel) in the
interest rate curve, as well as the maturity
profile of the positions.
B. The methods used by a banking entity
to calculate sensitivities to a common factor
shared by multiple trading desks, such as an
equity price factor, must be applied
consistently across its trading desks so that
the sensitivities can be compared from one
trading desk to another.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Value-at-Risk and Stress Value-at-Risk
i. Description: For purposes of this
appendix, Value-at-Risk (‘‘VaR’’) is the
commonly used percentile measurement of
the risk of future financial loss in the value
of a given set of aggregated positions over a
specified period of time, based on current
market conditions. For purposes of this
appendix, Stress Value-at-Risk (‘‘Stress VaR’’)
is the percentile measurement of the risk of
future financial loss in the value of a given
set of aggregated positions over a specified
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period of time, based on market conditions
during a period of significant financial stress.
ii. General Calculation Guidance: Banking
entities must compute and report VaR and
Stress VaR by employing generally accepted
standards and methods of calculation. VaR
should reflect a loss in a trading desk that is
expected to be exceeded less than one
percent of the time over a one-day period.
For those banking entities that are subject to
regulatory capital requirements imposed by a
Federal banking agency, VaR and Stress VaR
must be computed and reported in a manner
that is consistent with such regulatory capital
requirements. In cases where a trading desk
does not have a standalone VaR or Stress VaR
calculation but is part of a larger aggregation
of positions for which a VaR or Stress VaR
calculation is performed, a VaR or Stress VaR
calculation that includes only the trading
desk’s holdings must be performed consistent
with the VaR or Stress VaR model and
methodology used for the larger aggregation
of positions.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this
appendix, Comprehensive Profit and Loss
Attribution is an analysis that attributes the
daily fluctuation in the value of a trading
desk’s positions to various sources. First, the
daily profit and loss of the aggregated
positions is divided into three categories: (i)
Profit and loss attributable to a trading desk’s
existing positions that were also positions
held by the trading desk as of the end of the
prior day (‘‘existing positions’’); (ii) profit
and loss attributable to new positions
resulting from the current day’s trading
activity (‘‘new positions’’); and (iii) residual
profit and loss that cannot be specifically
attributed to existing positions or new
positions. The sum of (i), (ii), and (iii) must
equal the trading desk’s comprehensive profit
and loss at each point in time. In addition,
profit and loss measurements must calculate
volatility of comprehensive profit and loss
(i.e., the standard deviation of the trading
desk’s one-day profit and loss, in dollar
terms) for the reporting period for at least a
30-, 60- and 90-day lag period, from the end
of the reporting period, and any other period
that the banking entity deems necessary to
meet the requirements of the rule.
A. The comprehensive profit and loss
associated with existing positions must
reflect changes in the value of these positions
on the applicable day. The comprehensive
profit and loss from existing positions must
be further attributed, as applicable, to
changes in (i) the specific Risk Factors and
other factors that are monitored and managed
as part of the trading desk’s overall risk
management policies and procedures; and (ii)
any other applicable elements, such as cash
flows, carry, changes in reserves, and the
correction, cancellation, or exercise of a
trade.
B. The comprehensive profit and loss
attributed to new positions must reflect
commissions and fee income or expense and
market gains or losses associated with
transactions executed on the applicable day.
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New positions include purchases and sales of
financial instruments and other assets/
liabilities and negotiated amendments to
existing positions. The comprehensive profit
and loss from new positions may be reported
in the aggregate and does not need to be
further attributed to specific sources.
C. The portion of comprehensive profit and
loss that cannot be specifically attributed to
known sources must be allocated to a
residual category identified as an
unexplained portion of the comprehensive
profit and loss. Significant unexplained
profit and loss must be escalated for further
investigation and analysis.
ii. General Calculation Guidance: The
specific categories used by a trading desk in
the attribution analysis and amount of detail
for the analysis should be tailored to the type
and amount of trading activities undertaken
by the trading desk. The new position
attribution must be computed by calculating
the difference between the prices at which
instruments were bought and/or sold and the
prices at which those instruments are marked
to market at the close of business on that day
multiplied by the notional or principal
amount of each purchase or sale. Any fees,
commissions, or other payments received
(paid) that are associated with transactions
executed on that day must be added
(subtracted) from such difference. These
factors must be measured consistently over
time to facilitate historical comparisons.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
c. Customer-Facing Activity Measurements
1. Inventory Turnover
i. Description: For purposes of this
appendix, Inventory Turnover is a ratio that
measures the turnover of a trading desk’s
inventory. The numerator of the ratio is the
absolute value of all transactions over the
reporting period. The denominator of the
ratio is the value of the trading desk’s
inventory at the beginning of the reporting
period.
ii. General Calculation Guidance: For
purposes of this appendix, for derivatives,
other than options and interest rate
derivatives, value means gross notional
value, for options, value means delta
adjusted notional value, and for interest rate
derivatives, value means 10-year bond
equivalent value.
iii. Calculation Period: 30 days, 60 days,
and 90 days.
iv. Measurement Frequency: Daily.
2. Inventory Aging
i. Description: For purposes of this
appendix, Inventory Aging generally
describes a schedule of the trading desk’s
aggregate assets and liabilities and the
amount of time that those assets and
liabilities have been held. Inventory Aging
should measure the age profile of the trading
desk’s assets and liabilities.
ii. General Calculation Guidance: In
general, Inventory Aging must be computed
using a trading desk’s trading activity data
and must identify the value of a trading
desk’s aggregate assets and liabilities.
Inventory Aging must include two schedules,
an asset-aging schedule and a liability-aging
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schedule. Each schedule must record the
value of assets or liabilities held over all
holding periods. For derivatives, other than
options, and interest rate derivatives, value
means gross notional value, for options,
value means delta adjusted notional value
and, for interest rate derivatives, value means
10-year bond equivalent value.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Customer-Facing Trade Ratio—Trade
Count Based and Value Based
i. Description: For purposes of this
appendix, the Customer-Facing Trade Ratio
is a ratio comparing (i) the transactions
involving a counterparty that is a customer
of the trading desk to (ii) the transactions
involving a counterparty that is not a
customer of the trading desk. A trade count
based ratio must be computed that records
the number of transactions involving a
counterparty that is a customer of the trading
desk and the number of transactions
involving a counterparty that is not a
customer of the trading desk. A value based
ratio must be computed that records the
value of transactions involving a
counterparty that is a customer of the trading
desk and the value of transactions involving
a counterparty that is not a customer of the
trading desk.
ii. General Calculation Guidance: For
purposes of calculating the Customer-Facing
Trade Ratio, a counterparty is considered to
be a customer of the trading desk if the
counterparty is a market participant that
makes use of the banking entity’s market
making-related services by obtaining such
services, responding to quotations, or
entering into a continuing relationship with
respect to such services. However, a trading
desk or other organizational unit of another
banking entity would not be a client,
customer, or counterparty of the trading desk
if the other entity has trading assets and
liabilities of $50 billion or more as measured
in accordance with § 75.20(d)(1) unless the
trading desk documents how and why a
particular trading desk or other
organizational unit of the entity should be
treated as a client, customer, or counterparty
of the trading desk. Transactions conducted
anonymously on an exchange or similar
trading facility that permits trading on behalf
of a broad range of market participants would
be considered transactions with customers of
the trading desk. For derivatives, other than
options, and interest rate derivatives, value
means gross notional value, for options,
value means delta adjusted notional value,
and for interest rate derivatives, value means
10-year bond equivalent value.
iii. Calculation Period: 30 days, 60 days,
and 90 days.
iv. Measurement Frequency: Daily.
Appendix B to Part 75—Enhanced
Minimum Standards for Compliance
Programs
I. Overview
Section 75.20(c) requires certain banking
entities to establish, maintain, and enforce an
enhanced compliance program that includes
the requirements and standards in this
Appendix as well as the minimum written
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policies and procedures, internal controls,
management framework, independent
testing, training, and recordkeeping
provisions outlined in § 75.20. This
Appendix sets forth additional minimum
standards with respect to the establishment,
oversight, maintenance, and enforcement by
these banking entities of an enhanced
internal compliance program for ensuring
and monitoring compliance with the
prohibitions and restrictions on proprietary
trading and covered fund activities and
investments set forth in section 13 of the
BHC Act and this part.
a. This compliance program must:
1. Be reasonably designed to identify,
document, monitor, and report the permitted
trading and covered fund activities and
investments of the banking entity; identify,
monitor and promptly address the risks of
these covered activities and investments and
potential areas of noncompliance; and
prevent activities or investments prohibited
by, or that do not comply with, section 13 of
the BHC Act and this part;
2. Establish and enforce appropriate limits
on the covered activities and investments of
the banking entity, including limits on the
size, scope, complexity, and risks of the
individual activities or investments
consistent with the requirements of section
13 of the BHC Act and this part;
3. Subject the effectiveness of the
compliance program to periodic independent
review and testing, and ensure that the
entity’s internal audit, corporate compliance
and internal control functions involved in
review and testing are effective and
independent;
4. Make senior management, and others as
appropriate, accountable for the effective
implementation of the compliance program,
and ensure that the board of directors and
chief executive officer (or equivalent) of the
banking entity review the effectiveness of the
compliance program; and
5. Facilitate supervision and examination
by the Agencies of the banking entity’s
permitted trading and covered fund activities
and investments.
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II. Enhanced Compliance Program
a. Proprietary Trading Activities
A banking entity must establish, maintain
and enforce a compliance program that
includes written policies and procedures that
are appropriate for the types, size, and
complexity of, and risks associated with, its
permitted trading activities. The compliance
program may be tailored to the types of
trading activities conducted by the banking
entity, and must include a detailed
description of controls established by the
banking entity to reasonably ensure that its
trading activities are conducted in
accordance with the requirements and
limitations applicable to those trading
activities under section 13 of the BHC Act
and this part, and provide for appropriate
revision of the compliance program before
expansion of the trading activities of the
banking entity. A banking entity must devote
adequate resources and use knowledgeable
personnel in conducting, supervising and
managing its trading activities, and promote
consistency, independence and rigor in
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implementing its risk controls and
compliance efforts. The compliance program
must be updated with a frequency sufficient
to account for changes in the activities of the
banking entity, results of independent testing
of the program, identification of weaknesses
in the program, and changes in legal,
regulatory or other requirements.
1. Trading Desks: The banking entity must
have written policies and procedures
governing each trading desk that include a
description of:
i. The process for identifying, authorizing
and documenting financial instruments each
trading desk may purchase or sell, with
separate documentation for market makingrelated activities conducted in reliance on
§ 75.4(b) and for hedging activity conducted
in reliance on § 75.5;
ii. A mapping for each trading desk to the
division, business line, or other
organizational structure that is responsible
for managing and overseeing the trading
desk’s activities;
iii. The mission (i.e., the type of trading
activity, such as market-making, trading in
sovereign debt, etc.) and strategy (i.e.,
methods for conducting authorized trading
activities) of each trading desk;
iv. The activities that the trading desk is
authorized to conduct, including (i)
authorized instruments and products, and (ii)
authorized hedging strategies, techniques and
instruments;
v. The types and amount of risks allocated
by the banking entity to each trading desk to
implement the mission and strategy of the
trading desk, including an enumeration of
material risks resulting from the activities in
which the trading desk is authorized to
engage (including but not limited to price
risks, such as basis, volatility and correlation
risks, as well as counterparty credit risk).
Risk assessments must take into account both
the risks inherent in the trading activity and
the strength and effectiveness of controls
designed to mitigate those risks;
vi. How the risks allocated to each trading
desk will be measured;
vii. Why the allocated risks levels are
appropriate to the activities authorized for
the trading desk;
viii. The limits on the holding period of,
and the risk associated with, financial
instruments under the responsibility of the
trading desk;
ix. The process for setting new or revised
limits, as well as escalation procedures for
granting exceptions to any limits or to any
policies or procedures governing the desk,
the analysis that will be required to support
revising limits or granting exceptions, and
the process for independently reviewing and
documenting those exceptions and the
underlying analysis;
x. The process for identifying,
documenting and approving new products,
trading strategies, and hedging strategies;
xi. The types of clients, customers, and
counterparties with whom the trading desk
may trade; and
xii. The compensation arrangements,
including incentive arrangements, for
employees associated with the trading desk,
which may not be designed to reward or
incentivize prohibited proprietary trading or
excessive or imprudent risk-taking.
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2. Description of risks and risk
management processes: The compliance
program for the banking entity must include
a comprehensive description of the risk
management program for the trading activity
of the banking entity. The compliance
program must also include a description of
the governance, approval, reporting,
escalation, review and other processes the
banking entity will use to reasonably ensure
that trading activity is conducted in
compliance with section 13 of the BHC Act
and this part. Trading activity in similar
financial instruments should be subject to
similar governance, limits, testing, controls,
and review, unless the banking entity
specifically determines to establish different
limits or processes and documents those
differences. Descriptions must include, at a
minimum, the following elements:
i. A description of the supervisory and risk
management structure governing all trading
activity, including a description of processes
for initial and senior-level review of new
products and new strategies;
ii. A description of the process for
developing, documenting, testing, approving
and reviewing all models used for valuing,
identifying and monitoring the risks of
trading activity and related positions,
including the process for periodic
independent testing of the reliability and
accuracy of those models;
iii. A description of the process for
developing, documenting, testing, approving
and reviewing the limits established for each
trading desk;
iv. A description of the process by which
a security may be purchased or sold pursuant
to the liquidity management plan, including
the process for authorizing and monitoring
such activity to ensure compliance with the
banking entity’s liquidity management plan
and the restrictions on liquidity management
activities in this part;
v. A description of the management review
process, including escalation procedures, for
approving any temporary exceptions or
permanent adjustments to limits on the
activities, positions, strategies, or risks
associated with each trading desk; and
vi. The role of the audit, compliance, risk
management and other relevant units for
conducting independent testing of trading
and hedging activities, techniques and
strategies.
3. Authorized risks, instruments, and
products. The banking entity must
implement and enforce limits and internal
controls for each trading desk that are
reasonably designed to ensure that trading
activity is conducted in conformance with
section 13 of the BHC Act and this part and
with the banking entity’s written policies and
procedures. The banking entity must
establish and enforce risk limits appropriate
for the activity of each trading desk. These
limits should be based on probabilistic and
non-probabilistic measures of potential loss
(e.g., Value-at-Risk and notional exposure,
respectively), and measured under normal
and stress market conditions. At a minimum,
these internal controls must monitor,
establish and enforce limits on:
i. The financial instruments (including, at
a minimum, by type and exposure) that the
trading desk may trade;
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ii. The types and levels of risks that may
be taken by each trading desk; and
iii. The types of hedging instruments used,
hedging strategies employed, and the amount
of risk effectively hedged.
4. Hedging policies and procedures. The
banking entity must establish, maintain, and
enforce written policies and procedures
regarding the use of risk-mitigating hedging
instruments and strategies that, at a
minimum, describe:
i. The positions, techniques and strategies
that each trading desk may use to hedge the
risk of its positions;
ii. The manner in which the banking entity
will identify the risks arising in connection
with and related to the individual or
aggregated positions, contracts or other
holdings of the banking entity that are to be
hedged and determine that those risks have
been properly and effectively hedged;
iii. The level of the organization at which
hedging activity and management will occur;
iv. The manner in which hedging strategies
will be monitored and the personnel
responsible for such monitoring;
v. The risk management processes used to
control unhedged or residual risks; and
vi. The process for developing,
documenting, testing, approving and
reviewing all hedging positions, techniques
and strategies permitted for each trading desk
and for the banking entity in reliance on
§ 75.5.
5. Analysis and quantitative
measurements. The banking entity must
perform robust analysis and quantitative
measurement of its trading activities that is
reasonably designed to ensure that the
trading activity of each trading desk is
consistent with the banking entity’s
compliance program; monitor and assist in
the identification of potential and actual
prohibited proprietary trading activity; and
prevent the occurrence of prohibited
proprietary trading. Analysis and models
used to determine, measure and limit risk
must be rigorously tested and be reviewed by
management responsible for trading activity
to ensure that trading activities, limits,
strategies, and hedging activities do not
understate the risk and exposure to the
banking entity or allow prohibited
proprietary trading. This review should
include periodic and independent backtesting and revision of activities, limits,
strategies and hedging as appropriate to
contain risk and ensure compliance. In
addition to the quantitative measurements
reported by any banking entity subject to
Appendix A of this part, each banking entity
must develop and implement, to the extent
appropriate to facilitate compliance with this
part, additional quantitative measurements
specifically tailored to the particular risks,
practices, and strategies of its trading desks.
The banking entity’s analysis and
quantitative measurements must incorporate
the quantitative measurements reported by
the banking entity pursuant to Appendix A
of this part (if applicable) and include, at a
minimum, the following:
i. Internal controls and written policies and
procedures reasonably designed to ensure the
accuracy and integrity of quantitative
measurements;
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ii. Ongoing, timely monitoring and review
of calculated quantitative measurements;
iii. The establishment of numerical
thresholds and appropriate trading measures
for each trading desk and heightened review
of trading activity not consistent with those
thresholds to ensure compliance with section
13 of the BHC Act and this part, including
analysis of the measurement results or other
information, appropriate escalation
procedures, and documentation related to the
review; and
iv. Immediate review and compliance
investigation of the trading desk’s activities,
escalation to senior management with
oversight responsibilities for the applicable
trading desk, timely notification to the
Commission, appropriate remedial action
(e.g., divesting of impermissible positions,
cessation of impermissible activity,
disciplinary actions), and documentation of
the investigation findings and remedial
action taken when quantitative
measurements or other information,
considered together with the facts and
circumstances, or findings of internal audit,
independent testing or other review suggest
a reasonable likelihood that the trading desk
has violated any part of section 13 of the BHC
Act or this part.
6. Other Compliance Matters. In addition
to the requirements specified above, the
banking entity’s compliance program must:
i. Identify activities of each trading desk
that will be conducted in reliance on
exemptions contained in §§ 75.4 through
75.6, including an explanation of:
A. How and where in the organization the
activity occurs; and
B. Which exemption is being relied on and
how the activity meets the specific
requirements for reliance on the applicable
exemption;
ii. Include an explanation of the process for
documenting, approving and reviewing
actions taken pursuant to the liquidity
management plan, where in the organization
this activity occurs, the securities permissible
for liquidity management, the process for
ensuring that liquidity management activities
are not conducted for the purpose of
prohibited proprietary trading, and the
process for ensuring that securities
purchased as part of the liquidity
management plan are highly liquid and
conform to the requirements of this part;
iii. Describe how the banking entity
monitors for and prohibits potential or actual
material exposure to high-risk assets or highrisk trading strategies presented by each
trading desk that relies on the exemptions
contained in §§ 75.3(d)(3) and 75.4 through
75.6, which must take into account potential
or actual exposure to:
A. Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
B. Assets whose changes in value cannot
be adequately mitigated by effective hedging;
C. New products with rapid growth,
including those that do not have a market
history;
D. Assets or strategies that include
significant embedded leverage;
E. Assets or strategies that have
demonstrated significant historical volatility;
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F. Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
G. Assets or strategies that result in large
and significant concentrations to sectors, risk
factors, or counterparties;
iv. Establish responsibility for compliance
with the reporting and recordkeeping
requirements of subpart B of this part and
§ 75.20; and
v. Establish policies for monitoring and
prohibiting potential or actual material
conflicts of interest between the banking
entity and its clients, customers, or
counterparties.
7. Remediation of violations. The banking
entity’s compliance program must be
reasonably designed and established to
effectively monitor and identify for further
analysis any trading activity that may
indicate potential violations of section 13 of
the BHC Act and this part and to prevent
actual violations of section 13 of the BHC Act
and this part. The compliance program must
describe procedures for identifying and
remedying violations of section 13 of the
BHC Act and this part, and must include, at
a minimum, a requirement to promptly
document, address and remedy any violation
of section 13 of the BHC Act or this part, and
document all proposed and actual
remediation efforts. The compliance program
must include specific written policies and
procedures that are reasonably designed to
assess the extent to which any activity
indicates that modification to the banking
entity’s compliance program is warranted
and to ensure that appropriate modifications
are implemented. The written policies and
procedures must provide for prompt
notification to appropriate management,
including senior management and the board
of directors, of any material weakness or
significant deficiencies in the design or
implementation of the compliance program
of the banking entity.
b. Covered Fund Activities or Investments
A banking entity must establish, maintain
and enforce a compliance program that
includes written policies and procedures that
are appropriate for the types, size,
complexity and risks of the covered fund and
related activities conducted and investments
made, by the banking entity.
1. Identification of covered funds. The
banking entity’s compliance program must
provide a process, which must include
appropriate management review and
independent testing, for identifying and
documenting covered funds that each unit
within the banking entity’s organization
sponsors or organizes and offers, and covered
funds in which each such unit invests. In
addition to the documentation requirements
for covered funds, as specified under
§ 75.20(e), the documentation must include
information that identifies all pools that the
banking entity sponsors or has an interest in
and the type of exemption from the
Commodity Exchange Act (whether or not
the pool relies on § 4.7 of the regulations
under the Commodity Exchange Act (§ 4.7 of
this chapter)), and the amount of ownership
interest the banking entity has in those pools.
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2. Identification of covered fund activities
and investments. The banking entity’s
compliance program must identify,
document and map each unit within the
organization that is permitted to acquire or
hold an interest in any covered fund or
sponsor any covered fund and map each unit
to the division, business line, or other
organizational structure that will be
responsible for managing and overseeing that
unit’s activities and investments.
3. Explanation of compliance. The banking
entity’s compliance program must explain
how:
i. The banking entity monitors for and
prohibits potential or actual material
conflicts of interest between the banking
entity and its clients, customers, or
counterparties related to its covered fund
activities and investments;
ii. The banking entity monitors for and
prohibits potential or actual transactions or
activities that may threaten the safety and
soundness of the banking entity related to its
covered fund activities and investments; and
iii. The banking entity monitors for and
prohibits potential or actual material
exposure to high-risk assets or high-risk
trading strategies presented by its covered
fund activities and investments, taking into
account potential or actual exposure to:
A. Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
B. Assets whose changes in values cannot
be adequately mitigated by effective hedging;
C. New products with rapid growth,
including those that do not have a market
history;
D. Assets or strategies that include
significant embedded leverage;
E. Assets or strategies that have
demonstrated significant historical volatility;
F. Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
G. Assets or strategies that expose the
banking entity to large and significant
concentrations with respect to sectors, risk
factors, or counterparties;
4. Description and documentation of
covered fund activities and investments. For
each organizational unit engaged in covered
fund activities and investments, the banking
entity’s compliance program must document:
i. The covered fund activities and
investments that the unit is authorized to
conduct;
ii. The banking entity’s plan for actively
seeking unaffiliated investors to ensure that
any investment by the banking entity
conforms to the limits contained in § 75.12 or
registered in compliance with the securities
laws and thereby exempt from those limits
within the time periods allotted in § 75.12;
and
iii. How it complies with the requirements
of subpart C of this part.
5. Internal Controls. A banking entity must
establish, maintain, and enforce internal
controls that are reasonably designed to
ensure that its covered fund activities or
investments comply with the requirements of
section 13 of the BHC Act and this part and
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are appropriate given the limits on risk
established by the banking entity. These
written internal controls must be reasonably
designed and established to effectively
monitor and identify for further analysis any
covered fund activity or investment that may
indicate potential violations of section 13 of
the BHC Act or this part. The internal
controls must, at a minimum require:
i. Monitoring and limiting the banking
entity’s individual and aggregate investments
in covered funds;
ii. Monitoring the amount and timing of
seed capital investments for compliance with
the limitations under subpart C of this part
(including but not limited to the redemption,
sale or disposition requirements of § 75.12),
and the effectiveness of efforts to seek
unaffiliated investors to ensure compliance
with those limits;
iii. Calculating the individual and
aggregate levels of ownership interests in one
or more covered fund required by § 75.12;
iv. Attributing the appropriate instruments
to the individual and aggregate ownership
interest calculations above;
v. Making disclosures to prospective and
actual investors in any covered fund
organized and offered or sponsored by the
banking entity, as provided under
§ 75.11(a)(8);
vi. Monitoring for and preventing any
relationship or transaction between the
banking entity and a covered fund that is
prohibited under § 75.14, including where
the banking entity has been designated as the
sponsor, investment manager, investment
adviser, or commodity trading advisor to a
covered fund by another banking entity; and
vii. Appropriate management review and
supervision across legal entities of the
banking entity to ensure that services and
products provided by all affiliated entities
comply with the limitation on services and
products contained in § 75.14.
6. Remediation of violations. The banking
entity’s compliance program must be
reasonably designed and established to
effectively monitor and identify for further
analysis any covered fund activity or
investment that may indicate potential
violations of section 13 of the BHC Act or
this part and to prevent actual violations of
section 13 of the BHC Act and this part. The
banking entity’s compliance program must
describe procedures for identifying and
remedying violations of section 13 of the
BHC Act and this part, and must include, at
a minimum, a requirement to promptly
document, address and remedy any violation
of section 13 of the BHC Act or this part,
including § 75.21, and document all
proposed and actual remediation efforts. The
compliance program must include specific
written policies and procedures that are
reasonably designed to assess the extent to
which any activity or investment indicates
that modification to the banking entity’s
compliance program is warranted and to
ensure that appropriate modifications are
implemented. The written policies and
procedures must provide for prompt
notification to appropriate management,
including senior management and the board
of directors, of any material weakness or
significant deficiencies in the design or
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implementation of the compliance program
of the banking entity.
III. Responsibility and Accountability for the
Compliance Program
a. A banking entity must establish,
maintain, and enforce a governance and
management framework to manage its
business and employees with a view to
preventing violations of section 13 of the
BHC Act and this part. A banking entity must
have an appropriate management framework
reasonably designed to ensure that:
Appropriate personnel are responsible and
accountable for the effective implementation
and enforcement of the compliance program;
a clear reporting line with a chain of
responsibility is delineated; and the
compliance program is reviewed periodically
by senior management. The board of
directors (or equivalent governance body)
and senior management should have the
appropriate authority and access to personnel
and information within the organizations as
well as appropriate resources to conduct
their oversight activities effectively.
1. Corporate governance. The banking
entity must adopt a written compliance
program approved by the board of directors,
an appropriate committee of the board, or
equivalent governance body, and senior
management.
2. Management procedures. The banking
entity must establish, maintain, and enforce
a governance framework that is reasonably
designed to achieve compliance with section
13 of the BHC Act and this part, which, at
a minimum, provides for:
i. The designation of appropriate senior
management or committee of senior
management with authority to carry out the
management responsibilities of the banking
entity for each trading desk and for each
organizational unit engaged in covered fund
activities;
ii. Written procedures addressing the
management of the activities of the banking
entity that are reasonably designed to achieve
compliance with section 13 of the BHC Act
and this part, including:
A. A description of the management
system, including the titles, qualifications,
and locations of managers and the specific
responsibilities of each person with respect
to the banking entity’s activities governed by
section 13 of the BHC Act and this part; and
B. Procedures for determining
compensation arrangements for traders
engaged in underwriting or market makingrelated activities under § 75.4 or riskmitigating hedging activities under § 75.5 so
that such compensation arrangements are
designed not to reward or incentivize
prohibited proprietary trading and
appropriately balance risk and financial
results in a manner that does not encourage
employees to expose the banking entity to
excessive or imprudent risk.
3. Business line managers. Managers with
responsibility for one or more trading desks
of the banking entity are accountable for the
effective implementation and enforcement of
the compliance program with respect to the
applicable trading desk(s).
4. Board of directors, or similar corporate
body, and senior management. The board of
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directors, or similar corporate body, and
senior management are responsible for
setting and communicating an appropriate
culture of compliance with section 13 of the
BHC Act and this part and ensuring that
appropriate policies regarding the
management of trading activities and covered
fund activities or investments are adopted to
comply with section 13 of the BHC Act and
this part. The board of directors or similar
corporate body (such as a designated
committee of the board or an equivalent
governance body) must ensure that senior
management is fully capable, qualified, and
properly motivated to manage compliance
with this part in light of the organization’s
business activities and the expectations of
the board of directors. The board of directors
or similar corporate body must also ensure
that senior management has established
appropriate incentives and adequate
resources to support compliance with this
part, including the implementation of a
compliance program meeting the
requirements of this appendix into
management goals and compensation
structures across the banking entity.
5. Senior management. Senior management
is responsible for implementing and
enforcing the approved compliance program.
Senior management must also ensure that
effective corrective action is taken when
failures in compliance with section 13 of the
BHC Act and this part are identified. Senior
management and control personnel charged
with overseeing compliance with section 13
of the BHC Act and this part should review
the compliance program for the banking
entity periodically and report to the board, or
an appropriate committee thereof, on the
effectiveness of the compliance program and
compliance matters with a frequency
appropriate to the size, scope, and risk
profile of the banking entity’s trading
activities and covered fund activities or
investments, which shall be at least annually.
6. CEO attestation. Based on a review by
the CEO of the banking entity, the CEO of the
banking entity must, annually, attest in
writing to the Commission that the banking
entity has in place processes to establish,
maintain, enforce, review, test and modify
the compliance program established under
this appendix and § 75.20 in a manner
reasonably designed to achieve compliance
with section 13 of the BHC Act and this part.
In the case of a U.S. branch or agency of a
foreign banking entity, the attestation may be
provided for the entire U.S. operations of the
foreign banking entity by the senior
management officer of the United States
operations of the foreign banking entity who
is located in the United States.
IV. Independent Testing
a. Independent testing must occur with a
frequency appropriate to the size, scope, and
risk profile of the banking entity’s trading
and covered fund activities or investments,
which shall be at least annually. This
independent testing must include an
evaluation of:
1. The overall adequacy and effectiveness
of the banking entity’s compliance program,
including an analysis of the extent to which
the program contains all the required
elements of this appendix;
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2. The effectiveness of the banking entity’s
internal controls, including an analysis and
documentation of instances in which such
internal controls have been breached, and
how such breaches were addressed and
resolved; and
3. The effectiveness of the banking entity’s
management procedures.
b. A banking entity must ensure that
independent testing regarding the
effectiveness of the banking entity’s
compliance program is conducted by a
qualified independent party, such as the
banking entity’s internal audit department,
compliance personnel or risk managers
independent of the organizational unit being
tested, outside auditors, consultants, or other
qualified independent parties. A banking
entity must promptly take appropriate action
to remedy any significant deficiencies or
material weaknesses in its compliance
program and to terminate any violations of
section 13 of the BHC Act or this part.
V. Training
Banking entities must provide adequate
training to personnel and managers of the
banking entity engaged in activities or
investments governed by section 13 of the
BHC Act or this part, as well as other
appropriate supervisory, risk, independent
testing, and audit personnel, in order to
effectively implement and enforce the
compliance program. This training should
occur with a frequency appropriate to the
size and the risk profile of the banking
entity’s trading activities and covered fund
activities or investments.
VI. Recordkeeping
Banking entities must create and retain
records sufficient to demonstrate compliance
and support the operations and effectiveness
of the compliance program. A banking entity
must retain these records for a period that is
no less than 5 years or such longer period as
required by the Commission in a form that
allows it to promptly produce such records
to the Commission on request.
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Chapter II
Authority and Issuance
For the reasons set forth in the
Common Preamble, the Securities and
Exchange Commission amends part 255
to chapter II of Title 17 of the Code of
Federal Regulations as follows:
PART 255—PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS
60. The authority citation for part 255
continues to read as follows:
■
Authority: 12 U.S.C. 1851.
Subpart A—Authority and Definitions
61. Section 255.2 is revised to read as
follows:
■
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§ 255.2
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Definitions.
Unless otherwise specified, for
purposes of this part:
(a) Affiliate has the same meaning as
in section 2(k) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(k)).
(b) Bank holding company has the
same meaning as in section 2 of the
Bank Holding Company Act of 1956 (12
U.S.C. 1841).
(c) Banking entity. (1) Except as
provided in paragraph (c)(2) of this
section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an
insured depository institution;
(iii) Any company that is treated as a
bank holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any
entity described in paragraph (c)(1)(i),
(ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a
banking entity under paragraph (c)(1)(i),
(ii), or (iii) of this section;
(ii) A portfolio company held under
the authority contained in section
4(k)(4)(H) or (I) of the BHC Act (12
U.S.C. 1843(k)(4)(H), (I)), or any
portfolio concern, as defined under 13
CFR 107.50, that is controlled by a small
business investment company, as
defined in section 103(3) of the Small
Business Investment Act of 1958 (15
U.S.C. 662), so long as the portfolio
company or portfolio concern is not
itself a banking entity under paragraph
(c)(1)(i), (ii), or (iii) of this section; or
(iii) The FDIC acting in its corporate
capacity or as conservator or receiver
under the Federal Deposit Insurance Act
or Title II of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
(d) Board means the Board of
Governors of the Federal Reserve
System.
(e) CFTC means the Commodity
Futures Trading Commission.
(f) Dealer has the same meaning as in
section 3(a)(5) of the Exchange Act (15
U.S.C. 78c(a)(5)).
(g) Depository institution has the same
meaning as in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)).
(h) Derivative. (1) Except as provided
in paragraph (h)(2) of this section,
derivative means:
(i) Any swap, as that term is defined
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)), or
security-based swap, as that term is
defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68));
(ii) Any purchase or sale of a
commodity, that is not an excluded
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commodity, for deferred shipment or
delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as
that term is defined in section 1a(24) of
the Commodity Exchange Act (7 U.S.C.
1a(24)) or foreign exchange swap (as
that term is defined in section 1a(25) of
the Commodity Exchange Act (7 U.S.C.
1a(25));
(iv) Any agreement, contract, or
transaction in foreign currency
described in section 2(c)(2)(C)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(C)(i));
(v) Any agreement, contract, or
transaction in a commodity other than
foreign currency described in section
2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under
section 19 of the Commodity Exchange
Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or
other agreement, contract, or transaction
that the CFTC and SEC have further
defined by joint regulation,
interpretation, or other action as not
within the definition of swap, as that
term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C.
1a(47)), or security-based swap, as that
term is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)); or
(ii) Any identified banking product, as
defined in section 402(b) of the Legal
Certainty for Bank Products Act of 2000
(7 U.S.C. 27(b)), that is subject to section
403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the
immediate family of the employee.
(j) Exchange Act means the Securities
Exchange Act of 1934 (15 U.S.C. 78a et
seq.).
(k) Excluded commodity has the same
meaning as in section 1a(19) of the
Commodity Exchange Act (7 U.S.C.
1a(19)).
(l) FDIC means the Federal Deposit
Insurance Corporation.
(m) Federal banking agencies means
the Board, the Office of the Comptroller
of the Currency, and the FDIC.
(n) Foreign banking organization has
the same meaning as in § 211.21(o) of
the Board’s Regulation K (12 CFR
211.21(o)), but does not include a
foreign bank, as defined in section
1(b)(7) of the International Banking Act
of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the
Commonwealth of Puerto Rico, Guam,
American Samoa, the United States
Virgin Islands, or the Commonwealth of
the Northern Mariana Islands.
(o) Foreign insurance regulator means
the insurance commissioner, or a
similar official or agency, of any country
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other than the United States that is
engaged in the supervision of insurance
companies under foreign insurance law.
(p) General account means all of the
assets of an insurance company except
those allocated to one or more separate
accounts.
(q) Insurance company means a
company that is organized as an
insurance company, primarily and
predominantly engaged in writing
insurance or reinsuring risks
underwritten by insurance companies,
subject to supervision as such by a state
insurance regulator or a foreign
insurance regulator, and not operated
for the purpose of evading the
provisions of section 13 of the BHC Act
(12 U.S.C. 1851).
(r) Insured depository institution has
the same meaning as in section 3(c) of
the Federal Deposit Insurance Act (12
U.S.C. 1813(c)), but does not include:
(1) An insured depository institution
that is described in section 2(c)(2)(D) of
the BHC Act (12 U.S.C. 1841(c)(2)(D));
or
(2) An insured depository institution
if it has, and if every company that
controls it has, total consolidated assets
of $10 billion or less and total trading
assets and trading liabilities, on a
consolidated basis, that are 5 percent or
less of total consolidated assets.
(s) Limited trading assets and
liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together
with its affiliates and subsidiaries,
trading assets and liabilities (excluding
trading assets and liabilities attributable
to trading activities permitted pursuant
to § 255.6(a)(1) and (2) of subpart B) the
average gross sum of which over the
previous consecutive four quarters, as
measured as of the last day of each of
the four previous calendar quarters, is
less than $1 billion; and
(ii) The SEC has not determined
pursuant to § 255.20(g) or (h) of this part
that the banking entity should not be
treated as having limited trading assets
and liabilities.
(2) With respect to a banking entity
other than a banking entity described in
paragraph (s)(3) of this section, trading
assets and liabilities for purposes of this
paragraph (s) means trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 255.6(a)(1) and (2) of subpart B) on a
worldwide consolidated basis.
(3)(i) With respect to a banking entity
that is a foreign banking organization or
a subsidiary of a foreign banking
organization, trading assets and
liabilities for purposes of this paragraph
(s) means the trading assets and
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liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 255.6(a)(1) and (2) of subpart B) of the
combined U.S. operations of the top-tier
foreign banking organization (including
all subsidiaries, affiliates, branches, and
agencies of the foreign banking
organization operating, located, or
organized in the United States).
(ii) For purposes of paragraph (s)(3)(i)
of this section, a U.S. branch, agency, or
subsidiary of a banking entity is located
in the United States; however, the
foreign bank that operates or controls
that branch, agency, or subsidiary is not
considered to be located in the United
States solely by virtue of operating or
controlling the U.S. branch, agency, or
subsidiary. For purposes of paragraph
(s)(3)(i) of this section, all foreign
operations of a U.S. agency, branch, or
subsidiary of a foreign banking
organization are considered to be
located in the United States, including
branches outside the United States that
are managed or controlled by a U.S.
branch or agency of the foreign banking
organization, for purposes of calculating
the banking entity’s U.S. trading assets
and liabilities.
(t) Loan means any loan, lease,
extension of credit, or secured or
unsecured receivable that is not a
security or derivative.
(u) Moderate trading assets and
liabilities means, with respect to a
banking entity, that the banking entity
does not have significant trading assets
and liabilities or limited trading assets
and liabilities.
(v) Primary financial regulatory
agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act (12 U.S.C. 5301(12)).
(w) Purchase includes any contract to
buy, purchase, or otherwise acquire. For
security futures products, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a commodity future, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a derivative, purchase
includes the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(x) Qualifying foreign banking
organization means a foreign banking
organization that qualifies as such under
§ 211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c), or
(e)).
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(y) SEC means the Securities and
Exchange Commission.
(z) Sale and sell each include any
contract to sell or otherwise dispose of.
For security futures products, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a commodity future, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a derivative, such terms
include the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(aa) Security has the meaning
specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(bb) Security-based swap dealer has
the same meaning as in section 3(a)(71)
of the Exchange Act (15 U.S.C.
78c(a)(71)).
(cc) Security future has the meaning
specified in section 3(a)(55) of the
Exchange Act (15 U.S.C. 78c(a)(55)).
(dd) Separate account means an
account established and maintained by
an insurance company in connection
with one or more insurance contracts to
hold assets that are legally segregated
from the insurance company’s other
assets, under which income, gains, and
losses, whether or not realized, from
assets allocated to such account, are, in
accordance with the applicable contract,
credited to or charged against such
account without regard to other income,
gains, or losses of the insurance
company.
(ee) Significant trading assets and
liabilities means with respect to a
banking entity that: (1)(i) The banking
entity has, together with its affiliates
and subsidiaries, trading assets and
liabilities the average gross sum of
which over the previous consecutive
four quarters, as measured as of the last
day of each of the four previous
calendar quarters, equals or exceeds $20
billion; or
(ii) The SEC has determined pursuant
to § 255.20(h) of this part that the
banking entity should be treated as
having significant trading assets and
liabilities.
(2) With respect to a banking entity,
other than a banking entity described in
paragraph (ee)(3) of this section, trading
assets and liabilities for purposes of this
paragraph (ee) means trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 255.6(a)(1) and (2) of subpart B) on a
worldwide consolidated basis.
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(3)(i) With respect to a banking entity
that is a foreign banking organization or
a subsidiary of a foreign banking
organization, trading assets and
liabilities for purposes of this paragraph
(ee) means the trading assets and
liabilities (excluding trading assets and
liabilities attributable to trading
activities permitted pursuant to
§ 255.6(a)(1) and (2) of subpart B) of the
combined U.S. operations of the top-tier
foreign banking organization (including
all subsidiaries, affiliates, branches, and
agencies of the foreign banking
organization operating, located, or
organized in the United States as well
as branches outside the United States
that are managed or controlled by a
branch or agency of the foreign banking
entity operating, located or organized in
the United States).
(ii) For purposes of paragraph
(ee)(3)(i) of this section, a U.S. branch,
agency, or subsidiary of a banking entity
is located in the United States; however,
the foreign bank that operates or
controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary. For
purposes of paragraph (ee)(3)(i) of this
section, all foreign operations of a U.S.
agency, branch, or subsidiary of a
foreign banking organization are
considered to be located in the United
States for purposes of calculating the
banking entity’s U.S. trading assets and
liabilities.
(ff) State means any State, the District
of Columbia, the Commonwealth of
Puerto Rico, Guam, American Samoa,
the United States Virgin Islands, and the
Commonwealth of the Northern Mariana
Islands.
(gg) Subsidiary has the same meaning
as in section 2(d) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(d)).
(hh) State insurance regulator means
the insurance commissioner, or a
similar official or agency, of a State that
is engaged in the supervision of
insurance companies under State
insurance law.
(ii) Swap dealer has the same meaning
as in section 1(a)(49) of the Commodity
Exchange Act (7 U.S.C. 1a(49)).
Subpart B—Proprietary Trading
62. Section 255.3 is amended by:
a. Revising paragraphs (b) and (d)(3),
(8), and (9);
■ b. Adding paragraphs (d)(10) through
(13);
■ c. Redesignating paragraphs (e)(5)
through (13) as paragraphs (e)(6)
through (14);
■
■
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62239
d. Adding new paragraph (e)(5); and
e. Revising paragraph (e)(11), (12), and
(14).
The revisions and additions read as
follows:
■
■
§ 255.3
Prohibition on proprietary trading.
*
*
*
*
*
(b) Definition of trading account. (1)
Trading account. Trading account
means:
(i) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments principally
for the purpose of short-term resale,
benefitting from actual or expected
short-term price movements, realizing
short-term arbitrage profits, or hedging
one or more of the positions resulting
from the purchases or sales of financial
instruments described in this paragraph;
(ii) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments that are both
market risk capital rule covered
positions and trading positions (or
hedges of other market risk capital rule
covered positions), if the banking entity,
or any affiliate with which the banking
entity is consolidated for regulatory
reporting purposes, calculates riskbased capital ratios under the market
risk capital rule; or
(iii) Any account that is used by a
banking entity to purchase or sell one or
more financial instruments, if the
banking entity:
(A) Is licensed or registered, or is
required to be licensed or registered, to
engage in the business of a dealer, swap
dealer, or security-based swap dealer, to
the extent the instrument is purchased
or sold in connection with the activities
that require the banking entity to be
licensed or registered as such; or
(B) Is engaged in the business of a
dealer, swap dealer, or security-based
swap dealer outside of the United
States, to the extent the instrument is
purchased or sold in connection with
the activities of such business.
(2) Trading account application for
certain banking entities. (i) A banking
entity that is subject to paragraph
(b)(1)(ii) of this section in determining
the scope of its trading account is not
subject to paragraph (b)(1)(i) of this
section.
(ii) A banking entity that does not
calculate risk-based capital ratios under
the market risk capital rule and is not
a consolidated affiliate for regulatory
reporting purposes of a banking entity
that calculates risk based capital ratios
under the market risk capital rule may
elect to apply paragraph (b)(1)(ii) of this
section in determining the scope of its
trading account as if it were subject to
that paragraph. A banking entity that
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elects under this section to apply
paragraph (b)(1)(ii) of this section in
determining the scope of its trading
account as if it were subject to that
paragraph is not required to apply
paragraph (b)(1)(i) of this section.
(3) Consistency of account election for
certain banking entities. (i) Any election
or change to an election under
paragraph (b)(2)(ii) of this section must
apply to the electing banking entity and
all of its wholly owned subsidiaries.
The primary financial regulatory agency
of a banking entity that is affiliated with
but is not a wholly owned subsidiary of
such electing banking entity may
require that the banking entity be
subject to this uniform application
requirement if the primary financial
regulatory agency determines that it is
necessary to prevent evasion of the
requirements of this part after notice
and opportunity for response as
provided in subpart D.
(ii) A banking entity that does not
elect under paragraph (b)(2)(ii) of this
section to be subject to the trading
account definition in (b)(1)(ii) may
continue to apply the trading account
definition in paragraph (b)(1)(i) of this
section for one year from the date on
which it becomes, or becomes a
consolidated affiliate for regulatory
reporting purposes with, a banking
entity that calculates risk-based capital
ratios under the market risk capital rule.
(4) Rebuttable presumption for certain
purchases and sales. The purchase (or
sale) of a financial instrument by a
banking entity shall be presumed not to
be for the trading account of the banking
entity under paragraph (b)(1)(i) of this
section if the banking entity holds the
financial instrument for sixty days or
longer and does not transfer
substantially all of the risk of the
financial instrument within sixty days
of the purchase (or sale).
*
*
*
*
*
(d) * * *
(3) Any purchase or sale of a security,
foreign exchange forward (as that term
is defined in section 1a(24) of the
Commodity Exchange Act (7 U.S.C.
1a(24)), foreign exchange swap (as that
term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C.
1a(25)), or cross-currency swap by a
banking entity for the purpose of
liquidity management in accordance
with a documented liquidity
management plan of the banking entity
that:
(i) Specifically contemplates and
authorizes the particular financial
instruments to be used for liquidity
management purposes, the amount,
types, and risks of these financial
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instruments that are consistent with
liquidity management, and the liquidity
circumstances in which the particular
financial instruments may or must be
used;
(ii) Requires that any purchase or sale
of financial instruments contemplated
and authorized by the plan be
principally for the purpose of managing
the liquidity of the banking entity, and
not for the purpose of short-term resale,
benefitting from actual or expected
short-term price movements, realizing
short-term arbitrage profits, or hedging a
position taken for such short-term
purposes;
(iii) Requires that any financial
instruments purchased or sold for
liquidity management purposes be
highly liquid and limited to financial
instruments the market, credit, and
other risks of which the banking entity
does not reasonably expect to give rise
to appreciable profits or losses as a
result of short-term price movements;
(iv) Limits any financial instruments
purchased or sold for liquidity
management purposes, together with
any other financial instruments
purchased or sold for such purposes, to
an amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan;
(v) Includes written policies and
procedures, internal controls, analysis,
and independent testing to ensure that
the purchase and sale of financial
instruments that are not permitted
under § 255.6(a) or (b) of this subpart are
for the purpose of liquidity management
and in accordance with the liquidity
management plan described in this
paragraph (d)(3); and
(vi) Is consistent with the SEC’s
regulatory requirements regarding
liquidity management;
*
*
*
*
*
(8) Any purchase or sale of one or
more financial instruments by a banking
entity through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity that is
established and administered in
accordance with the law of the United
States or a foreign sovereign, if the
purchase or sale is made directly or
indirectly by the banking entity as
trustee for the benefit of persons who
are or were employees of the banking
entity;
(9) Any purchase or sale of one or
more financial instruments by a banking
entity in the ordinary course of
collecting a debt previously contracted
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in good faith, provided that the banking
entity divests the financial instrument
as soon as practicable, and in no event
may the banking entity retain such
instrument for longer than such period
permitted by the SEC;
(10) Any purchase or sale of one or
more financial instruments that was
made in error by a banking entity in the
course of conducting a permitted or
excluded activity or is a subsequent
transaction to correct such an error;
(11) Contemporaneously entering into
a customer-driven swap or customerdriven security-based swap and a
matched swap or security-based swap if:
(i) The banking entity retains no more
than minimal price risk; and
(ii) The banking entity is not a
registered dealer, swap dealer, or
security-based swap dealer;
(12) Any purchase or sale of one or
more financial instruments that the
banking entity uses to hedge mortgage
servicing rights or mortgage servicing
assets in accordance with a documented
hedging strategy; or
(13) Any purchase or sale of a
financial instrument that does not meet
the definition of trading asset or trading
liability under the applicable reporting
form for a banking entity as of January
1, 2020.
(e) * * *
(5) Cross-currency swap means a swap
in which one party exchanges with
another party principal and interest rate
payments in one currency for principal
and interest rate payments in another
currency, and the exchange of principal
occurs on the date the swap is entered
into, with a reversal of the exchange of
principal at a later date that is agreed
upon when the swap is entered into.
*
*
*
*
*
(11) Market risk capital rule covered
position and trading position means a
financial instrument that meets the
criteria to be a covered position and a
trading position, as those terms are
respectively defined, without regard to
whether the financial instrument is
reported as a covered position or trading
position on any applicable regulatory
reporting forms:
(i) In the case of a banking entity that
is a bank holding company, savings and
loan holding company, or insured
depository institution, under the market
risk capital rule that is applicable to the
banking entity; and
(ii) In the case of a banking entity that
is affiliated with a bank holding
company or savings and loan holding
company, other than a banking entity to
which a market risk capital rule is
applicable, under the market risk capital
rule that is applicable to the affiliated
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bank holding company or savings and
loan holding company.
(12) Market risk capital rule means
the market risk capital rule that is
contained in 12 CFR part 3, subpart F,
with respect to a banking entity for
which the OCC is the primary financial
regulatory agency, 12 CFR part 217 with
respect to a banking entity for which the
Board is the primary financial
regulatory agency, or 12 CFR part 324
with respect to a banking entity for
which the FDIC is the primary financial
regulatory agency.
*
*
*
*
*
(14) Trading desk means a unit of
organization of a banking entity that
purchases or sells financial instruments
for the trading account of the banking
entity or an affiliate thereof that is:
(i)(A) Structured by the banking entity
to implement a well-defined business
strategy;
(B) Organized to ensure appropriate
setting, monitoring, and management
review of the desk’s trading and hedging
limits, current and potential future loss
exposures, and strategies; and
(C) Characterized by a clearly defined
unit that:
(1) Engages in coordinated trading
activity with a unified approach to its
key elements;
(2) Operates subject to a common and
calibrated set of risk metrics, risk levels,
and joint trading limits;
(3) Submits compliance reports and
other information as a unit for
monitoring by management; and
(4) Books its trades together; or
(ii) For a banking entity that
calculates risk-based capital ratios
under the market risk capital rule, or a
consolidated affiliate for regulatory
reporting purposes of a banking entity
that calculates risk-based capital ratios
under the market risk capital rule,
established by the banking entity or its
affiliate for purposes of market risk
capital calculations under the market
risk capital rule.
■ 63. Section 255.4 is revised to read as
follows:
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§ 255.4 Permitted underwriting and market
making-related activities.
(a) Underwriting activities—(1)
Permitted underwriting activities. The
prohibition contained in § 255.3(a) does
not apply to a banking entity’s
underwriting activities conducted in
accordance with this paragraph (a).
(2) Requirements. The underwriting
activities of a banking entity are
permitted under paragraph (a)(1) of this
section only if:
(i) The banking entity is acting as an
underwriter for a distribution of
securities and the trading desk’s
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underwriting position is related to such
distribution;
(ii)(A) The amount and type of the
securities in the trading desk’s
underwriting position are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, taking into account the
liquidity, maturity, and depth of the
market for the relevant types of
securities; and
(B) Reasonable efforts are made to sell
or otherwise reduce the underwriting
position within a reasonable period,
taking into account the liquidity,
maturity, and depth of the market for
the relevant types of securities;
(iii) In the case of a banking entity
with significant trading assets and
liabilities, the banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (a)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The products, instruments or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
(B) Limits for each trading desk, in
accordance with paragraph (a)(2)(ii)(A)
of this section;
(C) Written authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
and
(D) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits.
(iv) A banking entity with significant
trading assets and liabilities may satisfy
the requirements in paragraphs
(a)(2)(iii)(B) and (C) of this section by
complying with the requirements set
forth below in paragraph (c) of this
section;
(v) The compensation arrangements of
persons performing the activities
described in this paragraph (a) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in the activity
described in this paragraph (a) in
accordance with applicable law.
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62241
(3) Definition of distribution. For
purposes of this paragraph (a), a
distribution of securities means:
(i) An offering of securities, whether
or not subject to registration under the
Securities Act of 1933, that is
distinguished from ordinary trading
transactions by the presence of special
selling efforts and selling methods; or
(ii) An offering of securities made
pursuant to an effective registration
statement under the Securities Act of
1933.
(4) Definition of underwriter. For
purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an
issuer or selling security holder to:
(A) Purchase securities from the
issuer or selling security holder for
distribution;
(B) Engage in a distribution of
securities for or on behalf of the issuer
or selling security holder; or
(C) Manage a distribution of securities
for or on behalf of the issuer or selling
security holder; or
(ii) A person who has agreed to
participate or is participating in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.
(5) Definition of selling security
holder. For purposes of this paragraph
(a), selling security holder means any
person, other than an issuer, on whose
behalf a distribution is made.
(6) Definition of underwriting
position. For purposes of this section,
underwriting position means the long or
short positions in one or more securities
held by a banking entity or its affiliate,
and managed by a particular trading
desk, in connection with a particular
distribution of securities for which such
banking entity or affiliate is acting as an
underwriter.
(7) Definition of client, customer, and
counterparty. For purposes of this
paragraph (a), the terms client,
customer, and counterparty, on a
collective or individual basis, refer to
market participants that may transact
with the banking entity in connection
with a particular distribution for which
the banking entity is acting as
underwriter.
(b) Market making-related activities—
(1) Permitted market making-related
activities. The prohibition contained in
§ 255.3(a) does not apply to a banking
entity’s market making-related activities
conducted in accordance with this
paragraph (b).
(2) Requirements. The market makingrelated activities of a banking entity are
permitted under paragraph (b)(1) of this
section only if:
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(i) The trading desk that establishes
and manages the financial exposure,
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure, and is willing and available to
quote, purchase and sell, or otherwise
enter into long and short positions in
those types of financial instruments for
its own account, in commercially
reasonable amounts and throughout
market cycles on a basis appropriate for
the liquidity, maturity, and depth of the
market for the relevant types of financial
instruments;
(ii) The trading desk’s market-making
related activities are designed not to
exceed, on an ongoing basis, the
reasonably expected near term demands
of clients, customers, or counterparties,
taking into account the liquidity,
maturity, and depth of the market for
the relevant types of financial
instruments;
(iii) In the case of a banking entity
with significant trading assets and
liabilities, the banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (b)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The financial instruments each
trading desk stands ready to purchase
and sell in accordance with paragraph
(b)(2)(i) of this section;
(B) The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the limits
required under paragraph (b)(2)(iii)(C) of
this section; the products, instruments,
and exposures each trading desk may
use for risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and
positions; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
desk to mitigate these risks are and
continue to be effective;
(C) Limits for each trading desk, in
accordance with paragraph (b)(2)(ii) of
this section;
(D) Written authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
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independent review of such
demonstrable analysis and approval;
and
(E) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits.
(iv) A banking entity with significant
trading assets and liabilities may satisfy
the requirements in paragraphs
(b)(2)(iii)(C) and (D) of this section by
complying with the requirements set
forth below in paragraph (c) of this
section;
(v) The compensation arrangements of
persons performing the activities
described in this paragraph (b) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in activity
described in this paragraph (b) in
accordance with applicable law.
(3) Definition of client, customer, and
counterparty. For purposes of paragraph
(b) of this section, the terms client,
customer, and counterparty, on a
collective or individual basis refer to
market participants that make use of the
banking entity’s market making-related
services by obtaining such services,
responding to quotations, or entering
into a continuing relationship with
respect to such services, provided that:
(i) A trading desk or other
organizational unit of another banking
entity is not a client, customer, or
counterparty of the trading desk if that
other entity has trading assets and
liabilities of $50 billion or more as
measured in accordance with the
methodology described in § 255.2(ee) of
this part, unless:
(A) The trading desk documents how
and why a particular trading desk or
other organizational unit of the entity
should be treated as a client, customer,
or counterparty of the trading desk for
purposes of paragraph (b)(2) of this
section; or
(B) The purchase or sale by the
trading desk is conducted anonymously
on an exchange or similar trading
facility that permits trading on behalf of
a broad range of market participants.
(ii) [Reserved]
(4) Definition of financial exposure.
For purposes of this section, financial
exposure means the aggregate risks of
one or more financial instruments and
any associated loans, commodities, or
foreign exchange or currency, held by a
banking entity or its affiliate and
managed by a particular trading desk as
part of the trading desk’s market
making-related activities.
(5) Definition of market-maker
positions. For the purposes of this
section, market-maker positions means
all of the positions in the financial
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instruments for which the trading desk
stands ready to make a market in
accordance with paragraph (b)(2)(i) of
this section, that are managed by the
trading desk, including the trading
desk’s open positions or exposures
arising from open transactions.
(c) Rebuttable presumption of
compliance—(1) Internal limits. (i) A
banking entity shall be presumed to
meet the requirement in paragraph
(a)(2)(ii)(A) or (b)(2)(ii) of this section
with respect to the purchase or sale of
a financial instrument if the banking
entity has established and implements,
maintains, and enforces the internal
limits for the relevant trading desk as
described in paragraph (c)(1)(ii) of this
section.
(ii)(A) With respect to underwriting
activities conducted pursuant to
paragraph (a) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall be available
to each trading desk that establishes,
implements, maintains, and enforces
internal limits that should take into
account the liquidity, maturity, and
depth of the market for the relevant
types of securities and are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, based on the nature and
amount of the trading desk’s
underwriting activities, on the:
(1) Amount, types, and risk of its
underwriting position;
(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held.
(B) With respect to market makingrelated activities conducted pursuant to
paragraph (b) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall be available
to each trading desk that establishes,
implements, maintains, and enforces
internal limits that should take into
account the liquidity, maturity, and
depth of the market for the relevant
types of financial instruments and are
designed not to exceed the reasonably
expected near term demands of clients,
customers, or counterparties, based on
the nature and amount of the trading
desk’s market-making related activities,
that address the:
(1) Amount, types, and risks of its
market-maker positions;
(2) Amount, types, and risks of the
products, instruments, and exposures
the trading desk may use for risk
management purposes;
(3) Level of exposures to relevant risk
factors arising from its financial
exposure; and
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(4) Period of time a financial
instrument may be held.
(2) Supervisory review and oversight.
The limits described in paragraph (c)(1)
of this section shall be subject to
supervisory review and oversight by the
SEC on an ongoing basis.
(3) Limit breaches and increases. (i)
With respect to any limit set pursuant
to paragraphs (c)(1)(ii)(A) or (c)(1)(ii)(B)
of this section, a banking entity shall
maintain and make available to the SEC
upon request records regarding any
limit that is exceeded and any
temporary or permanent increase to any
limit(s), in each case in the form and
manner as directed by the SEC.
(ii) In the event of a breach or increase
of any limit set pursuant to paragraph
(c)(1)(ii)(A) or (B) of this section, the
presumption described in paragraph
(c)(1)(i) of this section shall continue to
be available only if the banking entity:
(A) Takes action as promptly as
possible after a breach to bring the
trading desk into compliance; and
(B) Follows established written
authorization procedures, including
escalation procedures that require
review and approval of any trade that
exceeds a trading desk’s limit(s),
demonstrable analysis of the basis for
any temporary or permanent increase to
a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval.
(4) Rebutting the presumption. The
presumption in paragraph (c)(1)(i) of
this section may be rebutted by the SEC
if the SEC determines, taking into
account the liquidity, maturity, and
depth of the market for the relevant
types of financial instruments and based
on all relevant facts and circumstances,
that a trading desk is engaging in
activity that is not based on the
reasonably expected near term demands
of clients, customers, or counterparties.
The SEC’s rebuttal of the presumption
in paragraph (c)(1)(i) must be made in
accordance with the notice and
response procedures in subpart D of this
part.
■ 64. Section 255.5 is amended by
revising paragraphs (b) and (c)(1)
introductory text and adding paragraph
(c)(4) to read as follows:
§ 255.5 Permitted risk-mitigating hedging
activities.
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*
*
*
*
*
(b) Requirements. (1) The riskmitigating hedging activities of a
banking entity that has significant
trading assets and liabilities are
permitted under paragraph (a) of this
section only if:
(i) The banking entity has established
and implements, maintains and enforces
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an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures regarding the
positions, techniques and strategies that
may be used for hedging, including
documentation indicating what
positions, contracts or other holdings a
particular trading desk may use in its
risk-mitigating hedging activities, as
well as position and aging limits with
respect to such positions, contracts or
other holdings;
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(C) The conduct of analysis and
independent testing designed to ensure
that the positions, techniques and
strategies that may be used for hedging
may reasonably be expected to reduce or
otherwise significantly mitigate the
specific, identifiable risk(s) being
hedged;
(ii) The risk-mitigating hedging
activity:
(A) Is conducted in accordance with
the written policies, procedures, and
internal controls required under this
section;
(B) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks, including
market risk, counterparty or other credit
risk, currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section;
(D) Is subject to continuing review,
monitoring and management by the
banking entity that:
(1) Is consistent with the written
hedging policies and procedures
required under paragraph (b)(1)(i) of this
section;
(2) Is designed to reduce or otherwise
significantly mitigate the specific,
identifiable risks that develop over time
from the risk-mitigating hedging
activities undertaken under this section
and the underlying positions, contracts,
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62243
and other holdings of the banking
entity, based upon the facts and
circumstances of the underlying and
hedging positions, contracts and other
holdings of the banking entity and the
risks and liquidity thereof; and
(3) Requires ongoing recalibration of
the hedging activity by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(1)(ii) of this section and is
not prohibited proprietary trading; and
(iii) The compensation arrangements
of persons performing risk-mitigating
hedging activities are designed not to
reward or incentivize prohibited
proprietary trading.
(2) The risk-mitigating hedging
activities of a banking entity that does
not have significant trading assets and
liabilities are permitted under paragraph
(a) of this section only if the riskmitigating hedging activity:
(i) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks, including
market risk, counterparty or other credit
risk, currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to
ongoing recalibration by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(2) of this section and is
not prohibited proprietary trading.
(c) * * *
(1) A banking entity that has
significant trading assets and liabilities
must comply with the requirements of
paragraphs (c)(2) and (3) of this section,
unless the requirements of paragraph
(c)(4) of this section are met, with
respect to any purchase or sale of
financial instruments made in reliance
on this section for risk-mitigating
hedging purposes that is:
*
*
*
*
*
(4) The requirements of paragraphs
(c)(2) and (3) of this section do not
apply to the purchase or sale of a
financial instrument described in
paragraph (c)(1) of this section if:
(i) The financial instrument
purchased or sold is identified on a
written list of pre-approved financial
instruments that are commonly used by
the trading desk for the specific type of
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hedging activity for which the financial
instrument is being purchased or sold;
and
(ii) At the time the financial
instrument is purchased or sold, the
hedging activity (including the purchase
or sale of the financial instrument)
complies with written, pre-approved
limits for the trading desk purchasing or
selling the financial instrument for
hedging activities undertaken for one or
more other trading desks. The limits
shall be appropriate for the:
(A) Size, types, and risks of the
hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased
and sold for hedging activities by the
trading desk; and
(C) Levels and duration of the risk
exposures being hedged.
■ 65. Section 255.6 is amended by
revising paragraph (e)(3); removing
paragraphs (e)(4) and (6); and
redesignating paragraph (e)(5) as
paragraph (e)(4).
The revision reads as follows:
§ 255.6 Other permitted proprietary trading
activities.
*
*
*
*
*
(e) * * *
(3) A purchase or sale by a banking
entity is permitted for purposes of this
paragraph (e) if:
(i) The banking entity engaging as
principal in the purchase or sale
(including relevant personnel) is not
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State; and
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State.
*
*
*
*
*
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Subpart C—Covered Funds Activities
and Investments
66. Section 255.10 is amended by
revising paragraphs (c)(7)(ii) and
(c)(8)(i)(A) to read as follows:
■
§ 255.10 Prohibition on Acquiring or
Retaining an Ownership Interest in and
Having Certain Relationships with a
Covered Fund.
*
*
*
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*
*
18:12 Nov 13, 2019
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(c) * * *
(7) * * *
(ii) Participates in the profits and
losses of the separate account other than
in compliance with applicable
requirements regarding bank owned life
insurance.
(8) * * *
(i) * * *
(A) Loans as defined in § 255.2(t) of
subpart A;
*
*
*
*
*
■ 67. Section 255.11 is amended by
revising paragraph (c) to read as follows:
§ 255.11 Permitted organizing and
offering, underwriting, and market making
with respect to a covered fund.
*
*
*
*
*
(c) Underwriting and market making
in ownership interests of a covered
fund. The prohibition contained in
§ 255.10(a) of this subpart does not
apply to a banking entity’s underwriting
activities or market making-related
activities involving a covered fund so
long as:
(1) Those activities are conducted in
accordance with the requirements of
§ 255.4(a) or § 255.4(b) of subpart B,
respectively; and
(2) With respect to any banking entity
(or any affiliate thereof) that: Acts as a
sponsor, investment adviser or
commodity trading advisor to a
particular covered fund or otherwise
acquires and retains an ownership
interest in such covered fund in reliance
on paragraph (a) of this section; or
acquires and retains an ownership
interest in such covered fund and is
either a securitizer, as that term is used
in section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)), or is acquiring
and retaining an ownership interest in
such covered fund in compliance with
section 15G of that Act (15 U.S.C.78o–
11) and the implementing regulations
issued thereunder each as permitted by
paragraph (b) of this section, then in
each such case any ownership interests
acquired or retained by the banking
entity and its affiliates in connection
with underwriting and market making
related activities for that particular
covered fund are included in the
calculation of ownership interests
permitted to be held by the banking
entity and its affiliates under the
limitations of § 255.12(a)(2)(ii);
§ 255.12(a)(2)(iii), and § 255.12(d) of this
subpart.
§ 255.12
[Amended]
68. Section 255.12 is amended by
redesignating the second instance of
paragraph (e)(2)(vi) as paragraph
(e)(2)(vii).
■
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69. Section 255.13 is amended by
revising paragraphs (a), (b)(3) and (4),
and (c) to read as follows:
■
§ 255.13 Other permitted covered fund
activities and investments.
(a) Permitted risk-mitigating hedging
activities. (1) The prohibition contained
in § 255.10(a) of this subpart does not
apply with respect to an ownership
interest in a covered fund acquired or
retained by a banking entity that is
designed to reduce or otherwise
significantly mitigate the specific,
identifiable risks to the banking entity
in connection with:
(i) A compensation arrangement with
an employee of the banking entity or an
affiliate thereof that directly provides
investment advisory, commodity trading
advisory or other services to the covered
fund; or
(ii) A position taken by the banking
entity when acting as intermediary on
behalf of a customer that is not itself a
banking entity to facilitate the exposure
by the customer to the profits and losses
of the covered fund.
(2) The risk-mitigating hedging
activities of a banking entity are
permitted under this paragraph (a) only
if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program in
accordance with subpart D of this part
that is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures; and
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(ii) The acquisition or retention of the
ownership interest:
(A) Is made in accordance with the
written policies, procedures, and
internal controls required under this
section;
(B) At the inception of the hedge, is
designed to reduce or otherwise
significantly mitigate one or more
specific, identifiable risks arising:
(1) Out of a transaction conducted
solely to accommodate a specific
customer request with respect to the
covered fund; or
(2) In connection with the
compensation arrangement with the
employee that directly provides
investment advisory, commodity trading
advisory, or other services to the
covered fund;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section; and
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(D) Is subject to continuing review,
monitoring and management by the
banking entity.
(iii) With respect to risk-mitigating
hedging activity conducted pursuant to
paragraph (a)(1)(i) of this section, the
compensation arrangement relates
solely to the covered fund in which the
banking entity or any affiliate has
acquired an ownership interest pursuant
to paragraph (a)(1)(i) and such
compensation arrangement provides
that any losses incurred by the banking
entity on such ownership interest will
be offset by corresponding decreases in
amounts payable under such
compensation arrangement.
(b) * * *
(3) An ownership interest in a covered
fund is not offered for sale or sold to a
resident of the United States for
purposes of paragraph (b)(1)(iii) of this
section only if it is not sold and has not
been sold pursuant to an offering that
targets residents of the United States in
which the banking entity or any affiliate
of the banking entity participates. If the
banking entity or an affiliate sponsors or
serves, directly or indirectly, as the
investment manager, investment
adviser, commodity pool operator or
commodity trading advisor to a covered
fund, then the banking entity or affiliate
will be deemed for purposes of this
paragraph (b)(3) to participate in any
offer or sale by the covered fund of
ownership interests in the covered fund.
(4) An activity or investment occurs
solely outside of the United States for
purposes of paragraph (b)(1)(iv) of this
section only if:
(i) The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
and is not controlled directly or
indirectly by, a banking entity that is
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
laws of the United States or of any State;
and
(iii) The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
as principal directly or indirectly on a
consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State.
*
*
*
*
*
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(c) Permitted covered fund interests
and activities by a regulated insurance
company. The prohibition contained in
§ 255.10(a) of this subpart does not
apply to the acquisition or retention by
an insurance company, or an affiliate
thereof, of any ownership interest in, or
the sponsorship of, a covered fund only
if:
(1) The insurance company or its
affiliate acquires and retains the
ownership interest solely for the general
account of the insurance company or for
one or more separate accounts
established by the insurance company;
(2) The acquisition and retention of
the ownership interest is conducted in
compliance with, and subject to, the
insurance company investment laws
and regulations of the State or
jurisdiction in which such insurance
company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law or
regulation described in paragraph (c)(2)
of this section is insufficient to protect
the safety and soundness of the banking
entity, or the financial stability of the
United States.
70. Section 255.14 is amended by
revising paragraph (a)(2)(ii)(B) to read as
follows:
■
§ 255.14 Limitations on relationships with
a covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or
equivalent officer) of the banking entity
certifies in writing annually no later
than March 31 to the SEC (with a duty
to update the certification if the
information in the certification
materially changes) that the banking
entity does not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests; and
*
*
*
*
*
Subpart D—Compliance Program
Requirement; Violations
71. Section 255.20 is amended by
eevising paragraphs (a), (b) introductory
text, (c), (d), (e) introductory text, and
(f)(2) and adding paragraphs (g), (h) and
(i) to read as follows:
■
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§ 255.20 Program for compliance;
reporting.
(a) Program requirement. Each
banking entity (other than a banking
entity with limited trading assets and
liabilities) shall develop and provide for
the continued administration of a
compliance program reasonably
designed to ensure and monitor
compliance with the prohibitions and
restrictions on proprietary trading and
covered fund activities and investments
set forth in section 13 of the BHC Act
and this part. The terms, scope, and
detail of the compliance program shall
be appropriate for the types, size, scope,
and complexity of activities and
business structure of the banking entity.
(b) Banking entities with significant
trading assets and liabilities. With
respect to a banking entity with
significant trading assets and liabilities,
the compliance program required by
paragraph (a) of this section, at a
minimum, shall include:
*
*
*
*
*
(c) CEO attestation. The CEO of a
banking entity that has significant
trading assets and liabilities must, based
on a review by the CEO of the banking
entity, attest in writing to the SEC, each
year no later than March 31, that the
banking entity has in place processes to
establish, maintain, enforce, review, test
and modify the compliance program
required by paragraph (b) of this section
in a manner reasonably designed to
achieve compliance with section 13 of
the BHC Act and this part. In the case
of a U.S. branch or agency of a foreign
banking entity, the attestation may be
provided for the entire U.S. operations
of the foreign banking entity by the
senior management officer of the U.S.
operations of the foreign banking entity
who is located in the United States.
(d) Reporting requirements under
appendix A to this part. (1) A banking
entity engaged in proprietary trading
activity permitted under subpart B of
this part shall comply with the reporting
requirements described in appendix A
to this part, if:
(i) The banking entity has significant
trading assets and liabilities; or
(ii) The SEC notifies the banking
entity in writing that it must satisfy the
reporting requirements contained in
appendix A to this part.
(2) Frequency of reporting: Unless the
SEC notifies the banking entity in
writing that it must report on a different
basis, a banking entity subject to
appendix A to this part shall report the
information required by appendix A for
each quarter within 30 days of the end
of the quarter.
(e) Additional documentation for
covered funds. A banking entity with
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significant trading assets and liabilities
shall maintain records that include:
*
*
*
*
*
(f) * * *
(2) Banking entities with moderate
trading assets and liabilities. A banking
entity with moderate trading assets and
liabilities may satisfy the requirements
of this section by including in its
existing compliance policies and
procedures appropriate references to the
requirements of section 13 of the BHC
Act and this part and adjustments as
appropriate given the activities, size,
scope, and complexity of the banking
entity.
(g) Rebuttable presumption of
compliance for banking entities with
limited trading assets and liabilities—
(1) Rebuttable presumption. Except as
otherwise provided in this paragraph, a
banking entity with limited trading
assets and liabilities shall be presumed
to be compliant with subpart B and
subpart C of this part and shall have no
obligation to demonstrate compliance
with this part on an ongoing basis.
(2) Rebuttal of presumption. If upon
examination or audit, the SEC
determines that the banking entity has
engaged in proprietary trading or
covered fund activities that are
otherwise prohibited under subpart B or
subpart C of this part, the SEC may
require the banking entity to be treated
under this part as if it did not have
limited trading assets and liabilities.
The SEC’s rebuttal of the presumption
in this paragraph must be made in
accordance with the notice and
response procedures in paragraph (i) of
this section.
(h) Reservation of authority.
Notwithstanding any other provision of
this part, the SEC retains its authority to
require a banking entity without
significant trading assets and liabilities
to apply any requirements of this part
that would otherwise apply if the
banking entity had significant or
moderate trading assets and liabilities if
the SEC determines that the size or
complexity of the banking entity’s
trading or investment activities, or the
risk of evasion of subpart B or subpart
C of this part, does not warrant a
presumption of compliance under
paragraph (g) of this section or treatment
as a banking entity with moderate
trading assets and liabilities, as
applicable. The SEC’s exercise of this
reservation of authority must be made in
accordance with the notice and
response procedures in paragraph (i) of
this section.
(i) Notice and response procedures—
(1) Notice. The SEC will notify the
banking entity in writing of any
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determination requiring notice under
this part and will provide an
explanation of the determination.
(2) Response. The banking entity may
respond to any or all items in the notice
described in paragraph (i)(1) of this
section. The response should include
any matters that the banking entity
would have the SEC consider in
deciding whether to make the
determination. The response must be in
writing and delivered to the designated
SEC official within 30 days after the
date on which the banking entity
received the notice. The SEC may
shorten the time period when, in the
opinion of the SEC, the activities or
condition of the banking entity so
requires, provided that the banking
entity is informed of the time period at
the time of notice, or with the consent
of the banking entity. In its discretion,
the SEC may extend the time period for
good cause.
(3) Waiver. Failure to respond within
30 days or such other time period as
may be specified by the SEC shall
constitute a waiver of any objections to
the SEC’s determination.
(4) Decision. The SEC will notify the
banking entity of the decision in
writing. The notice will include an
explanation of the decision.
■ 72. Revise appendix A to part 255 to
read as follows:
Appendix A to Part 255—Reporting and
Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and
recordkeeping requirements that certain
banking entities must satisfy in connection
with the restrictions on proprietary trading
set forth in subpart B (‘‘proprietary trading
restrictions’’). Pursuant to § 255.20(d), this
appendix applies to a banking entity that,
together with its affiliates and subsidiaries,
has significant trading assets and liabilities.
These entities are required to (i) furnish
periodic reports to the SEC regarding a
variety of quantitative measurements of their
covered trading activities, which vary
depending on the scope and size of covered
trading activities, and (ii) create and maintain
records documenting the preparation and
content of these reports. The requirements of
this appendix must be incorporated into the
banking entity’s internal compliance program
under § 255.20.
b. The purpose of this appendix is to assist
banking entities and the SEC in:
(1) Better understanding and evaluating the
scope, type, and profile of the banking
entity’s covered trading activities;
(2) Monitoring the banking entity’s covered
trading activities;
(3) Identifying covered trading activities
that warrant further review or examination
by the banking entity to verify compliance
with the proprietary trading restrictions;
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(4) Evaluating whether the covered trading
activities of trading desks engaged in market
making-related activities subject to § 255.4(b)
are consistent with the requirements
governing permitted market making-related
activities;
(5) Evaluating whether the covered trading
activities of trading desks that are engaged in
permitted trading activity subject to § 255.4,
§ 255.5, or § 255.6(a) and (b) (i.e.,
underwriting and market making-related
activity, risk-mitigating hedging, or trading in
certain government obligations) are
consistent with the requirement that such
activity not result, directly or indirectly, in
a material exposure to high-risk assets or
high-risk trading strategies;
(6) Identifying the profile of particular
covered trading activities of the banking
entity, and the individual trading desks of
the banking entity, to help establish the
appropriate frequency and scope of
examination by SEC of such activities; and
(7) Assessing and addressing the risks
associated with the banking entity’s covered
trading activities.
c. Information that must be furnished
pursuant to this appendix is not intended to
serve as a dispositive tool for the
identification of permissible or
impermissible activities.
d. In addition to the quantitative
measurements required in this appendix, a
banking entity may need to develop and
implement other quantitative measurements
in order to effectively monitor its covered
trading activities for compliance with section
13 of the BHC Act and this part and to have
an effective compliance program, as required
by § 255.20. The effectiveness of particular
quantitative measurements may differ based
on the profile of the banking entity’s
businesses in general and, more specifically,
of the particular trading desk, including
types of instruments traded, trading activities
and strategies, and history and experience
(e.g., whether the trading desk is an
established, successful market maker or a
new entrant to a competitive market). In all
cases, banking entities must ensure that they
have robust measures in place to identify and
monitor the risks taken in their trading
activities, to ensure that the activities are
within risk tolerances established by the
banking entity, and to monitor and examine
for compliance with the proprietary trading
restrictions in this part.
e. On an ongoing basis, banking entities
must carefully monitor, review, and evaluate
all furnished quantitative measurements, as
well as any others that they choose to utilize
in order to maintain compliance with section
13 of the BHC Act and this part. All
measurement results that indicate a
heightened risk of impermissible proprietary
trading, including with respect to otherwisepermitted activities under §§ 255.4 through
255.6(a) and (b), or that result in a material
exposure to high-risk assets or high-risk
trading strategies, must be escalated within
the banking entity for review, further
analysis, explanation to SEC, and
remediation, where appropriate. The
quantitative measurements discussed in this
appendix should be helpful to banking
entities in identifying and managing the risks
related to their covered trading activities.
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II. Definitions
The terms used in this appendix have the
same meanings as set forth in §§ 255.2 and
255.3. In addition, for purposes of this
appendix, the following definitions apply:
Applicability identifies the trading desks
for which a banking entity is required to
calculate and report a particular quantitative
measurement based on the type of covered
trading activity conducted by the trading
desk.
Calculation period means the period of
time for which a particular quantitative
measurement must be calculated.
Comprehensive profit and loss means the
net profit or loss of a trading desk’s material
sources of trading revenue over a specific
period of time, including, for example, any
increase or decrease in the market value of
a trading desk’s holdings, dividend income,
and interest income and expense.
Covered trading activity means trading
conducted by a trading desk under § 255.4,
§ 255.5, § 255.6(a), or § 255.6(b). A banking
entity may include in its covered trading
activity trading conducted under § 255.3(d),
§ 255.6(c), § 255.6(d), or § 255.6(e).
Measurement frequency means the
frequency with which a particular
quantitative metric must be calculated and
recorded.
Trading day means a calendar day on
which a trading desk is open for trading.
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III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each
banking entity made subject to this appendix
by § 255.20 must furnish the following
quantitative measurements, as applicable, for
each trading desk of the banking entity
engaged in covered trading activities and
calculate these quantitative measurements in
accordance with this appendix:
i. Internal Limits and Usage;
ii. Value-at-Risk;
iii. Comprehensive Profit and Loss
Attribution;
iv. Positions; and
v. Transaction Volumes.
2. Trading desk information. Each banking
entity made subject to this appendix by
§ 255.20 must provide certain descriptive
information, as further described in this
appendix, regarding each trading desk
engaged in covered trading activities.
3. Quantitative measurements identifying
information. Each banking entity made
subject to this appendix by § 255.20 must
provide certain identifying and descriptive
information, as further described in this
appendix, regarding its quantitative
measurements.
4. Narrative statement. Each banking entity
made subject to this appendix by § 255.20
may provide an optional narrative statement,
as further described in this appendix.
5. File identifying information. Each
banking entity made subject to this appendix
by § 255.20 must provide file identifying
information in each submission to the SEC
pursuant to this appendix, including the
name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the
Board, and identification of the reporting
period and creation date and time.
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b. Trading Desk Information
1. Each banking entity must provide
descriptive information regarding each
trading desk engaged in covered trading
activities, including:
i. Name of the trading desk used internally
by the banking entity and a unique
identification label for the trading desk;
ii. Identification of each type of covered
trading activity in which the trading desk is
engaged;
iii. Brief description of the general strategy
of the trading desk;
v. A list identifying each Agency receiving
the submission of the trading desk;
2. Indication of whether each calendar date
is a trading day or not a trading day for the
trading desk; and
3. Currency reported and daily currency
conversion rate.
c. Quantitative Measurements Identifying
Information
Each banking entity must provide the
following information regarding the
quantitative measurements:
1. An Internal Limits Information Schedule
that provides identifying and descriptive
information for each limit reported pursuant
to the Internal Limits and Usage quantitative
measurement, including the name of the
limit, a unique identification label for the
limit, a description of the limit, the unit of
measurement for the limit, the type of limit,
and identification of the corresponding risk
factor attribution in the particular case that
the limit type is a limit on a risk factor
sensitivity and profit and loss attribution to
the same risk factor is reported; and
2. A Risk Factor Attribution Information
Schedule that provides identifying and
descriptive information for each risk factor
attribution reported pursuant to the
Comprehensive Profit and Loss Attribution
quantitative measurement, including the
name of the risk factor or other factor, a
unique identification label for the risk factor
or other factor, a description of the risk factor
or other factor, and the risk factor or other
factor’s change unit.
d. Narrative Statement
Each banking entity made subject to this
appendix by § 255.20 may submit in a
separate electronic document a Narrative
Statement to the SEC with any information
the banking entity views as relevant for
assessing the information reported. The
Narrative Statement may include further
description of or changes to calculation
methods, identification of material events,
description of and reasons for changes in the
banking entity’s trading desk structure or
trading desk strategies, and when any such
changes occurred.
e. Frequency and Method of Required
Calculation and Reporting
A banking entity must calculate any
applicable quantitative measurement for each
trading day. A banking entity must report the
Trading Desk Information, the Quantitative
Measurements Identifying Information, and
each applicable quantitative measurement
electronically to the SEC on the reporting
schedule established in § 255.20 unless
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62247
otherwise requested by the SEC. A banking
entity must report the Trading Desk
Information, the Quantitative Measurements
Identifying Information, and each applicable
quantitative measurement to the SEC in
accordance with the XML Schema specified
and published on the SEC’s website.
f. Recordkeeping
A banking entity must, for any quantitative
measurement furnished to the SEC pursuant
to this appendix and § 255.20(d), create and
maintain records documenting the
preparation and content of these reports, as
well as such information as is necessary to
permit the SEC to verify the accuracy of such
reports, for a period of five years from the
end of the calendar year for which the
measurement was taken. A banking entity
must retain the Narrative Statement, the
Trading Desk Information, and the
Quantitative Measurements Identifying
Information for a period of five years from
the end of the calendar year for which the
information was reported to the SEC.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Internal Limits and Usage
i. Description: For purposes of this
appendix, Internal Limits are the constraints
that define the amount of risk and the
positions that a trading desk is permitted to
take at a point in time, as defined by the
banking entity for a specific trading desk.
Usage represents the value of the trading
desk’s risk or positions that are accounted for
by the current activity of the desk. Internal
limits and their usage are key compliance
and risk management tools used to control
and monitor risk taking and include, but are
not limited to, the limits set out in §§ 255.4
and 255.5. A trading desk’s risk limits,
commonly including a limit on ‘‘Value-atRisk,’’ are useful in the broader context of the
trading desk’s overall activities, particularly
for the market making activities under
§ 255.4(b) and hedging activity under § 255.5.
Accordingly, the limits required under
§§ 255.4(b)(2)(iii)(C) and 255.5(b)(1)(i)(A)
must meet the applicable requirements under
§§ 255.4(b)(2)(iii)(C) and 255.5(b)(1)(i)(A) and
also must include appropriate metrics for the
trading desk limits including, at a minimum,
‘‘Value-at-Risk’’ except to the extent the
‘‘Value-at-Risk’’ metric is demonstrably
ineffective for measuring and monitoring the
risks of a trading desk based on the types of
positions traded by, and risk exposures of,
that desk.
A. A banking entity must provide the
following information for each limit reported
pursuant to this quantitative measurement:
The unique identification label for the limit
reported in the Internal Limits Information
Schedule, the limit size (distinguishing
between an upper and a lower limit), and the
value of usage of the limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
2. Value-at-Risk
i. Description: For purposes of this
appendix, Value-at-Risk (‘‘VaR’’) is the
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measurement of the risk of future financial
loss in the value of a trading desk’s
aggregated positions at the ninety-nine
percent confidence level over a one-day
period, based on current market conditions.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
b. Source-of-Revenue Measurements
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1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this
appendix, Comprehensive Profit and Loss
Attribution is an analysis that attributes the
daily fluctuation in the value of a trading
desk’s positions to various sources. First, the
daily profit and loss of the aggregated
positions is divided into two categories: (i)
Profit and loss attributable to a trading desk’s
existing positions that were also positions
held by the trading desk as of the end of the
prior day (‘‘existing positions’’); and (ii)
profit and loss attributable to new positions
resulting from the current day’s trading
activity (‘‘new positions’’).
A. The comprehensive profit and loss
associated with existing positions must
reflect changes in the value of these positions
on the applicable day. The comprehensive
profit and loss from existing positions must
be further attributed, as applicable, to (i)
changes in the specific risk factors and other
factors that are monitored and managed as
part of the trading desk’s overall risk
management policies and procedures; and (ii)
any other applicable elements, such as cash
flows, carry, changes in reserves, and the
correction, cancellation, or exercise of a
trade.
B. For the attribution of comprehensive
profit and loss from existing positions to
specific risk factors and other factors, a
banking entity must provide the following
information for the factors that explain the
preponderance of the profit or loss changes
due to risk factor changes: The unique
identification label for the risk factor or other
factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss
due to the risk factor or other factor change.
C. The comprehensive profit and loss
attributed to new positions must reflect
commissions and fee income or expense and
market gains or losses associated with
transactions executed on the applicable day.
New positions include purchases and sales of
financial instruments and other assets/
liabilities and negotiated amendments to
existing positions. The comprehensive profit
and loss from new positions may be reported
in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and
loss from existing positions that is not
attributed to changes in specific risk factors
and other factors must be allocated to a
residual category. Significant unexplained
profit and loss must be escalated for further
investigation and analysis.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged
in covered trading activities.
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c. Positions and Transaction Volumes
Measurements
1. Positions
i. Description: For purposes of this
appendix, Positions is the value of securities
and derivatives positions managed by the
trading desk. For purposes of the Positions
quantitative measurement, do not include in
the Positions calculation for ‘‘securities’’
those securities that are also ‘‘derivatives,’’ as
those terms are defined under subpart A;
instead, report those securities that are also
derivatives as ‘‘derivatives.’’ 1 A banking
entity must separately report the trading
desk’s market value of long securities
positions, short securities positions,
derivatives receivables, and derivatives
payables.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely
on § 255.4(a) or (b) to conduct underwriting
activity or market-making-related activity,
respectively.
2. Transaction Volumes
i. Description: For purposes of this
appendix, Transaction Volumes measures
three exclusive categories of covered trading
activity conducted by a trading desk. A
banking entity is required to report the value
and number of security and derivative
transactions conducted by the trading desk
with: (i) Customers, excluding internal
transactions; (ii) non-customers, excluding
internal transactions; and (iii) trading desks
and other organizational units where the
transaction is booked into either the same
banking entity or an affiliated banking entity.
For securities, value means gross market
value. For derivatives, value means gross
notional value. For purposes of calculating
the Transaction Volumes quantitative
measurement, do not include in the
Transaction Volumes calculation for
‘‘securities’’ those securities that are also
‘‘derivatives,’’ as those terms are defined
under subpart A; instead, report those
securities that are also derivatives as
‘‘derivatives.’’ 2 Further, for purposes of the
Transaction Volumes quantitative
measurement, a customer of a trading desk
that relies on § 255.4(a) to conduct
underwriting activity is a market participant
identified in § 255.4(a)(7), and a customer of
a trading desk that relies on § 255.4(b) to
conduct market making-related activity is a
market participant identified in § 255.4(b)(3).
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely
on § 255.4(a) or (b) to conduct underwriting
activity or market-making-related activity,
respectively.
Appendix B to Part 255 [Removed]
73. Appendix B to part 255 is
removed.
■
1 See § 255.2(h), (aa). For example, under this
part, a security-based swap is both a ‘‘security’’ and
a ‘‘derivative.’’ For purposes of the Positions
quantitative measurement, security-based swaps are
reported as derivatives rather than securities.
2 See § 255.2(h), (aa).
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74. Effective January 1, 2020, until
December 31, 2020, appendix Z to part
255 is added to read as follows:
■
Appendix Z to Part 255—Proprietary
Trading and Certain Interests in and
Relationships With Covered Funds
(Alternative Compliance)
Note: The content of this appendix
reproduces the regulation implementing
Section 13 of the Bank Holding Company Act
as of November 13, 2019.
Subpart A—Authority and Definitions
§ 255.1 Authority, purpose, scope, and
relationship to other authorities.
(a) Authority. This part is issued by
the SEC under section 13 of the Bank
Holding Company Act of 1956, as
amended (12 U.S.C. 1851).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes
prohibitions and restrictions on
proprietary trading and investments in
or relationships with covered funds by
certain banking entities, including
registered broker-dealers, registered
investment advisers, and registered
security-based swap dealers, among
others identified in section 2(12)(B) of
the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (12
U.S.C. 5301(12)(B)). This part
implements section 13 of the Bank
Holding Company Act by defining terms
used in the statute and related terms,
establishing prohibitions and
restrictions on proprietary trading and
investments in or relationships with
covered funds, and explaining the
statute’s requirements.
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to banking
entities for which the SEC is the
primary financial regulatory agency, as
defined in this part, but does not
include such entities to the extent they
are not within the definition of banking
entity in § 255.2(c).
(d) Relationship to other authorities.
Except as otherwise provided under
section 13 of the Bank Holding
Company Act, and notwithstanding any
other provision of law, the prohibitions
and restrictions under section 13 of
Bank Holding Company Act shall apply
to the activities and investments of a
banking entity identified in paragraph
(c) of this section, even if such activities
and investments are authorized for the
banking entity under other applicable
provisions of law.
(e) Preservation of authority. Nothing
in this part limits in any way the
authority of the SEC to impose on a
banking entity identified in paragraph
(c) of this section additional
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requirements or restrictions with respect
to any activity, investment, or
relationship covered under section 13 of
the Bank Holding Company Act or this
part, or additional penalties for
violation of this part provided under
any other applicable provision of law.
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§ 255.2
Definitions.
Unless otherwise specified, for
purposes of this part:
(a) Affiliate has the same meaning as
in section 2(k) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(k)).
(b) Bank holding company has the
same meaning as in section 2 of the
Bank Holding Company Act of 1956 (12
U.S.C. 1841).
(c) Banking entity. (1) Except as
provided in paragraph (c)(2) of this
section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an
insured depository institution;
(iii) Any company that is treated as a
bank holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any
entity described in paragraphs (c)(1)(i),
(ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a
banking entity under paragraphs
(c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under
the authority contained in section
4(k)(4)(H) or (I) of the BHC Act (12
U.S.C. 1843(k)(4)(H), (I)), or any
portfolio concern, as defined under 13
CFR 107.50, that is controlled by a small
business investment company, as
defined in section 103(3) of the Small
Business Investment Act of 1958 (15
U.S.C. 662), so long as the portfolio
company or portfolio concern is not
itself a banking entity under paragraphs
(c)(1)(i), (ii), or (iii) of this section; or
(iii) The FDIC acting in its corporate
capacity or as conservator or receiver
under the Federal Deposit Insurance Act
or Title II of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
(d) Board means the Board of
Governors of the Federal Reserve
System.
(e) CFTC means the Commodity
Futures Trading Commission.
(f) Dealer has the same meaning as in
section 3(a)(5) of the Exchange Act (15
U.S.C. 78c(a)(5)).
(g) Depository institution has the same
meaning as in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)).
(h) Derivative. (1) Except as provided
in paragraph (h)(2) of this section,
derivative means:
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(i) Any swap, as that term is defined
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)), or
security-based swap, as that term is
defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68));
(ii) Any purchase or sale of a
commodity, that is not an excluded
commodity, for deferred shipment or
delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as
that term is defined in section 1a(24) of
the Commodity Exchange Act (7 U.S.C.
1a(24)) or foreign exchange swap (as
that term is defined in section 1a(25) of
the Commodity Exchange Act (7 U.S.C.
1a(25));
(iv) Any agreement, contract, or
transaction in foreign currency
described in section 2(c)(2)(C)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(C)(i));
(v) Any agreement, contract, or
transaction in a commodity other than
foreign currency described in section
2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under
section 19 of the Commodity Exchange
Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or
other agreement, contract, or transaction
that the CFTC and the SEC have further
defined by joint regulation,
interpretation, guidance, or other action
as not within the definition of swap, as
that term is defined in section 1a(47) of
the Commodity Exchange Act (7 U.S.C.
1a(47)), or security-based swap, as that
term is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)); or
(ii) Any identified banking product, as
defined in section 402(b) of the Legal
Certainty for Bank Products Act of 2000
(7 U.S.C. 27(b)), that is subject to section
403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the
immediate family of the employee.
(j) Exchange Act means the Securities
Exchange Act of 1934 (15 U.S.C. 78a et
seq.).
(k) Excluded commodity has the same
meaning as in section 1a(19) of the
Commodity Exchange Act (7 U.S.C.
1a(19)).
(l) FDIC means the Federal Deposit
Insurance Corporation.
(m) Federal banking agencies means
the Board, the Office of the Comptroller
of the Currency, and the FDIC.
(n) Foreign banking organization has
the same meaning as in section
211.21(o) of the Board’s Regulation K
(12 CFR 211.21(o)), but does not include
a foreign bank, as defined in section
1(b)(7) of the International Banking Act
of 1978 (12 U.S.C. 3101(7)), that is
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organized under the laws of the
Commonwealth of Puerto Rico, Guam,
American Samoa, the United States
Virgin Islands, or the Commonwealth of
the Northern Mariana Islands.
(o) Foreign insurance regulator means
the insurance commissioner, or a
similar official or agency, of any country
other than the United States that is
engaged in the supervision of insurance
companies under foreign insurance law.
(p) General account means all of the
assets of an insurance company except
those allocated to one or more separate
accounts.
(q) Insurance company means a
company that is organized as an
insurance company, primarily and
predominantly engaged in writing
insurance or reinsuring risks
underwritten by insurance companies,
subject to supervision as such by a state
insurance regulator or a foreign
insurance regulator, and not operated
for the purpose of evading the
provisions of section 13 of the BHC Act
(12 U.S.C. 1851).
(r) Insured depository institution,
unless otherwise indicated, has the
same meaning as in section 3(c) of the
Federal Deposit Insurance Act (12
U.S.C. 1813(c)), but does not include:
(1) An insured depository institution
that is described in section 2(c)(2)(D) of
the BHC Act (12 U.S.C. 1841(c)(2)(D));
or
(2) An insured depository institution
if it has, and if every company that
controls it has, total consolidated assets
of $10 billion or less and total trading
assets and trading liabilities, on a
consolidated basis, that are 5 percent or
less of total consolidated assets.
(s) Loan means any loan, lease,
extension of credit, or secured or
unsecured receivable that is not a
security or derivative.
(t) Primary financial regulatory
agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act (12 U.S.C. 5301(12)).
(u) Purchase includes any contract to
buy, purchase, or otherwise acquire. For
security futures products, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a commodity future, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a derivative, purchase
includes the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
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(v) Qualifying foreign banking
organization means a foreign banking
organization that qualifies as such under
section 211.23(a), (c) or (e) of the
Board’s Regulation K (12 CFR 211.23(a),
(c), or (e)).
(w) SEC means the Securities and
Exchange Commission.
(x) Sale and sell each include any
contract to sell or otherwise dispose of.
For security futures products, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a commodity future, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a derivative, such terms
include the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(y) Security has the meaning specified
in section 3(a)(10) of the Exchange Act
(15 U.S.C. 78c(a)(10)).
(z) Security-based swap dealer has the
same meaning as in section 3(a)(71) of
the Exchange Act (15 U.S.C. 78c(a)(71)).
(aa) Security future has the meaning
specified in section 3(a)(55) of the
Exchange Act (15 U.S.C. 78c(a)(55)).
(bb) Separate account means an
account established and maintained by
an insurance company in connection
with one or more insurance contracts to
hold assets that are legally segregated
from the insurance company’s other
assets, under which income, gains, and
losses, whether or not realized, from
assets allocated to such account, are, in
accordance with the applicable contract,
credited to or charged against such
account without regard to other income,
gains, or losses of the insurance
company.
(cc) State means any State, the District
of Columbia, the Commonwealth of
Puerto Rico, Guam, American Samoa,
the United States Virgin Islands, and the
Commonwealth of the Northern Mariana
Islands.
(dd) Subsidiary has the same meaning
as in section 2(d) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(d)).
(ee) State insurance regulator means
the insurance commissioner, or a
similar official or agency, of a State that
is engaged in the supervision of
insurance companies under State
insurance law.
(ff) Swap dealer has the same meaning
as in section 1(a)(49) of the Commodity
Exchange Act (7 U.S.C. 1a(49)).
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Subpart B—Proprietary Trading
§ 255.3
Prohibition on proprietary trading.
(a) Prohibition. Except as otherwise
provided in this subpart, a banking
entity may not engage in proprietary
trading. Proprietary trading means
engaging as principal for the trading
account of the banking entity in any
purchase or sale of one or more
financial instruments.
(b) Definition of trading account. (1)
Trading account means any account that
is used by a banking entity to:
(i) Purchase or sell one or more
financial instruments principally for the
purpose of:
(A) Short-term resale;
(B) Benefitting from actual or
expected short-term price movements;
(C) Realizing short-term arbitrage
profits; or
(D) Hedging one or more positions
resulting from the purchases or sales of
financial instruments described in
paragraphs (b)(1)(i)(A), (B), or (C) of this
section;
(ii) Purchase or sell one or more
financial instruments that are both
market risk capital rule covered
positions and trading positions (or
hedges of other market risk capital rule
covered positions), if the banking entity,
or any affiliate of the banking entity, is
an insured depository institution, bank
holding company, or savings and loan
holding company, and calculates riskbased capital ratios under the market
risk capital rule; or
(iii) Purchase or sell one or more
financial instruments for any purpose, if
the banking entity:
(A) Is licensed or registered, or is
required to be licensed or registered, to
engage in the business of a dealer, swap
dealer, or security-based swap dealer, to
the extent the instrument is purchased
or sold in connection with the activities
that require the banking entity to be
licensed or registered as such; or
(B) Is engaged in the business of a
dealer, swap dealer, or security-based
swap dealer outside of the United
States, to the extent the instrument is
purchased or sold in connection with
the activities of such business.
(2) Rebuttable presumption for certain
purchases and sales. The purchase (or
sale) of a financial instrument by a
banking entity shall be presumed to be
for the trading account of the banking
entity under paragraph (b)(1)(i) of this
section if the banking entity holds the
financial instrument for fewer than sixty
days or substantially transfers the risk of
the financial instrument within sixty
days of the purchase (or sale), unless the
banking entity can demonstrate, based
on all relevant facts and circumstances,
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that the banking entity did not purchase
(or sell) the financial instrument
principally for any of the purposes
described in paragraph (b)(1)(i) of this
section.
(c) Financial instrument. (1) Financial
instrument means:
(i) A security, including an option on
a security;
(ii) A derivative, including an option
on a derivative; or
(iii) A contract of sale of a commodity
for future delivery, or option on a
contract of sale of a commodity for
future delivery.
(2) A financial instrument does not
include:
(i) A loan;
(ii) A commodity that is not:
(A) An excluded commodity (other
than foreign exchange or currency);
(B) A derivative;
(C) A contract of sale of a commodity
for future delivery; or
(D) An option on a contract of sale of
a commodity for future delivery; or
(iii) Foreign exchange or currency.
(d) Proprietary trading. Proprietary
trading does not include:
(1) Any purchase or sale of one or
more financial instruments by a banking
entity that arises under a repurchase or
reverse repurchase agreement pursuant
to which the banking entity has
simultaneously agreed, in writing, to
both purchase and sell a stated asset, at
stated prices, and on stated dates or on
demand with the same counterparty;
(2) Any purchase or sale of one or
more financial instruments by a banking
entity that arises under a transaction in
which the banking entity lends or
borrows a security temporarily to or
from another party pursuant to a written
securities lending agreement under
which the lender retains the economic
interests of an owner of such security,
and has the right to terminate the
transaction and to recall the loaned
security on terms agreed by the parties;
(3) Any purchase or sale of a security
by a banking entity for the purpose of
liquidity management in accordance
with a documented liquidity
management plan of the banking entity
that:
(i) Specifically contemplates and
authorizes the particular securities to be
used for liquidity management
purposes, the amount, types, and risks
of these securities that are consistent
with liquidity management, and the
liquidity circumstances in which the
particular securities may or must be
used;
(ii) Requires that any purchase or sale
of securities contemplated and
authorized by the plan be principally for
the purpose of managing the liquidity of
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the banking entity, and not for the
purpose of short-term resale, benefitting
from actual or expected short-term price
movements, realizing short-term
arbitrage profits, or hedging a position
taken for such short-term purposes;
(iii) Requires that any securities
purchased or sold for liquidity
management purposes be highly liquid
and limited to securities the market,
credit, and other risks of which the
banking entity does not reasonably
expect to give rise to appreciable profits
or losses as a result of short-term price
movements;
(iv) Limits any securities purchased or
sold for liquidity management purposes,
together with any other instruments
purchased or sold for such purposes, to
an amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan;
(v) Includes written policies and
procedures, internal controls, analysis,
and independent testing to ensure that
the purchase and sale of securities that
are not permitted under §§ 255.6(a) or
(b) of this subpart are for the purpose of
liquidity management and in
accordance with the liquidity
management plan described in
paragraph (d)(3) of this section; and
(vi) Is consistent with the SEC’s
supervisory requirements, guidance,
and expectations regarding liquidity
management;
(4) Any purchase or sale of one or
more financial instruments by a banking
entity that is a derivatives clearing
organization or a clearing agency in
connection with clearing financial
instruments;
(5) Any excluded clearing activities
by a banking entity that is a member of
a clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility;
(6) Any purchase or sale of one or
more financial instruments by a banking
entity, so long as:
(i) The purchase (or sale) satisfies an
existing delivery obligation of the
banking entity or its customers,
including to prevent or close out a
failure to deliver, in connection with
delivery, clearing, or settlement activity;
or
(ii) The purchase (or sale) satisfies an
obligation of the banking entity in
connection with a judicial,
administrative, self-regulatory
organization, or arbitration proceeding;
(7) Any purchase or sale of one or
more financial instruments by a banking
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entity that is acting solely as agent,
broker, or custodian;
(8) Any purchase or sale of one or
more financial instruments by a banking
entity through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity that is
established and administered in
accordance with the law of the United
States or a foreign sovereign, if the
purchase or sale is made directly or
indirectly by the banking entity as
trustee for the benefit of persons who
are or were employees of the banking
entity; or
(9) Any purchase or sale of one or
more financial instruments by a banking
entity in the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the financial instrument
as soon as practicable, and in no event
may the banking entity retain such
instrument for longer than such period
permitted by the SEC.
(e) Definition of other terms related to
proprietary trading. For purposes of this
subpart:
(1) Anonymous means that each party
to a purchase or sale is unaware of the
identity of the other party(ies) to the
purchase or sale.
(2) Clearing agency has the same
meaning as in section 3(a)(23) of the
Exchange Act (15 U.S.C. 78c(a)(23)).
(3) Commodity has the same meaning
as in section 1a(9) of the Commodity
Exchange Act (7 U.S.C. 1a(9)), except
that a commodity does not include any
security;
(4) Contract of sale of a commodity
for future delivery means a contract of
sale (as that term is defined in section
1a(13) of the Commodity Exchange Act
(7 U.S.C. 1a(13)) for future delivery (as
that term is defined in section 1a(27) of
the Commodity Exchange Act (7 U.S.C.
1a(27))).
(5) Derivatives clearing organization
means:
(i) A derivatives clearing organization
registered under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1);
(ii) A derivatives clearing organization
that, pursuant to CFTC regulation, is
exempt from the registration
requirements under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1); or
(iii) A foreign derivatives clearing
organization that, pursuant to CFTC
regulation, is permitted to clear for a
foreign board of trade that is registered
with the CFTC.
(6) Exchange, unless the context
otherwise requires, means any
designated contract market, swap
execution facility, or foreign board of
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trade registered with the CFTC, or, for
purposes of securities or security-based
swaps, an exchange, as defined under
section 3(a)(1) of the Exchange Act (15
U.S.C. 78c(a)(1)), or security-based swap
execution facility, as defined under
section 3(a)(77) of the Exchange Act (15
U.S.C. 78c(a)(77)).
(7) Excluded clearing activities means:
(i) With respect to customer
transactions cleared on a derivatives
clearing organization, a clearing agency,
or a designated financial market utility,
any purchase or sale necessary to
correct trading errors made by or on
behalf of a customer provided that such
purchase or sale is conducted in
accordance with, for transactions
cleared on a derivatives clearing
organization, the Commodity Exchange
Act, CFTC regulations, and the rules or
procedures of the derivatives clearing
organization, or, for transactions cleared
on a clearing agency, the rules or
procedures of the clearing agency, or,
for transactions cleared on a designated
financial market utility that is neither a
derivatives clearing organization nor a
clearing agency, the rules or procedures
of the designated financial market
utility;
(ii) Any purchase or sale in
connection with and related to the
management of a default or threatened
imminent default of a customer
provided that such purchase or sale is
conducted in accordance with, for
transactions cleared on a derivatives
clearing organization, the Commodity
Exchange Act, CFTC regulations, and
the rules or procedures of the
derivatives clearing organization, or, for
transactions cleared on a clearing
agency, the rules or procedures of the
clearing agency, or, for transactions
cleared on a designated financial market
utility that is neither a derivatives
clearing organization nor a clearing
agency, the rules or procedures of the
designated financial market utility;
(iii) Any purchase or sale in
connection with and related to the
management of a default or threatened
imminent default of a member of a
clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility;
(iv) Any purchase or sale in
connection with and related to the
management of the default or threatened
default of a clearing agency, a
derivatives clearing organization, or a
designated financial market utility; and
(v) Any purchase or sale that is
required by the rules or procedures of a
clearing agency, a derivatives clearing
organization, or a designated financial
market utility to mitigate the risk to the
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clearing agency, derivatives clearing
organization, or designated financial
market utility that would result from the
clearing by a member of security-based
swaps that reference the member or an
affiliate of the member.
(8) Designated financial market utility
has the same meaning as in section
803(4) of the Dodd-Frank Act (12 U.S.C.
5462(4)).
(9) Issuer has the same meaning as in
section 2(a)(4) of the Securities Act of
1933 (15 U.S.C. 77b(a)(4)).
(10) Market risk capital rule covered
position and trading position means a
financial instrument that is both a
covered position and a trading position,
as those terms are respectively defined:
(i) In the case of a banking entity that
is a bank holding company, savings and
loan holding company, or insured
depository institution, under the market
risk capital rule that is applicable to the
banking entity; and
(ii) In the case of a banking entity that
is affiliated with a bank holding
company or savings and loan holding
company, other than a banking entity to
which a market risk capital rule is
applicable, under the market risk capital
rule that is applicable to the affiliated
bank holding company or savings and
loan holding company.
(11) Market risk capital rule means
the market risk capital rule that is
contained in subpart F of 12 CFR part
3, 12 CFR parts 208 and 225, or 12 CFR
part 324, as applicable.
(12) Municipal security means a
security that is a direct obligation of or
issued by, or an obligation guaranteed as
to principal or interest by, a State or any
political subdivision thereof, or any
agency or instrumentality of a State or
any political subdivision thereof, or any
municipal corporate instrumentality of
one or more States or political
subdivisions thereof.
(13) Trading desk means the smallest
discrete unit of organization of a
banking entity that purchases or sells
financial instruments for the trading
account of the banking entity or an
affiliate thereof.
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§ 255.4 Permitted underwriting and market
making-related activities.
(a) Underwriting activities—(1)
Permitted underwriting activities. The
prohibition contained in § 255.3(a) does
not apply to a banking entity’s
underwriting activities conducted in
accordance with this paragraph (a).
(2) Requirements. The underwriting
activities of a banking entity are
permitted under paragraph (a)(1) of this
section only if:
(i) The banking entity is acting as an
underwriter for a distribution of
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securities and the trading desk’s
underwriting position is related to such
distribution;
(ii) The amount and type of the
securities in the trading desk’s
underwriting position are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, and reasonable efforts
are made to sell or otherwise reduce the
underwriting position within a
reasonable period, taking into account
the liquidity, maturity, and depth of the
market for the relevant type of security;
(iii) The banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (a)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The products, instruments or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
(B) Limits for each trading desk, based
on the nature and amount of the trading
desk’s underwriting activities, including
the reasonably expected near term
demands of clients, customers, or
counterparties, on the:
(1) Amount, types, and risk of its
underwriting position;
(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held;
(C) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
(D) Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;
(iv) The compensation arrangements
of persons performing the activities
described in this paragraph (a) are
designed not to reward or incentivize
prohibited proprietary trading; and
(v) The banking entity is licensed or
registered to engage in the activity
described in this paragraph (a) in
accordance with applicable law.
(3) Definition of distribution. For
purposes of this paragraph (a), a
distribution of securities means:
(i) An offering of securities, whether
or not subject to registration under the
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Securities Act of 1933, that is
distinguished from ordinary trading
transactions by the presence of special
selling efforts and selling methods; or
(ii) An offering of securities made
pursuant to an effective registration
statement under the Securities Act of
1933.
(4) Definition of underwriter. For
purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an
issuer or selling security holder to:
(A) Purchase securities from the
issuer or selling security holder for
distribution;
(B) Engage in a distribution of
securities for or on behalf of the issuer
or selling security holder; or
(C) Manage a distribution of securities
for or on behalf of the issuer or selling
security holder; or
(ii) A person who has agreed to
participate or is participating in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.
(5) Definition of selling security
holder. For purposes of this paragraph
(a), selling security holder means any
person, other than an issuer, on whose
behalf a distribution is made.
(6) Definition of underwriting
position. For purposes of this paragraph
(a), underwriting position means the
long or short positions in one or more
securities held by a banking entity or its
affiliate, and managed by a particular
trading desk, in connection with a
particular distribution of securities for
which such banking entity or affiliate is
acting as an underwriter.
(7) Definition of client, customer, and
counterparty. For purposes of this
paragraph (a), the terms client,
customer, and counterparty, on a
collective or individual basis, refer to
market participants that may transact
with the banking entity in connection
with a particular distribution for which
the banking entity is acting as
underwriter.
(b) Market making-related activities—
(1) Permitted market making-related
activities. The prohibition contained in
§ 255.3(a) does not apply to a banking
entity’s market making-related activities
conducted in accordance with this
paragraph (b).
(2) Requirements. The market makingrelated activities of a banking entity are
permitted under paragraph (b)(1) of this
section only if:
(i) The trading desk that establishes
and manages the financial exposure
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure and is willing and available to
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quote, purchase and sell, or otherwise
enter into long and short positions in
those types of financial instruments for
its own account, in commercially
reasonable amounts and throughout
market cycles on a basis appropriate for
the liquidity, maturity, and depth of the
market for the relevant types of financial
instruments;
(ii) The amount, types, and risks of
the financial instruments in the trading
desk’s market-maker inventory are
designed not to exceed, on an ongoing
basis, the reasonably expected near term
demands of clients, customers, or
counterparties, based on:
(A) The liquidity, maturity, and depth
of the market for the relevant types of
financial instrument(s); and
(B) Demonstrable analysis of
historical customer demand, current
inventory of financial instruments, and
market and other factors regarding the
amount, types, and risks, of or
associated with financial instruments in
which the trading desk makes a market,
including through block trades;
(iii) The banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (b)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The financial instruments each
trading desk stands ready to purchase
and sell in accordance with paragraph
(b)(2)(i) of this section;
(B) The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the limits
required under paragraph (b)(2)(iii)(C) of
this section; the products, instruments,
and exposures each trading desk may
use for risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and
inventory; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
desk to mitigate these risks are and
continue to be effective;
(C) Limits for each trading desk, based
on the nature and amount of the trading
desk’s market making-related activities,
that address the factors prescribed by
paragraph (b)(2)(ii) of this section, on:
(1) The amount, types, and risks of its
market-maker inventory;
(2) The amount, types, and risks of the
products, instruments, and exposures
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the trading desk may use for risk
management purposes;
(3) The level of exposures to relevant
risk factors arising from its financial
exposure; and
(4) The period of time a financial
instrument may be held;
(D) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
(E) Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis that the
basis for any temporary or permanent
increase to a trading desk’s limit(s) is
consistent with the requirements of this
paragraph (b), and independent review
of such demonstrable analysis and
approval;
(iv) To the extent that any limit
identified pursuant to paragraph
(b)(2)(iii)(C) of this section is exceeded,
the trading desk takes action to bring the
trading desk into compliance with the
limits as promptly as possible after the
limit is exceeded;
(v) The compensation arrangements of
persons performing the activities
described in this paragraph (b) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in activity
described in this paragraph (b) in
accordance with applicable law.
(3) Definition of client, customer, and
counterparty. For purposes of paragraph
(b) of this section, the terms client,
customer, and counterparty, on a
collective or individual basis refer to
market participants that make use of the
banking entity’s market making-related
services by obtaining such services,
responding to quotations, or entering
into a continuing relationship with
respect to such services, provided that:
(i) A trading desk or other
organizational unit of another banking
entity is not a client, customer, or
counterparty of the trading desk if that
other entity has trading assets and
liabilities of $50 billion or more as
measured in accordance with
§ 255.20(d)(1) of subpart D, unless:
(A) The trading desk documents how
and why a particular trading desk or
other organizational unit of the entity
should be treated as a client, customer,
or counterparty of the trading desk for
purposes of paragraph (b)(2) of this
section; or
(B) The purchase or sale by the
trading desk is conducted anonymously
on an exchange or similar trading
facility that permits trading on behalf of
a broad range of market participants.
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(4) Definition of financial exposure.
For purposes of this paragraph (b),
financial exposure means the aggregate
risks of one or more financial
instruments and any associated loans,
commodities, or foreign exchange or
currency, held by a banking entity or its
affiliate and managed by a particular
trading desk as part of the trading desk’s
market making-related activities.
(5) Definition of market-maker
inventory. For the purposes of this
paragraph (b), market-maker inventory
means all of the positions in the
financial instruments for which the
trading desk stands ready to make a
market in accordance with paragraph
(b)(2)(i) of this section, that are managed
by the trading desk, including the
trading desk’s open positions or
exposures arising from open
transactions.
§ 255.5 Permitted risk-mitigating hedging
activities.
(a) Permitted risk-mitigating hedging
activities. The prohibition contained in
§ 255.3(a) does not apply to the riskmitigating hedging activities of a
banking entity in connection with and
related to individual or aggregated
positions, contracts, or other holdings of
the banking entity and designed to
reduce the specific risks to the banking
entity in connection with and related to
such positions, contracts, or other
holdings.
(b) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under paragraph (a) of this
section only if:
(1) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(i) Reasonably designed written
policies and procedures regarding the
positions, techniques and strategies that
may be used for hedging, including
documentation indicating what
positions, contracts or other holdings a
particular trading desk may use in its
risk-mitigating hedging activities, as
well as position and aging limits with
respect to such positions, contracts or
other holdings;
(ii) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(iii) The conduct of analysis,
including correlation analysis, and
independent testing designed to ensure
that the positions, techniques and
strategies that may be used for hedging
may reasonably be expected to
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demonstrably reduce or otherwise
significantly mitigate the specific,
identifiable risk(s) being hedged, and
such correlation analysis demonstrates
that the hedging activity demonstrably
reduces or otherwise significantly
mitigates the specific, identifiable risk(s)
being hedged;
(2) The risk-mitigating hedging
activity:
(i) Is conducted in accordance with
the written policies, procedures, and
internal controls required under this
section;
(ii) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks, including market risk,
counterparty or other credit risk,
currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof;
(iii) Does not give rise, at the
inception of the hedge, to any
significant new or additional risk that is
not itself hedged contemporaneously in
accordance with this section;
(iv) Is subject to continuing review,
monitoring and management by the
banking entity that:
(A) Is consistent with the written
hedging policies and procedures
required under paragraph (b)(1) of this
section;
(B) Is designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates the specific, identifiable risks
that develop over time from the riskmitigating hedging activities undertaken
under this section and the underlying
positions, contracts, and other holdings
of the banking entity, based upon the
facts and circumstances of the
underlying and hedging positions,
contracts and other holdings of the
banking entity and the risks and
liquidity thereof; and
(C) Requires ongoing recalibration of
the hedging activity by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(2) of this section and is
not prohibited proprietary trading; and
(3) The compensation arrangements of
persons performing risk-mitigating
hedging activities are designed not to
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reward or incentivize prohibited
proprietary trading.
(c) Documentation requirement—(1) A
banking entity must comply with the
requirements of paragraphs (c)(2) and
(3) of this section with respect to any
purchase or sale of financial
instruments made in reliance on this
section for risk-mitigating hedging
purposes that is:
(i) Not established by the specific
trading desk establishing or responsible
for the underlying positions, contracts,
or other holdings the risks of which the
hedging activity is designed to reduce;
(ii) Established by the specific trading
desk establishing or responsible for the
underlying positions, contracts, or other
holdings the risks of which the
purchases or sales are designed to
reduce, but that is effected through a
financial instrument, exposure,
technique, or strategy that is not
specifically identified in the trading
desk’s written policies and procedures
established under paragraph (b)(1) of
this section or under § 255.4(b)(2)(iii)(B)
of this subpart as a product, instrument,
exposure, technique, or strategy such
trading desk may use for hedging; or
(iii) Established to hedge aggregated
positions across two or more trading
desks.
(2) In connection with any purchase
or sale identified in paragraph (c)(1) of
this section, a banking entity must, at a
minimum, and contemporaneously with
the purchase or sale, document:
(i) The specific, identifiable risk(s) of
the identified positions, contracts, or
other holdings of the banking entity that
the purchase or sale is designed to
reduce;
(ii) The specific risk-mitigating
strategy that the purchase or sale is
designed to fulfill; and
(iii) The trading desk or other
business unit that is establishing and
responsible for the hedge.
(3) A banking entity must create and
retain records sufficient to demonstrate
compliance with the requirements of
this paragraph (c) for a period that is no
less than five years in a form that allows
the banking entity to promptly produce
such records to the SEC on request, or
such longer period as required under
other law or this part.
§ 255.6 Other permitted proprietary trading
activities.
(a) Permitted trading in domestic
government obligations. The prohibition
contained in § 255.3(a) does not apply to
the purchase or sale by a banking entity
of a financial instrument that is:
(1) An obligation of, or issued or
guaranteed by, the United States;
(2) An obligation, participation, or
other instrument of, or issued or
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guaranteed by, an agency of the United
States, the Government National
Mortgage Association, the Federal
National Mortgage Association, the
Federal Home Loan Mortgage
Corporation, a Federal Home Loan
Bank, the Federal Agricultural Mortgage
Corporation or a Farm Credit System
institution chartered under and subject
to the provisions of the Farm Credit Act
of 1971 (12 U.S.C. 2001 et seq.);
(3) An obligation of any State or any
political subdivision thereof, including
any municipal security; or
(4) An obligation of the FDIC, or any
entity formed by or on behalf of the
FDIC for purpose of facilitating the
disposal of assets acquired or held by
the FDIC in its corporate capacity or as
conservator or receiver under the
Federal Deposit Insurance Act or Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
(b) Permitted trading in foreign
government obligations—(1) Affiliates of
foreign banking entities in the United
States. The prohibition contained in
§ 255.3(a) does not apply to the
purchase or sale of a financial
instrument that is an obligation of, or
issued or guaranteed by, a foreign
sovereign (including any multinational
central bank of which the foreign
sovereign is a member), or any agency
or political subdivision of such foreign
sovereign, by a banking entity, so long
as:
(i) The banking entity is organized
under or is directly or indirectly
controlled by a banking entity that is
organized under the laws of a foreign
sovereign and is not directly or
indirectly controlled by a top-tier
banking entity that is organized under
the laws of the United States;
(ii) The financial instrument is an
obligation of, or issued or guaranteed
by, the foreign sovereign under the laws
of which the foreign banking entity
referred to in paragraph (b)(1)(i) of this
section is organized (including any
multinational central bank of which the
foreign sovereign is a member), or any
agency or political subdivision of that
foreign sovereign; and
(iii) The purchase or sale as principal
is not made by an insured depository
institution.
(2) Foreign affiliates of a U.S. banking
entity. The prohibition contained in
§ 255.3(a) does not apply to the
purchase or sale of a financial
instrument that is an obligation of, or
issued or guaranteed by, a foreign
sovereign (including any multinational
central bank of which the foreign
sovereign is a member), or any agency
or political subdivision of that foreign
sovereign, by a foreign entity that is
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owned or controlled by a banking entity
organized or established under the laws
of the United States or any State, so long
as:
(i) The foreign entity is a foreign bank,
as defined in section 211.2(j) of the
Board’s Regulation K (12 CFR 211.2(j)),
or is regulated by the foreign sovereign
as a securities dealer;
(ii) The financial instrument is an
obligation of, or issued or guaranteed
by, the foreign sovereign under the laws
of which the foreign entity is organized
(including any multinational central
bank of which the foreign sovereign is
a member), or any agency or political
subdivision of that foreign sovereign;
and
(iii) The financial instrument is
owned by the foreign entity and is not
financed by an affiliate that is located in
the United States or organized under the
laws of the United States or of any State.
(c) Permitted trading on behalf of
customers—(1) Fiduciary transactions.
The prohibition contained in § 255.3(a)
does not apply to the purchase or sale
of financial instruments by a banking
entity acting as trustee or in a similar
fiduciary capacity, so long as:
(i) The transaction is conducted for
the account of, or on behalf of, a
customer; and
(ii) The banking entity does not have
or retain beneficial ownership of the
financial instruments.
(2) Riskless principal transactions.
The prohibition contained in § 255.3(a)
does not apply to the purchase or sale
of financial instruments by a banking
entity acting as riskless principal in a
transaction in which the banking entity,
after receiving an order to purchase (or
sell) a financial instrument from a
customer, purchases (or sells) the
financial instrument for its own account
to offset a contemporaneous sale to (or
purchase from) the customer.
(d) Permitted trading by a regulated
insurance company. The prohibition
contained in § 255.3(a) does not apply to
the purchase or sale of financial
instruments by a banking entity that is
an insurance company or an affiliate of
an insurance company if:
(1) The insurance company or its
affiliate purchases or sells the financial
instruments solely for:
(i) The general account of the
insurance company; or
(ii) A separate account established by
the insurance company;
(2) The purchase or sale is conducted
in compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
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(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (d)(2) of this
section is insufficient to protect the
safety and soundness of the covered
banking entity, or the financial stability
of the United States.
(e) Permitted trading activities of
foreign banking entities. (1) The
prohibition contained in § 255.3(a) does
not apply to the purchase or sale of
financial instruments by a banking
entity if:
(i) The banking entity is not organized
or directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of any
State;
(ii) The purchase or sale by the
banking entity is made pursuant to
paragraph (9) or (13) of section 4(c) of
the BHC Act; and
(iii) The purchase or sale meets the
requirements of paragraph (e)(3) of this
section.
(2) A purchase or sale of financial
instruments by a banking entity is made
pursuant to paragraph (9) or (13) of
section 4(c) of the BHC Act for purposes
of paragraph (e)(1)(ii) of this section
only if:
(i) The purchase or sale is conducted
in accordance with the requirements of
paragraph (e) of this section; and
(ii)(A) With respect to a banking
entity that is a foreign banking
organization, the banking entity meets
the qualifying foreign banking
organization requirements of section
211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c) or
(e)), as applicable; or
(B) With respect to a banking entity
that is not a foreign banking
organization, the banking entity is not
organized under the laws of the United
States or of any State and the banking
entity, on a fully-consolidated basis,
meets at least two of the following
requirements:
(1) Total assets of the banking entity
held outside of the United States exceed
total assets of the banking entity held in
the United States;
(2) Total revenues derived from the
business of the banking entity outside of
the United States exceed total revenues
derived from the business of the
banking entity in the United States; or
(3) Total net income derived from the
business of the banking entity outside of
the United States exceeds total net
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income derived from the business of the
banking entity in the United States.
(3) A purchase or sale by a banking
entity is permitted for purposes of this
paragraph (e) if:
(i) The banking entity engaging as
principal in the purchase or sale
(including any personnel of the banking
entity or its affiliate that arrange,
negotiate or execute such purchase or
sale) is not located in the United States
or organized under the laws of the
United States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State;
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State;
(iv) No financing for the banking
entity’s purchases or sales is provided,
directly or indirectly, by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
(v) The purchase or sale is not
conducted with or through any U.S.
entity, other than:
(A) A purchase or sale with the
foreign operations of a U.S. entity if no
personnel of such U.S. entity that are
located in the United States are
involved in the arrangement,
negotiation, or execution of such
purchase or sale;
(B) A purchase or sale with an
unaffiliated market intermediary acting
as principal, provided the purchase or
sale is promptly cleared and settled
through a clearing agency or derivatives
clearing organization acting as a central
counterparty; or
(C) A purchase or sale through an
unaffiliated market intermediary acting
as agent, provided the purchase or sale
is conducted anonymously on an
exchange or similar trading facility and
is promptly cleared and settled through
a clearing agency or derivatives clearing
organization acting as a central
counterparty.
(4) For purposes of this paragraph (e),
a U.S. entity is any entity that is, or is
controlled by, or is acting on behalf of,
or at the direction of, any other entity
that is, located in the United States or
organized under the laws of the United
States or of any State.
(5) For purposes of this paragraph (e),
a U.S. branch, agency, or subsidiary of
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a foreign banking entity is considered to
be located in the United States;
however, the foreign bank that operates
or controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(6) For purposes of this paragraph (e),
unaffiliated market intermediary means
an unaffiliated entity, acting as an
intermediary, that is:
(i) A broker or dealer registered with
the SEC under section 15 of the
Exchange Act or exempt from
registration or excluded from regulation
as such;
(ii) A swap dealer registered with the
CFTC under section 4s of the
Commodity Exchange Act or exempt
from registration or excluded from
regulation as such;
(iii) A security-based swap dealer
registered with the SEC under section
15F of the Exchange Act or exempt from
registration or excluded from regulation
as such; or
(iv) A futures commission merchant
registered with the CFTC under section
4f of the Commodity Exchange Act or
exempt from registration or excluded
from regulation as such.
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§ 255.7 Limitations on permitted
proprietary trading activities.
(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ 255.4 through
255.6 if the transaction, class of
transactions, or activity would:
(1) Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
(2) Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
(3) Pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.
(b) Definition of material conflict of
interest. (1) For purposes of this section,
a material conflict of interest between a
banking entity and its clients,
customers, or counterparties exists if the
banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the banking entity’s interests being
materially adverse to the interests of its
client, customer, or counterparty with
respect to such transaction, class of
transactions, or activity, and the
banking entity has not taken at least one
of the actions in paragraph (b)(2) of this
section.
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(2) Prior to effecting the specific
transaction or class or type of
transactions, or engaging in the specific
activity, the banking entity:
(i) Timely and effective disclosure. (A)
Has made clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest; and
(B) Such disclosure is made in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
mitigate, any materially adverse effect
on the client, customer, or counterparty
created by the conflict of interest; or
(ii) Information barriers. Has
established, maintained, and enforced
information barriers that are
memorialized in written policies and
procedures, such as physical separation
of personnel, or functions, or limitations
on types of activity, that are reasonably
designed, taking into consideration the
nature of the banking entity’s business,
to prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A banking entity may not
rely on such information barriers if, in
the case of any specific transaction,
class or type of transactions or activity,
the banking entity knows or should
reasonably know that, notwithstanding
the banking entity’s establishment of
information barriers, the conflict of
interest may involve or result in a
materially adverse effect on a client,
customer, or counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
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§§ 255.8–255.9
[Reserved]
Subpart C—Covered Funds Activities
and Investments
§ 255.10 Prohibition on acquiring or
retaining an ownership interest in and
having certain relationships with a covered
fund.
(a) Prohibition. (1) Except as
otherwise provided in this subpart, a
banking entity may not, as principal,
directly or indirectly, acquire or retain
any ownership interest in or sponsor a
covered fund.
(2) Paragraph (a)(1) of this section
does not include acquiring or retaining
an ownership interest in a covered fund
by a banking entity:
(i) Acting solely as agent, broker, or
custodian, so long as;
(A) The activity is conducted for the
account of, or on behalf of, a customer;
and
(B) The banking entity and its
affiliates do not have or retain beneficial
ownership of such ownership interest;
(ii) Through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity (or an affiliate
thereof) that is established and
administered in accordance with the
law of the United States or a foreign
sovereign, if the ownership interest is
held or controlled directly or indirectly
by the banking entity as trustee for the
benefit of persons who are or were
employees of the banking entity (or an
affiliate thereof);
(iii) In the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the ownership interest as
soon as practicable, and in no event may
the banking entity retain such
ownership interest for longer than such
period permitted by the SEC; or
(iv) On behalf of customers as trustee
or in a similar fiduciary capacity for a
customer that is not a covered fund, so
long as:
(A) The activity is conducted for the
account of, or on behalf of, the
customer; and
(B) The banking entity and its
affiliates do not have or retain beneficial
ownership of such ownership interest.
(b) Definition of covered fund. (1)
Except as provided in paragraph (c) of
this section, covered fund means:
(i) An issuer that would be an
investment company, as defined in the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.), but for section
3(c)(1) or 3(c)(7) of that Act (15 U.S.C.
80a–3(c)(1) or (7));
(ii) Any commodity pool under
section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10)) for
which:
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(A) The commodity pool operator has
claimed an exemption under 17 CFR
4.7; or
(B)(1) A commodity pool operator is
registered with the CFTC as a
commodity pool operator in connection
with the operation of the commodity
pool;
(2) Substantially all participation
units of the commodity pool are owned
by qualified eligible persons under 17
CFR 4.7(a)(2) and (3); and
(3) Participation units of the
commodity pool have not been publicly
offered to persons who are not qualified
eligible persons under 17 CFR 4.7(a)(2)
and (3); or
(iii) For any banking entity that is, or
is controlled directly or indirectly by a
banking entity that is, located in or
organized under the laws of the United
States or of any State, an entity that:
(A) Is organized or established outside
the United States and the ownership
interests of which are offered and sold
solely outside the United States;
(B) Is, or holds itself out as being, an
entity or arrangement that raises money
from investors primarily for the purpose
of investing in securities for resale or
other disposition or otherwise trading in
securities; and
(C)(1) Has as its sponsor that banking
entity (or an affiliate thereof); or
(2) Has issued an ownership interest
that is owned directly or indirectly by
that banking entity (or an affiliate
thereof).
(2) An issuer shall not be deemed to
be a covered fund under paragraph
(b)(1)(iii) of this section if, were the
issuer subject to U.S. securities laws, the
issuer could rely on an exclusion or
exemption from the definition of
‘‘investment company’’ under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) other than the
exclusions contained in section 3(c)(1)
and 3(c)(7) of that Act.
(3) For purposes of paragraph
(b)(1)(iii) of this section, a U.S. branch,
agency, or subsidiary of a foreign
banking entity is located in the United
States; however, the foreign bank that
operates or controls that branch, agency,
or subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(c) Notwithstanding paragraph (b) of
this section, unless the appropriate
Federal banking agencies, the SEC, and
the CFTC jointly determine otherwise, a
covered fund does not include:
(1) Foreign public funds. (i) Subject to
paragraphs (ii) and (iii) below, an issuer
that:
(A) Is organized or established outside
of the United States;
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(B) Is authorized to offer and sell
ownership interests to retail investors in
the issuer’s home jurisdiction; and
(C) Sells ownership interests
predominantly through one or more
public offerings outside of the United
States.
(ii) With respect to a banking entity
that is, or is controlled directly or
indirectly by a banking entity that is,
located in or organized under the laws
of the United States or of any State and
any issuer for which such banking
entity acts as sponsor, the sponsoring
banking entity may not rely on the
exemption in paragraph (c)(1)(i) of this
section for such issuer unless ownership
interests in the issuer are sold
predominantly to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring
banking entity or such issuer; and
(D) Directors and employees of such
entities.
(iii) For purposes of paragraph
(c)(1)(i)(C) of this section, the term
‘‘public offering’’ means a distribution
(as defined in § 255.4(a)(3) of subpart B)
of securities in any jurisdiction outside
the United States to investors, including
retail investors, provided that:
(A) The distribution complies with all
applicable requirements in the
jurisdiction in which such distribution
is being made;
(B) The distribution does not restrict
availability to investors having a
minimum level of net worth or net
investment assets; and
(C) The issuer has filed or submitted,
with the appropriate regulatory
authority in such jurisdiction, offering
disclosure documents that are publicly
available.
(2) Wholly-owned subsidiaries. An
entity, all of the outstanding ownership
interests of which are owned directly or
indirectly by the banking entity (or an
affiliate thereof), except that:
(i) Up to five percent of the entity’s
outstanding ownership interests, less
any amounts outstanding under
paragraph (c)(2)(ii) of this section, may
be held by employees or directors of the
banking entity or such affiliate
(including former employees or
directors if their ownership interest was
acquired while employed by or in the
service of the banking entity); and
(ii) Up to 0.5 percent of the entity’s
outstanding ownership interests may be
held by a third party if the ownership
interest is acquired or retained by the
third party for the purpose of
establishing corporate separateness or
addressing bankruptcy, insolvency, or
similar concerns.
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(3) Joint ventures. A joint venture
between a banking entity or any of its
affiliates and one or more unaffiliated
persons, provided that the joint venture:
(i) Is comprised of no more than 10
unaffiliated co-venturers;
(ii) Is in the business of engaging in
activities that are permissible for the
banking entity or affiliate, other than
investing in securities for resale or other
disposition; and
(iii) Is not, and does not hold itself out
as being, an entity or arrangement that
raises money from investors primarily
for the purpose of investing in securities
for resale or other disposition or
otherwise trading in securities.
(4) Acquisition vehicles. An issuer:
(i) Formed solely for the purpose of
engaging in a bona fide merger or
acquisition transaction; and
(ii) That exists only for such period as
necessary to effectuate the transaction.
(5) Foreign pension or retirement
funds. A plan, fund, or program
providing pension, retirement, or
similar benefits that is:
(i) Organized and administered
outside the United States;
(ii) A broad-based plan for employees
or citizens that is subject to regulation
as a pension, retirement, or similar plan
under the laws of the jurisdiction in
which the plan, fund, or program is
organized and administered; and
(iii) Established for the benefit of
citizens or residents of one or more
foreign sovereigns or any political
subdivision thereof.
(6) Insurance company separate
accounts. A separate account, provided
that no banking entity other than the
insurance company participates in the
account’s profits and losses.
(7) Bank owned life insurance. A
separate account that is used solely for
the purpose of allowing one or more
banking entities to purchase a life
insurance policy for which the banking
entity or entities is beneficiary,
provided that no banking entity that
purchases the policy:
(i) Controls the investment decisions
regarding the underlying assets or
holdings of the separate account; or
(ii) Participates in the profits and
losses of the separate account other than
in compliance with applicable
supervisory guidance regarding bank
owned life insurance.
(8) Loan securitizations. (i) Scope. An
issuing entity for asset-backed securities
that satisfies all the conditions of this
paragraph (c)(8) and the assets or
holdings of which are comprised solely
of:
(A) Loans as defined in § 255.2(s) of
subpart A;
(B) Rights or other assets designed to
assure the servicing or timely
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distribution of proceeds to holders of
such securities and rights or other assets
that are related or incidental to
purchasing or otherwise acquiring and
holding the loans, provided that each
asset meets the requirements of
paragraph (c)(8)(iii) of this section;
(C) Interest rate or foreign exchange
derivatives that meet the requirements
of paragraph (c)(8)(iv) of this section;
and
(D) Special units of beneficial interest
and collateral certificates that meet the
requirements of paragraph (c)(8)(v) of
this section.
(ii) Impermissible assets. For purposes
of this paragraph (c)(8), the assets or
holdings of the issuing entity shall not
include any of the following:
(A) A security, including an assetbacked security, or an interest in an
equity or debt security other than as
permitted in paragraph (c)(8)(iii) of this
section;
(B) A derivative, other than a
derivative that meets the requirements
of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities.
Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may
hold securities if those securities are:
(A) Cash equivalents for purposes of
the rights and assets in paragraph
(c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts
previously contracted with respect to
the loans supporting the asset-backed
securities.
(iv) Derivatives. The holdings of
derivatives by the issuing entity shall be
limited to interest rate or foreign
exchange derivatives that satisfy all of
the following conditions:
(A) The written terms of the
derivative directly relate to the loans,
the asset-backed securities, or the
contractual rights of other assets
described in paragraph (c)(8)(i)(B) of
this section; and
(B) The derivatives reduce the interest
rate and/or foreign exchange risks
related to the loans, the asset-backed
securities, or the contractual rights or
other assets described in paragraph
(c)(8)(i)(B) of this section.
(v) Special units of beneficial interest
and collateral certificates. The assets or
holdings of the issuing entity may
include collateral certificates and
special units of beneficial interest
issued by a special purpose vehicle,
provided that:
(A) The special purpose vehicle that
issues the special unit of beneficial
interest or collateral certificate meets
the requirements in this paragraph
(c)(8);
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(B) The special unit of beneficial
interest or collateral certificate is used
for the sole purpose of transferring to
the issuing entity for the loan
securitization the economic risks and
benefits of the assets that are
permissible for loan securitizations
under this paragraph (c)(8) and does not
directly or indirectly transfer any
interest in any other economic or
financial exposure;
(C) The special unit of beneficial
interest or collateral certificate is
created solely to satisfy legal
requirements or otherwise facilitate the
structuring of the loan securitization;
and
(D) The special purpose vehicle that
issues the special unit of beneficial
interest or collateral certificate and the
issuing entity are established under the
direction of the same entity that
initiated the loan securitization.
(9) Qualifying asset-backed
commercial paper conduits. (i) An
issuing entity for asset-backed
commercial paper that satisfies all of the
following requirements:
(A) The asset-backed commercial
paper conduit holds only:
(1) Loans and other assets permissible
for a loan securitization under
paragraph (c)(8)(i) of this section; and
(2) Asset-backed securities supported
solely by assets that are permissible for
loan securitizations under paragraph
(c)(8)(i) of this section and acquired by
the asset-backed commercial paper
conduit as part of an initial issuance
either directly from the issuing entity of
the asset-backed securities or directly
from an underwriter in the distribution
of the asset-backed securities;
(B) The asset-backed commercial
paper conduit issues only asset-backed
securities, comprised of a residual
interest and securities with a legal
maturity of 397 days or less; and
(C) A regulated liquidity provider has
entered into a legally binding
commitment to provide full and
unconditional liquidity coverage with
respect to all of the outstanding assetbacked securities issued by the assetbacked commercial paper conduit (other
than any residual interest) in the event
that funds are required to redeem
maturing asset-backed securities.
(ii) For purposes of this paragraph
(c)(9), a regulated liquidity provider
means:
(A) A depository institution, as
defined in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c));
(B) A bank holding company, as
defined in section 2(a) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1841(a)), or a subsidiary thereof;
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(C) A savings and loan holding
company, as defined in section 10a of
the Home Owners’ Loan Act (12 U.S.C.
1467a), provided all or substantially all
of the holding company’s activities are
permissible for a financial holding
company under section 4(k) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1843(k)), or a subsidiary thereof;
(D) A foreign bank whose home
country supervisor, as defined in
§ 211.21(q) of the Board’s Regulation K
(12 CFR 211.21(q)), has adopted capital
standards consistent with the Capital
Accord for the Basel Committee on
banking Supervision, as amended, and
that is subject to such standards, or a
subsidiary thereof; or
(E) The United States or a foreign
sovereign.
(10) Qualifying covered bonds—(i)
Scope. An entity owning or holding a
dynamic or fixed pool of loans or other
assets as provided in paragraph (c)(8) of
this section for the benefit of the holders
of covered bonds, provided that the
assets in the pool are comprised solely
of assets that meet the conditions in
paragraph (c)(8)(i) of this section.
(ii) Covered bond. For purposes of this
paragraph (c)(10), a covered bond
means:
(A) A debt obligation issued by an
entity that meets the definition of
foreign banking organization, the
payment obligations of which are fully
and unconditionally guaranteed by an
entity that meets the conditions set forth
in paragraph (c)(10)(i) of this section; or
(B) A debt obligation of an entity that
meets the conditions set forth in
paragraph (c)(10)(i) of this section,
provided that the payment obligations
are fully and unconditionally
guaranteed by an entity that meets the
definition of foreign banking
organization and the entity is a whollyowned subsidiary, as defined in
paragraph (c)(2) of this section, of such
foreign banking organization.
(11) SBICs and public welfare
investment funds. An issuer:
(i) That is a small business investment
company, as defined in section 103(3) of
the Small Business Investment Act of
1958 (15 U.S.C. 662), or that has
received from the Small Business
Administration notice to proceed to
qualify for a license as a small business
investment company, which notice or
license has not been revoked; or
(ii) The business of which is to make
investments that are:
(A) Designed primarily to promote the
public welfare, of the type permitted
under paragraph (11) of section 5136 of
the Revised Statutes of the United States
(12 U.S.C. 24), including the welfare of
low- and moderate-income communities
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or families (such as providing housing,
services, or jobs); or
(B) Qualified rehabilitation
expenditures with respect to a qualified
rehabilitated building or certified
historic structure, as such terms are
defined in section 47 of the Internal
Revenue Code of 1986 or a similar State
historic tax credit program.
(12) Registered investment companies
and excluded entities. An issuer:
(i) That is registered as an investment
company under section 8 of the
Investment Company Act of 1940 (15
U.S.C. 80a–8), or that is formed and
operated pursuant to a written plan to
become a registered investment
company as described in § 255.20(e)(3)
of subpart D and that complies with the
requirements of section 18 of the
Investment Company Act of 1940 (15
U.S.C. 80a–18);
(ii) That may rely on an exclusion or
exemption from the definition of
‘‘investment company’’ under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) other than the
exclusions contained in section 3(c)(1)
and 3(c)(7) of that Act; or
(iii) That has elected to be regulated
as a business development company
pursuant to section 54(a) of that Act (15
U.S.C. 80a–53) and has not withdrawn
its election, or that is formed and
operated pursuant to a written plan to
become a business development
company as described in § 255.20(e)(3)
of subpart D and that complies with the
requirements of section 61 of the
Investment Company Act of 1940 (15
U.S.C. 80a–60).
(13) Issuers in conjunction with the
FDIC’s receivership or conservatorship
operations. An issuer that is an entity
formed by or on behalf of the FDIC for
the purpose of facilitating the disposal
of assets acquired in the FDIC’s capacity
as conservator or receiver under the
Federal Deposit Insurance Act or Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
(14) Other excluded issuers. (i) Any
issuer that the appropriate Federal
banking agencies, the SEC, and the
CFTC jointly determine the exclusion of
which is consistent with the purposes of
section 13 of the BHC Act.
(ii) A determination made under
paragraph (c)(14)(i) of this section will
be promptly made public.
(d) Definition of other terms related to
covered funds. For purposes of this
subpart:
(1) Applicable accounting standards
means U.S. generally accepted
accounting principles, or such other
accounting standards applicable to a
banking entity that the SEC determines
are appropriate and that the banking
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entity uses in the ordinary course of its
business in preparing its consolidated
financial statements.
(2) Asset-backed security has the
meaning specified in Section 3(a)(79) of
the Exchange Act (15 U.S.C. 78c(a)(79)).
(3) Director has the same meaning as
provided in section 215.2(d)(1) of the
Board’s Regulation O (12 CFR
215.2(d)(1)).
(4) Issuer has the same meaning as in
section 2(a)(22) of the Investment
Company Act of 1940 (15 U.S.C. 80a–
2(a)(22)).
(5) Issuing entity means with respect
to asset-backed securities the special
purpose vehicle that owns or holds the
pool assets underlying asset-backed
securities and in whose name the assetbacked securities supported or serviced
by the pool assets are issued.
(6) Ownership interest—(i) Ownership
interest means any equity, partnership,
or other similar interest. An ‘‘other
similar interest’’ means an interest that:
(A) Has the right to participate in the
selection or removal of a general
partner, managing member, member of
the board of directors or trustees,
investment manager, investment
adviser, or commodity trading advisor
of the covered fund (excluding the
rights of a creditor to exercise remedies
upon the occurrence of an event of
default or an acceleration event);
(B) Has the right under the terms of
the interest to receive a share of the
income, gains or profits of the covered
fund;
(C) Has the right to receive the
underlying assets of the covered fund
after all other interests have been
redeemed and/or paid in full (excluding
the rights of a creditor to exercise
remedies upon the occurrence of an
event of default or an acceleration
event);
(D) Has the right to receive all or a
portion of excess spread (the positive
difference, if any, between the aggregate
interest payments received from the
underlying assets of the covered fund
and the aggregate interest paid to the
holders of other outstanding interests);
(E) Provides under the terms of the
interest that the amounts payable by the
covered fund with respect to the interest
could be reduced based on losses arising
from the underlying assets of the
covered fund, such as allocation of
losses, write-downs or charge-offs of the
outstanding principal balance, or
reductions in the amount of interest due
and payable on the interest;
(F) Receives income on a pass-through
basis from the covered fund, or has a
rate of return that is determined by
reference to the performance of the
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underlying assets of the covered fund;
or
(G) Any synthetic right to have,
receive, or be allocated any of the rights
in paragraphs (d)(6)(i)(A) through (F) of
this section.
(ii) Ownership interest does not
include: Restricted profit interest. An
interest held by an entity (or an
employee or former employee thereof)
in a covered fund for which the entity
(or employee thereof) serves as
investment manager, investment
adviser, commodity trading advisor, or
other service provider so long as:
(A) The sole purpose and effect of the
interest is to allow the entity (or
employee or former employee thereof)
to share in the profits of the covered
fund as performance compensation for
the investment management, investment
advisory, commodity trading advisory,
or other services provided to the
covered fund by the entity (or employee
or former employee thereof), provided
that the entity (or employee or former
employee thereof) may be obligated
under the terms of such interest to
return profits previously received;
(B) All such profit, once allocated, is
distributed to the entity (or employee or
former employee thereof) promptly after
being earned or, if not so distributed, is
retained by the covered fund for the sole
purpose of establishing a reserve
amount to satisfy contractual obligations
with respect to subsequent losses of the
covered fund and such undistributed
profit of the entity (or employee or
former employee thereof) does not share
in the subsequent investment gains of
the covered fund;
(C) Any amounts invested in the
covered fund, including any amounts
paid by the entity (or employee or
former employee thereof) in connection
with obtaining the restricted profit
interest, are within the limits of § 255.12
of this subpart; and
(D) The interest is not transferable by
the entity (or employee or former
employee thereof) except to an affiliate
thereof (or an employee of the banking
entity or affiliate), to immediate family
members, or through the intestacy, of
the employee or former employee, or in
connection with a sale of the business
that gave rise to the restricted profit
interest by the entity (or employee or
former employee thereof) to an
unaffiliated party that provides
investment management, investment
advisory, commodity trading advisory,
or other services to the fund.
(7) Prime brokerage transaction means
any transaction that would be a covered
transaction, as defined in section
23A(b)(7) of the Federal Reserve Act (12
U.S.C. 371c(b)(7)), that is provided in
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connection with custody, clearance and
settlement, securities borrowing or
lending services, trade execution,
financing, or data, operational, and
administrative support.
(8) Resident of the United States
means a person that is a ‘‘U.S. person’’
as defined in rule 902(k) of the SEC’s
Regulation S (17 CFR 230.902(k)).
(9) Sponsor means, with respect to a
covered fund:
(i) To serve as a general partner,
managing member, or trustee of a
covered fund, or to serve as a
commodity pool operator with respect
to a covered fund as defined in (b)(1)(ii)
of this section;
(ii) In any manner to select or to
control (or to have employees, officers,
or directors, or agents who constitute) a
majority of the directors, trustees, or
management of a covered fund; or
(iii) To share with a covered fund, for
corporate, marketing, promotional, or
other purposes, the same name or a
variation of the same name, except as
permitted under § 255.11(a)(6).
(10) Trustee. (i) For purposes of
paragraph (d)(9) of this section and
§ 255.11 of subpart C, a trustee does not
include:
(A) A trustee that does not exercise
investment discretion with respect to a
covered fund, including a trustee that is
subject to the direction of an
unaffiliated named fiduciary who is not
a trustee pursuant to section 403(a)(1) of
the Employee’s Retirement Income
Security Act (29 U.S.C. 1103(a)(1)); or
(B) A trustee that is subject to
fiduciary standards imposed under
foreign law that are substantially
equivalent to those described in
paragraph (d)(10)(i)(A) of this section;
(ii) Any entity that directs a person
described in paragraph (d)(10)(i) of this
section, or that possesses authority and
discretion to manage and control the
investment decisions of a covered fund
for which such person serves as trustee,
shall be considered to be a trustee of
such covered fund.
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§ 255.11 Permitted organizing and
offering, underwriting, and market making
with respect to a covered fund.
(a) Organizing and offering a covered
fund in general. Notwithstanding
§ 255.10(a) of this subpart, a banking
entity is not prohibited from acquiring
or retaining an ownership interest in, or
acting as sponsor to, a covered fund in
connection with, directly or indirectly,
organizing and offering a covered fund,
including serving as a general partner,
managing member, trustee, or
commodity pool operator of the covered
fund and in any manner selecting or
controlling (or having employees,
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officers, directors, or agents who
constitute) a majority of the directors,
trustees, or management of the covered
fund, including any necessary expenses
for the foregoing, only if:
(1) The banking entity (or an affiliate
thereof) provides bona fide trust,
fiduciary, investment advisory, or
commodity trading advisory services;
(2) The covered fund is organized and
offered only in connection with the
provision of bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services and only to
persons that are customers of such
services of the banking entity (or an
affiliate thereof), pursuant to a written
plan or similar documentation outlining
how the banking entity or such affiliate
intends to provide advisory or similar
services to its customers through
organizing and offering such fund;
(3) The banking entity and its
affiliates do not acquire or retain an
ownership interest in the covered fund
except as permitted under § 255.12 of
this subpart;
(4) The banking entity and its
affiliates comply with the requirements
of § 255.14 of this subpart;
(5) The banking entity and its
affiliates do not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests;
(6) The covered fund, for corporate,
marketing, promotional, or other
purposes:
(i) Does not share the same name or
a variation of the same name with the
banking entity (or an affiliate thereof)
except that a covered fund may share
the same name or a variation of the
same name with a banking entity that is
an investment adviser to the covered
fund if:
(A) The investment adviser is not an
insured depository institution, a
company that controls an insured
depository institution, or a company
that is treated as a bank holding
company for purposes of section 8 of the
International Banking Act of 1978 (12
U.S.C. 3106); and
(B) The investment adviser does not
share the same name or a variation of
the same name as an insured depository
institution, a company that controls an
insured depository institution, or a
company that is treated as a bank
holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(ii) Does not use the word ‘‘bank’’ in
its name;
(7) No director or employee of the
banking entity (or an affiliate thereof)
takes or retains an ownership interest in
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the covered fund, except for any
director or employee of the banking
entity or such affiliate who is directly
engaged in providing investment
advisory, commodity trading advisory,
or other services to the covered fund at
the time the director or employee takes
the ownership interest; and
(8) The banking entity:
(i) Clearly and conspicuously
discloses, in writing, to any prospective
and actual investor in the covered fund
(such as through disclosure in the
covered fund’s offering documents):
(A) That ‘‘any losses in [such covered
fund] will be borne solely by investors
in [the covered fund] and not by [the
banking entity] or its affiliates;
therefore, [the banking entity’s] losses in
[such covered fund] will be limited to
losses attributable to the ownership
interests in the covered fund held by
[the banking entity] and any affiliate in
its capacity as investor in the [covered
fund] or as beneficiary of a restricted
profit interest held by [the banking
entity] or any affiliate’’;
(B) That such investor should read the
fund offering documents before
investing in the covered fund;
(C) That the ‘‘ownership interests in
the covered fund are not insured by the
FDIC, and are not deposits, obligations
of, or endorsed or guaranteed in any
way, by any banking entity’’ (unless that
happens to be the case); and
(D) The role of the banking entity and
its affiliates and employees in
sponsoring or providing any services to
the covered fund; and
(ii) Complies with any additional
rules of the appropriate Federal banking
agencies, the SEC, or the CFTC, as
provided in section 13(b)(2) of the BHC
Act, designed to ensure that losses in
such covered fund are borne solely by
investors in the covered fund and not by
the covered banking entity and its
affiliates.
(b) Organizing and offering an issuing
entity of asset-backed securities. (1)
Notwithstanding § 255.10(a) of this
subpart, a banking entity is not
prohibited from acquiring or retaining
an ownership interest in, or acting as
sponsor to, a covered fund that is an
issuing entity of asset-backed securities
in connection with, directly or
indirectly, organizing and offering that
issuing entity, so long as the banking
entity and its affiliates comply with all
of the requirements of paragraph (a)(3)
through (8) of this section.
(2) For purposes of this paragraph (b),
organizing and offering a covered fund
that is an issuing entity of asset-backed
securities means acting as the
securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act
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(15 U.S.C. 78o–11(a)(3)) of the issuing
entity, or acquiring or retaining an
ownership interest in the issuing entity
as required by section 15G of that Act
(15 U.S.C.78o–11) and the
implementing regulations issued
thereunder.
(c) Underwriting and market making
in ownership interests of a covered
fund. The prohibition contained in
§ 255.10(a) of this subpart does not
apply to a banking entity’s underwriting
activities or market making-related
activities involving a covered fund so
long as:
(1) Those activities are conducted in
accordance with the requirements of
§ 255.4(a) or § 255.4(b) of subpart B,
respectively;
(2) With respect to any banking entity
(or any affiliate thereof) that: Acts as a
sponsor, investment adviser or
commodity trading advisor to a
particular covered fund or otherwise
acquires and retains an ownership
interest in such covered fund in reliance
on paragraph (a) of this section; acquires
and retains an ownership interest in
such covered fund and is either a
securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)), or is acquiring
and retaining an ownership interest in
such covered fund in compliance with
section 15G of that Act (15 U.S.C.78o–
11) and the implementing regulations
issued thereunder each as permitted by
paragraph (b) of this section; or, directly
or indirectly, guarantees, assumes, or
otherwise insures the obligations or
performance of the covered fund or of
any covered fund in which such fund
invests, then in each such case any
ownership interests acquired or retained
by the banking entity and its affiliates in
connection with underwriting and
market making related activities for that
particular covered fund are included in
the calculation of ownership interests
permitted to be held by the banking
entity and its affiliates under the
limitations of § 255.12(a)(2)(ii) and
§ 255.12(d) of this subpart; and
(3) With respect to any banking entity,
the aggregate value of all ownership
interests of the banking entity and its
affiliates in all covered funds acquired
and retained under § 255.11 of this
subpart, including all covered funds in
which the banking entity holds an
ownership interest in connection with
underwriting and market making related
activities permitted under this
paragraph (c), are included in the
calculation of all ownership interests
under § 255.12(a)(2)(iii) and § 255.12(d)
of this subpart.
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§ 255.12 Permitted investment in a
covered fund.
(a) Authority and limitations on
permitted investments in covered funds.
(1) Notwithstanding the prohibition
contained in § 255.10(a) of this subpart,
a banking entity may acquire and retain
an ownership interest in a covered fund
that the banking entity or an affiliate
thereof organizes and offers pursuant to
§ 255.11, for the purposes of:
(i) Establishment. Establishing the
fund and providing the fund with
sufficient initial equity for investment to
permit the fund to attract unaffiliated
investors, subject to the limits contained
in paragraphs (a)(2)(i) and (iii) of this
section; or
(ii) De minimis investment. Making
and retaining an investment in the
covered fund subject to the limits
contained in paragraphs (a)(2)(ii) and
(iii) of this section.
(2) Investment limits—(i) Seeding
period. With respect to an investment in
any covered fund made or held
pursuant to paragraph (a)(1)(i) of this
section, the banking entity and its
affiliates:
(A) Must actively seek unaffiliated
investors to reduce, through
redemption, sale, dilution, or other
methods, the aggregate amount of all
ownership interests of the banking
entity in the covered fund to the amount
permitted in paragraph (a)(2)(i)(B) of
this section; and
(B) Must, no later than 1 year after the
date of establishment of the fund (or
such longer period as may be provided
by the Board pursuant to paragraph (e)
of this section), conform its ownership
interest in the covered fund to the limits
in paragraph (a)(2)(ii) of this section;
(ii) Per-fund limits. (A) Except as
provided in paragraph (a)(2)(ii)(B) of
this section, an investment by a banking
entity and its affiliates in any covered
fund made or held pursuant to
paragraph (a)(1)(ii) of this section may
not exceed 3 percent of the total number
or value of the outstanding ownership
interests of the fund.
(B) An investment by a banking entity
and its affiliates in a covered fund that
is an issuing entity of asset-backed
securities may not exceed 3 percent of
the total fair market value of the
ownership interests of the fund
measured in accordance with paragraph
(b)(3) of this section, unless a greater
percentage is retained by the banking
entity and its affiliates in compliance
with the requirements of section 15G of
the Exchange Act (15 U.S.C. 78o–11)
and the implementing regulations
issued thereunder, in which case the
investment by the banking entity and its
affiliates in the covered fund may not
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62261
exceed the amount, number, or value of
ownership interests of the fund required
under section 15G of the Exchange Act
and the implementing regulations
issued thereunder.
(iii) Aggregate limit. The aggregate
value of all ownership interests of the
banking entity and its affiliates in all
covered funds acquired or retained
under this section may not exceed 3
percent of the tier 1 capital of the
banking entity, as provided under
paragraph (c) of this section, and shall
be calculated as of the last day of each
calendar quarter.
(iv) Date of establishment. For
purposes of this section, the date of
establishment of a covered fund shall
be:
(A) In general. The date on which the
investment adviser or similar entity to
the covered fund begins making
investments pursuant to the written
investment strategy for the fund;
(B) Issuing entities of asset-backed
securities. In the case of an issuing
entity of asset-backed securities, the
date on which the assets are initially
transferred into the issuing entity of
asset-backed securities.
(b) Rules of construction—(1)
Attribution of ownership interests to a
covered banking entity. (i) For purposes
of paragraph (a)(2) of this section, the
amount and value of a banking entity’s
permitted investment in any single
covered fund shall include any
ownership interest held under § 255ll
.12 directly by the banking entity,
including any affiliate of the banking
entity.
(ii) Treatment of registered investment
companies, SEC-regulated business
development companies and foreign
public funds. For purposes of paragraph
(b)(1)(i) of this section, a registered
investment company, SEC-regulated
business development companies or
foreign public fund as described in
§ 255ll.10(c)(1) of this subpart will
not be considered to be an affiliate of
the banking entity so long as the
banking entity:
(A) Does not own, control, or hold
with the power to vote 25 percent or
more of the voting shares of the
company or fund; and
(B) Provides investment advisory,
commodity trading advisory,
administrative, and other services to the
company or fund in compliance with
the limitations under applicable
regulation, order, or other authority.
(iii) Covered funds. For purposes of
paragraph (b)(1)(i) of this section, a
covered fund will not be considered to
be an affiliate of a banking entity so long
as the covered fund is held in
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compliance with the requirements of
this subpart.
(iv) Treatment of employee and
director investments financed by the
banking entity. For purposes of
paragraph (b)(1)(i) of this section, an
investment by a director or employee of
a banking entity who acquires an
ownership interest in his or her
personal capacity in a covered fund
sponsored by the banking entity will be
attributed to the banking entity if the
banking entity, directly or indirectly,
extends financing for the purpose of
enabling the director or employee to
acquire the ownership interest in the
fund and the financing is used to
acquire such ownership interest in the
covered fund.
(2) Calculation of permitted
ownership interests in a single covered
fund. Except as provided in paragraph
(b)(3) or (4), for purposes of determining
whether an investment in a single
covered fund complies with the
restrictions on ownership interests
under paragraphs (a)(2)(i)(B) and
(a)(2)(ii)(A) of this section:
(i) The aggregate number of the
outstanding ownership interests held by
the banking entity shall be the total
number of ownership interests held
under this section by the banking entity
in a covered fund divided by the total
number of ownership interests held by
all entities in that covered fund, as of
the last day of each calendar quarter
(both measured without regard to
committed funds not yet called for
investment);
(ii) The aggregate value of the
outstanding ownership interests held by
the banking entity shall be the aggregate
fair market value of all investments in
and capital contributions made to the
covered fund by the banking entity,
divided by the value of all investments
in and capital contributions made to
that covered fund by all entities, as of
the last day of each calendar quarter (all
measured without regard to committed
funds not yet called for investment). If
fair market value cannot be determined,
then the value shall be the historical
cost basis of all investments in and
contributions made by the banking
entity to the covered fund;
(iii) For purposes of the calculation
under paragraph (b)(2)(ii) of this section,
once a valuation methodology is chosen,
the banking entity must calculate the
value of its investment and the
investments of all others in the covered
fund in the same manner and according
to the same standards.
(3) Issuing entities of asset-backed
securities. In the case of an ownership
interest in an issuing entity of assetbacked securities, for purposes of
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determining whether an investment in a
single covered fund complies with the
restrictions on ownership interests
under paragraphs (a)(2)(i)(B) and
(a)(2)(ii)(B) of this section:
(i) For securitizations subject to the
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11), the
calculations shall be made as of the date
and according to the valuation
methodology applicable pursuant to the
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11) and
the implementing regulations issued
thereunder; or
(ii) For securitization transactions
completed prior to the compliance date
of such implementing regulations (or as
to which such implementing regulations
do not apply), the calculations shall be
made as of the date of establishment as
defined in paragraph (a)(2)(iv)(B) of this
section or such earlier date on which
the transferred assets have been valued
for purposes of transfer to the covered
fund, and thereafter only upon the date
on which additional securities of the
issuing entity of asset-backed securities
are priced for purposes of the sales of
ownership interests to unaffiliated
investors.
(iii) For securitization transactions
completed prior to the compliance date
of such implementing regulations (or as
to which such implementing regulations
do not apply), the aggregate value of the
outstanding ownership interests in the
covered fund shall be the fair market
value of the assets transferred to the
issuing entity of the securitization and
any other assets otherwise held by the
issuing entity at such time, determined
in a manner that is consistent with its
determination of the fair market value of
those assets for financial statement
purposes.
(iv) For purposes of the calculation
under paragraph (b)(3)(iii) of this
section, the valuation methodology used
to calculate the fair market value of the
ownership interests must be the same
for both the ownership interests held by
a banking entity and the ownership
interests held by all others in the
covered fund in the same manner and
according to the same standards.
(4) Multi-tier fund investments—(i)
Master-feeder fund investments. If the
principal investment strategy of a
covered fund (the ‘‘feeder fund’’) is to
invest substantially all of its assets in
another single covered fund (the
‘‘master fund’’), then for purposes of the
investment limitations in paragraphs
(a)(2)(i)(B) and (a)(2)(ii) of this section,
the banking entity’s permitted
investment in such funds shall be
measured only by reference to the value
of the master fund. The banking entity’s
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permitted investment in the master fund
shall include any investment by the
banking entity in the master fund, as
well as the banking entity’s pro-rata
share of any ownership interest of the
master fund that is held through the
feeder fund; and
(ii) Fund-of-funds investments. If a
banking entity organizes and offers a
covered fund pursuant to § 255.11 of
this subpart for the purpose of investing
in other covered funds (a ‘‘fund of
funds’’) and that fund of funds itself
invests in another covered fund that the
banking entity is permitted to own, then
the banking entity’s permitted
investment in that other fund shall
include any investment by the banking
entity in that other fund, as well as the
banking entity’s pro-rata share of any
ownership interest of the fund that is
held through the fund of funds. The
investment of the banking entity may
not represent more than 3 percent of the
amount or value of any single covered
fund.
(c) Aggregate permitted investments
in all covered funds. (1) For purposes of
paragraph (a)(2)(iii) of this section, the
aggregate value of all ownership
interests held by a banking entity shall
be the sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest in covered funds
(together with any amounts paid by the
entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § 255ll
.10(d)(6)(ii) of this subpart), on a
historical cost basis.
(2) Calculation of tier 1 capital. For
purposes of paragraph (a)(2)(iii) of this
section:
(i) Entities that are required to hold
and report tier 1 capital. If a banking
entity is required to calculate and report
tier 1 capital, the banking entity’s tier 1
capital shall be equal to the amount of
tier 1 capital of the banking entity as of
the last day of the most recent calendar
quarter, as reported to its primary
financial regulatory agency; and
(ii) If a banking entity is not required
to calculate and report tier 1 capital, the
banking entity’s tier 1 capital shall be
determined to be equal to:
(A) In the case of a banking entity that
is controlled, directly or indirectly, by a
depository institution that calculates
and reports tier 1 capital, be equal to the
amount of tier 1 capital reported by
such controlling depository institution
in the manner described in paragraph
(c)(2)(i) of this section;
(B) In the case of a banking entity that
is not controlled, directly or indirectly,
by a depository institution that
calculates and reports tier 1 capital:
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(1) Bank holding company
subsidiaries. If the banking entity is a
subsidiary of a bank holding company
or company that is treated as a bank
holding company, be equal to the
amount of tier 1 capital reported by the
top-tier affiliate of such covered banking
entity that calculates and reports tier 1
capital in the manner described in
paragraph (c)(2)(i) of this section; and
(2) Other holding companies and any
subsidiary or affiliate thereof. If the
banking entity is not a subsidiary of a
bank holding company or a company
that is treated as a bank holding
company, be equal to the total amount
of shareholders’ equity of the top-tier
affiliate within such organization as of
the last day of the most recent calendar
quarter that has ended, as determined
under applicable accounting standards.
(iii) Treatment of foreign banking
entities—(A) Foreign banking entities.
Except as provided in paragraph
(c)(2)(iii)(B) of this section, with respect
to a banking entity that is not itself, and
is not controlled directly or indirectly
by, a banking entity that is located or
organized under the laws of the United
States or of any State, the tier 1 capital
of the banking entity shall be the
consolidated tier 1 capital of the entity
as calculated under applicable home
country standards.
(B) U.S. affiliates of foreign banking
entities. With respect to a banking entity
that is located or organized under the
laws of the United States or of any State
and is controlled by a foreign banking
entity identified under paragraph
(c)(2)(iii)(A) of this section, the banking
entity’s tier 1 capital shall be as
calculated under paragraphs (c)(2)(i) or
(ii) of this section.
(d) Capital treatment for a permitted
investment in a covered fund. For
purposes of calculating compliance with
the applicable regulatory capital
requirements, a banking entity shall
deduct from the banking entity’s tier 1
capital (as determined under paragraph
(c)(2) of this section) the greater of:
(1) The sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest (together with any
amounts paid by the entity (or employee
thereof) in connection with obtaining a
restricted profit interest under § 255ll
.10(d)(6)(ii) of subpart C), on a historical
cost basis, plus any earnings received;
and
(2) The fair market value of the
banking entity’s ownership interests in
the covered fund as determined under
paragraph (b)(2)(ii) or (b)(3) of this
section (together with any amounts paid
by the entity (or employee thereof) in
connection with obtaining a restricted
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profit interest under § 255ll
.10(d)(6)(ii) of subpart C), if the banking
entity accounts for the profits (or losses)
of the fund investment in its financial
statements.
(e) Extension of time to divest an
ownership interest. (1) Upon application
by a banking entity, the Board may
extend the period under paragraph
(a)(2)(i) of this section for up to 2
additional years if the Board finds that
an extension would be consistent with
safety and soundness and not
detrimental to the public interest. An
application for extension must:
(i) Be submitted to the Board at least
90 days prior to the expiration of the
applicable time period;
(ii) Provide the reasons for
application, including information that
addresses the factors in paragraph (e)(2)
of this section; and
(iii) Explain the banking entity’s plan
for reducing the permitted investment
in a covered fund through redemption,
sale, dilution or other methods as
required in paragraph (a)(2) of this
section.
(2) Factors governing Board
determinations. In reviewing any
application under paragraph (e)(1) of
this section, the Board may consider all
the facts and circumstances related to
the permitted investment in a covered
fund, including:
(i) Whether the investment would
result, directly or indirectly, in a
material exposure by the banking entity
to high-risk assets or high-risk trading
strategies;
(ii) The contractual terms governing
the banking entity’s interest in the
covered fund;
(iii) The date on which the covered
fund is expected to have attracted
sufficient investments from investors
unaffiliated with the banking entity to
enable the banking entity to comply
with the limitations in paragraph
(a)(2)(i) of this section;
(iv) The total exposure of the covered
banking entity to the investment and the
risks that disposing of, or maintaining,
the investment in the covered fund may
pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of
divesting or disposing of the investment
within the applicable period;
(vi) Whether the investment or the
divestiture or conformance of the
investment would involve or result in a
material conflict of interest between the
banking entity and unaffiliated parties,
including clients, customers or
counterparties to which it owes a duty;
(vi) The banking entity’s prior efforts
to reduce through redemption, sale,
dilution, or other methods its ownership
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62263
interests in the covered fund, including
activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board
believes appropriate.
(3) Authority to impose restrictions on
activities or investment during any
extension period. The Board may
impose such conditions on any
extension approved under paragraph
(e)(1) of this section as the Board
determines are necessary or appropriate
to protect the safety and soundness of
the banking entity or the financial
stability of the United States, address
material conflicts of interest or other
unsound banking practices, or otherwise
further the purposes of section 13 of the
BHC Act and this part.
(4) Consultation. In the case of a
banking entity that is primarily
regulated by another Federal banking
agency, the SEC, or the CFTC, the Board
will consult with such agency prior to
acting on an application by the banking
entity for an extension under paragraph
(e)(1) of this section.
§ 255.13 Other permitted covered fund
activities and investments.
(a) Permitted risk-mitigating hedging
activities. (1) The prohibition contained
in § 255.10(a) of this subpart does not
apply with respect to an ownership
interest in a covered fund acquired or
retained by a banking entity that is
designed to demonstrably reduce or
otherwise significantly mitigate the
specific, identifiable risks to the banking
entity in connection with a
compensation arrangement with an
employee of the banking entity or an
affiliate thereof that directly provides
investment advisory, commodity trading
advisory or other services to the covered
fund.
(2) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under this paragraph (a) only
if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures; and
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(ii) The acquisition or retention of the
ownership interest:
(A) Is made in accordance with the
written policies, procedures and
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internal controls required under this
section;
(B) At the inception of the hedge, is
designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks arising in connection
with the compensation arrangement
with the employee that directly
provides investment advisory,
commodity trading advisory, or other
services to the covered fund;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged
contemporaneously in accordance with
this section; and
(D) Is subject to continuing review,
monitoring and management by the
banking entity.
(iii) The compensation arrangement
relates solely to the covered fund in
which the banking entity or any affiliate
has acquired an ownership interest
pursuant to this paragraph and such
compensation arrangement provides
that any losses incurred by the banking
entity on such ownership interest will
be offset by corresponding decreases in
amounts payable under such
compensation arrangement.
(b) Certain permitted covered fund
activities and investments outside of the
United States. (1) The prohibition
contained in § 255.10(a) of this subpart
does not apply to the acquisition or
retention of any ownership interest in,
or the sponsorship of, a covered fund by
a banking entity only if:
(i) The banking entity is not organized
or directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of one
or more States;
(ii) The activity or investment by the
banking entity is pursuant to paragraph
(9) or (13) of section 4(c) of the BHC Act;
(iii) No ownership interest in the
covered fund is offered for sale or sold
to a resident of the United States; and
(iv) The activity or investment occurs
solely outside of the United States.
(2) An activity or investment by the
banking entity is pursuant to paragraph
(9) or (13) of section 4(c) of the BHC Act
for purposes of paragraph (b)(1)(ii) of
this section only if:
(i) The activity or investment is
conducted in accordance with the
requirements of this section; and
(ii)(A) With respect to a banking
entity that is a foreign banking
organization, the banking entity meets
the qualifying foreign banking
organization requirements of section
211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c) or
(e)), as applicable; or
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(B) With respect to a banking entity
that is not a foreign banking
organization, the banking entity is not
organized under the laws of the United
States or of one or more States and the
banking entity, on a fully-consolidated
basis, meets at least two of the following
requirements:
(1) Total assets of the banking entity
held outside of the United States exceed
total assets of the banking entity held in
the United States;
(2) Total revenues derived from the
business of the banking entity outside of
the United States exceed total revenues
derived from the business of the
banking entity in the United States; or
(3) Total net income derived from the
business of the banking entity outside of
the United States exceeds total net
income derived from the business of the
banking entity in the United States.
(3) An ownership interest in a covered
fund is not offered for sale or sold to a
resident of the United States for
purposes of paragraph (b)(1)(iii) of this
section only if it is sold or has been sold
pursuant to an offering that does not
target residents of the United States.
(4) An activity or investment occurs
solely outside of the United States for
purposes of paragraph (b)(1)(iv) of this
section only if:
(i) The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
and is not controlled directly or
indirectly by, a banking entity that is
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
laws of the United States or of any State;
(iii) The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
as principal directly or indirectly on a
consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
(iv) No financing for the banking
entity’s ownership or sponsorship is
provided, directly or indirectly, by any
branch or affiliate that is located in the
United States or organized under the
laws of the United States or of any State.
(5) For purposes of this section, a U.S.
branch, agency, or subsidiary of a
foreign bank, or any subsidiary thereof,
is located in the United States; however,
a foreign bank of which that branch,
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agency, or subsidiary is a part is not
considered to be located in the United
States solely by virtue of operation of
the U.S. branch, agency, or subsidiary.
(c) Permitted covered fund interests
and activities by a regulated insurance
company. The prohibition contained in
§ 255.10(a) of this subpart does not
apply to the acquisition or retention by
an insurance company, or an affiliate
thereof, of any ownership interest in, or
the sponsorship of, a covered fund only
if:
(1) The insurance company or its
affiliate acquires and retains the
ownership interest solely for the general
account of the insurance company or for
one or more separate accounts
established by the insurance company;
(2) The acquisition and retention of
the ownership interest is conducted in
compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (c)(2) of this
section is insufficient to protect the
safety and soundness of the banking
entity, or the financial stability of the
United States.
§ 255.14 Limitations on relationships with
a covered fund.
(a) Relationships with a covered fund.
(1) Except as provided for in paragraph
(a)(2) of this section, no banking entity
that serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, that
organizes and offers a covered fund
pursuant to § 255.11 of this subpart, or
that continues to hold an ownership
interest in accordance with § 255.11(b)
of this subpart, and no affiliate of such
entity, may enter into a transaction with
the covered fund, or with any other
covered fund that is controlled by such
covered fund, that would be a covered
transaction as defined in section 23A of
the Federal Reserve Act (12 U.S.C.
371c(b)(7)), as if such banking entity
and the affiliate thereof were a member
bank and the covered fund were an
affiliate thereof.
(2) Notwithstanding paragraph (a)(1)
of this section, a banking entity may:
(i) Acquire and retain any ownership
interest in a covered fund in accordance
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with the requirements of § 255.11,
§ 255.12, or § 255.13 of this subpart; and
(ii) Enter into any prime brokerage
transaction with any covered fund in
which a covered fund managed,
sponsored, or advised by such banking
entity (or an affiliate thereof) has taken
an ownership interest, if:
(A) The banking entity is in
compliance with each of the limitations
set forth in § 255.11 of this subpart with
respect to a covered fund organized and
offered by such banking entity (or an
affiliate thereof);
(B) The chief executive officer (or
equivalent officer) of the banking entity
certifies in writing annually to the SEC
(with a duty to update the certification
if the information in the certification
materially changes) that the banking
entity does not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests; and
(C) The Board has not determined that
such transaction is inconsistent with the
safe and sound operation and condition
of the banking entity.
(b) Restrictions on transactions with
covered funds. A banking entity that
serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, or that
organizes and offers a covered fund
pursuant to § 255.11 of this subpart, or
that continues to hold an ownership
interest in accordance with § 255.11(b)
of this subpart, shall be subject to
section 23B of the Federal Reserve Act
(12 U.S.C. 371c–1), as if such banking
entity were a member bank and such
covered fund were an affiliate thereof.
(c) Restrictions on prime brokerage
transactions. A prime brokerage
transaction permitted under paragraph
(a)(2)(ii) of this section shall be subject
to section 23B of the Federal Reserve
Act (12 U.S.C. 371c–1) as if the
counterparty were an affiliate of the
banking entity.
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§ 255.15 Other limitations on permitted
covered fund activities.
(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ 255.11 through
255.13 of this subpart if the transaction,
class of transactions, or activity would:
(1) Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
(2) Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
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(3) Pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.
(b) Definition of material conflict of
interest. (1) For purposes of this section,
a material conflict of interest between a
banking entity and its clients,
customers, or counterparties exists if the
banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the banking entity’s interests being
materially adverse to the interests of its
client, customer, or counterparty with
respect to such transaction, class of
transactions, or activity, and the
banking entity has not taken at least one
of the actions in paragraph (b)(2) of this
section.
(2) Prior to effecting the specific
transaction or class or type of
transactions, or engaging in the specific
activity, the banking entity:
(i) Timely and effective disclosure. (A)
Has made clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest; and
(B) Such disclosure is made in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
mitigate, any materially adverse effect
on the client, customer, or counterparty
created by the conflict of interest; or
(ii) Information barriers. Has
established, maintained, and enforced
information barriers that are
memorialized in written policies and
procedures, such as physical separation
of personnel, or functions, or limitations
on types of activity, that are reasonably
designed, taking into consideration the
nature of the banking entity’s business,
to prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A banking entity may not
rely on such information barriers if, in
the case of any specific transaction,
class or type of transactions or activity,
the banking entity knows or should
reasonably know that, notwithstanding
the banking entity’s establishment of
information barriers, the conflict of
interest may involve or result in a
materially adverse effect on a client,
customer, or counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a banking entity, significantly
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62265
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
§ 255.16 Ownership of interests in and
sponsorship of issuers of certain
collateralized debt obligations backed by
trust-preferred securities.
(a) The prohibition contained in
§ 255.10(a)(1) does not apply to the
ownership by a banking entity of an
interest in, or sponsorship of, any issuer
if:
(1) The issuer was established, and
the interest was issued, before May 19,
2010;
(2) The banking entity reasonably
believes that the offering proceeds
received by the issuer were invested
primarily in Qualifying TruPS
Collateral; and
(3) The banking entity acquired such
interest on or before December 10, 2013
(or acquired such interest in connection
with a merger with or acquisition of a
banking entity that acquired the interest
on or before December 10, 2013).
(b) For purposes of this § 255.16,
Qualifying TruPS Collateral shall mean
any trust preferred security or
subordinated debt instrument issued
prior to May 19, 2010 by a depository
institution holding company that, as of
the end of any reporting period within
12 months immediately preceding the
issuance of such trust preferred security
or subordinated debt instrument, had
total consolidated assets of less than
$15,000,000,000 or issued prior to May
19, 2010 by a mutual holding company.
(c) Notwithstanding paragraph (a)(3)
of this section, a banking entity may act
as a market maker with respect to the
interests of an issuer described in
paragraph (a) of this section in
accordance with the applicable
provisions of §§ 255.4 and 255.11.
(d) Without limiting the applicability
of paragraph (a) of this section, the
Board, the FDIC and the OCC will make
public a non-exclusive list of issuers
that meet the requirements of paragraph
(a). A banking entity may rely on the list
published by the Board, the FDIC and
the OCC.
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§§ 255.17–255.19
[Reserved]
Subpart D—Compliance Program
Requirement; Violations
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§ 255.20 Program for compliance;
reporting.
(a) Program requirement. Each
banking entity shall develop and
provide for the continued
administration of a compliance program
reasonably designed to ensure and
monitor compliance with the
prohibitions and restrictions on
proprietary trading and covered fund
activities and investments set forth in
section 13 of the BHC Act and this part.
The terms, scope and detail of the
compliance program shall be
appropriate for the types, size, scope
and complexity of activities and
business structure of the banking entity.
(b) Contents of compliance program.
Except as provided in paragraph (f) of
this section, the compliance program
required by paragraph (a) of this section,
at a minimum, shall include:
(1) Written policies and procedures
reasonably designed to document,
describe, monitor and limit trading
activities subject to subpart B (including
those permitted under §§ 255.3 to 255.6
of subpart B), including setting,
monitoring and managing required
limits set out in § 2554 and § 2555, and
activities and investments with respect
to a covered fund subject to subpart C
(including those permitted under
§§ 255.11 through 255.14 of subpart C)
conducted by the banking entity to
ensure that all activities and
investments conducted by the banking
entity that are subject to section 13 of
the BHC Act and this part comply with
section 13 of the BHC Act and this part;
(2) A system of internal controls
reasonably designed to monitor
compliance with section 13 of the BHC
Act and this part and to prevent the
occurrence of activities or investments
that are prohibited by section 13 of the
BHC Act and this part;
(3) A management framework that
clearly delineates responsibility and
accountability for compliance with
section 13 of the BHC Act and this part
and includes appropriate management
review of trading limits, strategies,
hedging activities, investments,
incentive compensation and other
matters identified in this part or by
management as requiring attention;
(4) Independent testing and audit of
the effectiveness of the compliance
program conducted periodically by
qualified personnel of the banking
entity or by a qualified outside party;
(5) Training for trading personnel and
managers, as well as other appropriate
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personnel, to effectively implement and
enforce the compliance program; and
(6) Records sufficient to demonstrate
compliance with section 13 of the BHC
Act and this part, which a banking
entity must promptly provide to the SEC
upon request and retain for a period of
no less than 5 years or such longer
period as required by the SEC.
(c) Additional standards. In addition
to the requirements in paragraph (b) of
this section, the compliance program of
a banking entity must satisfy the
requirements and other standards
contained in Appendix B, if:
(1) The banking entity engages in
proprietary trading permitted under
subpart B and is required to comply
with the reporting requirements of
paragraph (d) of this section;
(2) The banking entity has reported
total consolidated assets as of the
previous calendar year end of $50
billion or more or, in the case of a
foreign banking entity, has total U.S.
assets as of the previous calendar year
end of $50 billion or more (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity
operating, located or organized in the
United States); or
(3) The SEC notifies the banking
entity in writing that it must satisfy the
requirements and other standards
contained in Appendix B to this part.
(d) Reporting requirements under
Appendix A to this part. (1) A banking
entity engaged in proprietary trading
activity permitted under subpart B shall
comply with the reporting requirements
described in Appendix A, if:
(i) The banking entity (other than a
foreign banking entity as provided in
paragraph (d)(1)(ii) of this section) has,
together with its affiliates and
subsidiaries, trading assets and
liabilities (excluding trading assets and
liabilities involving obligations of or
guaranteed by the United States or any
agency of the United States) the average
gross sum of which (on a worldwide
consolidated basis) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the threshold established in
paragraph (d)(2) of this section;
(ii) In the case of a foreign banking
entity, the average gross sum of the
trading assets and liabilities of the
combined U.S. operations of the foreign
banking entity (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity
operating, located or organized in the
United States and excluding trading
assets and liabilities involving
obligations of or guaranteed by the
United States or any agency of the
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United States) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the threshold established in
paragraph (d)(2) of this section; or
(iii) The SEC notifies the banking
entity in writing that it must satisfy the
reporting requirements contained in
Appendix A.
(2) The threshold for reporting under
paragraph (d)(1) of this section shall be
$50 billion beginning on June 30, 2014;
$25 billion beginning on April 30, 2016;
and $10 billion beginning on December
31, 2016.
(3) Frequency of reporting: Unless the
SEC notifies the banking entity in
writing that it must report on a different
basis, a banking entity with $50 billion
or more in trading assets and liabilities
(as calculated in accordance with
paragraph (d)(1) of this section) shall
report the information required by
Appendix A for each calendar month
within 30 days of the end of the relevant
calendar month; beginning with
information for the month of January
2015, such information shall be reported
within 10 days of the end of each
calendar month. Any other banking
entity subject to Appendix A shall
report the information required by
Appendix A for each calendar quarter
within 30 days of the end of that
calendar quarter unless the SEC notifies
the banking entity in writing that it
must report on a different basis.
(e) Additional documentation for
covered funds. Any banking entity that
has more than $10 billion in total
consolidated assets as reported on
December 31 of the previous two
calendar years shall maintain records
that include:
(1) Documentation of the exclusions
or exemptions other than sections
3(c)(1) and 3(c)(7) of the Investment
Company Act of 1940 relied on by each
fund sponsored by the banking entity
(including all subsidiaries and affiliates)
in determining that such fund is not a
covered fund;
(2) For each fund sponsored by the
banking entity (including all
subsidiaries and affiliates) for which the
banking entity relies on one or more of
the exclusions from the definition of
covered fund provided by
§§ 255.10(c)(1), 255.10(c)(5),
255.10(c)(8), 255.10(c)(9), or
255.10(c)(10) of subpart C,
documentation supporting the banking
entity’s determination that the fund is
not a covered fund pursuant to one or
more of those exclusions;
(3) For each seeding vehicle described
in § 255.10(c)(12)(i) or (iii) of subpart C
that will become a registered investment
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company or SEC-regulated business
development company, a written plan
documenting the banking entity’s
determination that the seeding vehicle
will become a registered investment
company or SEC-regulated business
development company; the period of
time during which the vehicle will
operate as a seeding vehicle; and the
banking entity’s plan to market the
vehicle to third-party investors and
convert it into a registered investment
company or SEC-regulated business
development company within the time
period specified in § 255.12(a)(2)(i)(B) of
subpart C;
(4) For any banking entity that is, or
is controlled directly or indirectly by a
banking entity that is, located in or
organized under the laws of the United
States or of any State, if the aggregate
amount of ownership interests in
foreign public funds that are described
in § 255.10(c)(1) of subpart C owned by
such banking entity (including
ownership interests owned by any
affiliate that is controlled directly or
indirectly by a banking entity that is
located in or organized under the laws
of the United States or of any State)
exceeds $50 million at the end of two
or more consecutive calendar quarters,
beginning with the next succeeding
calendar quarter, documentation of the
value of the ownership interests owned
by the banking entity (and such
affiliates) in each foreign public fund
and each jurisdiction in which any such
foreign public fund is organized,
calculated as of the end of each calendar
quarter, which documentation must
continue until the banking entity’s
aggregate amount of ownership interests
in foreign public funds is below $50
million for two consecutive calendar
quarters; and
(5) For purposes of paragraph (e)(4) of
this section, a U.S. branch, agency, or
subsidiary of a foreign banking entity is
located in the United States; however,
the foreign bank that operates or
controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(f) Simplified programs for less active
banking entities—(1) Banking entities
with no covered activities. A banking
entity that does not engage in activities
or investments pursuant to subpart B or
subpart C (other than trading activities
permitted pursuant to § 255.6(a) of
subpart B) may satisfy the requirements
of this section by establishing the
required compliance program prior to
becoming engaged in such activities or
making such investments (other than
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trading activities permitted pursuant to
§ 255.6(a) of subpart B).
(2) Banking entities with modest
activities. A banking entity with total
consolidated assets of $10 billion or less
as reported on December 31 of the
previous two calendar years that
engages in activities or investments
pursuant to subpart B or subpart C
(other than trading activities permitted
under § 255.6(a) of subpart B) may
satisfy the requirements of this section
by including in its existing compliance
policies and procedures appropriate
references to the requirements of section
13 of the BHC Act and this part and
adjustments as appropriate given the
activities, size, scope and complexity of
the banking entity.
§ 255.21 Termination of activities or
investments; penalties for violations.
(a) Any banking entity that engages in
an activity or makes an investment in
violation of section 13 of the BHC Act
or this part, or acts in a manner that
functions as an evasion of the
requirements of section 13 of the BHC
Act or this part, including through an
abuse of any activity or investment
permitted under subparts B or C, or
otherwise violates the restrictions and
requirements of section 13 of the BHC
Act or this part, shall, upon discovery,
promptly terminate the activity and, as
relevant, dispose of the investment.
(b) Whenever the SEC finds
reasonable cause to believe any banking
entity has engaged in an activity or
made an investment in violation of
section 13 of the BHC Act or this part,
or engaged in any activity or made any
investment that functions as an evasion
of the requirements of section 13 of the
BHC Act or this part, the SEC may take
any action permitted by law to enforce
compliance with section 13 of the BHC
Act and this part, including directing
the banking entity to restrict, limit, or
terminate any or all activities under this
part and dispose of any investment.
Appendix A to Part 255—Reporting and
Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and
recordkeeping requirements that certain
banking entities must satisfy in connection
with the restrictions on proprietary trading
set forth in subpart B (‘‘proprietary trading
restrictions’’). Pursuant to § 255.20(d), this
appendix generally applies to a banking
entity that, together with its affiliates and
subsidiaries, has significant trading assets
and liabilities. These entities are required to
(i) furnish periodic reports to the SEC
regarding a variety of quantitative
measurements of their covered trading
activities, which vary depending on the
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62267
scope and size of covered trading activities,
and (ii) create and maintain records
documenting the preparation and content of
these reports. The requirements of this
appendix must be incorporated into the
banking entity’s internal compliance program
under § 255.20 and Appendix B.
b. The purpose of this appendix is to assist
banking entities and the SEC in:
(i) Better understanding and evaluating the
scope, type, and profile of the banking
entity’s covered trading activities;
(ii) Monitoring the banking entity’s covered
trading activities;
(iii) Identifying covered trading activities
that warrant further review or examination
by the banking entity to verify compliance
with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading
activities of trading desks engaged in market
making-related activities subject to § 255.4(b)
are consistent with the requirements
governing permitted market making-related
activities;
(v) Evaluating whether the covered trading
activities of trading desks that are engaged in
permitted trading activity subject to §§ 255.4,
255.5, or 255.6(a)–(b) (i.e., underwriting and
market making-related related activity, riskmitigating hedging, or trading in certain
government obligations) are consistent with
the requirement that such activity not result,
directly or indirectly, in a material exposure
to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular
covered trading activities of the banking
entity, and the individual trading desks of
the banking entity, to help establish the
appropriate frequency and scope of
examination by the SEC of such activities;
and
(vii) Assessing and addressing the risks
associated with the banking entity’s covered
trading activities.
c. The quantitative measurements that
must be furnished pursuant to this appendix
are not intended to serve as a dispositive tool
for the identification of permissible or
impermissible activities.
d. In order to allow banking entities and
the Agencies to evaluate the effectiveness of
these metrics, banking entities must collect
and report these metrics for all trading desks
beginning on the dates established in
§ 255.20 of the final rule. The Agencies will
review the data collected and revise this
collection requirement as appropriate based
on a review of the data collected prior to
September 30, 2015.
e. In addition to the quantitative
measurements required in this appendix, a
banking entity may need to develop and
implement other quantitative measurements
in order to effectively monitor its covered
trading activities for compliance with section
13 of the BHC Act and this part and to have
an effective compliance program, as required
by § 255.20 and Appendix B to this part. The
effectiveness of particular quantitative
measurements may differ based on the profile
of the banking entity’s businesses in general
and, more specifically, of the particular
trading desk, including types of instruments
traded, trading activities and strategies, and
history and experience (e.g., whether the
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trading desk is an established, successful
market maker or a new entrant to a
competitive market). In all cases, banking
entities must ensure that they have robust
measures in place to identify and monitor the
risks taken in their trading activities, to
ensure that the activities are within risk
tolerances established by the banking entity,
and to monitor and examine for compliance
with the proprietary trading restrictions in
this part.
f. On an ongoing basis, banking entities
must carefully monitor, review, and evaluate
all furnished quantitative measurements, as
well as any others that they choose to utilize
in order to maintain compliance with section
13 of the BHC Act and this part. All
measurement results that indicate a
heightened risk of impermissible proprietary
trading, including with respect to otherwisepermitted activities under §§ 255.4 through
255.6(a) and (b), or that result in a material
exposure to high-risk assets or high-risk
trading strategies, must be escalated within
the banking entity for review, further
analysis, explanation to the SEC, and
remediation, where appropriate. The
quantitative measurements discussed in this
appendix should be helpful to banking
entities in identifying and managing the risks
related to their covered trading activities.
II. Definitions
The terms used in this appendix have the
same meanings as set forth in §§ 255.2 and
255.3. In addition, for purposes of this
appendix, the following definitions apply:
Calculation period means the period of
time for which a particular quantitative
measurement must be calculated.
Comprehensive profit and loss means the
net profit or loss of a trading desk’s material
sources of trading revenue over a specific
period of time, including, for example, any
increase or decrease in the market value of
a trading desk’s holdings, dividend income,
and interest income and expense.
Covered trading activity means trading
conducted by a trading desk under §§ 255.4,
255.5, 255.6(a), or 255.6(b). A banking entity
may include trading under §§ 255.3(d),
255.6(c), 255.6(d) or 255.6(e).
Measurement frequency means the
frequency with which a particular
quantitative metric must be calculated and
recorded.
Trading desk means the smallest discrete
unit of organization of a banking entity that
purchases or sells financial instruments for
the trading account of the banking entity or
an affiliate thereof.
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III. Reporting and Recordkeeping of
Quantitative Measurements
a. Scope of Required Reporting
General scope. Each banking entity made
subject to this part by § 255.20 must furnish
the following quantitative measurements for
each trading desk of the banking entity,
calculated in accordance with this appendix:
• Risk and Position Limits and Usage;
• Risk Factor Sensitivities;
• Value-at-Risk and Stress VaR;
• Comprehensive Profit and Loss
Attribution;
• Inventory Turnover;
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• Inventory Aging; and
• Customer-Facing Trade Ratio
b. Frequency of Required Calculation and
Reporting
A banking entity must calculate any
applicable quantitative measurement for each
trading day. A banking entity must report
each applicable quantitative measurement to
the SEC on the reporting schedule
established in § 255.20 unless otherwise
requested by the SEC. All quantitative
measurements for any calendar month must
be reported within the time period required
by § 255.20.
c. Recordkeeping
A banking entity must, for any quantitative
measurement furnished to the SEC pursuant
to this appendix and § 255.20(d), create and
maintain records documenting the
preparation and content of these reports, as
well as such information as is necessary to
permit the SEC to verify the accuracy of such
reports, for a period of 5 years from the end
of the calendar year for which the
measurement was taken.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Risk and Position Limits and Usage
i. Description: For purposes of this
appendix, Risk and Position Limits are the
constraints that define the amount of risk that
a trading desk is permitted to take at a point
in time, as defined by the banking entity for
a specific trading desk. Usage represents the
portion of the trading desk’s limits that are
accounted for by the current activity of the
desk. Risk and position limits and their usage
are key risk management tools used to
control and monitor risk taking and include,
but are not limited, to the limits set out in
§ 255.4 and § 255.5. A number of the metrics
that are described below, including ‘‘Risk
Factor Sensitivities’’ and ‘‘Value-at-Risk and
Stress Value-at-Risk,’’ relate to a trading
desk’s risk and position limits and are useful
in evaluating and setting these limits in the
broader context of the trading desk’s overall
activities, particularly for the market making
activities under § 255.4(b) and hedging
activity under § 255.5. Accordingly, the
limits required under § 255.4(b)(2)(iii) and
§ 255.5(b)(1)(i) must meet the applicable
requirements under § 255.4(b)(2)(iii) and
§ 255.5(b)(1)(i) and also must include
appropriate metrics for the trading desk
limits including, at a minimum, the ‘‘Risk
Factor Sensitivities’’ and ‘‘Value-at-Risk and
Stress Value-at-Risk’’ metrics except to the
extent any of the ‘‘Risk Factor Sensitivities’’
or ‘‘Value-at-Risk and Stress Value-at-Risk’’
metrics are demonstrably ineffective for
measuring and monitoring the risks of a
trading desk based on the types of positions
traded by, and risk exposures of, that desk.
ii. General Calculation Guidance: Risk and
Position Limits must be reported in the
format used by the banking entity for the
purposes of risk management of each trading
desk. Risk and Position Limits are often
expressed in terms of risk measures, such as
VaR and Risk Factor Sensitivities, but may
also be expressed in terms of other
observable criteria, such as net open
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positions. When criteria other than VaR or
Risk Factor Sensitivities are used to define
the Risk and Position Limits, both the value
of the Risk and Position Limits and the value
of the variables used to assess whether these
limits have been reached must be reported.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
2. Risk Factor Sensitivities
i. Description: For purposes of this
appendix, Risk Factor Sensitivities are
changes in a trading desk’s Comprehensive
Profit and Loss that are expected to occur in
the event of a change in one or more
underlying variables that are significant
sources of the trading desk’s profitability and
risk.
ii. General Calculation Guidance: A
banking entity must report the Risk Factor
Sensitivities that are monitored and managed
as part of the trading desk’s overall risk
management policy. The underlying data and
methods used to compute a trading desk’s
Risk Factor Sensitivities will depend on the
specific function of the trading desk and the
internal risk management models employed.
The number and type of Risk Factor
Sensitivities that are monitored and managed
by a trading desk, and furnished to the SEC,
will depend on the explicit risks assumed by
the trading desk. In general, however,
reported Risk Factor Sensitivities must be
sufficiently granular to account for a
preponderance of the expected price
variation in the trading desk’s holdings.
A. Trading desks must take into account
any relevant factors in calculating Risk Factor
Sensitivities, including, for example, the
following with respect to particular asset
classes:
• Commodity derivative positions: Risk
factors with respect to the related
commodities set out in 17 CFR 20.2, the
maturity of the positions, volatility and/or
correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), and the maturity profile of
the positions;
• Credit positions: Risk factors with
respect to credit spreads that are sufficiently
granular to account for specific credit sectors
and market segments, the maturity profile of
the positions, and risk factors with respect to
interest rates of all relevant maturities;
• Credit-related derivative positions: Risk
factor sensitivities, for example credit
spreads, shifts (parallel and non-parallel) in
credit spreads—volatility, and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
and the maturity profile of the positions;
• Equity derivative positions: Risk factor
sensitivities such as equity positions,
volatility, and/or correlation sensitivities
(expressed in a manner that demonstrates
any significant non-linearities), and the
maturity profile of the positions;
• Equity positions: Risk factors for equity
prices and risk factors that differentiate
between important equity market sectors and
segments, such as a small capitalization
equities and international equities;
• Foreign exchange derivative positions:
Risk factors with respect to major currency
pairs and maturities, exposure to interest
rates at relevant maturities, volatility, and/or
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correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), as well as the maturity
profile of the positions; and
• Interest rate positions, including interest
rate derivative positions: Risk factors with
respect to major interest rate categories and
maturities and volatility and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
and shifts (parallel and non-parallel) in the
interest rate curve, as well as the maturity
profile of the positions.
B. The methods used by a banking entity
to calculate sensitivities to a common factor
shared by multiple trading desks, such as an
equity price factor, must be applied
consistently across its trading desks so that
the sensitivities can be compared from one
trading desk to another.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Value-at-Risk and Stress Value-at-Risk
i. Description: For purposes of this
appendix, Value-at-Risk (‘‘VaR’’) is the
commonly used percentile measurement of
the risk of future financial loss in the value
of a given set of aggregated positions over a
specified period of time, based on current
market conditions. For purposes of this
appendix, Stress Value-at-Risk (‘‘Stress VaR’’)
is the percentile measurement of the risk of
future financial loss in the value of a given
set of aggregated positions over a specified
period of time, based on market conditions
during a period of significant financial stress.
ii. General Calculation Guidance: Banking
entities must compute and report VaR and
Stress VaR by employing generally accepted
standards and methods of calculation. VaR
should reflect a loss in a trading desk that is
expected to be exceeded less than one
percent of the time over a one-day period.
For those banking entities that are subject to
regulatory capital requirements imposed by a
Federal banking agency, VaR and Stress VaR
must be computed and reported in a manner
that is consistent with such regulatory capital
requirements. In cases where a trading desk
does not have a standalone VaR or Stress VaR
calculation but is part of a larger aggregation
of positions for which a VaR or Stress VaR
calculation is performed, a VaR or Stress VaR
calculation that includes only the trading
desk’s holdings must be performed consistent
with the VaR or Stress VaR model and
methodology used for the larger aggregation
of positions.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this
appendix, Comprehensive Profit and Loss
Attribution is an analysis that attributes the
daily fluctuation in the value of a trading
desk’s positions to various sources. First, the
daily profit and loss of the aggregated
positions is divided into three categories: (i)
Profit and loss attributable to a trading desk’s
existing positions that were also positions
held by the trading desk as of the end of the
prior day (‘‘existing positions’’); (ii) profit
and loss attributable to new positions
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resulting from the current day’s trading
activity (‘‘new positions’’); and (iii) residual
profit and loss that cannot be specifically
attributed to existing positions or new
positions. The sum of (i), (ii), and (iii) must
equal the trading desk’s comprehensive profit
and loss at each point in time. In addition,
profit and loss measurements must calculate
volatility of comprehensive profit and loss
(i.e., the standard deviation of the trading
desk’s one-day profit and loss, in dollar
terms) for the reporting period for at least a
30-, 60- and 90-day lag period, from the end
of the reporting period, and any other period
that the banking entity deems necessary to
meet the requirements of the rule.
A. The comprehensive profit and loss
associated with existing positions must
reflect changes in the value of these positions
on the applicable day. The comprehensive
profit and loss from existing positions must
be further attributed, as applicable, to
changes in (i) the specific Risk Factors and
other factors that are monitored and managed
as part of the trading desk’s overall risk
management policies and procedures; and (ii)
any other applicable elements, such as cash
flows, carry, changes in reserves, and the
correction, cancellation, or exercise of a
trade.
B. The comprehensive profit and loss
attributed to new positions must reflect
commissions and fee income or expense and
market gains or losses associated with
transactions executed on the applicable day.
New positions include purchases and sales of
financial instruments and other assets/
liabilities and negotiated amendments to
existing positions. The comprehensive profit
and loss from new positions may be reported
in the aggregate and does not need to be
further attributed to specific sources.
C. The portion of comprehensive profit and
loss that cannot be specifically attributed to
known sources must be allocated to a
residual category identified as an
unexplained portion of the comprehensive
profit and loss. Significant unexplained
profit and loss must be escalated for further
investigation and analysis.
ii. General Calculation Guidance: The
specific categories used by a trading desk in
the attribution analysis and amount of detail
for the analysis should be tailored to the type
and amount of trading activities undertaken
by the trading desk. The new position
attribution must be computed by calculating
the difference between the prices at which
instruments were bought and/or sold and the
prices at which those instruments are marked
to market at the close of business on that day
multiplied by the notional or principal
amount of each purchase or sale. Any fees,
commissions, or other payments received
(paid) that are associated with transactions
executed on that day must be added
(subtracted) from such difference. These
factors must be measured consistently over
time to facilitate historical comparisons.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
c. Customer-Facing Activity Measurements
1. Inventory Turnover
i. Description: For purposes of this
appendix, Inventory Turnover is a ratio that
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measures the turnover of a trading desk’s
inventory. The numerator of the ratio is the
absolute value of all transactions over the
reporting period. The denominator of the
ratio is the value of the trading desk’s
inventory at the beginning of the reporting
period.
ii. General Calculation Guidance: For
purposes of this appendix, for derivatives,
other than options and interest rate
derivatives, value means gross notional
value, for options, value means delta
adjusted notional value, and for interest rate
derivatives, value means 10-year bond
equivalent value.
iii. Calculation Period: 30 days, 60 days,
and 90 days.
iv. Measurement Frequency: Daily.
2. Inventory Aging
i. Description: For purposes of this
appendix, Inventory Aging generally
describes a schedule of the trading desk’s
aggregate assets and liabilities and the
amount of time that those assets and
liabilities have been held. Inventory Aging
should measure the age profile of the trading
desk’s assets and liabilities.
ii. General Calculation Guidance: In
general, Inventory Aging must be computed
using a trading desk’s trading activity data
and must identify the value of a trading
desk’s aggregate assets and liabilities.
Inventory Aging must include two schedules,
an asset-aging schedule and a liability-aging
schedule. Each schedule must record the
value of assets or liabilities held over all
holding periods. For derivatives, other than
options, and interest rate derivatives, value
means gross notional value, for options,
value means delta adjusted notional value
and, for interest rate derivatives, value means
10-year bond equivalent value.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Customer-Facing Trade Ratio—Trade
Count Based and Value Based
i. Description: For purposes of this
appendix, the Customer-Facing Trade Ratio
is a ratio comparing (i) the transactions
involving a counterparty that is a customer
of the trading desk to (ii) the transactions
involving a counterparty that is not a
customer of the trading desk. A trade count
based ratio must be computed that records
the number of transactions involving a
counterparty that is a customer of the trading
desk and the number of transactions
involving a counterparty that is not a
customer of the trading desk. A value based
ratio must be computed that records the
value of transactions involving a
counterparty that is a customer of the trading
desk and the value of transactions involving
a counterparty that is not a customer of the
trading desk.
ii. General Calculation Guidance: For
purposes of calculating the Customer-Facing
Trade Ratio, a counterparty is considered to
be a customer of the trading desk if the
counterparty is a market participant that
makes use of the banking entity’s market
making-related services by obtaining such
services, responding to quotations, or
entering into a continuing relationship with
respect to such services. However, a trading
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desk or other organizational unit of another
banking entity would not be a client,
customer, or counterparty of the trading desk
if the other entity has trading assets and
liabilities of $50 billion or more as measured
in accordance with § 255.20(d)(1) unless the
trading desk documents how and why a
particular trading desk or other
organizational unit of the entity should be
treated as a client, customer, or counterparty
of the trading desk. Transactions conducted
anonymously on an exchange or similar
trading facility that permits trading on behalf
of a broad range of market participants would
be considered transactions with customers of
the trading desk. For derivatives, other than
options, and interest rate derivatives, value
means gross notional value, for options,
value means delta adjusted notional value,
and for interest rate derivatives, value means
10-year bond equivalent value.
iii. Calculation Period: 30 days, 60 days,
and 90 days.
iv. Measurement Frequency: Daily.
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Appendix B to Part 255—Enhanced
Minimum Standards for Compliance
Programs
I. Overview
Section 255.20(c) requires certain banking
entities to establish, maintain, and enforce an
enhanced compliance program that includes
the requirements and standards in this
Appendix as well as the minimum written
policies and procedures, internal controls,
management framework, independent
testing, training, and recordkeeping
provisions outlined in § 255.20. This
Appendix sets forth additional minimum
standards with respect to the establishment,
oversight, maintenance, and enforcement by
these banking entities of an enhanced
internal compliance program for ensuring
and monitoring compliance with the
prohibitions and restrictions on proprietary
trading and covered fund activities and
investments set forth in section 13 of the
BHC Act and this part.
a. This compliance program must:
1. Be reasonably designed to identify,
document, monitor, and report the permitted
trading and covered fund activities and
investments of the banking entity; identify,
monitor and promptly address the risks of
these covered activities and investments and
potential areas of noncompliance; and
prevent activities or investments prohibited
by, or that do not comply with, section 13 of
the BHC Act and this part;
2. Establish and enforce appropriate limits
on the covered activities and investments of
the banking entity, including limits on the
size, scope, complexity, and risks of the
individual activities or investments
consistent with the requirements of section
13 of the BHC Act and this part;
3. Subject the effectiveness of the
compliance program to periodic independent
review and testing, and ensure that the
entity’s internal audit, corporate compliance
and internal control functions involved in
review and testing are effective and
independent;
4. Make senior management, and others as
appropriate, accountable for the effective
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implementation of the compliance program,
and ensure that the board of directors and
chief executive officer (or equivalent) of the
banking entity review the effectiveness of the
compliance program; and
5. Facilitate supervision and examination
by the Agencies of the banking entity’s
permitted trading and covered fund activities
and investments.
II. Enhanced Compliance Program
a. Proprietary Trading Activities. A
banking entity must establish, maintain and
enforce a compliance program that includes
written policies and procedures that are
appropriate for the types, size, and
complexity of, and risks associated with, its
permitted trading activities. The compliance
program may be tailored to the types of
trading activities conducted by the banking
entity, and must include a detailed
description of controls established by the
banking entity to reasonably ensure that its
trading activities are conducted in
accordance with the requirements and
limitations applicable to those trading
activities under section 13 of the BHC Act
and this part, and provide for appropriate
revision of the compliance program before
expansion of the trading activities of the
banking entity. A banking entity must devote
adequate resources and use knowledgeable
personnel in conducting, supervising and
managing its trading activities, and promote
consistency, independence and rigor in
implementing its risk controls and
compliance efforts. The compliance program
must be updated with a frequency sufficient
to account for changes in the activities of the
banking entity, results of independent testing
of the program, identification of weaknesses
in the program, and changes in legal,
regulatory or other requirements.
1. Trading Desks: The banking entity must
have written policies and procedures
governing each trading desk that include a
description of:
i. The process for identifying, authorizing
and documenting financial instruments each
trading desk may purchase or sell, with
separate documentation for market makingrelated activities conducted in reliance on
§ 255.4(b) and for hedging activity conducted
in reliance on § 255.5;
ii. A mapping for each trading desk to the
division, business line, or other
organizational structure that is responsible
for managing and overseeing the trading
desk’s activities;
iii. The mission (i.e., the type of trading
activity, such as market-making, trading in
sovereign debt, etc.) and strategy (i.e.,
methods for conducting authorized trading
activities) of each trading desk;
iv. The activities that the trading desk is
authorized to conduct, including (i)
authorized instruments and products, and (ii)
authorized hedging strategies, techniques and
instruments;
v. The types and amount of risks allocated
by the banking entity to each trading desk to
implement the mission and strategy of the
trading desk, including an enumeration of
material risks resulting from the activities in
which the trading desk is authorized to
engage (including but not limited to price
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risks, such as basis, volatility and correlation
risks, as well as counterparty credit risk).
Risk assessments must take into account both
the risks inherent in the trading activity and
the strength and effectiveness of controls
designed to mitigate those risks;
vi. How the risks allocated to each trading
desk will be measured;
vii. Why the allocated risks levels are
appropriate to the activities authorized for
the trading desk;
viii. The limits on the holding period of,
and the risk associated with, financial
instruments under the responsibility of the
trading desk;
ix. The process for setting new or revised
limits, as well as escalation procedures for
granting exceptions to any limits or to any
policies or procedures governing the desk,
the analysis that will be required to support
revising limits or granting exceptions, and
the process for independently reviewing and
documenting those exceptions and the
underlying analysis;
x. The process for identifying,
documenting and approving new products,
trading strategies, and hedging strategies;
xi. The types of clients, customers, and
counterparties with whom the trading desk
may trade; and
xii. The compensation arrangements,
including incentive arrangements, for
employees associated with the trading desk,
which may not be designed to reward or
incentivize prohibited proprietary trading or
excessive or imprudent risk-taking.
2. Description of risks and risk
management processes: The compliance
program for the banking entity must include
a comprehensive description of the risk
management program for the trading activity
of the banking entity. The compliance
program must also include a description of
the governance, approval, reporting,
escalation, review and other processes the
banking entity will use to reasonably ensure
that trading activity is conducted in
compliance with section 13 of the BHC Act
and this part. Trading activity in similar
financial instruments should be subject to
similar governance, limits, testing, controls,
and review, unless the banking entity
specifically determines to establish different
limits or processes and documents those
differences. Descriptions must include, at a
minimum, the following elements:
i. A description of the supervisory and risk
management structure governing all trading
activity, including a description of processes
for initial and senior-level review of new
products and new strategies;
ii. A description of the process for
developing, documenting, testing, approving
and reviewing all models used for valuing,
identifying and monitoring the risks of
trading activity and related positions,
including the process for periodic
independent testing of the reliability and
accuracy of those models;
iii. A description of the process for
developing, documenting, testing, approving
and reviewing the limits established for each
trading desk;
iv. A description of the process by which
a security may be purchased or sold pursuant
to the liquidity management plan, including
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the process for authorizing and monitoring
such activity to ensure compliance with the
banking entity’s liquidity management plan
and the restrictions on liquidity management
activities in this part;
v. A description of the management review
process, including escalation procedures, for
approving any temporary exceptions or
permanent adjustments to limits on the
activities, positions, strategies, or risks
associated with each trading desk; and
vi. The role of the audit, compliance, risk
management and other relevant units for
conducting independent testing of trading
and hedging activities, techniques and
strategies.
3. Authorized risks, instruments, and
products. The banking entity must
implement and enforce limits and internal
controls for each trading desk that are
reasonably designed to ensure that trading
activity is conducted in conformance with
section 13 of the BHC Act and this part and
with the banking entity’s written policies and
procedures. The banking entity must
establish and enforce risk limits appropriate
for the activity of each trading desk. These
limits should be based on probabilistic and
non-probabilistic measures of potential loss
(e.g., Value-at-Risk and notional exposure,
respectively), and measured under normal
and stress market conditions. At a minimum,
these internal controls must monitor,
establish and enforce limits on:
i. The financial instruments (including, at
a minimum, by type and exposure) that the
trading desk may trade;
ii. The types and levels of risks that may
be taken by each trading desk; and
iii. The types of hedging instruments used,
hedging strategies employed, and the amount
of risk effectively hedged.
4. Hedging policies and procedures. The
banking entity must establish, maintain, and
enforce written policies and procedures
regarding the use of risk-mitigating hedging
instruments and strategies that, at a
minimum, describe:
i. The positions, techniques and strategies
that each trading desk may use to hedge the
risk of its positions;
ii. The manner in which the banking entity
will identify the risks arising in connection
with and related to the individual or
aggregated positions, contracts or other
holdings of the banking entity that are to be
hedged and determine that those risks have
been properly and effectively hedged;
iii. The level of the organization at which
hedging activity and management will occur;
iv. The manner in which hedging strategies
will be monitored and the personnel
responsible for such monitoring;
v. The risk management processes used to
control unhedged or residual risks; and
vi. The process for developing,
documenting, testing, approving and
reviewing all hedging positions, techniques
and strategies permitted for each trading desk
and for the banking entity in reliance on
§ 255.5.
5. Analysis and quantitative
measurements. The banking entity must
perform robust analysis and quantitative
measurement of its trading activities that is
reasonably designed to ensure that the
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trading activity of each trading desk is
consistent with the banking entity’s
compliance program; monitor and assist in
the identification of potential and actual
prohibited proprietary trading activity; and
prevent the occurrence of prohibited
proprietary trading. Analysis and models
used to determine, measure and limit risk
must be rigorously tested and be reviewed by
management responsible for trading activity
to ensure that trading activities, limits,
strategies, and hedging activities do not
understate the risk and exposure to the
banking entity or allow prohibited
proprietary trading. This review should
include periodic and independent backtesting and revision of activities, limits,
strategies and hedging as appropriate to
contain risk and ensure compliance. In
addition to the quantitative measurements
reported by any banking entity subject to
Appendix A to this part, each banking entity
must develop and implement, to the extent
appropriate to facilitate compliance with this
part, additional quantitative measurements
specifically tailored to the particular risks,
practices, and strategies of its trading desks.
The banking entity’s analysis and
quantitative measurements must incorporate
the quantitative measurements reported by
the banking entity pursuant to Appendix A
(if applicable) and include, at a minimum,
the following:
i. Internal controls and written policies and
procedures reasonably designed to ensure the
accuracy and integrity of quantitative
measurements;
ii. Ongoing, timely monitoring and review
of calculated quantitative measurements;
iii. The establishment of numerical
thresholds and appropriate trading measures
for each trading desk and heightened review
of trading activity not consistent with those
thresholds to ensure compliance with section
13 of the BHC Act and this part, including
analysis of the measurement results or other
information, appropriate escalation
procedures, and documentation related to the
review; and
iv. Immediate review and compliance
investigation of the trading desk’s activities,
escalation to senior management with
oversight responsibilities for the applicable
trading desk, timely notification to the SEC,
appropriate remedial action (e.g., divesting of
impermissible positions, cessation of
impermissible activity, disciplinary actions),
and documentation of the investigation
findings and remedial action taken when
quantitative measurements or other
information, considered together with the
facts and circumstances, or findings of
internal audit, independent testing or other
review suggest a reasonable likelihood that
the trading desk has violated any part of
section 13 of the BHC Act or this part.
6. Other Compliance Matters. In addition
to the requirements specified above, the
banking entity’s compliance program must:
i. Identify activities of each trading desk
that will be conducted in reliance on
exemptions contained in §§ 255.4 through
255.6, including an explanation of:
A. How and where in the organization the
activity occurs; and
B. Which exemption is being relied on and
how the activity meets the specific
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requirements for reliance on the applicable
exemption;
ii. Include an explanation of the process for
documenting, approving and reviewing
actions taken pursuant to the liquidity
management plan, where in the organization
this activity occurs, the securities permissible
for liquidity management, the process for
ensuring that liquidity management activities
are not conducted for the purpose of
prohibited proprietary trading, and the
process for ensuring that securities
purchased as part of the liquidity
management plan are highly liquid and
conform to the requirements of this part;
iii. Describe how the banking entity
monitors for and prohibits potential or actual
material exposure to high-risk assets or highrisk trading strategies presented by each
trading desk that relies on the exemptions
contained in §§ 255.3(d)(3), and 255.4
through 255.6, which must take into account
potential or actual exposure to:
A. Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
B. Assets whose changes in value cannot
be adequately mitigated by effective hedging;
C. New products with rapid growth,
including those that do not have a market
history;
D. Assets or strategies that include
significant embedded leverage;
E. Assets or strategies that have
demonstrated significant historical volatility;
F. Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
G. Assets or strategies that result in large
and significant concentrations to sectors, risk
factors, or counterparties;
iv. Establish responsibility for compliance
with the reporting and recordkeeping
requirements of subpart B and § 255.20; and
v. Establish policies for monitoring and
prohibiting potential or actual material
conflicts of interest between the banking
entity and its clients, customers, or
counterparties.
7. Remediation of violations. The banking
entity’s compliance program must be
reasonably designed and established to
effectively monitor and identify for further
analysis any trading activity that may
indicate potential violations of section 13 of
the BHC Act and this part and to prevent
actual violations of section 13 of the BHC Act
and this part. The compliance program must
describe procedures for identifying and
remedying violations of section 13 of the
BHC Act and this part, and must include, at
a minimum, a requirement to promptly
document, address and remedy any violation
of section 13 of the BHC Act or this part, and
document all proposed and actual
remediation efforts. The compliance program
must include specific written policies and
procedures that are reasonably designed to
assess the extent to which any activity
indicates that modification to the banking
entity’s compliance program is warranted
and to ensure that appropriate modifications
are implemented. The written policies and
procedures must provide for prompt
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notification to appropriate management,
including senior management and the board
of directors, of any material weakness or
significant deficiencies in the design or
implementation of the compliance program
of the banking entity.
b. Covered Fund Activities or Investments.
A banking entity must establish, maintain
and enforce a compliance program that
includes written policies and procedures that
are appropriate for the types, size,
complexity and risks of the covered fund and
related activities conducted and investments
made, by the banking entity.
1. Identification of covered funds. The
banking entity’s compliance program must
provide a process, which must include
appropriate management review and
independent testing, for identifying and
documenting covered funds that each unit
within the banking entity’s organization
sponsors or organizes and offers, and covered
funds in which each such unit invests. In
addition to the documentation requirements
for covered funds, as specified under
§ 255.20(e), the documentation must include
information that identifies all pools that the
banking entity sponsors or has an interest in
and the type of exemption from the
Commodity Exchange Act (whether or not
the pool relies on section 4.7 of the
regulations under the Commodity Exchange
Act), and the amount of ownership interest
the banking entity has in those pools.
2. Identification of covered fund activities
and investments. The banking entity’s
compliance program must identify,
document and map each unit within the
organization that is permitted to acquire or
hold an interest in any covered fund or
sponsor any covered fund and map each unit
to the division, business line, or other
organizational structure that will be
responsible for managing and overseeing that
unit’s activities and investments.
3. Explanation of compliance. The banking
entity’s compliance program must explain
how:
i. The banking entity monitors for and
prohibits potential or actual material
conflicts of interest between the banking
entity and its clients, customers, or
counterparties related to its covered fund
activities and investments;
ii. The banking entity monitors for and
prohibits potential or actual transactions or
activities that may threaten the safety and
soundness of the banking entity related to its
covered fund activities and investments; and
iii. The banking entity monitors for and
prohibits potential or actual material
exposure to high-risk assets or high-risk
trading strategies presented by its covered
fund activities and investments, taking into
account potential or actual exposure to:
A. Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
B. Assets whose changes in values cannot
be adequately mitigated by effective hedging;
C. New products with rapid growth,
including those that do not have a market
history;
D. Assets or strategies that include
significant embedded leverage;
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18:12 Nov 13, 2019
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E. Assets or strategies that have
demonstrated significant historical volatility;
F. Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
G. Assets or strategies that expose the
banking entity to large and significant
concentrations with respect to sectors, risk
factors, or counterparties;
4. Description and documentation of
covered fund activities and investments. For
each organizational unit engaged in covered
fund activities and investments, the banking
entity’s compliance program must document:
i. The covered fund activities and
investments that the unit is authorized to
conduct;
ii. The banking entity’s plan for actively
seeking unaffiliated investors to ensure that
any investment by the banking entity
conforms to the limits contained in § 255.12
or registered in compliance with the
securities laws and thereby exempt from
those limits within the time periods allotted
in§ 255.12; and
iii. How it complies with the requirements
of subpart C.
5. Internal Controls. A banking entity must
establish, maintain, and enforce internal
controls that are reasonably designed to
ensure that its covered fund activities or
investments comply with the requirements of
section 13 of the BHC Act and this part and
are appropriate given the limits on risk
established by the banking entity. These
written internal controls must be reasonably
designed and established to effectively
monitor and identify for further analysis any
covered fund activity or investment that may
indicate potential violations of section 13 of
the BHC Act or this part. The internal
controls must, at a minimum require:
i. Monitoring and limiting the banking
entity’s individual and aggregate investments
in covered funds;
ii. Monitoring the amount and timing of
seed capital investments for compliance with
the limitations under subpart C (including
but not limited to the redemption, sale or
disposition requirements) of § 255.12, and
the effectiveness of efforts to seek unaffiliated
investors to ensure compliance with those
limits;
iii. Calculating the individual and
aggregate levels of ownership interests in one
or more covered fund required by § 255.12;
iv. Attributing the appropriate instruments
to the individual and aggregate ownership
interest calculations above;
v. Making disclosures to prospective and
actual investors in any covered fund
organized and offered or sponsored by the
banking entity, as provided under
§ 255.11(a)(8);
vi. Monitoring for and preventing any
relationship or transaction between the
banking entity and a covered fund that is
prohibited under § 255.14, including where
the banking entity has been designated as the
sponsor, investment manager, investment
adviser, or commodity trading advisor to a
covered fund by another banking entity; and
vii. Appropriate management review and
supervision across legal entities of the
banking entity to ensure that services and
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products provided by all affiliated entities
comply with the limitation on services and
products contained in § 255.14.
6. Remediation of violations. The banking
entity’s compliance program must be
reasonably designed and established to
effectively monitor and identify for further
analysis any covered fund activity or
investment that may indicate potential
violations of section 13 of the BHC Act or
this part and to prevent actual violations of
section 13 of the BHC Act and this part. The
banking entity’s compliance program must
describe procedures for identifying and
remedying violations of section 13 of the
BHC Act and this part, and must include, at
a minimum, a requirement to promptly
document, address and remedy any violation
of section 13 of the BHC Act or this part,
including § 255.21, and document all
proposed and actual remediation efforts. The
compliance program must include specific
written policies and procedures that are
reasonably designed to assess the extent to
which any activity or investment indicates
that modification to the banking entity’s
compliance program is warranted and to
ensure that appropriate modifications are
implemented. The written policies and
procedures must provide for prompt
notification to appropriate management,
including senior management and the board
of directors, of any material weakness or
significant deficiencies in the design or
implementation of the compliance program
of the banking entity.
III. Responsibility and Accountability for the
Compliance Program
a. A banking entity must establish,
maintain, and enforce a governance and
management framework to manage its
business and employees with a view to
preventing violations of section 13 of the
BHC Act and this part. A banking entity must
have an appropriate management framework
reasonably designed to ensure that:
Appropriate personnel are responsible and
accountable for the effective implementation
and enforcement of the compliance program;
a clear reporting line with a chain of
responsibility is delineated; and the
compliance program is reviewed periodically
by senior management. The board of
directors (or equivalent governance body)
and senior management should have the
appropriate authority and access to personnel
and information within the organizations as
well as appropriate resources to conduct
their oversight activities effectively.
1. Corporate governance. The banking
entity must adopt a written compliance
program approved by the board of directors,
an appropriate committee of the board, or
equivalent governance body, and senior
management.
2. Management procedures. The banking
entity must establish, maintain, and enforce
a governance framework that is reasonably
designed to achieve compliance with section
13 of the BHC Act and this part, which, at
a minimum, provides for:
i. The designation of appropriate senior
management or committee of senior
management with authority to carry out the
management responsibilities of the banking
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entity for each trading desk and for each
organizational unit engaged in covered fund
activities;
ii. Written procedures addressing the
management of the activities of the banking
entity that are reasonably designed to achieve
compliance with section 13 of the BHC Act
and this part, including:
A. A description of the management
system, including the titles, qualifications,
and locations of managers and the specific
responsibilities of each person with respect
to the banking entity’s activities governed by
section 13 of the BHC Act and this part; and
B. Procedures for determining
compensation arrangements for traders
engaged in underwriting or market makingrelated activities under § 255.4 or riskmitigating hedging activities under § 255.5 so
that such compensation arrangements are
designed not to reward or incentivize
prohibited proprietary trading and
appropriately balance risk and financial
results in a manner that does not encourage
employees to expose the banking entity to
excessive or imprudent risk.
3. Business line managers. Managers with
responsibility for one or more trading desks
of the banking entity are accountable for the
effective implementation and enforcement of
the compliance program with respect to the
applicable trading desk(s).
4. Board of directors, or similar corporate
body, and senior management. The board of
directors, or similar corporate body, and
senior management are responsible for
setting and communicating an appropriate
culture of compliance with section 13 of the
BHC Act and this part and ensuring that
appropriate policies regarding the
management of trading activities and covered
fund activities or investments are adopted to
comply with section 13 of the BHC Act and
this part. The board of directors or similar
corporate body (such as a designated
committee of the board or an equivalent
governance body) must ensure that senior
management is fully capable, qualified, and
properly motivated to manage compliance
with this part in light of the organization’s
business activities and the expectations of
the board of directors. The board of directors
or similar corporate body must also ensure
that senior management has established
appropriate incentives and adequate
resources to support compliance with this
part, including the implementation of a
compliance program meeting the
requirements of this appendix into
management goals and compensation
structures across the banking entity.
5. Senior management. Senior management
is responsible for implementing and
enforcing the approved compliance program.
Senior management must also ensure that
effective corrective action is taken when
failures in compliance with section 13 of the
BHC Act and this part are identified. Senior
management and control personnel charged
with overseeing compliance with section 13
of the BHC Act and this part should review
the compliance program for the banking
entity periodically and report to the board, or
an appropriate committee thereof, on the
effectiveness of the compliance program and
compliance matters with a frequency
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18:12 Nov 13, 2019
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appropriate to the size, scope, and risk
profile of the banking entity’s trading
activities and covered fund activities or
investments, which shall be at least annually.
6. CEO attestation. Based on a review by
the CEO of the banking entity, the CEO of the
banking entity must, annually, attest in
writing to the SEC that the banking entity has
in place processes to establish, maintain,
enforce, review, test and modify the
compliance program established under this
Appendix and § 255.20 of this part in a
manner reasonably designed to achieve
compliance with section 13 of the BHC Act
and this part. In the case of a U.S. branch or
agency of a foreign banking entity, the
attestation may be provided for the entire
U.S. operations of the foreign banking entity
by the senior management officer of the
United States operations of the foreign
banking entity who is located in the United
States.
IV. Independent Testing
a. Independent testing must occur with a
frequency appropriate to the size, scope, and
risk profile of the banking entity’s trading
and covered fund activities or investments,
which shall be at least annually. This
independent testing must include an
evaluation of:
1. The overall adequacy and effectiveness
of the banking entity’s compliance program,
including an analysis of the extent to which
the program contains all the required
elements of this appendix;
2. The effectiveness of the banking entity’s
internal controls, including an analysis and
documentation of instances in which such
internal controls have been breached, and
how such breaches were addressed and
resolved; and
3. The effectiveness of the banking entity’s
management procedures.
b. A banking entity must ensure that
independent testing regarding the
effectiveness of the banking entity’s
compliance program is conducted by a
qualified independent party, such as the
banking entity’s internal audit department,
compliance personnel or risk managers
independent of the organizational unit being
tested, outside auditors, consultants, or other
qualified independent parties. A banking
entity must promptly take appropriate action
to remedy any significant deficiencies or
material weaknesses in its compliance
program and to terminate any violations of
section 13 of the BHC Act or this part.
V. Training
Banking entities must provide adequate
training to personnel and managers of the
banking entity engaged in activities or
investments governed by section 13 of the
BHC Act or this part, as well as other
appropriate supervisory, risk, independent
testing, and audit personnel, in order to
effectively implement and enforce the
compliance program. This training should
occur with a frequency appropriate to the
size and the risk profile of the banking
entity’s trading activities and covered fund
activities or investments.
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62273
VI. Recordkeeping
Banking entities must create and retain
records sufficient to demonstrate compliance
and support the operations and effectiveness
of the compliance program. A banking entity
must retain these records for a period that is
no less than 5 years or such longer period as
required by the SEC in a form that allows it
to promptly produce such records to the SEC
on request.
Dated: August 19, 2019.
Joseph M. Otting,
Comptroller of the Currency.
By order of the Board of Governors of the
Federal Reserve System, October 9, 2019.
Ann E. Misback,
Secretary of the Board.
Dated at Washington, DC, on August 20,
2019.
By order of the Board of Directors.
Federal Deposit Insurance Corporation.
Valerie Jean Best,
Assistant Executive Secretary.
By the Securities and Exchange
Commission.
Dated: September 18, 2019.
Vanessa A. Countryman.
Issued in Washington, DC, on October 11,
2019, by the Commodity Futures Trading
Commission.
Christopher Kirkpatrick,
Secretary of the Commodity Futures Trading
Commission.
Note: The following appendices will not
appear in the Code of Federal Regulations.
Appendices to Revisions to Prohibitions
and Restrictions on Proprietary
Trading and Certain Interests in, and
Relationships With, Hedge Funds and
Private Equity Funds—Commission
Voting Summary and Commissioners’
Statements
Appendix 1—CFTC Voting Summary
On this matter, Chairman Tarbert and
Commissioners Quintenz and Stump voted in
the affirmative. Commissioners Behnam and
Berkovitz voted in the negative. The
document submitted to the CFTC
Commissioners for a vote did not include
Section V.F. SEC Economic Analysis or
Section V.G. Congressional Review Act.
Appendix 2—Statement of CFTC Chairman
Heath Tarbert in Support of Revisions to the
Volcker Rule
I have voted to approve revisions to the
Volcker Rule, among the most wellintentioned but poorly designed regulations
in the history of American finance. My
involvement with the Volcker Rule started
nearly a decade ago when I served as special
counsel to the Senate Banking Committee
before the passage of the Dodd-Frank Act. In
fact, I was the staff member responsible for
arranging for former Federal Reserve
Chairman Paul Volcker to testify before the
committee on the original version of the rule
that now bears his name. Having had the
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opportunity to interact with Chairman
Volcker at various points throughout my
career, I have always had immense respect
for him. He had a clear-cut vision: Banks
should be barred from speculating in the
markets (a practice known as proprietary
trading) and from running hedge funds and
private-equity firms. ‘‘If you are doing this
stuff,’’ he would say, ‘‘you should not be a
commercial bank.’’
Five federal agencies—the Federal Reserve,
the FDIC, the OCC, the SEC, and the CFTC
(together, the ‘‘Agencies’’)—issued final
regulations in December 2013 to implement
the statutory language of the Volcker Rule in
Title VI of the Dodd-Frank Act. The basic
premise of this law is to restrict financial
institutions with deposits insured by the
Federal Government from engaging in
proprietary trading, but permit trading for
market making, hedging, and other
traditional financial services activities.
We now have five years of experience with
the initial version of the regulations
implementing the Volcker Rule, and over that
time, a number of legitimate concerns have
arisen. In my view, the initial regulations
adopted by the Agencies have metastasized
from Mr. Volcker’s original, simple vision to
the degree where his distinction between
proprietary and non-proprietary trading is
hardly recognizable. I agree with Mr. Volcker
that the rule has become overly complex and
hard to understand; 1 at this point it is also
nearly unadministrable. Among other things,
the regulations create confusion over what is
acceptable activity for banking entities.2
Indeed, the Agencies have had to issue 21
sets of frequently asked questions (‘‘FAQs’’)
in the first three years since the regulations
were adopted.3 This is not a model of clear
1 See, e.g., ‘‘Why Paul Volcker Soured on His
Own Rule,’’ Time (Oct. 25, 2011), available at:
https://business.time.com/2011/10/25/why-paulvolcker-soured-on-the-volcker-rule; ‘‘Paul Volcker
Says Volcker Rule Too Complicated,’’ Reuters (Nov.
9, 2011), available at https://www.reuters.com/
article/us-regulation-volcker/paul-volcker-saysvolcker-rule-too-complicated. This is not to suggest
that Mr. Volcker agrees with the proposed changes
now before the interagency process. See ‘‘Volcker
the Man Blasts Volcker the Rule in Letter to Fed
Chair,’’ Bloomberg (Sept. 10, 2019), available at
https://www.bloomberg.com/news/articles/2019-0910/volcker-the-man-blasts-volcker-the-rule-in-letterto-fed-chair (describing a private letter purportedly
criticizing the proposed amendments to the current
regulations).
2 I have written a number of legal articles over the
years to help market participants make sense of the
Volcker Rule and how it might apply to them. See,
e.g., The Vagaries of the Volcker Rule, Int’l Fin. L.
Rev. (Sept. 2010); The Volcker Rule and the Future
of Private Equity (co-author), Rev. of Banking & Fin.
Serv. (May 2011); and CLOs and the Volcker Rule
(co-author), Rev. of Banking & Fin. Serv. (Aug.
2015).
3 See FAQ on Conformance Period (June 10,
2014); FAQ on Foreign Public Fund Seeding
Vehicles (June 10, 2014); FAQ on Loan
Securitization Servicing Assets (June 10, 2014);
FAQ on Namesharing Prohibition (June 10, 2014);
FAQ on Metrics Reporting Date (June 10, 2014);
FAQ on Trading Desk (June 10, 2014); FAQ on
Mortgage-Backed Securities of GovernmentSponsored Enterprises (November 12, 2014); FAQ
on Metrics Reporting During the Conformance
Period (Nov. 13, 2014); FAQ on Annual CEO
Attestation (Sept. 10, 2014); FAQ on Metrics
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rulemaking. Furthermore, the Volcker Rule
imposes highly intensive compliance
burdens that unfairly benefit large Wall
Street banks over smaller regional ones. No
one ever intended these results.
In addition, the Volcker Rule has an
extraterritorial reach that is breathtaking in
its expansiveness, something I witnessed
personally several years ago in Australia.
There I met with a senior executive at a local,
Australian financial institution. He handed
me his business card, and it listed his title
as ‘‘Head of Volcker Rule Compliance.’’ In
Australia! We have created a mess not just for
the United States, but for the whole world.
I do not doubt the good intentions of the
original drafters of both the Volcker Rule and
its implementing regulations. I continue to
affirm that deposit insurance underwritten by
the FDIC and discount window access
provided by the Federal Reserve—both
ultimately backstopped by U.S. taxpayers—
should not subsidize non-banking activities.4
I will not raise the related question whether
non-banks affiliated with insured depository
institutions should be allowed to engage in
proprietary trading. I recognize that this is a
decision for Congress, not me.5
Reporting and Confidentiality (Dec. 23, 2014); FAQ
on Treasury STRIPS (Jan. 29, 2015); FAQ on 30-Day
Metrics Reporting During the Conformance Period
(Jan. 29, 2015); FAQ on SOTUS Covered Fund
Exemption: Marketing Restriction (Feb. 27, 2015);
FAQ on Foreign Public Funds Sponsored by
Banking Entities (June 12, 2015); FAQ on Joint
Venture Exclusion for Covered Funds (June 12,
2015); FAQ on Seeding Period Treatment of
Registered Investment Companies and Foreign
Public Funds (June 16, 2015); FAQ on CEO
Certification for Prime Brokerage Transactions
(Sept. 25, 2015); FAQ on Compliance for Market
Making and the Identification of Covered Funds
(Sept. 25, 2015); FAQ on Termination of Marketmaking Activity (Nov. 20, 2015); FAQ on
Applicability of the Restrictions in Section 13(f) of
the BHC Act (Nov. 20, 2015); FAQ on Capital
Treatment of Banking Entity Investments in TruPS
CDOs (Mar. 4, 2016).
4 See Hearing Before the Committee on Banking,
Housing, and Urban Affairs, United States Senate,
150th Congress, Session 1 (May 17, 2017) at 22 (‘‘I
[Heath Tarbert] believe that Federal deposit
insurance should not subsidize nonbanking
activities. . . . [This] should not be
controversial.’’).
5 It is worth noting that the Dodd-Frank Act of
2010 contained a provision addressing the specific
issue of insured banks engaging in trading activities
perceived to go beyond traditional banking services.
The ‘‘push-out’’ rule of Section 716, also known as
the Lincoln Amendment, would have confined an
insured depository institution’s trading of swaps to
those used for hedging or otherwise related to the
well-known list of eligible (and appropriately
conservative) investments permissible for national
banks. Exotic and non-traditional products such as
credit default swaps, equity swaps, and most
physical commodity swaps would have been
effectively ‘‘pushed out’’ out of insured banks and
into non-bank affiliates not directly backstopped by
U.S. taxpayers. Whatever the merits of the Lincoln
Amendment, no one can deny that it was a clear
rule aimed at an equally clear and widely-shared
policy objective. But it was not to last. In December
2014, a bipartisan Congress passed—and President
Obama signed into law—a budget bill containing a
provision that largely gutted the original push-out
rule of the Dodd-Frank Act. See Consolidated and
Further Continuing Appropriations Act, 2015,
Public Law 113–235, 128 Stat. 2130 at section 630
(2014).
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As Chairman of the CFTC, my job is to
ensure that the derivatives markets are
liquid, resilient, and vibrant so they can
serve the price discovery and risk
management functions critical to our real
economy. I have seen reports that liquidity in
bond markets may have been adversely
affected by the Volcker Rule.6 I am concerned
that the Volcker Rule may also affect
liquidity in the derivatives markets. This
could negatively impact the ability of
agricultural, energy, manufacturing, and
other companies in the real economy to
engage in risk mitigation activities.
I am happy to say that the amended
regulations we have now adopted help to
simplify the Volcker Rule and include a
number of important amendments that lessen
the burden on smaller regional banks and
benefit end users of derivatives. The
amendments seek to tailor the Volcker Rule
to increase efficiency, right-size firms’
compliance obligations, and allow banking
entities—especially smaller ones—to provide
services to clients more efficiently.
The amended regulations adopt a riskbased approach that relies on a set of clearly
articulated standards for prohibited and
permitted activities and investments. In
particular, the new regulations revise
elements of the prohibition on proprietary
trading to provide banking entities—
including CFTC-registered swap dealers and
futures commission merchants (‘‘FCMs’’)—
with greater flexibility in their trading
activities and simplified compliance
procedures.
The final regulations also expand existing,
and include additional, exclusions from the
definition of proprietary trading. For
example, the amended regulations add an
exclusion for matched derivatives
transactions to facilitate customer-driven
swaps, especially by customers of small
regional banks, which should benefit end
users who rely on derivatives to hedge their
commercial risks. The amended final
regulations also expand the list of
permissible products for the liquidity
management exclusion to include FX
forwards/swaps and cross-currency swaps.
Banking entities commonly purchase and sell
these instruments for the purpose of
managing their liquidity and funding needs.
This can ultimately benefit commercial firms
who use banks for loans and other products
to hedge their foreign exchange risks arising
from import and export transactions.
In addition, the final regulations tailor the
compliance and metrics reporting
requirements of the Volcker Rule to focus on
entities with relatively large trading
operations. As a result, financial institutions
on Wall Street will retain their reporting
procedures, while smaller and more
traditional commercial banks without major
trading operations will get some relief. What
6 See, e.g., M. Allahrakha & J. Cetina, et al., ‘‘The
Effects of the Volcker Rule on Corporate Bond
Trading: Evidence from the Underwriting
Exemption,’’ OFR Working Paper (Aug. 6, 2019); J.
Bao, & M. O’Hara, et al., The Volcker Rule and
Market-Making in Times of Stress, J. of Fin. Econ.
(2018); H. Bessembinder & S. Jacobsen, et al.,
Capital Commitment and Illiquidity in Corporate
Bonds, J. of Fin. (Aug. 2018).
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is more, the new regulations simplify
requirements by clarifying prohibited and
permissible activities, so that all
institutions—including those headquartered
abroad but who lend and deploy capital in
the United States—have a better
understanding of how to comply with our
laws.
I believe laws should be as clear and
concise as possible. The point of having laws
is for people to follow them, but before they
can follow them they first have to understand
them. As Judge Learned Hand put it 90 years
ago, ‘‘The language of the law must not be
foreign to the ears of those who are to obey
it.’’ 7 For too long the Volcker Rule has been
just that—very peculiar and virtually
unintelligible to market participants and
regulators alike.
In short, the amended regulations will
provide banking entities and their affiliates
(including a number of swap dealers, FCMs,
and commodity pools subject to CFTC
oversight) with greater clarity and certainty
about what activities are permitted under the
Volcker Rule. The revised regulations will
also generally reduce the compliance burden
for these entities, which will benefit those
end users of derivatives who are critical to
our real economy. These changes, which will
make the Volcker Rule simpler without
reducing its fundamental benefits, are
something we should all support.
Appendix 3—Supporting Statement of CFTC
Commissioner Brian Quintenz
I support today’s targeted amendments to
the Volcker Rule, which I believe will
simplify firms’ compliance with the statutory
ban on proprietary trading and improve the
agencies’ supervision of banking entities.
Based upon the agencies’ implementation
experience since 2013, it has become
apparent that the rule as originally adopted
has resulted in ambiguity over permissible
activities, an overbroad application, and
unnecessarily complex compliance
processes. The revised rule before us today
tailors and simplifies the rule to enable
banking entities to effectively provide
traditional banking services to their clients in
a manner that is consistent with the statute.
Adopting a risk-based approach, the
revised rule tailors the scale of a banking
entity’s compliance program to be
commensurate with the firm’s size and level
of trading activities. Under the final rule, the
most stringent compliance requirements
apply to those entities with the most
significant amount of trading activities, while
banks with simpler business models and
more limited trading operations would be
subject to tiered compliance requirements
tailored to the complexity and scope of their
activities. As a result, firms with little or no
activity subject to the Volcker Rule’s
prohibitions will face lower compliance costs
and reduced regulatory burdens. However,
because activity implicated by the Volcker
Rule is concentrated in a small number of
banks, the agencies estimate that, even under
this tiered approach, approximately 93% of
the trading assets and liabilities in the U.S.
banking system would continue to be held by
firms subject to the strictest compliance
standards.
The final rule also clarifies and simplifies
the application of the short-term intent
prong. Under the 2013 rule, the purchase (or
sale) of a financial instrument by a banking
entity was presumed to be for the trading
account if the banking entity held the
financial instrument for fewer than sixty days
(or substantially transferred the risk of the
financial instrument within 60 days of
purchase or sale). In practice, firms have
found it difficult to rebut the presumption,
with the result that the short term intent
prong has captured many activities that
should not be included in the definition of
proprietary trading. The final rule addresses
this issue by reversing the rebuttable
presumption, providing that the purchase or
sale of a financial instrument presumptively
lacks short-term trading intent if the banking
entity holds the financial instrument for 60
days or longer. In addition, the final rule
includes new or expanded exclusions from
the definition of proprietary trading for
liquidity management programs, certain
customer-driven swaps, error trades, and
certain traditional banking activities, such as
the hedging of mortgage servicing rights.
These modifications clarify the scope of
permissible activities and ensure that the
application of the proprietary trading ban is
not overbroad.
I believe today’s final rule serves as an
example of effective cooperation among five
regulators: The CFTC; the Securities and
Exchange Commission; the Federal Reserve
Board; the Office of the Comptroller of the
Currency; and the Federal Deposit Insurance
Corporation. The agencies have come
together to address many of the unintended
consequences of the prior rule, while
continuing to comply with statutory
requirements. Finally, I would like to thank
the staff of the Division of Swap Dealer and
Intermediary Oversight for their efforts on
this matter.
Appendix 4—Dissenting Statement of CFTC
Commissioner Rostin Behnam
I respectfully dissent as to the
Commission’s decision to approve revisions
to the Volcker Rule. In June 2018, when I
voted against the proposed rule, I expressed
that my biggest concern was that our action
would encourage a return to the risky
activities that led to the financial crisis, and
perhaps further consolidate trading activity
into a few institutions.1 My concern last June
was that we were weakening the Volcker
Rule around the edges, and I raised specific
issues regarding unnecessary complexity,
lack of clarity, and a flawed process that
chilled dissent. Unfortunately, today’s final
rule does not do anything to assuage these
concerns. To make matters worse, while the
proposal merely threatened to kill Volcker
through a thousand little cuts, the final rule
goes for the throat. It significantly weakens
1 Opening
7 Hand, L. Is There a Common Will? in The Spirit
of Liberty: Papers and Addresses of Learned Hand
56 (I. Dilliard, 3d ed. 1960) (quoting from address
before the American Law Institute in 1929).
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Statement of Commissioner Rostin
Behnam Before the Open Commission Meeting on
June 4, 2018 (Jun. 4, 2018), https://www.cftc.gov/
PressRoom/SpeechesTestimony/behnamstatement
060418.
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62275
the prohibition on proprietary trading by
narrowing the scope of financial instruments
subject to the Volcker Rule. What remains is
so watered down that it leaves one
questioning whether it should be called the
Volcker rule at all. To that point, Paul
Volcker himself recently sent a letter to the
Chairman of the Federal Reserve criticizing
the rule and stating that the rule ‘‘amplifies
risk in the financial system, increases moral
hazard and erodes protections against
conflicts of interest that were so glaringly on
display during the last crisis.’’ 2
In my dissent last June, I pointed out that
the proposal further complicated the Volcker
rule while calling it simplification. We do the
same thing in the final rule. Where once
there was one set of rules for all banking
entities, there will now be three categories of
banking entities with different rules for each:
Banking entities with Significant trading
assets and liabilities, banking entities with
Limited trading assets and liabilities, banking
entities in between with Moderate trading
assets and liabilities. While numerous
commenters expressed concerns with this
three-tiered compliance framework, we
nonetheless are finalizing this needlessly
complex system. In addition, the majority
today makes ‘‘targeted adjustments’’ that
further complicate matters. In some
instances, these adjustments are at least
requested by the commenters. In others, they
are invented seemingly out of whole cloth.
The most troubling aspect of today’s rule,
though, is something new. The final rule
includes changes to the definition of ‘‘trading
account’’ that will significantly reduce the
scope of financial instruments subject to the
Volcker Rule’s prohibition on proprietary
trading. This change is described in the
preamble to the final rule as avoiding having
the trading account definition
‘‘inappropriately scope in’’ certain financial
instruments, almost as if they were included
in the proposal’s scope by mistake. However,
these financial instruments were within the
scope of the 2013 rule, and they were within
the scope of the proposal. Removing them
now limits the scope of the Volcker rule so
significantly that it no longer will provide
meaningful constraints on speculative
proprietary trading by banks. As such, I
cannot vote for the rule.
Appendix 5—Dissenting Statement of CFTC
Commissioner Dan M. Berkovitz
Congress adopted the statute commonly
known as the ‘‘Volcker Rule’’ in the wake of
the 2008 financial crisis to prevent banks that
benefit from federal depository insurance or
other government support from taking
excessive risks that could lead to future
taxpayer bailouts. The Volcker Rule prohibits
proprietary trading and the owning of hedge
funds and private equity funds by banks and
their subsidiaries (‘‘banking entities’’), with
certain exceptions and exemptions. In 2013
the Commission and other financial
regulators adopted regulations to implement
2 Jesse Hamilton and Yalman Onaran, ‘‘Vocker the
Man Blasts Volcker the Rule in Letter to Fed Chair,’’
Bloomberg (Sep. 10, 2019), https://
www.bloomberg.com/news/articles/2019-09-10/
volcker-the-man-blasts-volcker-the-rule-in-letter-tofed-chair.
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the Volcker Rule. The final rule before the
Commission today (‘‘revised Volcker Rule’’)
substantially weakens these implementing
regulations.
The revised Volcker Rule eliminates or
reduces a variety of substantive standards in
the current rule. The revised Volcker Rule
will render enforcement of the rule difficult
if not impossible by leaving implementation
of significant requirements to the discretion
of the banking entities, creating
presumptions of compliance that would be
nearly impossible to overcome, and
eliminating numerous reporting
requirements. The revised Volcker Rule also
substantially reduces the bank trading
activity covered by the rule. Finally, the
revised Volcker Rule includes a number of
changes and additions not contemplated or
adequately discussed in the notice of
proposed rulemaking (NPRM) in violation of
the Administrative Procedure Act (‘‘APA’’)
requirements for public notice and comment
for rulemakings.
For these reasons, I dissent.
Weak Regulation and Enforceability
Concerns
Nearly every amending provision of the
revised Volcker Rule adopts the weakened
provisions from the NPRM, further weakens
the proposed changes, or makes new changes
that weaken or eliminate existing
requirements and standards. New
presumptions of compliance favoring the
banking entities, regulatory determinations
left to the banking entities, and reductions in
reporting requirements by the banking
entities will make the revised Volcker Rule
more difficult to enforce. The cumulative
effect of this myriad of changes is a set of
regulations that is ineffective and
unenforceable. Although a single chip off a
sculpture, by itself, may not create a
noticeable blemish, widespread chiseling
will disfigure the object. Such is the result
here.
The ‘‘trading account’’ definition and
related regulatory exclusions in the 2013 rule
determine which financial transactions are
subject to the restrictions on proprietary
trading. Financial transactions of banking
entities are subject to the Volcker regulations
if they fall within certain ‘‘prongs’’
established in the trading account provision.
The revised Volcker Rule rejects the
‘‘accounting prong’’ proposed in the NPRM
and effectively jettisons the existing ‘‘shortterm intent prong’’ for most entities.1 In
addition, there are a number of newly created
outright exclusions of whole types of
transactions and broadening of existing
exclusions under the revised Volcker Rule.
FDIC Commissioner Martin Gruenberg
provided an analysis of how these changes
will significantly reduce the banking activity
subject to Volcker oversight. ‘‘By excluding
these financial instruments from the Volcker
Rule, the final rule . . . opens up vast new
1 While the short-term intent prong remains for a
limited number of banks not subject to the market
risk capital rules in banking regulations,
compliance with the short-term intent prong is now
optional if those banking entities instead elect to
comply with the market risk capital rules for
Volcker compliance.
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opportunity—hundreds of billions of dollars
of financial instruments—at both the bank
and bank holding company level, for
speculative proprietary trading funded by the
public safety net.’’ 2
The 2013 Volcker rules define the ‘‘trading
desk’’ as the ‘‘smallest discrete unit of
organization’’ that purchases and sells
financial instruments. The revised Volcker
Rule removes the quoted text, and instead
provides four broad criteria for designating a
trading desk. The rule then allows the
banking entities to designate the trading
desks for purposes of Volcker.
The new trading desk designation criteria
appear to be broad enough that a ‘‘trading
desk’’ could include whole business lines,
divisions, or an entire swap dealer. The
opportunities for undertaking greater
amounts of proprietary trading expand
significantly when the limits (which are set
by the banking entities themselves), the deskspecific positions being hedged, and
reporting requirements are applied to much
larger trading portfolios. Because the revised
Volcker Rule effectively presumes that these
trading desk designations by the banking
entities are valid, it will be more difficult for
the applicable regulator to reign in
proprietary trading undertaken by more
expansively designated trading desks.
How much proprietary trading can occur
under the market making exemption in the
revised Volcker Rule will be determined by
the risk limits set for each trading desk. The
risk limits are to be established at the
discretion of each banking entity and, as
noted above, the scope of a trading desk also
will be determined by the banking entity
within broad criteria. ‘‘Reasonably expected
near-term demand’’ (‘‘RENTD’’) of customers
is included in the Volcker statute to establish
the level of market making permissible.
While the RENTD concept is still in the
revised Volcker Rule, a presumption has
been added that the RENTD levels set by
each banking entity are correct.
Because these determinations will be
established by the banking entity and
presumed to be compliant, it will be difficult
for any regulator to challenge them or take
any enforcement action—even if a banking
entity experiences large losses from
proprietary trading—so long as the trading is
found to be within the set limits.
These concerns about enforcement and
oversight are exacerbated by the reduced
metrics and other reporting, documentation,
and compliance requirements. Numerous
changes are made both as proposed and
added on in this final rule. To name a few,
stressed value at risk, daily risk factor
sensitivities, and risk limit breaches need not
be reported. In some cases, changes to
reporting requirements make sense if
experience shows a metric has little or no
regulatory value. But most of these changes
in the revised Volcker Rule are purportedly
justified because they reduce the burden on
banking entities and the cumulative effect on
the ability of a regulator to monitor for
2 Statement by Martin J. Gruenberg, Member,
FDIC Board of Directors, The Volcker Rule (Aug. 20,
2019) at 3, available at https://www.fdic.gov/news/
news/speeches/spaug2019b.pdf.
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compliance and potential significant issues is
not addressed.
Logical Outgrowth Concerns
The revised Volcker Rule includes a
number of new rules and amendments that
were not mentioned or adequately described
in the NPRM. The APA requires that a
proposed rulemaking be published in the
Federal Register and that interested persons
be given an opportunity to comment.3 A
‘‘notice of proposed rulemaking must provide
sufficient factual detail and rationale for the
rule to permit interested parties to comment
meaningfully.’’ 4
In comparing the revised Volcker Rule to
the NPRM, there are a number of changes
that were either not addressed in the NPRM
or at best are based on comments received in
response to general questions. For example,
the NPRM included a proposal to replace the
short-term intent prong with what is
commonly referred to as the ‘‘accounting
prong.’’ In the revised Volcker Rule, the
accounting prong was rejected, but the shortterm interest prong also is eliminated for
most banking entities.5 While replacing the
short-term intent prong was discussed in the
proposal, effectively eliminating the prong
without a replacement was not proposed.
Similarly the option for certain banking
entities to now elect to comply with the
market risk capital rule prong rather than the
short-term intent prong was not discussed as
an alternative. Nor was the replacement of
the rebuttable presumption of proprietary
trading for positions held shorter than 60
days with the opposite presumption that
positions held longer than 60 days are not
proprietary trading for purposes of the
Volcker Rule. Agencies cannot ‘‘pull a
surprise switcheroo’’ in the rulemaking
process.6
Furthermore, the NPRM appears to not
even contemplate excluding government
bond assets and liabilities, mortgage
servicing rights hedges, or financial
instruments that are not trading assets or
trading liabilities from counting as
proprietary trading. Other changes, such as
the elimination of incentive compensation
limits, the matched derivatives transaction
exclusion, and elimination of risk factor
sensitivity metrics reporting appear to be
based on general questions in the NPRM. In
each case, no draft rule text or adequate
discussion of such amendments was
provided that would allow the public to have
anticipated those amendments. Rather, many
of these changes appear to be based on de
novo comments made by banks or their trade
organizations. ‘‘[I]f the final rule
‘substantially departs from the terms or
substance of the proposed rule,’ the notice is
inadequate.’’ 7
35
U.S.C. 553(b) and (c).
Int’l, Inc. v. EPA, 372 F.3d 441, 445
(D.C. Cir. 2004) (internal quotation marks omitted).
5 Firms subject to, or which elect to be subject to,
the market risk capital rule prong are no longer
subject to the short-term intent prong.
6 Environmental Integrity Project v. EPA, 425 F.3d
992, 996 (D.C. Cir. 2005).
7 Chocolate Manufacturers Assoc. of the United
States v. Block, 755 F.2d 1098, 1105 (4th Cir. 1985)
(quoting Rowell v. Andrus, 631 F.2d 699, 702 n.2
(10th Cir. 1980).
4 Honeywell
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Conclusion
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Self-regulation failed us in the early part of
this century. Dodd-Frank, including the
Volcker Rule, has helped this country rebuild
a strong and better managed financial sector.
To maintain a robust financial sector that
benefits the American people, we must
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maintain strong standards and vigorous
oversight. Otherwise, it is only a matter of
time before the memory of the huge losses
and resulting pressures for a taxpayer bailout
fades and excessive risk taking comes home
to roost. While the Dodd-Frank regulations
may not be perfect and modest adjustments
may be appropriate, the wholesale revision of
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regulations that greatly weaken the
enforceability of those regulations such as we
have before us today will, in the long run,
weaken the financial sector and pose risks to
the American public.
[FR Doc. 2019–22695 Filed 11–13–19; 8:45 am]
BILLING CODE P
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]]>Agencies
[Federal Register Volume 84, Number 220 (Thursday, November 14, 2019)]
[Rules and Regulations]
[Pages 61974-62277]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-22695]
[[Page 61973]]
Vol. 84
Thursday,
No. 220
November 14, 2019
Part II
Department of Treasury
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Office of the Comptroller of the Currency
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12 CFR Part 44
Federal Reserve System
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12 CFR Part 248
Federal Deposit Insurance Corporation
-----------------------------------------------------------------------
12 CFR Part 351
Commodity Futures Trading Commission
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17 CFR Part 75
Securities and Exchange Commission
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17 CFR Part 255
Prohibitions and Restrictions on Proprietary Trading and Certain
Interests in, and Relationships With, Hedge Funds and Private Equity
Funds; Final Rule
Federal Register / Vol. 84 , No. 220 / Thursday, November 14, 2019 /
Rules and Regulations
[[Page 61974]]
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DEPARTMENT OF TREASURY
Office of the Comptroller of the Currency
12 CFR Part 44
[Docket No. OCC-2018-0010]
RIN 1557-AE27
FEDERAL RESERVE SYSTEM
12 CFR Part 248
[Docket No. R-1608]
RIN 7100-AF 06
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 351
RIN 3064-AE67
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 75
RIN 3038-AE72
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 255
[Release no. BHCA-7; File no. S7-14-18]
RIN 3235-AM10
Prohibitions and Restrictions on Proprietary Trading and Certain
Interests in, and Relationships With, Hedge Funds and Private Equity
Funds
AGENCY: Office of the Comptroller of the Currency, Treasury (OCC);
Board of Governors of the Federal Reserve System (Board); Federal
Deposit Insurance Corporation (FDIC); Securities and Exchange
Commission (SEC); and Commodity Futures Trading Commission (CFTC).
ACTION: Final rule.
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SUMMARY: The OCC, Board, FDIC, SEC, and CFTC are adopting amendments to
the regulations implementing section 13 of the Bank Holding Company
Act. Section 13 contains certain restrictions on the ability of a
banking entity and nonbank financial company supervised by the Board to
engage in proprietary trading and have certain interests in, or
relationships with, a hedge fund or private equity fund. These final
amendments are intended to provide banking entities with clarity about
what activities are prohibited and to improve supervision and
implementation of section 13.
DATES:
Effective date: The effective date for amendatory instructions 1
through 14 (OCC), 16 through 29 (Board), 31 through 44 (FDIC), and 46
through 58 (CFTC) is January 1, 2020; the effective date for amendatory
instructions 60 through 73 (SEC) is January 13, 2020; and the effective
date for the addition of appendices Z at amendatory instructions 15
(OCC), 30 (Board), and 45 (FDIC) is January 1, 2020, through December
31, 2020, except for amendatory instruction 74 (SEC), which is
effective January 13, 2020, through December 31, 2020.
Compliance date: Banking entities must comply with the final
amendments by January 1, 2021. Until the compliance date, banking
entities must continue to comply with the 2013 rule (as set forth in
appendices Z to 12 CFR parts 44, 248, and 351 and 17 CFR parts 75 and
255). Alternatively, a banking entity may voluntarily comply, in whole
or in part, with the amendments adopted in this release prior to the
compliance date, subject to the agencies' completion of necessary
technological changes.
FOR FURTHER INFORMATION CONTACT:
OCC: Roman Goldstein, Risk Specialist, Treasury and Market Risk
Policy, (202) 649-6360; Tabitha Edgens, Counsel; Mark O'Horo, Senior
Attorney, Chief Counsel's Office, (202) 649-5490; for persons who are
deaf or hearing impaired, TTY, (202) 649-5597, Office of the
Comptroller of the Currency, 400 7th Street SW, Washington, DC 20219.
Board: Flora Ahn, Special Counsel, (202) 452-2317, Gregory
Frischmann, Senior Counsel, (202) 452-2803, Kirin Walsh, Attorney,
(202) 452-3058, or Sarah Podrygula, Attorney, (202) 912-4658, Legal
Division, Cecily Boggs, Senior Financial Institution Policy Analyst,
(202) 530-6209, David Lynch, Deputy Associate Director, (202) 452-2081,
David McArthur, Senior Economist, (202) 452-2985, Division of
Supervision and Regulation; Board of Governors of the Federal Reserve
System, 20th and C Streets NW, Washington, DC 20551.
FDIC: Bobby R. Bean, Associate Director, [email protected], Michael E.
Spencer, Chief, Capital Markets Strategies, [email protected],
Andrew D. Carayiannis, Senior Policy Analyst, [email protected], or
Brian Cox, Senior Policy Analyst, [email protected], Capital Markets
Branch, (202) 898-6888; Michael B. Phillips, Counsel,
[email protected], Benjamin J. Klein, Counsel, [email protected], or
Annmarie H. Boyd, Counsel, [email protected], Legal Division, Federal
Deposit Insurance Corporation, 550 17th Street NW, Washington, DC
20429.
SEC: Andrew R. Bernstein, Senior Special Counsel, Sam Litz,
Attorney-Adviser, Aaron Washington, Special Counsel, or Carol McGee,
Assistant Director, at (202) 551-5870, Office of Derivatives Policy and
Trading Practices, Division of Trading and Markets, and Matthew Cook,
Senior Counsel, Benjamin Tecmire, Senior Counsel, and Jennifer Songer,
Branch Chief at (202) 551-6787 or [email protected], Division of
Investment Management, U.S. Securities and Exchange Commission, 100 F
Street NE, Washington, DC 20549.
CFTC: Cantrell Dumas, Special Counsel, (202) 418-5043,
[email protected]; Jeffrey Hasterok, Data and Risk Analyst, (646) 746-
9736, [email protected], Division of Swap Dealer and Intermediary
Oversight; Mark Fajfar, Assistant General Counsel, (202) 418-6636,
[email protected], Office of the General Counsel; Stephen Kane, Research
Economist, (202) 418-5911, [email protected], Office of the Chief
Economist; Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
II. Notice of Proposed Rulemaking
III. Overview of the Final Rule and Modifications From the Proposal
A. The Final Rule
B. Agency Coordination and Other Comments
IV. Section by Section Summary of the Final Rule
A. Subpart A--Authority and Definitions
B. Subpart B--Proprietary Trading Restrictions
C. Subpart C--Covered Fund Activities and Investments
D. Subpart D--Compliance Program Requirement; Violations
E. Subpart E--Metrics
V. Administrative Law Matters
A. Use of Plain Language
B. Paperwork Reduction Act
C. Regulatory Flexibility Act Analysis
D. Riegle Community Development and Regulatory Improvement Act
E. OCC Unfunded Mandates Reform Act Determination
F. SEC Economic Analysis
G. Congressional Review Act
I. Background
Section 13 of the Bank Holding Company Act of 1956 (BHC Act),\1\
also known as the Volcker Rule, generally prohibits any banking entity
from engaging in proprietary trading or from
[[Page 61975]]
acquiring or retaining an ownership interest in, sponsoring, or having
certain relationships with a hedge fund or private equity fund (covered
fund).\2\ The statute expressly exempts from these prohibitions various
activities, including among other things:
---------------------------------------------------------------------------
\1\ 12 U.S.C. 1851.
\2\ Id.
---------------------------------------------------------------------------
Trading in U.S. government, agency, and municipal
obligations;
Underwriting and market making-related activities;
Risk-mitigating hedging activities;
Trading on behalf of customers;
Trading for the general account of insurance companies;
and
Foreign trading by non-U.S. banking entities.\3\
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\3\ 12 U.S.C. 1851(d)(1).
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In addition, section 13 of the BHC Act contains several exemptions
that permit banking entities to engage in certain activities with
respect to covered funds, subject to certain restrictions designed to
ensure that banking entities do not rescue investors in those funds
from loss, and do not guarantee nor expose themselves to significant
losses due to investments in or other relationships with these
funds.\4\
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\4\ E.g., 12 U.S.C. 1851(d)(1)(G).
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Authority under section 13 for developing and adopting regulations
to implement the prohibitions and restrictions of section 13 of the BHC
Act is shared among the Board, the FDIC, the OCC, the SEC, and the CFTC
(individually, an agency, and collectively, the agencies).\5\ The
agencies issued a final rule implementing section 13 of the BHC Act in
December 2013 (the 2013 rule), and those provisions became effective on
April 1, 2014.\6\
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\5\ 12 U.S.C. 1851(b)(2).
\6\ Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships with, Hedge Funds and
Private Equity Funds; Final Rule, 79 FR 5535 (Jan. 31, 2014).
---------------------------------------------------------------------------
Since the adoption of the 2013 rule, the agencies have gained
several years of experience implementing the 2013 rule, and banking
entities have had more than five years of becoming familiar and
complying with the 2013 rule. The agencies have received various
communications from the public and other sources since adoption of the
2013 rule and over the course of the 2013 rule's implementation. Staffs
of the agencies also have held numerous meetings with banking entities
and other market participants to discuss the 2013 rule and its
implementation. In addition, the data collected in connection with the
2013 rule, compliance efforts by banking entities, and the agencies'
experiences in reviewing trading, investment, and other activity under
the 2013 rule have provided valuable insights into the effectiveness of
the 2013 rule. Together, these experiences have highlighted areas in
which the 2013 rule may have resulted in ambiguity, overbroad
application, or unduly complex compliance routines or may otherwise not
have been as effective or efficient in achieving its purpose as
intended or expected.
II. Notice of Proposed Rulemaking
Based on their experience implementing the 2013 rule, the agencies
published a notice of proposed rulemaking (the proposed rule or
proposal) on July 17, 2018, that proposed amendments to the 2013 rule.
These amendments sought to provide greater clarity and certainty about
what activities are prohibited under the 2013 rule and to improve the
effective allocation of compliance resources where possible.\7\
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\7\ Proposed Revisions to Prohibitions and Restrictions on
Proprietary Trading and Certain Interests in, and Relationships
With, Hedge Funds and Private Equity Funds, 83 FR 33432 (July 17,
2018).
---------------------------------------------------------------------------
The agencies sought to address a number of targeted areas for
revision in the proposal. First, the agencies proposed further
tailoring to make the scale of compliance activity required by the 2013
rule commensurate with a banking entity's size and level of trading
activity. In particular, the agencies proposed to establish three
categories of banking entities based on the firms' level of trading
activity--those with significant trading assets and liabilities, those
with moderate trading assets and liabilities, and those with limited
trading assets and liabilities.\8\ The agencies also invited comments
on whether certain definitions, including ``banking entity'' \9\ and
``trading desk,'' \10\ and ``covered fund'' \11\ should be modified.
---------------------------------------------------------------------------
\8\ See 83 FR 33437, 40-42.
\9\ See 83 FR 33442-46.
\10\ See 83 FR 33453-54.
\11\ See 83 FR 33471-82.
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The agencies also proposed making several changes to subpart B of
the 2013 rule, which implements the statutory prohibition on
proprietary trading and the various statutory exemptions to this
prohibition. The agencies proposed revisions to the trading account
definition,\12\ including replacing the short-term intent prong of the
trading account definition in the 2013 rule with a new prong based on
the accounting treatment of a position (the accounting prong) and, with
respect to trading activity subject only to the accounting prong,
establishing a presumption of compliance with the prohibition on
proprietary trading, based on the absolute value of a trading desk's
profit and loss.\13\ Under the proposed accounting prong, the trading
account would have encompassed financial instruments recorded at fair
value on a recurring basis under applicable accounting standards.
---------------------------------------------------------------------------
\12\ The definition of ``trading account'' is a threshold
definition that determines whether the purchase or sale of a
financial instrument by a banking entity is subject to the
restrictions and requirements of section 13 of the BHC Act and the
2013 rule.
\13\ See 83 FR 33446-51.
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In addition, the proposal would have modified several of the
exemptions and exclusions from the prohibition on proprietary trading
in subpart B to clarify how banking entities may qualify for those
exemptions and exclusions, as well as to reduce associated compliance
burdens. For example, the agencies proposed revising the 2013 rule's
exemptions for underwriting and market making-related activities,\14\
the exemption for risk-mitigating hedging activities,\15\ the exemption
for trading by a foreign banking entity that occurs solely outside of
the United States,\16\ and the liquidity management exclusion.\17\ In
addition, the agencies proposed establishing an exclusion for
transactions to correct trading errors.\18\
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\14\ See 83 FR 33454-62.
\15\ See 83 FR 33464-67.
\16\ See 83 FR 33467-70.
\17\ See 83 FR 33451-52.
\18\ See 83 FR 33452-53.
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The agencies also proposed certain modifications to the
prohibitions in subpart C on banking entities directly or indirectly
acquiring or retaining an ownership interest in, or having certain
relationships with, a covered fund. For example, the proposed rule
would have modified provisions related to the underwriting or market
making of ownership interests in covered funds \19\ and the exemption
for certain permitted covered fund activities and investments outside
of the United States. The proposal also would have expanded a banking
entity's ability to engage in hedging activities involving an ownership
interest in a covered fund.\20\ In addition, the agencies requested
comment regarding tailoring the definition of ``covered fund,''
including potential additional exclusions,\21\ and revising the
provisions limiting banking entities' relationships with covered
funds.\22\
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\19\ See 83 FR 33482-83
\20\ See 83 FR 33483-86.
\21\ See 83 FR 33471-82.
\22\ See 83 FR 33486-87.
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To enhance compliance efficiencies, the agencies proposed tailoring
the
[[Page 61976]]
compliance requirements based on new compliance tiers. The proposed
rule would have applied the six-pillar compliance program, and a CEO
attestation requirement largely consistent with the 2013 rule, to firms
with significant trading assets and liabilities and eliminated the
enhanced minimum standards for compliance programs in Appendix B of the
2013 rule.\23\ Firms with moderate trading assets and liabilities would
have been required to adhere to a simplified compliance program, with a
CEO attestation requirement,\24\ and firms with limited trading assets
and liabilities would have had a presumption of compliance with the
rule.\25\ The proposal also included a reservation of authority
specifying that the agencies could impose additional requirements on
banking entities with limited or moderate trading assets and
liabilities if warranted.\26\ The proposal would have revised the
metrics reporting and recordkeeping requirements by, for example,
applying those requirements based on a banking entity's size and level
of trading activity, eliminating some metrics, and adding a limited set
of new metrics to enhance compliance efficiencies.\27\ In addition, the
agencies requested comment on whether some or all of the reported
quantitative measurements should be made publically available.
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\23\ See 83 FR 33487-89; 33490-94.
\24\ See 83 FR 33489.
\25\ See 83 FR 33490.
\26\ See 83 FR 33454.
\27\ See 83 FR 33494-514.
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The agencies invited comment on all aspects of the proposal,
including specific proposed revisions and questions posed by the
agencies. The agencies received over 75 unique comments from banking
entities and industry groups, public interest groups, and other
organizations and individuals. In addition, the agencies received
approximately 3,700 comments from individuals using a version of a
short form letter to express opposition to the proposed rule. For the
reasons discussed below, the agencies are now adopting a final rule
that incorporates a number of modifications.
III. Overview of the Final Rule and Modifications From the Proposal
A. The Final Rule
Similar to the proposal, the final rule includes a risk-based
approach to revising the 2013 rule that relies on a set of clearly
articulated standards for both prohibited and permitted activities and
investments. The final rule is intended to further tailor and simplify
the rule to allow banking entities to more efficiently provide
financial services in a manner that is consistent with the requirements
of section 13 of the BHC Act.
The comments the agencies received from banking entities and
financial services industry trade groups were generally supportive of
the proposal, with the exception of the proposed accounting prong, and
provided recommendations for further targeted changes. The agencies
also received a few comments in opposition to the proposal from various
organizations and individuals.\28\ As described further below, the
agencies have adopted many of the proposed changes to the 2013 rule,
with certain targeted adjustments based on comments received.
Furthermore, the agencies intend to issue an additional notice of
proposed rulemaking that would propose additional, specific changes to
the restrictions on covered fund investments and activities and other
issues related to the treatment of investment funds under the
regulations implementing section 13 of the BHC Act.
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\28\ See, e.g., Senators Merkley et al.; Elise J. Bean (Bean);
National Association of Federally-Insured Credit Unions (NAFCU);
Better Markets, Inc. (Better Markets); Americans for Financial
Reform (AFR); Volcker Alliance; Occupy the SEC; and Volcker 2.0 Form
Letter.
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The final rule includes the same general three-tiered approach to
tailoring the compliance program requirements as the proposal. However,
based on comments received, the agencies have modified the threshold
for banking entities in the ``significant'' compliance category from
$10 billion in gross trading assets and liabilities to $20 billion in
gross trading assets and liabilities. The final rule also includes
modifications to the calculation of trading assets and liabilities for
purposes of determining which compliance tier a banking entity falls
into by excluding certain financial instruments that banking entities
are permitted to trade without limit under section 13. Additionally,
the final rule aligns the methodologies for calculating the ``limited''
and ``significant'' compliance thresholds for foreign banking
organizations by basing both thresholds on the trading assets and
liabilities of the firm's U.S. operations.\29\
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\29\ Under the proposal, the ``limited'' compliance threshold
would have been based on the trading assets and liabilities of a
foreign banking organization's worldwide operations whereas the
``significant'' compliance threshold would have been based on the
trading assets and liabilities of a foreign banking organization's
U.S. operations.
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The final rule also includes many of the proposed changes to the
proprietary trading restrictions, with certain changes based on
comments received. One such change is that the final rule does not
include the proposed accounting prong in the trading account
definition. Instead, the final rule retains a modified version of the
short-term intent prong and replaces the 2013 rule's rebuttable
presumption that financial instruments held for fewer than 60 days are
within the short-term intent prong of the trading account with a
rebuttable presumption that financial instruments held for 60 days or
longer are not within the short-term intent prong of the trading
account. The final rule also provides that a banking entity that is
subject to the market risk capital rule prong of the trading account
definition is not also subject to the short-term intent prong, and a
banking entity that is not subject to the market risk capital rule
prong may elect to apply the market risk capital rule prong (as an
alternative to the short-term intent prong). Additionally, the final
rule modifies the liquidity management exclusion from the proprietary
trading restrictions to permit banking entities to use a broader range
of financial instruments to manage liquidity, and it adds new
exclusions for error trades, certain customer-driven swaps, hedges of
mortgage servicing rights, and purchases or sales of instruments that
do not meet the definition of trading assets or liabilities.
Furthermore, the final rule revises the trading desk definition to
provide more flexibility to banking entities to align the definition
with other trading desk definitions in existing or planned compliance
programs. This modified definition also will provide for consistent
treatment across different regulatory regimes.
The final rule also includes the proposed changes to the exemptions
from the prohibitions in section 13 of the BHC Act for underwriting and
market making-related activities, risk-mitigating hedging, and trading
by foreign banking entities solely outside the United States. The final
rule also includes the proposed changes to the covered funds provisions
for which specific rule text was proposed, including with respect to
permitted underwriting and market making and risk-mitigating hedging
with respect to a covered fund, as well as investment in or sponsorship
of covered funds by foreign banking entities solely outside the United
States and the exemption for prime brokerage transactions. With respect
to the exemptions for underwriting and market making-related
activities, the final rule adopts the presumption of compliance with
the
[[Page 61977]]
reasonably expected near-term demand requirement for trading within
certain internal limits, but instead of requiring banking entities to
promptly report limit breaches or increases to the agencies, banking
entities are required to maintain and make available upon request
records of any such breaches or increases and follow certain internal
escalation and approval procedures in order to remain qualified for the
presumption of compliance.
With respect to the compliance program requirements, the final rule
includes the changes from the proposal to eliminate the enhanced
compliance requirements in Appendix B of the 2013 rule and to tailor
the compliance program requirements based on the size of the banking
entity's trading activity. However, different from the proposal, the
final rule only applies the CEO attestation requirement to firms with
significant trading assets and liabilities. Also, in response to
comments, the final rule includes modifications to the metrics
collection requirements to, among other things, eliminate certain
metrics and reduce the compliance burden associated with the
requirement.
For the OCC, Board, FDIC, and CFTC, the final amendments will be
effective on January 1, 2020. For the SEC, the final amendments will be
effective on January 13, 2020. In order to give banking entities a
sufficient amount of time to comply with the changes adopted, banking
entities will not be required to comply with the final amendments until
January 1, 2021. During that time, the 2013 rule will remain in effect
as codified in appendix Z, which is a temporary appendix that will
expire on the compliance date. However, banking entities may
voluntarily comply, in whole or in part, with the amendments adopted in
this release prior to the compliance date, subject to the agencies'
completion of necessary technical changes. In particular, the agencies
need to complete certain technological programming in order to accept
metrics compliant with the final amendments. The agencies will conduct
a test run with banking entities of the revised metrics submission
format. A banking entity seeking to switch to the revised metrics prior
to January 1, 2021, must first successfully test submission of the
revised metrics in the new XML format. Accordingly, banking entities
should work with each appropriate agency to determine how and when to
voluntarily comply with the metrics requirements under the final rules
and to notify such agencies of their intent to comply, prior to the
January 1, 2021, compliance date.
B. Interagency Coordination and Other Comments
Section 13(b)(2)(B)(ii) of the BHC Act directs the agencies to
``consult and coordinate'' in developing and issuing the implementing
regulations ``for the purpose of assuring, to the extent possible, that
such regulations are comparable and provide for consistent application
and implementation of the applicable provisions of [section 13 of the
BHC Act] to avoid providing advantages or imposing disadvantages to the
companies affected . . . .'' \30\ The agencies recognize that
coordinating with each other to the greatest extent practicable with
respect to regulatory interpretations, examinations, supervision, and
sharing of information is important to maintaining consistent
oversight, promoting compliance with section 13 of the BHC Act and
implementing regulations, and to fostering a level playing field for
affected market participants. The agencies further recognize that
coordinating these activities helps to avoid unnecessary duplication of
oversight, reduces costs for banking entities, and provides for more
efficient regulation.
---------------------------------------------------------------------------
\30\ 12 U.S.C. 1851(b)(2)(B)(ii).
---------------------------------------------------------------------------
In the proposal, the agencies requested comment on interagency
coordination regarding the Volcker Rule in general and asked several
specific questions relating to transparency, efficiency, and safety and
soundness.\31\ Numerous commenters, including banking entities and
industry groups, suggested that the agencies more effectively
coordinate Volcker Rule related supervision, examinations, and
enforcement, in order to improve efficiency and predictability in
supervision and oversight.\32\ For example, several commenters
suggested that Volcker Rule related supervision should be conducted
solely by a bank's prudential onsite examiner,\33\ and that the two
market regulators be required to consult and coordinate with the
prudential onsite examiner.\34\ Several commenters encouraged the
agencies to memorialize coordination and information sharing between
the agencies by entering into a formal written agreement, such as an
interagency Memorandum of Understanding.\35\
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\31\ 83 FR 33436.
\32\ See, e.g., American Bankers Association (ABA); Institute of
International Bankers (IIB); BB&T; Committee on Capital Markets
Regulation (CCMR); Japanese Bankers Association (JBA); and the CFA
Institute (CFA). Commenters also recommended designating to one
agency the task of interpreting the implementing regulations and
issuing guidance to smaller banking entities. See, e.g., Credit
Suisse and Lori Nuckolls.
\33\ See, e.g., ABA; Arvest Bank (Arvest); Credit Suisse; and
Financial Services Forum (FSF).
\34\ See ABA.
\35\ See, e.g., ABA; BB&T; CCMR; and FSF.
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Several comment letters from public interest organizations
suggested that the agencies have not provided sufficient transparency
when implementing and enforcing the Volcker Rule, and urged the
agencies to make public certain information related to enforcement
actions, metrics, and covered funds activities.\36\ In addition,
several commenters, including a member of Congress, argued that the
agencies have not adequately explained or provided evidence to support
the current rulemaking.\37\
---------------------------------------------------------------------------
\36\ See, e.g., AFR; Public Citizen; Volcker Alliance; and CFA.
\37\ See, e.g., CAP; Merkley; and Public Citizen.
---------------------------------------------------------------------------
The agencies agree with commenters that interagency coordination
plays an important role in the effective implementation and enforcement
of the Volcker Rule, and acknowledge the benefits of providing
transparency in proposing and adopting rules to implement section 13 of
the BHC Act. Accordingly, the agencies have endeavored to provide
specificity and clarity in the final rule to avoid conflicting
interpretations or uncertainty. The final rule also includes notice and
response procedures that provide a greater degree of certainty about
the process by which the agencies will make certain determinations
under the final rule. The agencies continue to recognize the benefits
of consistent application of the rules implementing section 13 of the
BHC Act and intend to continue to consult with each other when
formulating guidance on the final rule that would be shared with the
public generally. That said, the agencies also are mindful of the need
to strike an appropriate balance between public disclosure and the
protection of sensitive, confidential information, and the agencies are
generally restricted from disclosing sensitive, confidential business
and supervisory information on a firm-specific basis.
Several commenters provided general comments regarding the proposal
and the current rulemaking. For example, several public interest
commenters suggested that the proposed rule did not provide a
sufficient financial disincentive against proprietary trading and
encouraged the agencies to adopt certain limitations on compensation
arrangements.\38\ A commenter also suggested possible penalties for
rule violations and encouraged the agencies to elaborate on the
consequences of
[[Page 61978]]
significant violations of the rule.\39\ Other commenters recommended
that the agencies impose strong penalties on banking entities that
break the law.\40\ The agencies believe that the appropriate
consequences for a violation of the rule will likely depend on the
specific facts and circumstances in individual cases, as well as each
agency's statutory authority under section 13, and therefore are not
amending the rule to provide for specific penalties or financial
disincentives for violations. Finally, several commenters suggested
that the proposed rule is too complex and may provide too much
deference to a banking entity's internal procedures and models (for
example, in provisions related to underwriting, market making, and
hedging), and that the proposed revisions would make the rule less
effective.\41\ As discussed further below, the agencies believe that
the particular changes adopted in the final rule are meaningfully
simpler and streamlined compared to the 2013 rule, and are appropriate
for the reasons described in greater detail below.
---------------------------------------------------------------------------
\38\ See, e.g., Public Citizen and CAP.
\39\ See Public Citizen.
\40\ See Volcker 2.0 Form Letter.
\41\ See, e.g., Systemic Risk Council and Oonagh McDonald.
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IV. Section by Section Summary of the Final Rule
A. Subpart A--Authority and Definitions
1. Section __.2: Definitions
a. Banking Entity
Section 13(a)(1)(A) of the BHC Act prohibits a banking entity from
engaging in proprietary trading or acquiring or retaining an ownership
interest, or sponsoring, a covered fund, unless the activity is
otherwise permissible under section 13.\42\ Therefore, the definition
of the term ``banking entity'' defines the scope of entities subject to
restrictions under the rule. Section 13(h)(1) of the BHC Act defines
the term ``banking entity'' to include (i) any insured depository
institution (as defined by statute); (ii) any company that controls an
insured depository institution; (iii) any company that is treated as a
bank holding company for purposes of section 8 of the International
Banking Act of 1978; and (iv) any affiliate or subsidiary of any such
entity.\43\ The regulations implementing this provision are consistent
with the statute and also exclude covered funds that are not themselves
banking entities, certain portfolio companies, and the FDIC acting in
its corporate capacity as conservator or receiver.\44\
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\42\ 12 U.S.C. 1851(a)(1)(A). A banking entity may engage in an
activity that is permissible under section 13 of the BHC Act only to
the extent permitted by any other provision of Federal and State
law, and subject to other applicable restrictions. See 12 U.S.C.
1851(d)(1).
\43\ 12 U.S.C. 1851(h)(1).
\44\ See 2013 rule Sec. __.2(c).
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In addition, the agencies note that, consistent with the statute,
for purposes of this definition, the term ``insured depository
institution'' does not include certain institutions that function
solely in a trust or fiduciary capacity, and certain community banks
and their affiliates.\45\ Section 203 of the Economic Growth,
Regulatory Relief, and Consumer Protection Act (EGRRCPA) amended the
definition of ``banking entity'' in the Volcker Rule to exclude certain
community banks from the definition of insured depository institution,
the general result of which was to exclude community banks and their
affiliates and subsidiaries from the scope of the Volcker Rule.\46\ On
July 22, 2019, the agencies adopted a final rule amending the
definition of ``insured depository institution,'' in a manner
consistent with EGRRCPA.\47\
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\45\ See final rule Sec. __.2(r).
\46\ Public Law 115-174 (May 24, 2018).
\47\ See 84 FR 35008.
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The proposed rule did not propose specific rule text to amend the
definition of ``banking entity,'' but invited comment on a number of
specific issues.\48\ The agencies received several comments about the
``banking entity'' definition, many of which asked that the agencies
revise this definition to exclude specific types of entities.
---------------------------------------------------------------------------
\48\ See 83 FR 33442-446.
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Several commenters expressed concern about the treatment of certain
funds that are excluded from the definition of ``covered fund'' in the
2013 rule, including registered investment companies (RICs), foreign
public funds (FPFs), and, with respect to a foreign banking entity,
certain foreign funds offered and sold outside of the United States
(foreign excluded funds).\49\ In particular, these commenters noted
that when a banking entity invests in such funds, or has certain
corporate governance rights or other control rights with respect to
such funds, the funds could meet the definition of ``banking entity''
for purposes of the Volcker Rule.\50\ Concerns about certain funds'
potential status as banking entities arise, in part, because of the
interaction between the statute's and the 2013 rule's definitions of
the terms ``banking entity'' and ``covered fund.'' Sponsors of RICs,
FPFs, and foreign excluded funds have noted that the treatment of such
funds as ``banking entities'' would disrupt bona fide asset management
activities (including fund investment strategies that may include
proprietary trading or investing in covered funds), which these
sponsors argued would be inconsistent with section 13 of the BHC
Act.\51\ Commenters also noted that treatment of RICs, FPFs, and
foreign excluded funds as ``banking entities'' would put such banking
entity-affiliated funds at a competitive disadvantage compared to funds
not affiliated with a banking entity, and therefore not subject to
restrictions under section 13 of the BHC Act.\52\ In general,
commenters also asserted that the treatment of RICs, FPFs, and foreign
excluded funds as banking entities would not further the policy
objectives of section 13 of the BHC Act.\53\
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\49\ See, e.g., ABA; American Investment Council (AIC);
Bundesverband Investment (BVI); Canadian Bankers Association (CBA);
European Banking Federation (EBF); Federated Investors II; Financial
Services Agency and Bank of Japan (FSA/Bank of Japan); European Fund
and Asset Management Association (EFAMA); and IIB.
\50\ Id.
\51\ See, e.g., IIB and Securities Industry and Financial
Markets Association (SIFMA).
\52\ See, e.g., Capital One et al.; Credit Suisse; EBF; and
Investment Adviser Association (IAA).
\53\ See, e.g., ABA; EBF; and Investment Company Institute
(ICI).
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Several commenters suggested that the agencies exclude from the
definition of ``banking entity'' foreign excluded funds.\54\ These
commenters generally noted that failing to exclude such funds from the
definition of ``banking entity'' in the 2013 rule has the unintended
consequence of imposing proprietary trading restrictions and compliance
obligations on foreign excluded funds that are in some ways more
burdensome than the requirements that would apply under the 2013 rule
to covered funds. Another commenter expressed opposition to carving out
foreign excluded funds from the definition of banking entity.\55\ The
staffs of the agencies continue to consider ways in which the
regulations may be amended in a manner consistent with the statutory
definition of ``banking entity,'' or other appropriate actions that may
be taken, to address any unintended consequences of section 13 of the
BHC Act and the 2013 rule. The agencies intend to issue a separate
proposed
[[Page 61979]]
rulemaking that specifically addresses the fund structures under the
rule, including the treatment of foreign excluded funds.
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\54\ Id. In addition to the requests from commenters for the
agencies to exclude foreign excluded funds from the ``banking
entity'' definition, commenters also asked the agencies to adopt
other amendments to address the treatment of such funds, including
by providing a presumption of compliance for such funds (CBA; EBF;
and IIB), to permit a banking entity to elect to treat a foreign
excluded fund as a covered fund (CBA; EBF; and IIB), and to
permanently extend the temporary relief currently provided to
foreign excluded funds (IIB).
\55\ See Data Boiler Technologies, LLC (Data Boiler).
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To provide additional time to complete this rulemaking, the Federal
banking agencies released a policy statement on July 17, 2019, in
response to concerns about the treatment of foreign excluded funds.
This policy statement provides that the Federal banking agencies would
not propose to take action during the two-year period ending on July
21, 2021, against a foreign banking entity based on attribution of the
activities and investments of a qualifying foreign excluded fund to the
foreign banking entity,\56\ or against a qualifying foreign excluded
fund as a banking entity, in each case where the foreign banking
entity's acquisition or retention of any ownership interest in, or
sponsorship of, the qualifying foreign excluded fund would meet the
requirements for permitted covered fund activities and investments
solely outside the United States, as provided in section 13(d)(1)(I) of
the BHC Act and Sec. __.13(b) of the 2013 rule, as if the qualifying
foreign excluded fund were a covered fund.\57\
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\56\ Foreign banking entity was defined for purposes of the
policy statement to mean a banking entity that is not, and is not
controlled directly or indirectly by, a banking entity that is
located in or organized under the laws of the United States or any
State.
\57\ See Board of Governors of the Federal Reserve System,
Federal Deposit Insurance Corporation, and Office of the Comptroller
of the Currency, ``Statement regarding Treatment of Certain Foreign
Funds under the Rules Implementing Section 13 of the Bank Holding
Company Act'' (July 17, 2019). This policy statement continued the
position of the Federal banking agencies that was released on July
21, 2017, and the position that the agencies expressed in the
proposal. See 83 FR 33444.
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Several commenters expressed concern with the treatment of RICs and
FPFs, which are subject to significant regulatory requirements in the
United States and foreign jurisdictions, respectively. These commenters
encouraged the agencies to consider excluding such entities from the
definition of ``banking entity.'' \58\ In the past, the staffs of the
agencies issued several FAQs to address the treatment of RICs and
FPFs.\59\ One of these staff FAQs provides guidance about the treatment
of RICs and FPFs during the period in which the banking entity is
testing the fund's investment strategy, establishing a track record of
the fund's performance for marketing purposes, and attempting to
distribute the fund's shares (the so-called seeding period).\60\
Another FAQ stated that staffs of the agencies would not view the
activities and investments of an FPF that meets certain eligibility
requirements in the 2013 rule as being attributed to the banking entity
for purposes of section 13 of the BHC Act or the 2013 rule, where the
banking entity (i) does not own, control, or hold with the power to
vote 25 percent or more of any class of voting shares of the FPF (after
the seeding period), and (ii) provides investment advisory, commodity
trading advisory, administrative, and other services to the fund in
compliance with applicable limitations in the relevant foreign
jurisdiction. Similarly, this FAQ stated that the staffs of the
agencies would not view the FPF to be a banking entity for purposes of
section 13 of the BHC Act and the 2013 rule solely by virtue of its
relationship with the sponsoring banking entity, where these same
conditions are met.\61\
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\58\ See, e.g., CCMR; IAA; ICI; and Capital One et al. One
commenter also expressed support for a narrower exclusion for RICs
and FPFs that would apply only during a non-time-limited seeding
period. JP Morgan Asset Management.
\59\ See https://www.occ.treas.gov/topics/capitalmarkets/financial-markets/trading-volcker-rule/volcker-rule-implementation-faqs.html (OCC); https://www.federalreserve.gov/bankinforeg/volcker-rule/faq.htm (Board); https://www.fdic.gov/regulations/reform/volcker/faq.html (FDIC); https://www.sec.gov/divisions/marketreg/faq-volcker-rulesection13.htm (SEC); https://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_28_VolckerRule/index.htm
(CFTC).
\60\ Id., FAQ 16.
\61\ Id., FAQ 14.
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As noted above, the agencies intend to issue a separate proposal
addressing and requesting comment on the covered fund provisions and
other fund-related issues. The final rule does not modify or revoke any
previously issued staff FAQs or guidance related to RICs, FPFs, and
foreign excluded funds.\62\
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\62\ The FAQs represent the views of staff of the agencies. They
are not rules, regulations, or statements of the agencies.
Furthermore, the agencies have neither approved nor disapproved
their content. The FAQs, like all staff guidance, have no legal
force or effect: They do not alter or amend applicable law, and they
create no new or additional obligations for any person.
---------------------------------------------------------------------------
Apart from these topics, the agencies received numerous other
comments about the treatment of entities as ``banking entities'' under
section 13 of the BHC Act. In general, these commenters requested that
the agencies provide additional exclusions from the definition of
``banking entity'' for various types of entities. One commenter
suggested that, as an alternative to excluding certain entities from
the banking entity definition, the agencies could exempt the activities
of these entities from the proprietary trading and covered fund
prohibitions.\63\
---------------------------------------------------------------------------
\63\ See Bank Policy Institute (BPI).
---------------------------------------------------------------------------
One commenter recommended that the agencies provide a general
exemption from the banking entity definition for investment funds,
except in circumstances where the investment fund is determined to have
been organized to permit the banking entity sponsor to engage in
impermissible proprietary trading.\64\ Some commenters encouraged the
agencies to exclude employee securities companies from the definition
of ``banking entity.'' \65\ One commenter argued that despite a banking
entity's role as a general partner in employee securities companies,
treating such entities as ``banking entities'' does not further the
policy goals of section 13 of the BHC Act.\66\ Several commenters
encouraged the agencies to exclude from the definition of ``banking
entity'' any non-consolidated subsidiaries not operated or managed by a
banking entity, on the basis that such entities were never intended to
be subject to section 13 of the BHC Act.\67\ Another commenter said the
agencies should exclude from the definition of ``banking entity'' all
employee compensation plans, regardless of whether such plans are
qualified or non-qualified.\68\ Other commenters suggested that the
agencies should exclude subsidiaries of foreign banking entities that
do not engage in trading activities in the United States, or otherwise
limit application to foreign subsidiaries of foreign banking
groups.\69\ Other commenters requested modification of the definition
of ``banking entity'' to exclude parent companies and affiliates of
industrial loan companies, noting that such companies are generally not
subject to other restrictions on their activities under the BHC
Act.\70\
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\64\ See EFAMA.
\65\ See, e.g., ABA and FSF.
\66\ See ABA.
\67\ See, e.g., ABA; BPI; SIFMA; JBA.
\68\ See BB&T.
\69\ See JBA. This commenter suggested that in the absence of an
exclusion for such entities, simplified compliance program
requirements should apply to foreign subsidiaries of foreign banking
entities that do not engage in trading activities in the United
States. The agencies believe that several of the other changes in
this final rule will provide relief to foreign banking entities that
engage in no trading activities in the United States, including
simplifications to the exemption for foreign banking entities
engaged in trading outside of the United States, and more tailored
compliance program requirements. See also FSA/Bank of Japan; IIB.
\70\ See, e.g., EnerBank USA (EnerBank); Marketplace Lending
Association; National Association of Industrial Bankers.
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One commenter encouraged the agencies to exclude international
banks from the definition of ``banking entity'' if they have limited
U.S. trading assets and liabilities.\71\ This commenter also
[[Page 61980]]
encouraged the agencies to exclude certain non-U.S. commercial
companies that are comparable to U.S. merchant banking portfolio
companies.\72\ This commenter argued that excluding these entities
would not pose material risks to the financial stability of the United
States.
---------------------------------------------------------------------------
\71\ See IIB. This commenter also proposed modifying the manner
in which ``banking entity'' status is determined by disaggregating
separate, independent corporate groups.
\72\ Id.
---------------------------------------------------------------------------
Some commenters suggested that the agencies should clarify the
standards for what constitutes ``control'' in the context of
determining whether an entity is an ``affiliate'' or ``subsidiary'' for
purposes of the definition of ``banking entity'' in the Volcker
Rule.\73\ One commenter suggested that the definition of ``banking
entity'' should include only a company in which a banking entity owns,
controls, or has the power to vote 25 percent or more of a class of
voting securities of the company.\74\
---------------------------------------------------------------------------
\73\ See, e.g., EnerBank and Capital One et al. See 12 U.S.C.
1841(a)(2)(C).
\74\ See Capital One et al.
---------------------------------------------------------------------------
The definition of ``banking entity'' in section 13 of the BHC Act
uses the definition of control in section 2 of the BHC Act.\75\ Under
the BHC Act, ``control'' is defined by a three-pronged test. A company
has control over another company if the first company (i) directly or
indirectly or acting through one or more other persons owns, controls,
or has power to vote 25 percent or more of any class of voting
securities of the other company; (ii) controls in any manner the
election of a majority of the directors of the other company; or (iii)
directly or indirectly exercises a controlling influence over the
management or policies of the other company.\76\ The Board recently
issued a proposed rulemaking that would clarify the standards for
evaluating whether one company exercises a controlling influence over
another company for purposes of the BHC Act.\77\
---------------------------------------------------------------------------
\75\ 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e).
\76\ Id.
\77\ See ``Control and Divestiture Proceedings,'' 84 FR 21634-
666 (May 14, 2019).
---------------------------------------------------------------------------
The final rule does not amend the definition of banking entity.
Commenters raised important considerations with respect to the
consequences of the current ``banking entity'' definition under section
13 of the BHC Act and the 2013 rule. The agencies believe that other
amendments to the requirements of the regulations implementing the
Volcker Rule may address some of the issues raised by commenters.
Certain concerns raised by commenters may need to be addressed through
amendments to section 13 of the BHC Act.\78\ In addition, as noted
above, the agencies intend to revisit the fund-related provisions of
the Volcker Rule in a separate rulemaking.
---------------------------------------------------------------------------
\78\ See, e.g., Economic Growth, Regulatory Relief, and Consumer
Protection Act Sec. 203 (excluding community banks from the
definition of ``banking entity'').
---------------------------------------------------------------------------
b. Limited, Moderate, and Significant Trading Assets and Liabilities
The proposal would have established three categories of banking
entities based on their level of trading activity, as measured by the
average gross trading assets and liabilities of the banking entity and
its subsidiaries and affiliates (excluding obligations of or guaranteed
by the United States or any agency of the United States) over the
previous four consecutive quarters.\79\ These categories would have
been used to calibrate compliance requirements for banking entities,
with the most stringent compliance requirements applicable to those
with the greatest level of trading activities.
---------------------------------------------------------------------------
\79\ See proposed rule Sec. __.2(t), (v), (ff). Under the
proposal, a foreign banking entity's trading assets and liabilities
would have been calculated based on worldwide trading assets and
liabilities with respect to the $1 billion threshold between limited
and moderate trading assets and liabilities, but based on the
trading assets and liabilities only of its combined U.S. operations
with respect to the $10 billion threshold between moderate and
significant trading assets and liabilities. See proposed rule Sec.
__.2(t)(1), (ff)(2)-(3).
---------------------------------------------------------------------------
The first category would have included firms with ``significant''
trading assets and liabilities, defined as those banking entities that
have consolidated trading assets and liabilities equal to or exceeding
$10 billion.\80\ The second category would have included firms with
``moderate'' trading assets and liabilities, which would have included
those banking entities that have consolidated trading assets and
liabilities of $1 billion or more, but with less than $10 billion in
consolidated trading assets and liabilities.\81\ The final category
would have included firms with ``limited'' trading assets and
liabilities, defined as those banking entities that have less than $1
billion in consolidated trading assets and liabilities.\82\ The
proposal would have also provided the agencies with a reservation of
authority to require a banking entity with limited or moderate trading
assets and liabilities to apply the compliance program requirements of
a higher compliance tier if an agency determined that the size or
complexity of the banking entity's trading or investment activities, or
the risk of evasion of the requirements of the rule, warranted such
treatment.\83\ The proposal also solicited comment as to whether there
should be further tailoring of the thresholds for a banking entity that
is an affiliate of another banking entity with significant trading
assets and liabilities, if that entity generally operates on a basis
that is separate and independent from its affiliates and parent
companies.\84\
---------------------------------------------------------------------------
\80\ Proposed rule Sec. __.2(ff).
\81\ Proposed rule Sec. __.2(v).
\82\ Proposed rule Sec. __.2(t).
\83\ Proposed rule Sec. __.20(h).
\84\ See 83 FR at 33442 (question 7).
---------------------------------------------------------------------------
Commenters provided feedback on multiple aspects of the tiered
compliance framework, including the level of the proposed thresholds
between the categories ($1 billion and $10 billion in trading assets
and liabilities), the manner in which ``trading assets and
liabilities'' should be measured, and alternative approaches that
commenters believed would be preferable to the proposed three-tiered
compliance framework. As described further below, after consideration
of the comments received, the agencies are adopting a three-tiered
compliance framework that is consistent with the proposal, with
targeted adjustments to further tailor compliance program requirements
based on the level of a firm's trading activities, and in light of
concerns raised by commenters.\85\ The agencies believe that this
approach will increase compliance efficiencies for all banking entities
relative to the 2013 rule and the proposal, and will further reduce
compliance costs for firms that have little or no activity subject to
the prohibitions and restrictions of section 13 of the BHC Act.
---------------------------------------------------------------------------
\85\ See final rule Sec. __.2(s), (u), (ee).
---------------------------------------------------------------------------
Several commenters expressed support for the proposed three-tiered
compliance framework in the proposal.\86\ One commenter noted that the
2013 rule's compliance regime, which imposes significant compliance
obligations on all banking entities with $50 billion or more in total
consolidated assets, does not appropriately tailor compliance
obligations to the scope of activities covered under the regulation,
particularly for firms engaged in limited trading activities.\87\ Other
commenters expressed general opposition to the proposed three-tiered
compliance program.\88\ Another commenter expressed concern in
particular that banking entities with ``limited'' trading assets and
liabilities would have been presumed compliant with the requirements of
section 13 of the BHC
[[Page 61981]]
Act under the proposed rule.\89\ Some commenters also suggested that
the agencies adopt a two-tiered compliance program, bifurcating banking
entities into those with and without significant trading assets and
liabilities.\90\ One commenter expressed opposition to tailoring
compliance requirements for banking entities that operate separately
and independently from their affiliates, by calculating trading assets
and liabilities for such entities independent of the activities of
affiliates.\91\ The agencies believe that the three-tiered framework
set forth in the proposal, subject to the additional amendments
described below, appropriately differentiates among banking entities
for the purposes of tailoring compliance requirements. Specifically,
the agencies believe that the significant differences in business
models and activities among banking entities that would have
significant trading assets and liabilities, moderate trading assets and
liabilities, and limited trading assets and liabilities, as described
below, support having a three-tiered compliance framework.
---------------------------------------------------------------------------
\86\ See, e.g., BB&T Corporation; CFA; CCMR; and State Street
Corporation (State Street).
\87\ See State Street.
\88\ See, e.g., Bean; Data Boiler Technologies; and Occupy the
SEC.
\89\ See Occupy the SEC.
\90\ See, e.g., ABA; Capital One et al.; and KeyCorp and KeyBank
(KeyCorp).
\91\ See Data Boiler Technologies.
---------------------------------------------------------------------------
A few commenters recommended that the agencies raise the proposed
$1 billion threshold between banking entities with limited and moderate
trading assets and liabilities.\92\ These commenters suggested that
raising this threshold to $5 billion in trading assets and liabilities
would be consistent with the objective of the proposal to have the most
streamlined requirements imposed on banking entities with a relatively
small amount of trading activities. Other commenters recommended that
the threshold between banking entities with limited and moderate
trading activities was appropriate or should be set at a lower
level.\93\ The agencies believe that the compliance obligations
applicable to banking entities with limited trading assets and
liabilities are most appropriately reserved for banking entities below
the $1 billion threshold set forth in the proposal. Such banking
entities tend to have simpler business models and do not have large
trading operations that would warrant the expanded compliance
obligations applicable to banking entities with moderate and
significant trading assets and liabilities. As discussed further below,
these banking entities also hold a relatively small amount of the
trading assets and liabilities in the U.S. banking system. Therefore,
the final rule adopts the threshold from the proposed rule for
determining whether a banking entity has limited trading assets and
liabilities.\94\
---------------------------------------------------------------------------
\92\ See, e.g., ABA; Capital One et al.; and BPI.
\93\ See, e.g., Data Boiler (encouraging the agencies to lower
the threshold to $500 million in trading assets and liabilities) and
B&F Capital Markets (B&F) (expressing support for the proposed $1
billion threshold).
\94\ See final rule Sec. __.2(s)(2)-(3).
---------------------------------------------------------------------------
Several commenters recommended that the agencies modify the
threshold for ``significant'' trading assets and liabilities.\95\
Generally, these commenters expressed support for raising the threshold
from $10 billion in trading assets and liabilities to $20 billion in
trading assets and liabilities.\96\ These commenters noted that this
change would have minimal impact on the number of banking entities that
would remain categorized as having significant trading assets and
liabilities.\97\ Several commenters also noted that increasing the
threshold from $10 billion to $20 billion would provide additional
certainty to banking entities that are near or approaching the $10
billion threshold, because market events or unusual customer demands
could cause such banking entities to exceed (permanently or on a short-
term basis) the $10 billion trading assets and liabilities
threshold.\98\ The final rule adopts the change recommended by several
commenters to raise the threshold from $10 billion to $20 billion for
calculating whether a banking entity has significant trading assets and
liabilities.\99\
---------------------------------------------------------------------------
\95\ See, e.g., ABA; Bank of New York Mellon Corporation,
Northern Trust Corporation, and State Street Corporation (Custody
Banks); New England Council; Capital One et al.; SIFMA; State
Street; and BPI.
\96\ Id.
\97\ Id.
\98\ See, e.g., ABA; Capital One et al.; and SIFMA.
\99\ See final rule Sec. __.2(ee)(1)(i).
---------------------------------------------------------------------------
The agencies estimate that, under the final rule with the increased
threshold from $10 billion to $20 billion described above, banking
entities classified as having significant trading assets and
liabilities would hold approximately 93 percent of the trading assets
and liabilities in the U.S. banking system. The agencies also estimate
that banking entities with significant trading assets and liabilities
and those with moderate trading assets and liabilities in combination
would hold approximately 99 percent of the trading assets and
liabilities in the U.S. banking system. Therefore, both of these
thresholds will tailor the compliance obligations under the final rule
for all firms by virtue of imposing greater compliance obligations on
those banking entities with the most substantial levels of trading
activities.
One commenter suggested that the agencies index the compliance tier
thresholds to inflation.\100\ At present, the agencies do not believe
that the additional complexity associated with inflation-indexing the
thresholds in the final rule is necessary in light of the other changes
to the thresholds and calculation methodologies described below,
including the increase in the threshold for firms with significant
trading assets and liabilities from $10 billion to $20 billion, and the
modifications to the calculation of trading assets and liabilities
adopted in the final rule.\101\
---------------------------------------------------------------------------
\100\ See Capital One et al.
\101\ See, e.g., final rule Sec. __.2(ee)(1)(i).
---------------------------------------------------------------------------
Commenters recommended that the regulations incorporate a number of
changes to the methodology used in the proposed rule to classify firms
into different compliance tiers. Some commenters recommended that the
agencies apply a consistent methodology to foreign banking entities to
classify such firms as having significant trading assets and
liabilities, moderate trading assets and liabilities, or limited
trading assets and liabilities.\102\ For purposes of classifying the
banking entity as having significant trading assets and liabilities,
the proposal would have included only the trading assets and
liabilities of the combined U.S. operations of a foreign banking
entity, but used the banking entity's worldwide trading assets and
liabilities for purposes of classifying the firm as having either
limited trading assets and liabilities or moderate trading assets and
liabilities.\103\ Commenters recommended that the agencies apply a
consistent standard for classifying a foreign banking entity as having
significant trading assets and liabilities, moderate trading assets and
liabilities, or limited trading assets and liabilities, and that the
most appropriate measure would look only at the combined U.S.
operations of such a banking entity.\104\ These commenters noted that
classifying foreign banking entities based on their global trading
activities could have the result of imposing extensive compliance
obligations on the non-U.S. trading activities of a banking entity with
minimal U.S. trading activities.\105\
---------------------------------------------------------------------------
\102\ See, e.g., IIB and JBA.
\103\ See proposed rule Sec. __.2(t)(1), (ff)(2)-(3).
\104\ See, e.g., IIB and JBA.
\105\ Id.
---------------------------------------------------------------------------
The final rule adopts a consistent methodology for calculating the
trading assets and liabilities of foreign banking entities across all
categories, taking into account only the trading assets and
[[Page 61982]]
liabilities of such banking entities' combined U.S. operations.\106\
The agencies believe this approach is appropriate, particularly for
foreign firms with little or no U.S. trading activity but substantial
worldwide trading operations. The agencies further believe that the
trading activities of foreign banking entities that occur outside of
the United States and are booked into such foreign banking entities (or
into their foreign affiliates), pose substantially less risk to the
U.S. financial system than trading activities booked into a U.S.
banking entity, including a U.S. banking entity that is an affiliate of
a foreign banking entity. This approach is also appropriate in light of
provisions in section 13 of the BHC Act that provide foreign banking
entities with significant flexibility to conduct trading and covered
fund activities outside of the United States.\107\
---------------------------------------------------------------------------
\106\ See final rule Sec. __.2(s)(3), (ee)(3).
\107\ See Section 13(d)(1)(H), (I) (12 U.S.C. 1851(d)(1)(H),
(I)).
---------------------------------------------------------------------------
One commenter expressed concern that the regulations did not give
banking entities sufficient guidance as to how to calculate their
trading assets and liabilities, and asked that the regulations
expressly permit a banking entity to rely on home jurisdiction
accounting standards when calculating trading assets and
liabilities.\108\ In light of the changes to the methodology for
calculating trading assets and liabilities noted above, in particular
using combined U.S. trading assets and liabilities for establishing the
appropriate compliance tier for foreign banking entities, the agencies
believe that further clarifications to the standards for calculating
``trading assets and liabilities'' are not necessary for banking
entities to have sufficient information available as to the manner in
which to calculate trading assets and liabilities.
---------------------------------------------------------------------------
\108\ See JBA.
---------------------------------------------------------------------------
A few commenters suggested that the threshold for ``significant
trading assets and liabilities'' should be determined based on the
relative size of the banking entity's total trading assets and
liabilities as compared to other metrics, such as total consolidated
assets or capital, thereby establishing a banking entity's compliance
requirements based on the significance of trading activities to the
banking entity.\109\ Some commenters suggested that the use of trading
assets and liabilities alone as a metric to classify banking entities
for determining compliance obligations was inappropriate.\110\ The
agencies believe that a banking entity's trading assets and
liabilities, as calculated under the methodology described in the final
rule, is an appropriate metric to use in establishing compliance
requirements for banking entities. Imposing compliance obligations on a
banking entity based on the relative significance of trading activities
to the firm could have the result of imposing fewer compliance
obligations on a larger banking entity with identical trading
activities to a smaller counterpart, simply because of that entity's
larger size.
---------------------------------------------------------------------------
\109\ See, e.g., ABA; Capital One et al.
\110\ See, e.g., Data Boiler and John Hoffman.
---------------------------------------------------------------------------
Several commenters recommended that the regulations exclude
particular types of trading assets and liabilities for purposes of
determining whether a banking entity has significant trading assets and
liabilities, moderate trading assets and liabilities, or limited
trading assets and liabilities. In particular, some commenters
encouraged the agencies to exclude all government obligations and other
assets and liabilities that are not subject to the prohibition on
proprietary trading under section 13 of the BHC Act and the
regulations.\111\ The final rule modifies the methodology for
calculating a firm's trading assets and liabilities to exclude all
financial instruments that are obligations of, or guaranteed by, the
United States, or that are obligations, participations, or other
instruments of or guaranteed by an agency of the United States or a
government-sponsored enterprise as described in the regulations.\112\
As commenters noted, banking entities are permitted to engage in
trading activities in these products under section 13 of the BHC Act
and the implementing regulations, and therefore the exclusion of such
instruments for the final rule will result in a more appropriately
tailored standard than under the proposal. The agencies also believe
that the calculation of trading assets and liabilities, subject to
these modifications, should continue to be relatively simple for
banking entities and the agencies, without requiring the imposition of
additional reporting requirements.
---------------------------------------------------------------------------
\111\ See, e.g., BMO Financial Group (BMO); Capital One et al.;
and KeyCorp.
\112\ See final rule Sec. __.2(s)(2), (3); see also final rule
Sec. __.6(a)(1), (2).
---------------------------------------------------------------------------
A few commenters recommended that certain de minimis risk
portfolios, such as matched derivatives holdings and loan-related
swaps, be excluded from the calculation of trading assets and
liabilities.\113\ Another commenter recommended the calculation of
trading assets and liabilities should exclude insurance assets.\114\
Another commenter proposed that the trading assets and liabilities of
non-consolidated affiliates be excluded, because tracking the trading
assets and liabilities of such subsidiaries on an ongoing basis may
present significant practical burdens.\115\ As discussed herein, the
final rule makes several amendments to the methodology for calculating
trading assets and liabilities, for example by excluding securities
issued or guaranteed by certain government-sponsored enterprises, and
by calculating trading assets and liabilities for foreign banking
entities based only on the combined U.S. operations of such banking
entities.\116\ The agencies believe that the revisions in the final
rule should simplify the manner in which a banking entity calculates
its trading assets and liabilities. However, the final rule does not
adopt the changes recommended by a few commenters to exclude trading
assets and liabilities associated with particular business activities
or business lines, other than the express modifications noted above, or
to exclude the trading assets and liabilities of certain types of
subsidiaries. Rather, the final rule adopts an approach that is
intended to be straightforward and consistent and allow banking
entities greater ability to leverage regulatory reports that banking
entities are already required to prepare under existing law, such as
the Form Y9-C and the Call Report.\117\
---------------------------------------------------------------------------
\113\ See, e.g., ABA; Arvest; and BOK Financial (BOK).
\114\ See Insurance Coalition.
\115\ See JBA.
\116\ See final rule Sec. __.2(s)(2)-(3), (ee)(2)-(3).
\117\ Compliance obligations are determined on a consolidated
basis under the final rule. For that reason, where a banking entity
has an unconsolidated subsidiary, the banking entity would not need
to examine additional financial reports to determine its compliance
obligations.
---------------------------------------------------------------------------
Some commenters noted that the regulations should clarify the
manner in which a banking entity should calculate trading assets and
liabilities, and make clear whether it would be appropriate to rely on
regulatory reporting forms such as the Board's Consolidated Financial
Statements for Holding Companies, Form FR Y-9C or call report
information, or other regulatory reporting forms.\118\ Other commenters
recommended that the agencies clarify whether the calculation of
``trading assets and liabilities'' should include only positions that
would be within the scope of the ``trading account'' definition, or
should otherwise exclude
[[Page 61983]]
certain types of instruments.\119\ The agencies support banking
entities relying on current regulatory reporting forms to the extent
possible to determine their compliance obligations under the final
rule. As discussed above, the calculation of significant trading assets
and liabilities, moderate trading assets and liabilities, and limited
trading assets and liabilities is based on a four-quarter average, and
therefore would not require daily or more frequent monitoring of
trading assets and liabilities.\120\
---------------------------------------------------------------------------
\118\ See, e.g., Bank of Oklahoma; KeyCorp; BPI; and Capital One
et al Banks.
\119\ See, e.g., BMO and Capital One et al.
\120\ See final rule Sec. __.2(s)(1)(i), (ee)(1)(i).
---------------------------------------------------------------------------
A few commenters encouraged the agencies to include transition
periods for a banking entity that moves to a higher compliance tier, to
allow the banking entity time to comply with the different expectations
under the compliance tier.\121\ Some commenters said that the
regulations should permit a banking entity to breach a threshold for a
higher compliance category without needing to comply with the
heightened compliance requirements applicable to banking entities with
that level of trading assets and liabilities, provided the banking
entity's trading assets and liabilities drop below the relevant
threshold within a limited period of time.\122\ The final rule does not
adopt transition periods or cure periods as recommended by commenters.
The calculation of a banking entity's trading assets and liabilities is
calculated based on a 4-quarter average, which should provide banking
entities with ample notice to come into compliance with the
requirements of the final rule when crossing from having limited to
moderate trading assets and liabilities, or from moderate to
significant trading assets and liabilities.\123\
---------------------------------------------------------------------------
\121\ See, e.g., ABA; BPI; Custody Banks; Capital One et al.;
and State Street.
\122\ See State Street.
\123\ A banking entity approaching a compliance threshold is
encouraged to contact its primary financial regulatory agency to
discuss the steps the banking entity should take to satisfy its
compliance obligations under the new threshold.
---------------------------------------------------------------------------
One commenter recommended that the agencies provide for notice and
response procedures prior to exercising the reservation of authority to
require a banking entity to apply the requirements of a higher
compliance program tier, and, if a banking entity is determined to be
required to apply increased compliance program requirements, it should
be given a two-year conformance period to come into compliance with
such requirements.\124\ After considering this comment, the agencies
believe that the notice and response procedures provided in the
proposal for rebutting the presumption of compliance for banking
entities with limited trading assets and liabilities would also be
appropriate with respect to an agency exercising this reservation of
authority. However, the agencies believe that providing an automatic
two-year conformance period would be inappropriate, especially in
instances where the agency has concerns regarding evasion of the
requirements of the final rule. Therefore, the agencies are adopting
the reservation of authority with a modification to require that the
agencies exercise such authority in accordance with the notice and
response procedures in section __.20(i) of the final rule.\125\ To the
extent that an agency exercises this authority to require a banking
entity to apply increased compliance program requirements, an
appropriate conformance period shall be determined through the notice
and response procedures.
---------------------------------------------------------------------------
\124\ See BPI.
\125\ See final rule Sec. __.20(i).
---------------------------------------------------------------------------
B. Subpart B--Proprietary Trading Restrictions
Section 13(a)(1)(A) of the BHC Act prohibits a banking entity from
engaging in proprietary trading unless otherwise permitted in section
13. Section 13(h)(4) of the BHC Act defines proprietary trading, in
relevant part, as engaging as principal for the trading account of the
banking entity in any transaction to purchase or sell, or otherwise
acquire or dispose of, a security, derivative, contract of sale of a
commodity for future delivery, or other financial instrument that the
agencies include by rule. Section 13(h)(6) of the BHC Act defines
``trading account'' to mean any account used for acquiring or taking
positions in the securities and instruments described in section
13(h)(4) principally for the purpose of selling in the near term (or
otherwise with the intent to resell in order to profit from short-term
price movements), and any such other accounts as the agencies, by rule
determine.\126\ Section 3 of the implementing regulations defines
``proprietary trading,'' ``trading account,'' and several related
definitions.
---------------------------------------------------------------------------
\126\ 12 U.S.C. 1851(h)(6).
---------------------------------------------------------------------------
1. Section __.3: Prohibition on Proprietary Trading and Related
Definitions
a. Trading Account
The 2013 rule's definition of trading account includes three prongs
and a rebuttable presumption. The short-term intent prong includes
within the definition of trading account the purchase or sale of one or
more financial instruments principally for the purpose of (A) short-
term resale, (B) benefitting from actual or expected short-term price
movements, (C) realizing short-term arbitrage profits, or (D) hedging
one or more positions resulting from the purchases or sales of
financial instruments for the foregoing purposes.\127\ Under the 2013
rule's rebuttable presumption, the purchase (or sale) of a financial
instrument by a banking entity is presumed to be for the trading
account under the short-term intent prong if the banking entity holds
the financial instrument for fewer than sixty days or substantially
transfers the risk of the financial instrument within sixty days of the
purchase (or sale). A banking entity could rebut the presumption by
demonstrating, based on all relevant facts and circumstances, that the
banking entity did not purchase (or sell) the financial instrument
principally for any of the purposes described in the short-term intent
prong.\128\
---------------------------------------------------------------------------
\127\ See 2013 rule Sec. __.3(b)(1)(i).
\128\ See 2013 rule Sec. __.3(b)(2).
---------------------------------------------------------------------------
The market risk capital rule prong (market risk capital prong)
includes within the definition of trading account the purchase or sale
of one or more financial instruments that are both covered positions
and trading positions under the market risk capital rule (or hedges of
other covered positions under the market risk capital rule), if the
banking entity, or any affiliate of the banking entity, is an insured
depository institution, bank holding company, or savings and loan
holding company, and calculates risk-based capital ratios under the
market risk capital rule.\129\
---------------------------------------------------------------------------
\129\ See 2013 rule Sec. __.3(b)(1)(ii).
---------------------------------------------------------------------------
Finally, the dealer prong includes within the definition of trading
account any purchase or sale of one or more financial instruments for
any purpose if the banking entity (A) is licensed or registered, or is
required to be licensed or registered, to engage in the business of a
dealer, swap dealer, or security-based swap dealer, to the extent the
instrument is purchased or sold in connection with the activities that
require the banking entity to be licensed or registered as such; or (B)
is engaged in the business of a dealer, swap dealer, or security-based
swap dealer outside of the United States, to the extent the instrument
is purchased or sold in
[[Page 61984]]
connection with the activities of such business.\130\
---------------------------------------------------------------------------
\130\ See 2013 rule Sec. __.3(b)(1)(iii). An insured depository
institution may be registered as a swap dealer, but only the swap
dealing activities that require it to be so registered are covered
by the dealer trading account. If an insured depository institution
purchases or sells a financial instrument in connection with
activities of the insured depository institution that do not trigger
registration as a swap dealer, such as lending, deposit-taking, the
hedging of business risks, or other end-user activity, the financial
instrument is included in the trading account only if the instrument
falls within the definition of trading account under at least one of
the other prongs. See 79 FR at 5549.
---------------------------------------------------------------------------
The proposal would have replaced the 2013 rule's short-term intent
prong with a new third prong based on the accounting treatment of a
position (the accounting prong). The proposal also would have added a
presumption of compliance with the proposed rule's prohibition on
proprietary trading for trading desks whose activities are not covered
by the market risk capital prong or the dealer prong if the activities
did not exceed a specified quantitative threshold. The proposal would
have retained a modified version of the market risk capital prong and
would have retained the dealer prong unchanged from the 2013 rule. As
described in detail below, the final rule retains the three-pronged
definition of trading account from the 2013 rule and does not adopt the
proposed accounting prong or presumption of compliance with the
proprietary trading prohibition. Rather, the final rule makes targeted
changes to the definition of trading account.
Among other changes, the final rule eliminates the 2013 rule's
rebuttable presumption and replaces it with a rebuttable presumption
that financial instruments held for sixty days or more are not included
in the trading account under the short-term intent prong.\131\ The
agencies believe that the market risk capital prong, which expressly
includes certain short-term trading activities, is an appropriate
interpretation of the statutory definition of trading account for all
firms subject to the market risk capital rule.\132\ Therefore, the
final rule provides that banking entities that are subject to the
market risk capital prong are not subject to the short-term intent
prong.\133\ However, the final rule provides that banking entities that
are subject to the short-term intent prong may elect to apply the
market risk capital prong instead of the short-term intent prong.\134\
These changes are designed to simplify and tailor the trading account
definition in a manner that is consistent with section 13 of the BHC
Act and applicable safety and soundness standards.
---------------------------------------------------------------------------
\131\ See final rule Sec. __.3(b)(4).
\132\ See 12 U.S.C. 1851(h)(6); see also Instructions for
Preparation of Consolidated Financial Statements for Holding
Companies, Trading Assets and Liabilities, Schedule HC-D, available
at https://www.federalreserve.gov/reportforms/forms/FR_Y-9C20190731_i.pdf, and Instructions for Preparation of Consolidated
Reports of Condition and Income, Schedule RC-D, available at https://www.ffiec.gov/pdf/FFIEC_forms/FFIEC031_FFIEC041_201803_i.pdf.
\133\ See final rule Sec. __.3(b)(2)(i).
\134\ See final rule Sec. __.3(b)(2)(ii).
---------------------------------------------------------------------------
i. Accounting Prong
The proposed accounting prong would have provided that ``trading
account'' meant any account used by a banking entity to purchase or
sell one or more financial instruments that is recorded at fair value
on a recurring basis under applicable accounting standards.\135\ Such
instruments generally include, but are not limited to, derivatives,
trading securities, and available-for-sale securities. The proposed
inclusion of this prong in the definition of ``trading account'' was
intended to provide greater certainty and clarity to banking entities
than the short-term intent prong in the 2013 rule about which
transactions would be included in the trading account, because banking
entities could more readily determine which positions are recorded at
fair value on their balance sheets.\136\
---------------------------------------------------------------------------
\135\ See proposed rule Sec. __.3(b)(3); 83 FR at 33447-48.
\136\ See 83 FR at 33447-48.
---------------------------------------------------------------------------
Many commenters strongly opposed replacing the short-term intent
prong with the accounting prong.\137\ These commenters asserted that
the accounting prong could inappropriately scope in, among other
things: Over $400 billion in available-for-sale debt securities; \138\
certain long term investments; \139\ static hedging of long term
investments; \140\ traditional asset-liability management activities;
\141\ derivative transactions entered into for any purpose and
duration; \142\ long-term holdings of commercial mortgage-backed
securities; \143\ seed capital investments; \144\ investments that are
expressly permitted under the covered fund provisions; \145\
investments in connection with employee compensation; \146\ bank
holding company-permissible investments in enterprises engaging in
activities that are part of the business of banking or incidental
thereto, as well as other investments made pursuant to the BHC Act;
\147\ and financial holding company merchant banking investments.\148\
Some commenters argued that the accounting prong was inconsistent with
the statute; \149\ would lead to increased regulatory burden and
uncertainty; \150\ could encourage banking entities not to elect to
account for financial instruments at fair value, thereby reducing
transparency into banking entities' financial reporting and frustrating
risk management practices that are based on the fair value option;
\151\ could result in disparate treatment of the same activity between
two banking entities where one banking entity elects the fair value
option and the other does not; \152\ would have a disproportionately
negative impact on midsize and regional banks; \153\ could negatively
impact the securitization industry if liquidity for asset-backed
securities is impeded; \154\ could inappropriately scope in investment
advisers' use of seed capital to develop products, services, or
strategies for asset management clients; \155\ could lead to increased
burden for international banks by requiring them to apply both local
accounting standards and U.S. generally accepted accounting principles
(GAAP) to non-U.S. positions, one for regular accounting purposes and
one specifically for assessing compliance with the regulations
implementing section 13 of the BHC Act; \156\ that the exclusions and
exemptions from the prohibition on proprietary trading in the 2013 rule
are ill-suited with respect to positions captured by the accounting
prong; \157\ and that fair valuation of
[[Page 61985]]
assets and liabilities under applicable accounting standards is not
indicative of short-term trading intent.\158\
---------------------------------------------------------------------------
\137\ See, e.g., BOK; New York Community Bank (NYCB); IAA; ABA;
KeyCorp; International Swaps and Derivatives Association (ISDA);
Mortgage Bankers Association (MBA); Commercial Real Estate Finance
Council (CREFC), Mortgage Bankers Association, and the Real Estate
Roundtable (Real Estate Associations); State Street; Chatham
Financial et al. (Chatham); Capital One et al.; BPI; FSF; Goldman
Sachs; SIFMA; Center for Capital Markets Competitiveness (CCMC);
IIB; Credit Suisse; EBF; and Arvest.
\138\ See, e.g., BPI and SIFMA.
\139\ See, e.g., Capital One et al.; BPI; SIFMA; and CCMR.
\140\ See, e.g., BPI and ISDA.
\141\ See, e.g., KeyCorp; BPI; Capital One et al.; FSF; and
Goldman Sachs.
\142\ See e.g., ISDA and BPI.
\143\ See MBA.
\144\ See, e.g., ICI; Capital One et al.; Credit Suisse; FSF;
and SIFMA.
\145\ See, e.g., Capital One et al. and BPI.
\146\ See, e.g., Capital One et al. and BPI.
\147\ See Capital One et al.
\148\ See Capital One et al.
\149\ See, e.g., Capital One et al.; CCMC; IAA; ABA; ISDA;
Credit Suisse; CREFC; BPI; FSF; Goldman Sachs; and SIFMA.
\150\ See, e.g., CCMC; JBA; Structured Finance Industry Group
(SFIG); IIB; American Action Forum; ABA; BPI; ISDA; and SIFMA.
\151\ See, e.g., BPI and IIB.
\152\ See BPI.
\153\ See, e.g., BOK; ABA; and NYCB.
\154\ See SFIG.
\155\ See IAA.
\156\ See IIB.
\157\ See, e.g., SIFMA; BPI; CCMR; FSF; and BB&T.
\158\ See, e.g., Capital One et al.; ABA; BPI; FSF; SIFMA; and
Credit Suisse.
---------------------------------------------------------------------------
Some commenters expressed a preference for the 2013 rule's short-
term intent prong over the accounting prong.\159\ Other commenters
suggested revisions to the accounting prong if adopted, such as
excluding from the definition of trading account any financial
instrument for which financial institutions record the change in value
in other comprehensive income; \160\ expressly excluding available-for-
sale portfolios from the accounting prong; \161\ and clarifying that
non-U.S. banking entities are permitted to use accounting standards
adopted by individual banking entities other than International
Financial Reporting Standards and GAAP.\162\ One commenter expressed
concern that a banking entity could circumvent the prohibition on
proprietary trading by recording financial instruments at amortized
cost instead of fair value.\163\
---------------------------------------------------------------------------
\159\ See, e.g., Chatham; BPI; SIFMA; IIB; Credit Suisse; and
Arvest.
\160\ See BOK.
\161\ See BOK.
\162\ See JBA.
\163\ See Volcker Alliance.
---------------------------------------------------------------------------
Some commenters supported adopting the accounting prong.\164\ One
commenter urged the agencies to retain the short-term intent prong and
to adopt the accounting prong as an additional test without any
presumption of compliance.\165\ Another commenter argued that the
accounting prong should be implemented as a new presumption within the
short-term trading prong.\166\ This commenter urged the agencies to
revise the accounting prong by codifying language from the applicable
accounting standards and coupling this with preamble language
indicating that the agencies intend to interpret the accounting prong
in a manner that is consistent with GAAP and international accounting
codifications and guidance, thereby allowing the agencies to
definitively interpret the text rather than accounting authorities, who
might not consider the regulations implementing section 13 of the BHC
Act when making further changes to accounting standards.\167\
---------------------------------------------------------------------------
\164\ See, e.g., Public Citizen; CAP; Better Markets; and AFR.
\165\ See CAP.
\166\ See Better Markets.
\167\ See Better Markets.
---------------------------------------------------------------------------
After considering all comments received,\168\ the agencies are not
adopting the accounting prong in the final rule. The agencies agree
with commenters' concerns that the accounting prong would have
inappropriately scoped in many financial instruments and activities
that section 13 of the BHC Act was not intended to capture, including
some long-term investments. In addition, the accounting prong would
have inappropriately scoped in entire categories of financial
instruments, regardless of the banking entity's purpose for buying or
selling the instrument, such as all derivatives and equity securities
with a readily determinable fair value. Furthermore, the accounting
prong would have captured certain seeding activity that would otherwise
be permitted under subpart C of the regulations implementing section 13
of the BHC Act. As noted in the preamble to the proposed rule, the
impetus behind replacing the short-term intent prong with the
accounting prong was to address the uncertain application of the short-
term intent prong to certain trades.\169\ As discussed in detail below,
the agencies have modified the short-term intent prong to provide more
clarity. The agencies have also provided further clarity to the trading
account definition in the final rule by adding additional exclusions
from the ``proprietary trading'' definition. The agencies are adopting
these clarifying measures as a more tailored approach to address the
difficulties that have arisen under the existing short-term intent
prong.
---------------------------------------------------------------------------
\168\ See, e.g., BOK; NYCB; IAA; ABA; KeyCorp; ISDA; MBA; Real
Estate Associations; State Street; Chatham; Capital One et al.; BPI;
FSF; Goldman Sachs; SIFMA; CCMC; IIB; Credit Suisse; EBF; CREFC; and
Arvest.
\169\ See 83 FR at 33448.
---------------------------------------------------------------------------
ii. Presumption of Compliance With the Prohibition on Proprietary
Trading
Under the accounting prong, the proposal would have added a
presumption of compliance with the proprietary trading prohibition
based on an objective, quantitative measure of a trading desk's
activities.\170\ Under this proposed presumption of compliance, the
activities of a trading desk of a banking entity that are not covered
by the market risk capital prong or the dealer prong-- i.e., the
activities that would be within the trading account under the proposed
accounting prong--would have been presumed to comply with the proposed
rule's prohibition on proprietary trading if the activities did not
exceed a specified quantitative threshold. The trading desk would have
remained subject to the prohibition on proprietary trading and, unless
the desk engaged in a material level of trading activity (or the
presumption of compliance was rebutted), the desk would not have been
required to comply with the more extensive requirements that would
otherwise apply under the proposal to demonstrate compliance. The
agencies proposed to use the absolute value of the trading desk's
profit and loss on a 90-calendar-day rolling basis as the relevant
quantitative measure for this threshold.
---------------------------------------------------------------------------
\170\ See proposed rule Sec. __.3(c); 83 FR at 33449-51.
---------------------------------------------------------------------------
Two commenters supported adopting the presumption of compliance
with the prohibition on proprietary trading.\171\ Several commenters
opposed adopting this presumption of compliance.\172\ Some of these
commenters argued that the presumption of compliance could allow banks
to evade the restrictions on proprietary trading by splitting trades
over multiple trading desks.\173\ One of these commenters suggested
that the presumption of compliance for trading desk activities that
would have been within the trading account under the accounting prong
in the proposed rule could invite proprietary trading within the $25
million threshold.\174\ Another commenter had several concerns with
this proposal, including that not all businesses calculate daily
profits and losses, and that even businesses that do not sell a single
position within a 90-day period might exceed $25 million in unrealized
gains and losses.\175\ Two commenters asserted there is no statutory
basis to permit a de minimis amount of proprietary trading.\176\ Other
commenters asserted that the presumption could increase regulatory
burden.\177\ Several commenters argued that, if the presumption is
adopted, the threshold should be increased,\178\ or the method of
calculating profit and loss should be modified.\179\ Many commenters
stated that the proposed trading desk-level presumption of compliance
did not adequately address the overbreadth of the accounting
prong.\180\
---------------------------------------------------------------------------
\171\ See, e.g., New England Council and CFA.
\172\ See, e.g., Volcker Alliance; Public Citizen; CAP; Bean;
Feng; AFR; and Better Markets.
\173\ See, e.g., Volcker Alliance; Public Citizen; CAP; and
Bean.
\174\ See Public Citizen.
\175\ See IIB.
\176\ See, e.g., Bean and CAP.
\177\ See, e.g., BOK; BPI; IIB; and JBA.
\178\ See, e.g., BOK; BPI; IIB; and Capital One et al.
\179\ See, e.g., CFA.
\180\ See, e.g., Capital One et al.; BPI; FSF; and SIFMA.
---------------------------------------------------------------------------
After considering the comments, the agencies have decided not to
adopt a trading desk-level presumption of compliance with the
prohibition on
[[Page 61986]]
proprietary trading. As discussed in the preamble to the proposal, this
presumption of compliance would have been available only for a trading
desk's activities that would have been within the trading account under
the proposed accounting prong, and not for a trading desk that is
subject to the market risk capital prong or the dealer prong of the
trading account definition. This presumption of compliance was intended
to address the potential impact of the accounting prong, which the
proposal recognized would have been a significant change from the 2013
rule. In particular, the proposal noted that the proposed trading desk-
level presumption of compliance with the prohibition on proprietary
trading was intended to allow banking entities to conduct ordinary
banking activities without having to assess every individual trade for
compliance with subpart B of the implementing regulations and the
proposed accounting prong.\181\ Since the agencies are not adopting the
accounting prong and are adopting additional clarifying revisions to
the short-term intent prong, the agencies have determined it is not
necessary to adopt the presumption of compliance.
---------------------------------------------------------------------------
\181\ See 83 FR at 33449.
---------------------------------------------------------------------------
iii. Short-Term Intent Prong
The 2013 rule's short-term intent prong included within the
definition of trading account the purchase or sale of one or more
financial instruments principally for the purpose of (A) short-term
resale, (B) benefitting from actual or expected short-term price
movements, (C) realizing short-term arbitrage profits, or (D) hedging
one or more positions resulting from the purchases or sales of
financial instruments for the foregoing purposes.\182\ Under the 2013
rule's rebuttable presumption, the purchase (or sale) of a financial
instrument by a banking entity was presumed to be for the trading
account under the short-term intent prong if the banking entity held
the financial instrument for fewer than sixty days or substantially
transferred the risk of the financial instrument within sixty days of
the purchase (or sale). A banking entity could rebut the presumption by
demonstrating, based on all relevant facts and circumstances, that the
banking entity did not purchase (or sell) the financial instrument
principally for any of the purposes described in the short-term intent
prong.\183\
---------------------------------------------------------------------------
\182\ See 2013 rule Sec. __.3(b)(1)(i).
\183\ See 2013 rule Sec. __.3(b(2).
---------------------------------------------------------------------------
Several commenters stated that, for banking entities that are
subject to the market risk capital prong, the short-term intent prong
is redundant.\184\ In addition, several commenters stated that the
final rule should eliminate the short-term intent prong altogether, as
proposed.\185\ Other commenters stated that, consistent with the
statutory definition of trading account, the agencies should not
eliminate the short-term intent prong.\186\ One commenter suggested re-
adopting the short-term intent prong but defining the term ``short-
term'' differently based on asset class.\187\ Several commenters
supported retaining the short-term intent prong with modifications,
such as eliminating or reversing the rebuttable presumption or aligning
the short-term intent prong more closely with the market risk capital
prong.\188\ The agencies agree that there is substantial overlap
between the short-term intent prong and the market risk capital prong
and have revised the definition of trading account accordingly.
---------------------------------------------------------------------------
\184\ See, e.g., Capital One et al.; BPI; FSF; KeyCorp; and
SIFMA.
\185\ See, e.g., JBA; Credit Suisse; CREFC; and SIFMA.
\186\ See AFR and Bean.
\187\ See Occupy the SEC.
\188\ See, e.g., SIFMA; BPI; State Street; Chatham; FSF; CCMR;
ABA; KeyCorp; Capital One et al.; Arvest; and IIB.
---------------------------------------------------------------------------
Under the final rule, the definition of trading account includes
any account that is used by a banking entity to purchase or sell one or
more financial instruments principally for the purpose of short-term
resale, benefitting from actual or expected short-term price movements,
realizing short-term arbitrage profits, or hedging one or more of the
positions resulting from the purchases or sales of financial
instruments for the foregoing purposes.\189\ The agencies believe that
it is necessary to include a prong other than the market risk capital
prong or the dealer prong to define ``trading account'' for banking
entities that are subject to the final rule but are not subject to the
market risk capital prong. The agencies believe that requiring banking
entities that are not subject to the market risk capital rule to apply
the market risk capital prong in order to identify the scope of
positions subject to the Volcker Rule's proprietary trading provisions
could be unduly complex and burdensome for banking entities with
smaller and less active trading activities. The final rule allows a
banking entity not subject to the market risk capital prong to define
its trading account by reference to either the short-term intent prong
or the market risk capital prong because both tests are consistent with
the statutory definition of trading account; this flexible approach for
banking entities with less trading activities is appropriate for
various reasons, including because these banking entities are already
familiar with the short-term intent prong.\190\
---------------------------------------------------------------------------
\189\ See final rule Sec. __.3(b)(1)(i).
\190\ See 12 U.S.C. 1851(h)(6).
---------------------------------------------------------------------------
Under the final rule, the regulatory short-term intent prong
applies only to a banking entity that is not subject to the market risk
capital prong and that has not elected to apply the market risk capital
prong to determine the scope of the banking entity's trading
account.\191\ For purposes of the final rule, a banking entity is
subject to the market risk capital prong if it, or any affiliate with
which the banking entity is consolidated for regulatory reporting
purposes, calculates risk-based capital ratios under the market risk
capital rule.\192\ Applying the short-term intent prong only to banking
entities whose trading account is not covered by the market risk
capital prong will simplify application of the rule. No longer applying
the short-term intent prong to banking entities that are subject to the
market risk capital prong is appropriate because the scope of
activities captured by the short-term intent prong is substantially
similar to the scope of activities captured by the market risk capital
prong. Indeed, the preamble to the 2013 rule noted that the definition
of trading position in the market risk capital rule largely parallels
the statutory definition of trading account,\193\ which in turn mirrors
the language in the short-term intent prong. Accordingly, the agencies
believe that a banking entity should be subject either to the short-
term intent prong or to the market risk capital prong, but not
both.\194\
---------------------------------------------------------------------------
\191\ See final rule Sec. __.3(b)(2)(i), (ii).
\192\ See 12 CFR part 3, subpart F; part 217, subpart F; part
324, subpart F.
\193\ See 79 FR at 5548.
\194\ A number of commenters suggested that, due to the overlap
between the market risk capital prong and the short-term intent
prong, banking entities that are subject to the market risk capital
prong should not also be subject to the short-term intent prong.
See, e.g., Capital One et al.; BPI; FSF; Goldman Sachs; CREFC; and
SIFMA.
---------------------------------------------------------------------------
The final rule allows a banking entity that is not subject to the
market risk capital prong to elect to apply the market risk capital
prong in place of the short-term intent prong.\195\ The final rule
includes this option to provide parity between smaller banking entities
that are not subject to the market risk capital rule and larger banking
entities with active trading businesses that are
[[Page 61987]]
subject to the market risk capital prong.\196\ Under the final rule, a
banking entity that is not subject to the market risk capital rule may
choose to define its trading account as if the banking entity were
subject to the market risk capital prong. If a banking entity opts into
the market risk capital prong, the banking entity's trading account
would include all accounts used by the banking entity to purchase or
sell one or more financial instruments that would be covered positions
and trading positions under the market risk capital rule if the banking
entity were subject to the market risk capital rule. Banking entities
that do not make this election will continue to apply the short-term
intent prong.
---------------------------------------------------------------------------
\195\ See final rule Sec. __.3(b)(2)(ii).
\196\ Several commenters recommended defining the trading
account solely by reference to the dealer prong and market risk
capital prong for banking entities subject to the market risk
capital rule. See, e.g., Capital One et al.; BPI; FSF; Goldman
Sachs; CREFC; and SIFMA. One commenter suggested that banking
entities that are not subject to the market risk capital rule and
subject to a third prong should be allowed to elect to be treated as
a banking entity subject to the market risk capital rule for
purposes of the regulations implementing section 13 of the BHC Act.
This approach would maintain parity between banking entities that
are subject to the market risk capital rule and those that are not.
See SIFMA.
---------------------------------------------------------------------------
Under the final rule, an election to apply the market risk capital
prong must be consistent among a banking entity and all of its wholly
owned subsidiaries.\197\ This consistency requirement is intended to
facilitate banking entities' compliance with the proprietary trading
prohibition by subjecting wholly owned legal entities within a firm to
the same definition. Requiring a consistent definition of ``trading
account'' is particularly important to simplify compliance because a
trading desk may book trades into different legal entities within an
organization, and having a consistent definition of ``trading account''
among these entities should help ensure that each banking entity can
identify relevant trading activity and meet its compliance obligations
under the final rule. This requirement is also expected to facilitate
the agencies' supervision of compliance with the final rule. This
consistency requirement would apply only to a banking entity and its
wholly owned subsidiaries. In the case of minority-owned subsidiaries
or other subsidiaries that the banking entity does not functionally
control, it may be impractical for one banking entity within the
organization to ensure that all affiliates will make a consistent
election. However, the relevant primary financial regulatory agency may
subject a banking entity that is not a wholly owned subsidiary to the
consistency requirement if the agency determines it is necessary to
prevent evasion of the rule's requirements. When exercising this
authority, the relevant primary financial regulatory agency will follow
the same notice and response procedures used elsewhere in the final
rule.
---------------------------------------------------------------------------
\197\ See final rule Sec. __.3(b)(3).
---------------------------------------------------------------------------
iv. 60-Day Rebuttable Presumption
The proposal would have eliminated the 2013 rule's 60-day
rebuttable presumption. Many commenters supported the proposed rule's
elimination of this rebuttable presumption.\198\ Some commenters urged
the agencies to establish a presumption that positions held for more
than 60 days are not proprietary trading.\199\ Some commenters
suggested that the agencies should presume, for banking entities not
subject to the market risk capital rule, that financial instruments
held for longer than 60 days, or that have an original maturity or
remaining maturity upon acquisition of fewer than 60 days to their
stated maturities, are not for the banking entity's trading
account.\200\ One commenter suggested that any third prong to the
definition of trading account that applies to banking entities that are
not subject to the market risk capital rule should have a rebuttable
presumption that any position held by the banking entity as principal
for 60 days or more is not for the trading account, as well as a
reasonable challenge procedure through which a banking entity would be
provided an opportunity to demonstrate to its primary financial
regulatory agency that positions held for fewer than 60 days do not
constitute proprietary trading.\201\ Several commenters asked that the
agencies--if they do not eliminate the presumption--provide guidance on
the rebuttal process,\202\ or make certain revisions to the
presumption, such as revising the ``substantial transfer of risk''
language; \203\ exempting financial instruments close to maturity;
\204\ and excluding hedging activity.\205\ Some commenters argued, in
contrast, that the 60-day rebuttable period was under-inclusive.\206\
One commenter argued that any position purchased or sold within 180
days should be automatically included within the definition of trading
account, or, in the alternative, that the presumption should be
extended from 60 to 180 days, and the agencies should mandate ongoing
monitoring and disclosure of all components, excluded or not, of the
banking entities' reported trading account assets.\207\ This commenter
also argued that there should not be a presumption that certain
positions are not within the trading account; that documentation
requirements for rebutting the presumption should be clearly specified
and the criteria more restrictive; that all arbitrage positions should
be presumed to be trading positions; and that the definition of
``short-term'' should vary by asset class. Another commenter generally
opposed eliminating the 60-day rebuttable presumption.\208\
---------------------------------------------------------------------------
\198\ See, e.g., State Street; Chatham; BPI; FSF; CCMR; and CFA.
\199\ See, e.g., ABA; KeyCorp; Capital One et al.; State Street;
and Arvest.
\200\ See, e.g., ABA; Arvest; BPI; SIFMA; and IIB.
\201\ See SIFMA.
\202\ See, e.g., ABA; Arvest; BPI; SIFMA; State Street; and FSF.
\203\ See, e.g., ABA and Arvest.
\204\ Id.
\205\ See Capital One et al.
\206\ See AFR and Occupy the SEC.
\207\ See Occupy the SEC.
\208\ See Bean.
---------------------------------------------------------------------------
After considering all comments received, the agencies are
eliminating the 60-day rebuttable presumption from the 2013 rule and
establishing a new rebuttable presumption that financial instruments
held for sixty days or more are not within the short-term intent prong.
Since the 2013 rule came into effect, the agencies have found that the
rebuttable presumption has captured many activities that should not be
included in the definition of proprietary trading,\209\ which, under
the statute, only covers buying and selling financial instruments
principally for the purpose of selling in the near term (or otherwise
with the intent to resell in order to profit from short-term price
movements).\210\ Several commenters supported eliminating the 2013
rule's rebuttable presumption for this reason or due to difficulties in
rebutting the presumption.\211\ Given the type of activities that have
triggered the 2013 rule's rebuttable presumption but that are not
undertaken principally for the purpose of selling in the near-
term,\212\
[[Page 61988]]
the agencies have concluded that it is not appropriate to continue to
presume short-term trading intent from holding a financial instrument
for fewer than 60 days.
---------------------------------------------------------------------------
\209\ For example, asset-liability, liquidity management
activities, transactions to correct error trades and loan-related
swaps. See Part IV.B.2.b.i-iii.
\210\ 12 U.S.C. 1851(h)(4) and (6).
\211\ See, e.g., State Street; Chatham; BPI; FSF; CCMR; and CFA.
\212\ Such activities include a foreign branch of a U.S. banking
entity purchasing a foreign sovereign debt obligation with remaining
maturity of fewer than 60 days in order to meet foreign regulatory
requirements. Similarly, error correcting trades and matched
derivative transactions, discussed infra may have triggered the 2013
rule's rebuttable presumption but are not undertaken principally for
the purpose of selling in the near term (or otherwise with the
intent to resell in order to profit from short-term price
movements).
---------------------------------------------------------------------------
However, the agencies recognize the utility for both the agencies
and the subject banking entities of an objective time-based
standard.\213\ The final rule contains a new rebuttable presumption:
The purchase or sale of a financial instrument presumptively lacks
short-term trading intent if the banking entity holds the financial
instrument for 60 days or longer and does not transfer substantially
all of the risk of the financial instrument within 60 days of the
purchase (or sale).\214\ The agencies agree with commenters that a
banking entity subject to the short-term intent prong that holds an
instrument for at least 60 days should receive the benefit of a
presumption that the trade was not entered into for the purpose of
selling in the near term or otherwise with the intent to resell in
order to profit from short-term price movements. Replacing the 2013
rule's rebuttable presumption with a rebuttable presumption that
financial instruments held for sixty days or longer are not within the
short-term intent prong will provide clarity for banking entities with
respect to such positions, without imposing the burden associated with
the 2013 rule's rebuttable presumption.
---------------------------------------------------------------------------
\213\ See 79 FR at 5550; see also ABA; KeyCorp; Capital One et
al.; State Street; Arvest; and SIFMA.
\214\ See final rule Sec. __.3(b)(4).
---------------------------------------------------------------------------
In light of the revision to the 60-day rebuttable presumption, the
agencies do not believe it is necessary to provide a formal challenge
procedure with respect to financial instruments that are purchased or
sold within 60 days. Under the final rule, such activity is no longer
presumptively within a banking entity's trading account.
As in the 2013 rule, the final rule's presumption only applies to
the short-term intent prong and does not apply to the market risk
capital or dealer prongs
v. Market Risk Capital Prong Modification
The proposal would have revised the market risk capital prong to
apply to the activities of foreign banking organizations (FBOs) to take
into account the different market risk frameworks FBOs may have in
their home countries.\215\ Specifically, the proposal included within
the market risk capital prong an alternative definition that permitted
a banking entity that is not, and is not controlled directly or
indirectly by a banking entity that is, located in or organized under
the laws of the United States or any State, to include any account used
by the banking entity to purchase or sell one or more financial
instruments that are subject to risk-based capital requirements under a
market risk framework established by the home-country supervisor that
is consistent with the market risk framework published by the Basel
Committee on Banking Supervision (Basel Committee), as amended from
time to time.
---------------------------------------------------------------------------
\215\ See proposed rule Sec. __. 3(b)(1)(ii); 83 FR at 33447.
---------------------------------------------------------------------------
One commenter asserted that, under some foreign regulatory market
risk capital frameworks, this expansion would capture positions that
are not held for short-term trading.\216\ This commenter advocated
adopting a flexible approach where foreign banking entities could
exclude a position subject to a foreign jurisdiction's market risk
capital framework from the trading account by demonstrating that the
position was not acquired for short-term purposes or otherwise should
not be treated as a trading account position.\217\
---------------------------------------------------------------------------
\216\ See IIB.
\217\ See id.
---------------------------------------------------------------------------
After considering the comments on this issue,\218\ the agencies
have decided not to modify the market risk capital prong to incorporate
foreign market risk capital frameworks. The agencies believe that
relying on the short-term intent prong, market risk capital prong, and
dealer prong will ensure consistent treatment of U.S. and foreign
banking entities. Foreign banking entities that are not subject to the
market risk capital rule may continue to use the short-term intent
prong to define their trading accounts. However, a banking entity,
including a foreign banking entity, may elect to apply the market risk
capital prong in determining the scope of its trading account. As
discussed above, a banking entity that uses the market risk capital
prong to determine the scope of its trading account is not also subject
to the short-term intent prong. This approach will provide appropriate
parity between U.S. and foreign banking entities and will also maintain
consistency with the statutory trading account definition.\219\
---------------------------------------------------------------------------
\218\ See IIB (noting that the scope of some foreign supervisory
market risk capital frameworks may capture positions that are not
held solely for short-term purposes and thus should be out of scope
for purposes of the final rule).
\219\ In the course of developing the final rule, the agencies
have considered the prudential actions of foreign regulators in this
area and the resulting effects on U.S. and non-U.S. financial
institutions and the relevant markets in which they participate.
---------------------------------------------------------------------------
Accordingly, the final rule retains a market risk capital prong
that is substantially similar to that in the 2013 rule. The final
rule's market risk capital prong includes within the definition of
trading account any account that is used by a banking entity to
purchase or sell one or more financial instruments that are both
covered positions and trading positions under the market risk capital
rule (or hedges of other covered positions under the market risk
capital rule), if the banking entity, or any affiliate that is
consolidated with the banking entity for regulatory reporting purposes,
calculates risk-based capital ratios under the market risk capital
rule.\220\
---------------------------------------------------------------------------
\220\ See final rule Sec. __.3(b)(1)(ii). The final rule's
market risk capital prong has, however, been modified as compared to
the 2013 rule to account for a banking entity that is not
consolidated with an affiliate (for regulatory reporting purposes)
that calculates risk-based capital ratios under the market risk
capital rule. For example, the trading positions of a broker-dealer
that is not consolidated with its parent bank holding company will
not be included in the holding company's trading positions in the
holding company's Form FR Y-9C. In such an instance, even though the
broker-dealer is affiliated with an entity that calculates risk-
based capital ratios under the market risk capital rule, it would
not be subject to the market capital risk prong due to the fact that
the broker-dealer is not consolidated with the affiliate for
regulatory reporting purposes. As a result, the broker-dealer would
be subject to the amended short-term intent prong and the dealer
prong (with respect to instruments purchased or sold in connection
with the activities that require the broker-dealer to be licensed or
registered as such). It may, however, be able to elect to use the
market risk capital prong (as an alternative to the short-term
intent prong) by following the procedures described above.
---------------------------------------------------------------------------
In addition, the final rule includes a transition period for
banking entities as they become subject to the market risk capital
prong.\221\ Under the final rule, if a banking entity is subject to the
short-term intent prong and then becomes subject to the market risk
capital prong, the banking entity may continue to apply the short-term
intent prong instead of the market risk capital prong for one year from
the date on which it becomes, or becomes consolidated for regulatory
reporting purposes with, a banking entity that calculates risk-based
capital ratios under the market risk capital rule. The agencies are
adopting this transition period to provide banking entities a
reasonable period to update compliance programs.
---------------------------------------------------------------------------
\221\ Unlike the Volcker Rule compliance program requirements,
which are based on average gross trading assets and liabilities over
the prior four quarters, the thresholds in the market risk capital
rule are based on the most recent quarter.
---------------------------------------------------------------------------
The market risk capital rule includes a position that is reported
as a covered position for regulatory reporting purposes on applicable
reporting forms.\222\ Certain banking entities that may be subject to,
or elect to apply, the
[[Page 61989]]
market risk capital prong may not report positions on applicable
regulatory reporting forms as trading assets or trading liabilities.
Therefore, the final rule amends the definition of ``market risk
capital rule covered position and trading position'' to clarify that
this definition includes any position that meets the criteria to be a
covered position and a trading position, without regard to whether the
financial instrument is reported as a covered position or trading
position on any applicable regulatory reporting forms. The final rule
also modifies the definition of ``market risk capital rule'' to update
a cross-reference to the Board's capital rules and to clarify what the
applicable market risk capital rule would be for a firm electing to
apply the market risk capital prong.\223\
---------------------------------------------------------------------------
\222\ See 12 CFR 3.202; 12 CFR 217.202; 12 CFR 324.202 (defining
``covered position'').
\223\ See 12 CFR part 217.
---------------------------------------------------------------------------
vi. Dealer Prong
The proposal did not propose revisions to the dealer prong.
However, several commenters requested that the agencies clarify that
not all purchases and sales of financial instruments by a dealer are
captured by the dealer prong.\224\ Specifically, these commenters
requested that the agencies clarify that the dealer prong does not
capture purchases or sales made by a dealer in a non-dealing capacity,
including financial instruments purchased for long-term investment
purposes.\225\ Among other things, those commenters noted that without
such modifications, the dealer prong may require a position-by-position
analysis to confirm whether a long-term investment is part of the
trading account. Another commenter requested that the agencies revise
the dealer prong to ensure that derivatives activities remain in the
trading account without regard to potential SEC and CFTC actions on the
de minimis thresholds or other registration requirements, and that such
derivatives activities do not benefit from any presumption of
compliance.\226\ The final rule retains the 2013 rule's dealer prong
without any substantive change.\227\
---------------------------------------------------------------------------
\224\ See, e.g., BPI; FSF; and SIFMA.
\225\ See e.g., BPI; FSF; and SIFMA.
\226\ See Better Markets.
\227\ In response to the commenter, the agencies clarify that
banking entities that are licensed or registered (or required to be
licensed or registered) as dealers, swap dealers, or security-based
swap dealers analyze the types of activities that would be captured
by the dealer prong without regard to the de minimis thresholds for
swap dealer or security-based swap dealer registration. However,
regardless of whether a banking entity is so licensed or registered,
the banking entity is also required to determine whether a purchase
or sale of a financial instrument would be captured by either the
short-term intent prong or the market risk capital prong, as
applicable.
---------------------------------------------------------------------------
The final rule's dealer prong includes within the definition of
trading account any account that the banking entity uses to purchase or
sell one or more financial instruments for any purpose if the banking
entity (A) is licensed or registered, or is required to be licensed or
registered, to engage in the business of a dealer, swap dealer, or
security-based swap dealer, to the extent the instrument is purchased
or sold in connection with the activities that require the banking
entity to be licensed or registered as such; or (B) is engaged in the
business of a dealer, swap dealer, or security-based swap dealer
outside of the United States, to the extent the instrument is purchased
or sold in connection with the activities of such business.\228\ In
response to commenters and consistent with the 2013 rule, the agencies
reaffirm that a banking entity may be licensed or registered as a
dealer, but only the types of activities that require it to be so
licensed or registered are covered by the dealer prong. Thus, if a
banking entity purchases or sells a financial instrument in connection
with activities that are not the types of activities that would trigger
registration as a dealer, the purchase or sale of the financial
instrument is not covered by the dealer prong. However, it may be
included in the trading account under the short-term intent prong or
the market risk capital prong, as applicable.\229\ Moreover, in
response to commenters' concerns that the existing rule may require
dealers to conduct a position-by-position analysis of their trading
activities to determine whether a position is captured by the dealer
prong, the agencies believe that the changes being adopted today,
particularly the exclusions for financial instruments that are not
trading assets or liabilities,\230\ should help alleviate those
concerns by narrowing the range of transactions covered by the rule.
---------------------------------------------------------------------------
\228\ See final rule Sec. __.3(b)(1)(iii).
\229\ See final rule Sec. __.3(b)(1)(i), (ii).
\230\ See infra section IV.B.1.b.v.
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b. Proprietary Trading Exclusions
Section __.3 of the 2013 rule generally prohibits a banking entity
from engaging in proprietary trading. In addition to defining the scope
of trading activity subject to the prohibition on proprietary trading,
the 2013 rule also provides several exclusions from the definition of
proprietary trading. Based on experience implementing the 2013 rule,
the agencies proposed modifying the exclusion for liquidity management
and adopting new exclusions for transactions made to correct errors and
for certain offsetting swap transactions. In addition, the agencies
requested comment regarding whether any additional exclusions should be
added, for example, to address certain derivatives entered into in
connection with a customer lending transaction. The agencies are
adopting the liquidity management exclusion as proposed, with a
modification to encompass non-deliverable cross-currency swaps, and
additional exclusions for the following activities: (i) Trading
activity to correct trades made in error, (ii) loan-related and other
customer accommodation swaps, (iii) matched derivative transactions,
(iv) hedges of mortgage servicing rights where trading in the
underlying mortgage servicing rights is not prohibited by the rule; and
(v) financial instruments that do not meet the definition of trading
assets or trading liabilities under applicable reporting forms.
i. Liquidity Management Exclusion Amendments
The 2013 rule excludes from the definition of proprietary trading
the purchase or sale of securities for the purpose of liquidity
management in accordance with a documented liquidity management
plan.\231\ This exclusion contains several requirements. First, the
liquidity management exclusion is limited by its terms to securities
and requires that transactions be conducted pursuant to a liquidity
management plan that specifically contemplates and authorizes the
particular securities to be used for liquidity management purposes;
describes the amounts, types, and risks of securities that are
consistent with the banking entity's liquidity management plan; and the
liquidity circumstances in which the particular securities may or must
be used. Second, any purchase or sale of securities contemplated and
authorized by the plan must be principally for the purpose of managing
the liquidity of the banking entity, and not for the purpose of short-
term resale, benefitting from actual or expected short-term price
movements, realizing short-term arbitrage profits, or hedging a
position taken for such short-term purposes. Third, the plan must
require that any securities purchased or sold for liquidity management
purposes be highly liquid and limited to instruments the market,
credit, and other risks of which the banking entity does not reasonably
expect to give rise to appreciable profits or losses as a result of
short-term price movements. Fourth, the plan must limit any
[[Page 61990]]
securities purchased or sold for liquidity management purposes to an
amount that is consistent with the banking entity's near-term funding
needs, including deviations from normal operations of the banking
entity or any affiliate thereof, as estimated and documented pursuant
to methods specified in the plan. Fifth, the banking entity must
incorporate into its compliance program internal controls, analysis,
and independent testing designed to ensure that activities undertaken
for liquidity management purposes are conducted in accordance with the
requirements of the 2013 rule and the banking entity's liquidity
management plan. Finally, the plan must be consistent with the
supervisory requirements, guidance, and expectations regarding
liquidity management of the agency responsible for regulating the
banking entity. The 2013 rule established these requirements to provide
some safeguards to ensure that the liquidity management exclusion is
not misused for the purpose of impermissible proprietary trading.\232\
While some safeguards around a banking entity's liquidity management
are appropriate, the restrictions under the 2013 rule have limited the
ability of banking entities to engage in certain types of bona fide
liquidity management activities.
---------------------------------------------------------------------------
\231\ See 2013 rule Sec. __.3(d)(3).
\232\ See 79 FR at 5555.
---------------------------------------------------------------------------
The proposal would have amended the exclusion for liquidity
management activities to allow banking entities to use foreign exchange
forwards and foreign exchange swaps, each as defined in the Commodity
Exchange Act,\233\ and physically settled cross-currency swaps (i.e.,
cross-currency swaps that involve an actual exchange of the underlying
currencies) as part of their liquidity management activities.\234\
Foreign exchange forwards, foreign exchange swaps, and physically
settled cross-currency swaps are often used by trading desks of foreign
branches and subsidiaries of a U.S. banking entity to manage liquidity
in foreign jurisdictions.\235\ The proposal would have provided that a
banking entity could use foreign exchange forwards, foreign exchange
swaps, and physically settled cross-currency swaps for liquidity
management purposes provided that the use of such financial instruments
was in accordance with a documented liquidity management plan.\236\
---------------------------------------------------------------------------
\233\ See 7 U.S.C. 1a(24) and 1a(25).
\234\ See proposed rule Sec. __.3(e)(3).
\235\ See 83 FR at 33451-52
\236\ See id.
---------------------------------------------------------------------------
Many commenters supported the proposed expansion of activities
covered by the liquidity management exclusion.\237\ However, some
commenters expressed the view that the expansion did not go far enough
and should be expanded to include other types of financial
instruments.\238\ One commenter asserted that expanding the scope of
the liquidity management exclusion would streamline compliance for
banking entities without introducing additional safety and soundness
concerns or the risk of impermissible proprietary trading.\239\ Some
commenters said that non-deliverable currency derivatives should also
qualify for the exclusion, because there are some currencies for which
physically settled cross-currency swaps are not available.\240\
Additionally, other commenters argued that given the role of
derivatives in liquidity risk management, the agencies should expand
the exclusion further to cover all derivatives, including interest rate
swaps.\241\ Certain commenters suggested that the agencies should
further expand the liquidity management exclusion to include all
financial instruments that would be convenient and useful for managing
liquidity and asset-liability mismatch risks of the organization.\242\
---------------------------------------------------------------------------
\237\ See, e.g., ISDA; Goldman Sachs; ABA; SIFMA; IIB; BPI;
GFMCA; CFA; New England Council, CCMC; Capital One et al., FSF; and
State Street.
\238\ See, e.g., ISDA; ABA; FSF; New England Council; CCMC;
Capital One et al.; Goldman Sachs; SIFMA; IIB; Credit Suisse; and
State Street.
\239\ See ISDA.
\240\ See, e.g., Global Financial Markets Association (GFMA)
(noting that certain non-deliverable financial instruments are also
used for liquidity management purposes); SIFMA; State Street; JBA;
ABA; BPI; IIB; and Credit Suisse.
\241\ See, e.g., FSF; Capital One et al.; IIB; and JBA.
\242\ See, e.g., IIB and State Street.
---------------------------------------------------------------------------
Several commenters claimed that the eligibility criteria of the
liquidity management exclusion are opaque and confusing, and suggested
modifying, clarifying, or eliminating some or all of the
requirements.\243\ For example, several commenters argued that the
requirement to maintain a documented liquidity management plan with
certain enumerated elements is unnecessarily prescriptive.\244\ Some
commenters stated that banking entities do not rely on the exclusion
due to the number and limiting nature of the requirements.\245\ Some
commenters argued that the agencies should be promoting, rather than
restricting, appropriate liquidity management and structural interest
rate risk management activities, and that the retention of these
requirements is not consistent with the removal of the prescriptive
requirements of Appendix B in the 2013 rule.\246\ Other commenters
argued that the agencies should eliminate the compliance-related
requirements and permit banking entities to design and manage their
liquidity management function according to their existing internal
compliance frameworks.\247\ In addition, a commenter recommended
clarifying whether treasury functions within banking entities may
manage global liquidity through the newly added financial
instruments.\248\
---------------------------------------------------------------------------
\243\ See, e.g., Capital One et al.; BPI; JBA; SIFMA; CCMC; and
FSF.
\244\ See, e.g., ISDA; KeyCorp; IIB; CCMC; SIFMA; and Goldman
Sachs.
\245\ See, e.g., FSF and Credit Suisse.
\246\ See, e.g., SIFMA and Goldman Sachs.
\247\ See, e.g., BPI; IIB; and FSF.
\248\ See ABA.
---------------------------------------------------------------------------
In contrast, other commenters did not support the proposed
expansion of the liquidity management exclusion.\249\ One commenter
asserted that the proposed rule fails to demonstrate the need for
providing banks greater opportunity to use foreign currency
transactions to manage their liquidity needs when those needs are
already being met via the securities markets.\250\ Another commenter
argued that the proposed change would create concern for the currency
markets by making it easier for trading desks to trade these
instruments for speculative purposes under the guise of legitimate
liquidity management.\251\ One commenter argued that the proposal would
encourage banking entities to exclude impermissible trades as liquidity
management and engage in speculative currency trading. As a result, it
would increase banks' risk-taking and moral hazard, reducing the
effectiveness of regulatory oversight.\252\ In addition, some
commenters suggested that the agencies did not provide sufficient
justification to support the proposed changes to the exclusion.\253\
---------------------------------------------------------------------------
\249\ See, e.g., Volcker Alliance; Data Boiler; NAFCU; Public
Citizen; CAP; Occupy the SEC; and Merkley.
\250\ See Bean.
\251\ See Volcker Alliance.
\252\ See Data Boiler.
\253\ See, e.g., Public Citizen and Bean.
---------------------------------------------------------------------------
After reviewing the comments received, the agencies are adopting
the liquidity management exclusion substantially as proposed, but with
a modification to permit the use of non-deliverable cross-currency
swaps. The agencies recognize the various types of financial
instruments that can be used by a banking entity for liquidity
management as noted by commenters. However, the agencies continue to
believe, as stated in the proposal, that the purpose of the expansion
is to streamline compliance for banking entities operating in foreign
[[Page 61991]]
jurisdictions.\254\ Thus, the final rule expands the liquidity
management exclusion to permit the purchase or sale of foreign exchange
forwards (as that term is defined in section 1a(24) of the Commodity
Exchange Act (7 U.S.C. 1a(24)), foreign exchange swaps (as that term is
defined in section 1a(25) of the Commodity Exchange Act (7 U.S.C.
1a(25)), and cross-currency swaps \255\ entered into by a banking
entity for the purpose of liquidity management in accordance with a
documented liquidity management plan.\256\
---------------------------------------------------------------------------
\254\ See 83 FR at 33451-52.
\255\ As proposed, the final rule defines a cross-currency swap
as a swap in which one party exchanges with another party principal
and interest rate payments in one currency for principal and
interest rate payments in another currency, and the exchange of
principal occurs on the date the swap is entered into, with a
reversal of the exchange of principal at a later date that is agreed
upon for when the swap is entered. This definition is consistent
with regulations pertaining to margin and capital requirements for
covered swap entities, swap dealers, and major swap participants.
See 12 CFR 45__.2; 12 CFR 237.2; 12 CFR 349.2; 17 CFR 23.151.
\256\ See final rule Sec. __.3(d)(3).
---------------------------------------------------------------------------
In response to commenters' concerns that physically settled cross-
currency swaps are not available for some currencies (e.g., due to
currency controls), the exclusion also encompasses non-deliverable
cross-currency swaps. For currencies where physically settled cross-
currency swaps are not available, a banking entity may have had to
engage in procedures such as using spot transactions or holding
currency at foreign custodians, which could be inefficient. Allowing
banking entities to use non-deliverable cross-currency swaps can
provide greater flexibility in conducting liquidity management in these
situations. Even though physically settled cross-currency swaps are
available in many currencies, the agencies believe it is appropriate to
allow non-deliverable cross-currency swaps to be used for liquidity
management in all currencies. Requiring physical settlement for some
cross-currency swaps but not others would make the exclusion more
difficult for banking entities to use and for the agencies to monitor,
particularly if currency controls change, causing the list of
currencies for which physical settlement is permitted to change. These
administrative hurdles would negate many of the benefits of allowing
the use of non-deliverable cross-currency swaps.
Regarding the assertion that banking entities could meet their
liquidity needs in the securities markets, the agencies have found
that, to the contrary, foreign exchange forwards, foreign exchange
swaps, and cross-currency swaps are often used by trading desks to
manage liquidity both in the United States and in foreign
jurisdictions. As foreign branches and subsidiaries of U.S. banking
entities often have liquidity requirements mandated by foreign
jurisdictions, U.S. banking entities often use foreign exchange
products to address currency risk arising from holding this liquidity
in foreign currencies. Thus, these foreign exchange products are
important for liquidity management and should be included in the
expansion of the liquidity management exclusion.
The agencies believe that adding foreign exchange forwards, foreign
exchange swaps, and cross-currency swaps to the exclusion addresses the
primary liquidity management needs for foreign entities, and therefore
are declining to expand the exclusion to other products as suggested by
some commenters. While some commenters asserted that further expanding
the liquidity management exclusion would streamline compliance without
introducing additional safety and soundness or proprietary trading
concerns, the agencies believe that the range of financial instruments
that will qualify for the exclusion under the final rule will be
sufficient for managing banking entities' liquidity risks.
The final rule permits a banking entity to purchase or sell foreign
exchange forwards, foreign exchange swaps, and cross-currency swaps to
the same extent that a banking entity may purchase or sell securities
under the liquidity management exclusion in the 2013 rule, and the
conditions that apply for securities transactions also apply to
transactions in foreign exchange forwards, foreign exchange swaps, and
cross-currency swaps.\257\
---------------------------------------------------------------------------
\257\ See Sec. __.3(e)(3)(i)-(vi) of the final rule.
---------------------------------------------------------------------------
The agencies acknowledge that, as stated in the proposal, cross-
currency swaps generally are more flexible in their terms, may have
longer durations, and may be used to achieve a greater variety of
potential outcomes, as compared to foreign exchange forwards and
foreign exchange swaps.\258\ However, the agencies believe that the
requirement to conduct liquidity management in accordance with a
documented liquidity management plan appropriately limits the use of
cross-currency swaps to activities conducted for liquidity management
purposes, and therefore banking entities' use of these swaps should not
adversely affect currency markets, as one commenter warned. Under the
plan, the purpose of the transactions must be liquidity management. The
timing of purchases and sales, the types and duration of positions
taken and the incentives provided to managers of these purchases and
sales must all indicate that managing liquidity, and not taking short-
term profits (or limiting short-term losses), is the purpose of these
activities. Thus, to be in compliance with the plan, cross-currency
swaps must be used principally for the purpose of managing the
liquidity of the banking entity, and not for the purpose of short-term
resale, benefitting from actual or expected short-term price movements,
realizing short-term arbitrage profits, or hedging a position taken for
such short-term purposes.\259\
---------------------------------------------------------------------------
\258\ See 83 FR at 33452.
\259\ See Sec. __.3(d)(3)(ii) of the final rule.
---------------------------------------------------------------------------
Regarding the assertion from some commenters that the compliance-
related requirements for the liquidity management exclusion are opaque
or unnecessarily prescriptive, the agencies believe it is important to
retain these requirements in order to provide clarity in administration
of the rule and to protect against potential misuse of the liquidity
management exclusion for proprietary trading. As noted above, the
documented liquidity management plan, required under the 2013 rule and
retained in the final rule,\260\ is a key element in assuring that
liquidity management is the purpose of the relevant transactions. The
agencies do not believe that the final rule will stand as an obstacle
to or otherwise impair the ability of banking entities to manage their
liquidity risks. Although other changes to the 2013 rule in the final
rule, such as the elimination of Appendix B, reflect efforts to tailor
compliance obligations, the agencies believe it is important to be
explicit in maintaining targeted compliance requirements for specific
provisions of the final rule, such as the liquidity management
exclusion.
---------------------------------------------------------------------------
\260\ See Sec. __.3(d)(3).
---------------------------------------------------------------------------
The agencies believe that the six required elements of the
liquidity management plan help to mitigate commenters' concerns that
the proposal would have encouraged banking entities to exclude
impermissible trades as liquidity management or increase risk-taking.
Under the liquidity management plan required by the final rule, the
exclusion does not apply to activities undertaken with the stated
purpose or effect of hedging aggregate risks incurred by the banking
entity or its affiliates related to asset-liability mismatches or other
general market risks to which the entity or affiliates may be exposed.
Further, the exclusion does not apply to any trading activities
[[Page 61992]]
that expose banking entities to substantial risk from fluctuations in
market values, unrelated to the management of near-term funding needs,
regardless of the stated purpose of the activities.\261\
---------------------------------------------------------------------------
\261\ See 79 FR at 5555.
---------------------------------------------------------------------------
This final rule also includes a change to one of the liquidity
management exclusion's requirements. The 2013 rule requires that
activity conducted under the liquidity management exclusion be
consistent with applicable ``supervisory requirements, guidance, and
expectations.'' \262\ Consistent with changes elsewhere in the final
rule and with the Federal banking agencies' Interagency Statement
Clarifying the Role of Supervisory Guidance,\263\ the agencies are
removing references to guidance and expectations from the regulatory
text of the liquidity management exclusion. In addition, the final rule
includes conforming changes that reflect the addition of foreign
exchange forwards, foreign exchange swaps, and cross-currency swaps as
permissible contracts in conjunction with the other criteria under the
exclusion.\264\
---------------------------------------------------------------------------
\262\ See 2013 rule Sec. __.3(d)(3)(vi).
\263\ Interagency Statement Clarifying the Role of Supervisory
Guidance (Sept. 11, 2018; https://www.occ.gov/news-issuances/news-releases/2018/nr-ia-2018-97a.pdf, https://www.fdic.gov/news/news/financial/2018/fil18049.html, https://www.federalreserve.gov/supervisionreg/srletters/sr1805.htm). The final rule similarly
removes references to ``guidance'' from subparts A and C.
\264\ The term ``financial instruments'' is substituted for the
term ``securities'' when referring to what contracts are permitted
under the exclusion.
---------------------------------------------------------------------------
ii. Transactions To Correct Bona Fide Trade Errors
The proposal included an exclusion from the definition of
proprietary trading for trading errors and subsequent correcting
transactions.\265\ As discussed in the proposal, the exclusion was
intended to address situations in which a banking entity erroneously
executes a purchase or sale of a financial instrument in the course of
conducting a permitted or excluded activity. For example, a trading
error may occur when a banking entity is acting solely in its capacity
as an agent, broker, or custodian pursuant to Sec. __.3(d)(7) of the
2013 rule, such as by trading the wrong financial instrument, buying or
selling an incorrect amount of a financial instrument, or purchasing
rather than selling a financial instrument (or vice versa). To correct
such errors, a banking entity may need to engage in a subsequent
transaction as principal to fulfill its obligation to deliver the
customer's desired financial instrument position and to eliminate any
principal exposure that the banking entity acquired in the course of
its effort to deliver on the customer's original request. As the
proposal noted, banking entities have expressed concern that, however,
under the 2013 rule, the initial trading error and any corrective
transactions could, depending on the facts and circumstances involved,
fall within the proprietary trading definition if the transaction is
covered by any of the prongs of the trading account definition and is
not otherwise excluded pursuant to a different provision of the rule.
---------------------------------------------------------------------------
\265\ See 83 FR at 33452-53.
---------------------------------------------------------------------------
To address this concern, the agencies proposed a new exclusion from
the definition of proprietary trading for trading errors and subsequent
correcting transactions. The proposal noted that the availability of
this exclusion would depend on the facts and circumstances of the
transactions, such as whether the banking entity made reasonable
efforts to prevent errors from occurring, or identified and corrected
trading errors in a timely and appropriate manner. The proposed
exclusion required that banking entities, once they identified
purchases or sales made in error, transfer the financial instrument to
a separately managed trade error account for disposition. The proposal
would have required that this separately managed trade error account be
monitored and managed by personnel independent from the traders
responsible for the error, and that banking entities monitor and manage
trade error corrections and trade error accounts.
The majority of commenters generally supported the proposed
exclusion for trade errors.\266\ Some commenters noted that, consistent
with operational risk management practices, bona fide trade error
activity is separately managed and classified as an operational loss
when there is a loss event or a ``near miss'' when error activity
results in a gain.\267\ Many commenters urged the agencies not to
mandate a separately managed trade error account, but to permit banking
entities to resolve trading errors in accordance with internal policies
and procedures to avoid duplicative resolution systems and unnecessary
regulatory costs.\268\ One commenter argued that error trades are
clearly outside the scope of activities meant to be prohibited by the
statute, so it should not be necessary to include any additional
documentation or administrative requirements related to them.\269\ One
comment letter requested that the agencies clarify that the exclusion
covers both pre-settlement trade errors (where the error is identified
and corrected prior to being settled in the client's account and is
settled in a separately managed trade error account) and post-
settlement trade errors (where the trade error is settled in and posted
directly to the client's account).\270\
---------------------------------------------------------------------------
\266\ See, e.g., ABA; BB&T; Capital One et al.; BPI; FSF; CFA;
and JBA.
\267\ See, e.g., ABA; BB&T; BPI; Capital One et al.; and FSF.
\268\ See, e.g., ABA; Credit Suisse; FSF; JBA; and SIFMA.
\269\ See SIFMA.
\270\ See Capital One et al.
---------------------------------------------------------------------------
One commenter supported providing an exclusion for bona fide error
trades, but suggested certain changes to the proposed exclusion.\271\
This commenter expressed concern that the proposed exclusion did not
provide sufficient protections to ensure that banking entities correct
errors in a timely and comprehensive manner and do not use the
exclusion to facilitate directional exposures. To this end, the
commenter recommended requiring banking entities to establish
reasonably designed controls, including periodic exception reports
containing certain specified fields. These reports, the commenter
argued, should be provided to independent personnel in the second line-
of-defense, including compliance and risk personnel, and escalated
internally in accordance with the banking entity's internal policies
and procedures. The commenter also recommended requiring periodic error
trade testing and audits conducted by the second line-of-defense.
---------------------------------------------------------------------------
\271\ See Better Markets.
---------------------------------------------------------------------------
One commenter argued against a blanket exclusion for error trades,
and urged the agencies to require any profit from error trades be
forfeited to the U.S. Treasury, thereby removing any incentive for a
banking entity to erroneously classify intentional financial positions
as error trades.\272\ Another commenter argued that the proposal did
not adequately explain or provide sufficient data to justify the
necessity of providing an exclusion for error trades, and that the
exclusion could be used to evade the prohibition on proprietary
trading.\273\
---------------------------------------------------------------------------
\272\ See Public Citizen.
\273\ See CAP.
---------------------------------------------------------------------------
After weighing the comments received, the agencies are excluding
from the definition of ``proprietary trading'' any purchase or sale of
one or more financial instruments that was made in error by a banking
entity in the course of conducting a permitted or
[[Page 61993]]
excluded activity or is a subsequent transaction to correct such an
error.\274\ The agencies do not believe bona fide trading errors and
correcting transactions are proprietary trading. Under the 2013 rule,
trading errors and subsequent transactions to correct such errors could
trigger the short-term intent prong's 60-day rebuttable presumption and
thus could be considered to be presumptively within the trading
account. In addition, trading errors and correcting transactions could
be within the definition of proprietary trading under the market risk
prong or dealer prong. While the final rule eliminates the 2013 rule's
60-day rebuttable presumption,\275\ the agencies believe it is useful
and appropriate to clarify in the final rule that trading errors and
subsequent correcting transactions are not proprietary trading because
banking entities do not enter into these transactions principally for
the purpose of selling in the near-term (or otherwise with the intent
to resell in order to profit from short-term price movements).\276\
Rather, the principal purpose of a trading error correction is to
remedy a mistake made in the ordinary course of the banking entity's
permissible activities.\277\ Accordingly, the agencies are adopting
this exclusion to provide clarity regarding bona fide trading errors
and subsequent correcting transactions.
---------------------------------------------------------------------------
\274\ Final rule Sec. __.3(d)(10).
\275\ See final rule Sec. __.3(b)(4).
\276\ See 12 U.S.C. 1851(h)(6).
\277\ See, e.g., BPI and FSF.
---------------------------------------------------------------------------
Consistent with feedback from several commenters,\278\ the
exclusion in the final rule does not require banking entities to
transfer erroneously purchased (or sold) financial instruments to a
separately managed trade error account for disposition. The agencies
agree that this requirement could have resulted in duplicative
resolution systems and imposed undue regulatory costs, which are not
appropriate in light of the narrow class of bona fide trading errors
that fall within the exclusion. As with all exclusions and permitted
trading activities, the agencies intend to monitor use of this
exclusion for evasion. For example, the magnitude or frequency of
errors could indicate that the trading activity is inconsistent with
this exclusion.
---------------------------------------------------------------------------
\278\ See, e.g., ABA; Credit Suisse; FSF; JBA; and SIFMA.
---------------------------------------------------------------------------
The agencies have considered comments suggesting that the agencies
should impose on banking entities certain reporting, auditing, and
testing requirements specifically related to trade error
transactions.\279\ As noted above, the agencies believe mandating
requirements such as these could lead to undue costs for banking
entities, which are not appropriate in light of the narrow class of
bona fide trading errors that fall within the exclusion. Such bona fide
trade errors and subsequent correcting transactions do not fall within
the statutory definition of ``proprietary trading'' because they lack
the requisite short-term intent. Accordingly, the agencies do not find
it necessary to impose additional requirements with respect to such
activities. Further, the agencies do not agree that any profits
resulting from trade error transactions should be remitted to the U.S.
Treasury.
---------------------------------------------------------------------------
\279\ See Better Markets.
---------------------------------------------------------------------------
iii. Matched Derivative Transactions
The proposal requested comment on the treatment of loan-related
swaps between a banking entity and customers that have received loans
from the banking entity.\280\ The proposal explained that, in a loan-
related swap transaction, a banking entity enters into a swap with a
customer in connection with the customer's loan and contemporaneously
offsets the swap with a third party. The swap with the customer is
directly related to the terms of the customer's loan.\281\ In one
typical type of loan-related swap, a banking entity seeks to make a
floating-rate loan to a customer that could have the benefit to the
banking entity of reducing the banking entity's interest rate risk, but
the customer would prefer to have the economics of a fixed-rate
loan.\282\ To achieve a result that addresses these divergent
preferences, the banking entity makes a floating-rate loan to the
customer and contemporaneously or nearly contemporaneously enters into
a floating rate to fixed rate interest rate swap with the same customer
and an offsetting swap with another counterparty.\283\ As a result, the
customer receives economic treatment similar to a fixed-rate loan.\284\
The banking entity has entered into the preferred floating rate loan,
provided the customer with the customer's preferred fixed rate
economics though the interest rate swap with the customer and offset
its market risk exposure from the customer-facing interest rate swap
through a swap with another counterparty.\285\
---------------------------------------------------------------------------
\280\ See 83 FR at 33462-64.
\281\ See id. at 33462.
\282\ Id.
\283\ Id.
\284\ Id.
\285\ Id. In this example, the banking entity retains the
counterparty risk from both swaps. However, depending on the type of
swap and the particular transaction, the banking entity may be able
to manage the counterparty risk, for example, by clearing the
transaction at a clearing agency or derivatives clearing
organization acting as a central counterparty, as applicable.
---------------------------------------------------------------------------
Loan-related swaps have presented a compliance challenge
particularly for smaller non-dealer banking entities.\286\ These
banking entities may enter into loan-related swaps infrequently, and
the decision to do so tends to be situational and dependent on changes
in market conditions as well as on the interaction of a number of
factors specific to the banking entity, such as the nature of the
customer relationship.\287\
---------------------------------------------------------------------------
\286\ Id.
\287\ Id. at 33463.
---------------------------------------------------------------------------
The proposal sought comment on whether loan-related swaps should be
excluded from the definition of proprietary trading, exempted from the
prohibition on proprietary trading, or permitted under the exemption
for market making-related activities.\288\ The proposal also asked
whether other types of swaps, such as end-user customer-driven swaps
that are used by a customer to hedge commercial risk should be treated
the same way as loan-related swaps.\289\ The proposal also requested
comment as to whether it is appropriate to permit loan-related swaps to
be conducted pursuant to the exemption for market making-related
activities where the frequency with which a banking entity executes
such swaps is minimal but the banking entity remains prepared to
execute such swaps when a customer makes an appropriate request.\290\
---------------------------------------------------------------------------
\288\ Id.
\289\ Id. at 33464.
\290\ Id. at 33463.
---------------------------------------------------------------------------
Most commenters supported allowing loan-related swaps, either by
adopting an exclusion from the definition of proprietary trading,\291\
creating a new exemption for loan-related swaps,\292\ or clarifying
that banking entities could enter into loan-related swaps under
existing exemptions.\293\ The majority of these commenters supported
explicitly excluding loan-related swaps from the definition of
proprietary trading.\294\ These commenters noted that loan-related swap
transactions generally do not fall within the statutory definition of
trading account and that these
[[Page 61994]]
transactions are important risk-mitigating activities.\295\ Commenters
stated that providing an exclusion or permitted activity exemption for
loan-related swaps would prevent section 13 of the BHC Act from having
an unintended chilling effect on an important and prudent lending-
related activity.\296\ Commenters also stated that these types of swap
transactions are important tools that facilitate bank customers'
ability to manage their risks.\297\ One commenter opposed providing an
exclusion for loan-related swaps, arguing that these activities instead
should be conducted under the risk-mitigating hedging exemption.\298\
---------------------------------------------------------------------------
\291\ See, e.g., BOK; ABA; Covington & Burling LLP (Covington);
JBA; Chatham; Credit Suisse; BPI; SIFMA; IIB, Covington; Arvest;
IIB; KeyCorp; and Capital One et al.
\292\ See, e.g., Covington and BPI.
\293\ See, e.g., Covington; BPI; SIFMA; Credit Suisse; and BB&T.
\294\ See, e.g., BOK; ABA; Covington; JBA; Chatham; Credit
Suisse; BPI; SIFMA; IIB, Covington; Arvest; IIB; KeyCorp; and
Capital One et al.
\295\ See, e.g., BOK; ABA; Covington; JBA; Chatham; Arvest; and
IIB.
\296\ See, e.g., Covington and Credit Suisse.
\297\ See, e.g., Arvest and BOK.
\298\ See Data Boiler.
---------------------------------------------------------------------------
Two commenters requested that the agencies adopt a permitted
activity exemption for loan-related swaps or revise the existing
exemption for market making-related activities if the agencies do not
explicitly exclude loan-related swaps from the definition of
proprietary trading.\299\ In addition, two commenters suggested that
the exemption for riskless principal transactions in Sec. __.6(c)(2)
of the 2013 rule could cover loan-related swaps.\300\ These commenters
and two others suggested that excluding loan-related swaps from the
definition of proprietary trading would be more effective than adopting
a new permitted activity exemption or relying on an existing permitted
activity exemption.\301\
---------------------------------------------------------------------------
\299\ See, e.g., Covington and BPI.
\300\ See, e.g., SIFMA and Credit Suisse.
\301\ See, e.g., Covington; BPI; SIFMA; and Credit Suisse.
---------------------------------------------------------------------------
Two commenters argued that banking entities should be allowed to
engage in loan-related swaps using the exemption for market making-
related activities.\302\ Several other commenters asserted that the
market-making exemption is a poor fit for loan-related swaps and that
the market-making exemption's requirements were unduly burdensome with
respect to this activity, particularly for smaller banking
entities.\303\
---------------------------------------------------------------------------
\302\ See, e.g., BB&T and Credit Suisse (Credit Suisse noted,
however, that an exclusion would be preferable to using the market-
making exemption).
\303\ See, e.g., IIB; Covington; SIFMA; Capital One et al.; BPI;
and B&F.
---------------------------------------------------------------------------
Several commenters supported excluding additional derivatives
activities from the definition of proprietary trading, such as
customer-driven matched-book trades that enable customers to hedge
commercial risk regardless of whether the swaps are related to a
loan.\304\ Commenters noted that such customer-driven matched-book
trades do not expose banking entities to risk other than counterparty
credit risk.\305\ Moreover, these trades reduce risks to the bank's
customer and thus also reduce the risk of the banking entity's loans to
that customer.\306\
---------------------------------------------------------------------------
\304\ See, e.g., BOK; JBA; ABA; Capital One et al.; and KeyCorp.
\305\ See, e.g., BOK and ABA.
\306\ See, e.g., BOK.
---------------------------------------------------------------------------
Three commenters requested that the exclusion be expanded to cover
instances where a banking entity enters into a loan-related swap with a
customer but does not offset that swap with a third party.\307\
---------------------------------------------------------------------------
\307\ See, e.g., ABA; Arvest; and IIB.
---------------------------------------------------------------------------
One commenter urged the agencies to adopt a definition of loan-
related swaps that is substantially similar to the definition adopted
by the CFTC for swaps executed in connection with originating loans to
customers, and to include in the definition, the derivatives
transaction entered into with a dealer to offset the risk of the
customer-facing swap.\308\ Another commenter opposed using the CFTC's
definition, noting that the CFTC's definition would not address
commodity-based matched-book derivative transactions.\309\ One
commenter recommended defining ``customer-facing loan-related swap'' to
mean any swap with a customer or affiliate thereof in which the rate,
asset, liability, or other notional item underlying the swap with the
customer or affiliate thereof is, or is directly related to, a
financial term of a loan or other credit facility with the customer or
affiliate thereof (including, without limitation, the loan or other
credit facility's duration, rate of interest, currency or currencies,
or principal amount).\310\ The same commenter stated that the exclusion
should not include a timing requirement with respect to the offsetting
swap or, if a timing condition is included, the banking entity should
be required to enter into the offsetting swap ``contemporaneously or
substantially contemporaneously'' with the customer-facing loan-related
swap.\311\
---------------------------------------------------------------------------
\308\ See Chatham.
\309\ See BOK.
\310\ See Covington.
\311\ See id.
---------------------------------------------------------------------------
After considering the comments received, the agencies are excluding
from the definition of ``proprietary trading'' entering into a
customer-driven swap or a customer-driven security-based swap and a
matched swap or security-based swap if: (i) The transactions are
entered into contemporaneously; (ii) the banking entity retains no more
than minimal price risk; \312\ and (iii) the banking entity is not a
registered dealer, swap dealer, or security-based swap dealer.\313\ The
agencies are adopting this exclusion to provide greater certainty for
non-dealer banking entities that engage in these customer-driven
matched-book swap transactions.
---------------------------------------------------------------------------
\312\ Price risk is the risk of loss on a fair-value position
that could result from movements in market prices.
\313\ Final rule Sec. __.3(d)(11).
---------------------------------------------------------------------------
Under the 2013 rule, these customer-driven matched swap
transactions could trigger the short-term intent prong's rebuttable
presumption and thus would be presumptively within the trading account.
Although the agencies are eliminating the 2013 rule's rebuttable
presumption,\314\ the agencies believe that it is nevertheless useful
and appropriate to clarify in the final rule that these customer-driven
matched swap transactions are not proprietary trading because banking
entities do not enter into these transactions principally for the
purpose of selling in the near-term (or otherwise with the intent to
resell in order to profit from short-term price movements).\315\ For
this reason, the agencies are providing an exclusion for these
activities from the proprietary trading definition rather than
requiring them to be conducted pursuant to the risk-mitigating hedging
exemption, as one commenter suggested.
---------------------------------------------------------------------------
\314\ See final rule Sec. __.3(b)(4).
\315\ See 12 U.S.C. 1851(h)(6).
---------------------------------------------------------------------------
The agencies believe that adopting this exclusion will reduce costs
for non-dealer banking entities and avoid disrupting a common and
traditional banking service provided to small and medium-sized
businesses. This exclusion will provide a greater degree of certainty
that these customer-driven matched swap transactions are outside the
scope of the final rule.
Consistent with feedback received from commenters,\316\ the
exclusion in the final rule is not limited to loan-related swaps.\317\
Thus, the exclusion in the final rule could apply to a swap with a
customer in connection with the
[[Page 61995]]
customer's end-user activity (provided that all the terms of the
exclusion are met). For example, a corn farmer is a customer of a non-
dealer banking entity. To manage its risk with respect to the price of
corn, the corn farmer enters into a swap on corn prices with the
banking entity. The banking entity contemporaneously enters into a
corn-price swap with another counterparty to offset the price risk of
the swap with the corn farmer. The swap with the corn farmer and the
offsetting swap with the counterparty have matching terms such that the
banking entity retains no more than minimal price risk. The agencies
have determined that it is appropriate to exclude these types of
transactions from the definition of proprietary trading because, like
matched loan-related swaps discussed above, banking entities do not
enter into these customer-driven transactions principally for the
purpose of selling in the near-term (or otherwise with the intent to
resell in order to profit from short-term price movements).\318\
---------------------------------------------------------------------------
\316\ See, e.g., BOK; JBA; ABA; Capital One et al.; and KeyCorp.
\317\ As a result, the agencies are not adopting a definition of
``loan-related swap'' substantially similar to the definition
adopted by the CFTC for swaps executed in connection with
originating loans to customers, as requested by one customer. See
Chatham. The agencies also note that this exclusion does not impact
the ``insured depository institution swaps in connection with
originating loans to customers'' provisions in the CFTC's definition
of ``swap dealer.'' See 17 CFR 1.3, Swap dealer, paragraphs
(4)(i)(C) and (5). Additionally, this exclusion does not affect any
other aspects of the ``swap dealer'' definition in CFTC regulations,
or how that term is interpreted by the CFTC.
\318\ See 12 U.S.C. 1851(h)(6).
---------------------------------------------------------------------------
Several conditions must be met for the exclusion to apply.\319\ The
exclusion applies only to banking entities that are not registered
dealers, swap dealers, or security-based swap dealers. This approach is
consistent with feedback from commenters noting that primarily smaller
banking entities have faced compliance challenges with respect to
customer-driven swaps activities.\320\ Banking entities that are
registered dealers, swap dealers, or security-based swap dealers
generally engage in these activities on a more regular basis and
therefore have been able to conduct their derivatives activities
pursuant to the exemption for market making-related activities.
Although some commenters argued that the exemption for market making-
related activities is too burdensome to apply to this type of
activity,\321\ the agencies note that the final rule streamlines
certain requirements of that exemption.\322\
---------------------------------------------------------------------------
\319\ If a transaction does not satisfy all of the conditions of
the exclusion but is not within the definition of trading account,
the transaction would not constitute proprietary trading.
\320\ See, e.g., Chatham; ABA; and Covington.
\321\ See, e.g., IIB; Covington; SIFMA; Capital One et al.; BPI;
and B&F.
\322\ See final rule Sec. __.4(b).
---------------------------------------------------------------------------
The exclusion only applies to transactions where one of the two
matched swaps or security-based swaps is customer-driven, in that the
transaction is entered into for a customer's valid and independent
business purposes. In addition, the hedging swap or hedging security-
based swap must match the customer-driven swap or customer-driven
security-based swap. The banking entity may retain no more than minimal
price risk between the two swaps or security-based swaps.\323\ Finally,
the banking entity must enter into the customer-driven swap or customer
driven security-based swap contemporaneously with the matching swap or
matching security-based swap.\324\ These conditions carve out from the
exclusion activities whose principal purpose is resale in the near
term.\325\ For example, if a banking entity entered into a hedging swap
whose economic terms did not match the terms of the customer-driven
swap, the banking entity would be exposed to price risk and could be
speculating on short-term price movements. Similarly, if a banking
entity waited multiple days between entering into a customer-driven
swap and entering into the offsetting swap, the banking entity could be
speculating on short-term price movements during the unhedged period of
the swap transaction. In either case, the banking entity could be
engaged in proprietary trading.\326\ The requirements in the final
rule's exclusion are intended to limit the exclusion to activities that
the agencies have determined lack the requisite short-term trading
intent.
---------------------------------------------------------------------------
\323\ The banking entity would retain minimal price risk if the
economic terms of the two swaps (e.g., index, amount, maturity, and
underlying reference asset or index) match.
\324\ The exclusion only applies to transactions where the
customer-driven swap or customer-driven security-based swap is
offset by a matching swap or security-based swap on a one-for-one
basis. The exclusion does not apply to portfolio-hedged derivatives
transactions.
\325\ See 12 U.S.C. 1851(h)(6).
\326\ Whether the banking entity is actually engaged in
impermissible proprietary trading would depend on the facts and
circumstances of the particular transaction.
---------------------------------------------------------------------------
The agencies have considered the comments requesting an exclusion
for unmatched loan-related swaps and determined that such an exclusion
is not necessary in the final rule.\327\ For example, if a bank
provides a loan to a customer and enters into a swap with the customer
related directly to the terms of that loan but does not offset that
customer-driven swap with a third-party, the exclusion does not apply.
Although the exclusion may not apply, the agencies believe that this
type of activity is unlikely to be within the trading account under the
final rule, particularly because the agencies are not adopting the
proposed accounting prong. Entering into such a loan-related swap would
be proprietary trading only if the purchase or sale of the swap is
principally for short term trading purposes or is otherwise within the
definition of trading account.\328\
---------------------------------------------------------------------------
\327\ See ABA and Arvest.
\328\ See final rule Sec. __.3(b).
---------------------------------------------------------------------------
iv. Hedges of Mortgage Servicing Rights or Assets
The final rule excludes from the definition of proprietary trading
any purchase or sale of one or more financial instruments that the
banking entity uses to hedge mortgage servicing rights or mortgage
servicing assets in accordance with a documented hedging strategy. The
agencies are adopting this exclusion to clarify the scope of the
prohibition on proprietary trading and to provide parity between
banking entities that are subject to the market risk capital prong and
banking entities that are subject to the short-term intent prong.
Section 13 of the BHC Act defines ``trading account'' to mean ``any
account used for acquiring or taking positions in . . . securities and
instruments . . . principally for the purpose of selling in the near
term (or otherwise with the intent to resell in order to profit from
short-term price movements),'' and any such other accounts that the
agencies determine by rule. The purchase or sale of a financial
instrument as part of a bona fide mortgage servicing rights or mortgage
servicing asset hedging program is not within the statutory definition
of ``trading account'' under the short-term intent prong because the
principal purpose of such a purchase or sale is hedging rather than
short-term resale for profit.
The agencies have determined to explicitly exclude this type of
hedging activity from the definition of ``proprietary trading'' to
provide greater clarity to banking entities that are subject to the
short-term intent prong in light of changes made elsewhere in the final
rule. Under the final rule, banking entities that are subject to the
market risk capital prong (or that elect to apply the market risk
capital prong) are not subject to the short-term intent prong. The
market risk capital rule explicitly excludes intangibles, including
servicing assets, from the definition of ``covered position.''
Financial instruments used to hedge mortgage servicing rights or assets
generally would not be captured under the market risk capital prong.
Therefore, absent an explicit exclusion, banking entities that are
subject to the market risk capital prong have more certainty than
banking entities that are subject to the short-term intent prong that
the purchase or sale of a financial instrument to hedge mortgage
servicing rights or mortgage servicing assets is not proprietary
[[Page 61996]]
trading. The agencies are explicitly excluding mortgage servicing
rights and mortgage servicing asset hedging activity to provide banking
entities that are not subject to the market risk capital prong (or that
elect to apply the market risk capital prong) the same degree of
certainty. As described in part IV.B.1.a.iii of this Supplementary
Information, the final rule seeks to provide parity between smaller
banking entities that are not subject to the market risk capital rule
and larger banking entities with active trading businesses that are
subject to the market risk capital prong. The agencies believe an
express exclusion for mortgage servicing rights and mortgage servicing
hedging activity is useful in light of the revision to the trading
account definition that applies the short-term intent prong only to
banking entities that are not subject to the market risk capital prong.
This exclusion applies only to bona fide hedging activities,
conducted in accordance with a documented hedging strategy. This
requirement will assist the agencies in monitoring for evasion or
abuse. In addition, the agencies note that banking entities' mortgage
servicing activities and related hedging activities remain subject to
applicable law and regulation, including the Federal banking agencies'
safety and soundness standards.
v. Financial Instruments That Are Not Trading Assets or Trading
Liabilities
The final rule excludes from the trading account any purchase or
sale of a financial instrument that does not meet the definition of
``trading asset'' or ``trading liability'' under the banking entity's
applicable reporting form. As with the exclusion for hedges of mortgage
servicing rights or assets, the agencies are adopting this exclusion to
clarify the scope of the prohibition on proprietary trading and to
provide parity between banking entities that are subject to the market
risk capital prong (or that elect to apply the market risk capital
prong) and banking entities that are subject to the short-term intent
prong.
The agencies have determined to exclude the purchase or sale of
assets that would not meet the definition of trading asset or trading
liability from the definition of ``proprietary trading'' to provide
greater clarity to banking entities that are subject to the short-term
intent prong. As described above, under the final rule, banking
entities that are subject to the market risk capital prong (or that
elect to apply the market risk capital prong) are not subject to the
short-term intent prong.\329\ Under the market risk capital prong, a
purchase or sale of a financial instrument is within the trading
account if it would be both a covered position and trading position
under the market risk capital rule. In general, a position is a covered
position under the market risk capital prong if it is a trading asset
or trading liability (whether on- or off-balance sheet).\330\ Thus, the
exclusion for financial instruments that are not ``trading assets and
liabilities'' extends the same certainty to banking entities subject to
the short-term intent prong as is provided by operation of the market
risk capital prong.
---------------------------------------------------------------------------
\329\ See final rule Sec. __.3(b).
\330\ See 12 CFR 3.202(b); 12 CFR 217.202(b); 12 CFR 324.202(b).
In addition, the market risk capital rule's ``covered position''
definition expressly includes and excludes additional classes of
instruments.
---------------------------------------------------------------------------
One commenter recommended that the agencies modify the short-term
intent prong to include only financial instruments that meet the
definition of trading assets and liabilities and that are held for the
purpose of short-term trading.\331\ The agencies have determined that
including only financial instruments that meet the definition of
trading assets and liabilities (by excluding instruments that do not
meet this definition) is appropriate because the trading asset and
liability definitions used for regulatory reporting purposes
incorporate substantially the same short-term trading standard as the
short-term intent prong and section 13 of the BHC Act. The Call Report
and FR Y-9C provide that trading activities typically include, among
other activities, acquiring or taking positions in financial
instruments ``principally for the purpose of selling in the near term
or otherwise with the intent to resell in order to profit from short-
term price movements.'' \332\ This language is substantially identical
to the statutory definition of trading account, which applies to any
account used for acquiring or taking positions in financial instruments
``principally for the purpose of selling in the near term (or otherwise
with the intent to resell in order to profit from short-term price
movements) . . . .'' \333\ Therefore, excluding any purchase or sale of
a financial instrument that would not be classified as a trading asset
or trading liability on these applicable reporting forms is consistent
with the statutory definition of trading account in section 13 of the
BHC Act. This exclusion is expected to provide additional clarity to
banking entities subject to the short-term intent prong, while also
better aligning the compliance program requirements with the scope of
activities subject to section 13 of the BHC Act.
---------------------------------------------------------------------------
\331\ See SIFMA.
\332\ See, e.g., Instructions for Preparation of Consolidated
Reports of Condition and Income, FFIEC 031 and FFIEC 041, Schedule
RC-D; Instructions for Preparation of Consolidated Financial
Statements for Holding Companies, Reporting Form FR Y-9C, Schedule
HC-D.
\333\ 12 U.S.C. 1851(h)(6).
---------------------------------------------------------------------------
This exclusion applies to any purchase or sale of a financial
instrument that does not meet the definition of ``trading asset'' or
``trading liability'' under the applicable reporting form as of the
effective date of this final rule. The final rule references the
reporting forms in effect as of the final rule's effective date to
ensure the scope of the exclusion remains consistent with the statutory
trading account definition. Because the reporting forms are used for
many purposes and are generally based on generally accepted accounting
principles, future revisions to the reporting forms could define
``trading asset'' and ``trading liability'' inconsistently with the
``trading account'' definition in section 13 of the BHC Act. Further,
tying the exclusion to the reporting forms currently in effect will
provide greater certainty to banking entities. If the scope of the
exclusion were subject to change based on revisions to the applicable
reporting forms, it could require banking entities to make
corresponding changes to compliance systems to remain in compliance
with the rule, which could result in disruption both for banking
entities and the agencies. Accordingly, the final rule excludes any
purchase or sale of a financial instrument that does not meet the
definition of trading asset or trading liability under the applicable
reporting form as of the effective date of the final rule.
c. Trading Desk
The 2013 rule applies certain requirements at the ``trading desk''-
level of organization.\334\ The 2013 rule defined ``trading desk'' to
mean the smallest discrete unit of organization of a banking entity
that purchases or sells financial instruments for the trading account
of the banking entity or an affiliate thereof.\335\
---------------------------------------------------------------------------
\334\ See 2013 rule Sec. Sec. __.4, __.5, App. A., App. B;
final rule Sec. Sec. __.4, __.5, App. A.
\335\ 2013 rule Sec. __.3(e)(13).
---------------------------------------------------------------------------
As noted in the proposal, some banking entities had indicated that,
in practice, the 2013 rule's definition of trading account had led to
uncertainty regarding the meaning of ``smallest discrete unit.'' \336\
In addition, banking
[[Page 61997]]
entities had communicated that this definition has caused confusion and
duplicative compliance and reporting efforts for banking entities that
also define trading desks for purposes unrelated to the 2013 rule,
including for internal risk management and reporting and calculating
regulatory capital requirements.\337\ In response to these concerns,
the proposal included a detailed request for comment on whether to
revise the trading desk definition to align with the trading desk
concept used for other purposes.\338\ Specifically, the proposal
requested comment on using a multi-factor trading desk definition based
on the same criteria typically used to establish trading desks for
other operational, management, and compliance purposes.\339\
---------------------------------------------------------------------------
\336\ See 83 FR at 33453.
\337\ See id.
\338\ See id.
\339\ See id.
---------------------------------------------------------------------------
Commenters that addressed the definition of ``trading desk''
generally supported revising the definition along the lines
contemplated in the proposal.\340\ Commenters asserted that the 2013
rule's ``smallest discrete unit language'' was subjective, ambiguous,
and had been interpreted in different ways.\341\ Commenters said that
adopting a multi-factor definition would be preferable to the 2013
rule's definition because a multi-factor definition would align the
definition of trading desk with other operational and managerial
structures, whereas the 2013 rule's definition could be interpreted to
require banking entities to designate certain units of organization as
trading desks purely for purposes of the regulations implementing
section 13 of the BHC Act.\342\ One commenter supported the multi-
factor definition in the proposal but recommended that the agencies
should be required to approve the initial trading desk designations and
any changes in trading desk designations.\343\ One commenter said the
agencies should allow the unit of the trading desk to be determined at
the discretion of each financial institution \344\ and another said it
is not necessary to introduce complexity into how banking entities
organize their internal operations.\345\
---------------------------------------------------------------------------
\340\ See, e.g., ABA; ISDA 1; CCMC; SIFMA 2; Goldman Sachs; FSF;
JBA; and AFR.
\341\ See, e.g., ABA and CCMC.
\342\ See, e.g., ABA; ISDA 1; CCMC; SIFMA 2; Goldman Sachs; FSF;
and JBA.
\343\ See AFR.
\344\ See JBA.
\345\ See CCMC.
---------------------------------------------------------------------------
The final rule adopts a multi-factor definition that is
substantially similar to the definition included in the request for
comment in the proposal, except that the first prong has been revised
and the reference to incentive compensation has been removed. This
multi-factor definition will align the criteria used to define trading
desk for purposes of the regulations implementing section 13 of the BHC
Act with the criteria used to establish trading desks for other
operational, management, and compliance purposes.
The definition of trading desk includes a new second prong that
explicitly aligns the definition with the market risk capital
rule.\346\ The final rule provides that, for a banking entity that
calculates risk-based capital ratios under the market risk capital
rule, or a consolidated affiliate of a banking entity that calculates
risk-based ratios under market risk capital rule, ``trading desk''
means a unit of organization that purchases or sells financial
instruments for the trading account of the banking entity or an
affiliate thereof that is established by the banking entity or its
affiliate for purposes of capital requirements under the market risk
capital rule.\347\ This change specifies that, for a banking entity
that is subject to the market risk capital prong, the trading desk
established for purposes of the market risk capital rule must be the
same unit of organization that is established as a trading desk under
the regulations implementing section 13 of the BHC Act. This prong of
the trading desk definition is expected to simplify the supervisory
activities of the Federal banking agencies that also oversee compliance
with the market risk capital rule because the same unit of organization
can be assessed for purposes of both the market risk capital rule and
section 13 of the BHC Act, which will reduce complexity and cost for
banking entities, and improve the effectiveness of the final rule.
Together with providing firms with the flexibility to leverage existing
or planned compliance programs in order to satisfy the elements of
Sec. __.20 as appropriate, the agencies expect aligning the definition
of trading desk will minimize compliance burden on banking entities
subject to both rules.
---------------------------------------------------------------------------
\346\ Currently, the market risk capital rule does not include a
definition of ``trading desk.'' However, the federal banking
agencies expect to implement the Basel Committee's revised market
risk capital standards, which do. See Basel Committee on Banking
Supervision, ``Minimum Capital Requirements for Market Risk,'' MAR12
(Feb. 2019). The federal banking agencies expect their revised
market risk capital rule will include a definition of ``trading
desk'' that is consistent with the trading desk concept described in
the ``Minimum Capital Requirements for Market Risk,'' and the
multifactor approach in this final rule.
\347\ See final rule Sec. __.3(e)(13)(ii).
---------------------------------------------------------------------------
To further align the final rule's trading desk concept with the
market risk capital rule, the final rule provides that a trading desk
must be ``structured by the banking entity to implement a well-defined
business strategy.'' \348\ This further aligns the trading desk
definition with the definition of ``trading desk'' in the Basel
Committee's minimum capital requirements for market risk.\349\ This
change will ensure that banking entities that are subject to the market
risk capital prong and banking entities that are not subject to the
market risk capital prong have comparable trading desk definitions. In
general, a well-defined business strategy typically includes a written
description of a desk's objectives, including the economics behind its
trading and hedging strategies, as well as the instruments and
activities the desk will use to accomplish its objectives. A desk's
well-defined business strategy may also include an annual budget and
staffing plan and management reports.
---------------------------------------------------------------------------
\348\ Final rule Sec. __.3(e)(13)(i)(A).
\349\ See Basel Committee on Banking Supervision, Minimum
Capital Requirements for Market Risk (Feb. 2019).
---------------------------------------------------------------------------
Like the proposal, the final rule states that a trading desk is
organized to ensure appropriate setting, monitoring, and management
review of the desk's trading and hedging limits, current and potential
future loss exposures, and strategies. The final rule also states that
a trading desk is characterized by a clearly-defined unit that: (i)
Engages in coordinated trading activity with a unified approach to its
key elements; (ii) operates subject to a common and calibrated set of
risk metrics, risk levels, and joint trading limits; (iii) submits
compliance reports and other information as a unit for monitoring by
management; and (iv) books its trades together. The agencies consider a
unit to be ``clearly-defined'' if it meets these four factors.
The proposal included a multi-factor definition of trading desk
that referenced incentive compensation as one defining factor. However,
the banking agencies do not incorporate incentive compensation in
regulatory capital rules generally, and therefore omitting this
criterion would better align the trading desk definition between the
market risk capital rule and the Volcker Rule. Thus, the final rule
does not incorporate any reference to incentive compensation.\350\
---------------------------------------------------------------------------
\350\ Compare 83 FR at 33453 with final rule Sec.
__.3(e)(13)(i)(B).
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The final rule does not require the agencies to approve banking
entities'
[[Page 61998]]
initial trading desk designations and any changes in trading desk
designations, as one commenter had recommended.\351\ The agencies
believe such an approval process is unnecessary for purposes of the
final rule because the agencies intend to continue assessing banking
entities' trading desk designations as part of the agencies' ongoing
supervision of banking entities' compliance with the final rule as well
as other safety and soundness regulations, as applicable. At the same
time, the final rule does not allow the trading desk to be set
completely at the discretion of the banking entity, as one commenter
suggested.\352\ The adopted definition will provide flexibility to
allow banking entities to define their trading desks based on the same
criteria typically used for other operational, management, and
compliance purposes but would not be so broad as to hinder the
agencies' or banking entities' ability to detect prohibited proprietary
trading.
---------------------------------------------------------------------------
\351\ See AFR.
\352\ See JBA.
---------------------------------------------------------------------------
d. Reservation of Authority
The proposal included a reservation of authority that would have
permitted an agency to determine, on a case-by-case basis, that any
purchase or sale of one or more financial instruments by a banking
entity for which it is the primary financial regulatory agency either
is or is not for the trading account as defined in section 13(h)(6) of
the BHC Act.\353\ The preamble requested comment on whether such a
reservation of authority would be necessary in connection with the
proposed trading account definition, which would have focused on
objective factors to define proprietary trading. The agencies explained
that this approach may have produced results that were over- or under-
inclusive with respect to the statutory trading account definition. The
agencies further explained that the reservation of authority could
provide appropriate balance by recognizing the subjective elements of
the statute in light of the bright-line approach of the proposed
accounting prong.
---------------------------------------------------------------------------
\353\ See 83 FR at 33454.
---------------------------------------------------------------------------
Two commenters supported adopting the reservation of
authority.\354\ Both of these commenters noted the importance of
coordination and consistent application of the reservation of
authority, particularly in instances where the primary financial
regulatory agency may vary by legal entity within a firm.\355\ One of
these commenters suggested that the agencies keep such authority in
reserve for use solely in those circumstances wherein poor management
is putting an institution at risk of failure.\356\
---------------------------------------------------------------------------
\354\ See, e.g., BB&T and CFA.
\355\ Id.
\356\ See CFA.
---------------------------------------------------------------------------
The final rule does not include the proposed reservation of
authority.\357\ The revised trading account definition in the final
rule retains a short-term intent standard that largely tracks the
statutory standard.\358\ Because the final trading account definition
does not include the proposed accounting prong and is aligned with the
statutory standard, the agencies do not find it necessary to retain a
reservation of authority.
---------------------------------------------------------------------------
\357\ See proposed rule Sec. __.3(g).
\358\ Although banking entities that are subject to the market
risk capital prong are not subject to the short-term intent prong,
the market risk capital prong incorporates a substantially similar
short-term intent standard. As described above, the market risk
capital rule's definition of trading position largely parallels the
statutory definition of trading account, which in turn mirrors the
language in the short-term intent prong.
---------------------------------------------------------------------------
2. Section __.4: Permitted Underwriting and Market Making Related
Activities
a. Current Exemptions for Underwriting and Market Making--Related
Activities \359\
---------------------------------------------------------------------------
\359\ In contrast to the proposal, the discussions of the
exemptions for underwriting and market making-related activity have
been combined in order to avoid any unnecessary redundancy as well
as any confusion that could arise to the extent there are
differences in the way that otherwise identical provisions of those
exemptions operate. However, the two exemptions remain separate and
distinct. Banking entities seeking to rely on one or both exemptions
are required to comply with the requirements and legal standards
contained in each applicable exemption, and will continue to be
required to do so following adoption of the final rule.
---------------------------------------------------------------------------
Section 13(d)(1)(B) of the BHC Act contains an exemption from the
prohibition on proprietary trading for the purchase, sale, acquisition,
or disposition of securities, derivatives, contracts of sale of a
commodity for future delivery, and options on any of the foregoing in
connection with underwriting or market making-related activities, to
the extent that such activities are designed not to exceed the
reasonably expected near term demands of clients, customers, or
counterparties (RENTD).\360\ As the agencies noted when they adopted
the 2013 rule, client-oriented financial services, which include
underwriting, market making, and asset management services, are
important to the U.S. financial markets and the participants in those
markets.\361\
---------------------------------------------------------------------------
\360\ 12 U.S.C. 1851(d)(1)(B).
\361\ See 79 FR at 5615.
---------------------------------------------------------------------------
In particular, underwriters play a key role in facilitating
issuers' access to funding, and are accordingly important to the
capital formation process and to economic growth.\362\ For example,
underwriters can help reduce issuers' costs of capital by mitigating
potential information asymmetries between issuers and their potential
investors.\363\ Similarly, market makers operate to help ensure that
securities, commodities, and derivatives markets in the United States
remain well-functioning by, among other things, providing important
intermediation and liquidity.\364\ At the same time, however, the
agencies also recognized that providing appropriate latitude to banking
entities to provide such client-oriented services need not and should
not conflict with clear, robust, and effective implementation of the
statute's prohibitions and restrictions.\365\
---------------------------------------------------------------------------
\362\ See 79 FR at 5561 (internal footnotes omitted).
\363\ Id.
\364\ See 79 FR at 5576.
\365\ See 79 FR at 5541.
---------------------------------------------------------------------------
Accordingly, the 2013 rule follows a comprehensive, multi-faceted
approach to implementing the statutory exemptions for underwriting and
market making-related activities. Specifically, section __.4(a) of the
2013 rule implements the statutory exemption for underwriting and sets
forth the requirements that banking entities must meet in order to rely
on the exemption. Among other things, the 2013 rule requires that:
The banking entity act as an ``underwriter'' for a
``distribution'' of securities and the trading desk's underwriting
position be related to such distribution;
The amount and types of securities in the trading desk's
underwriting position be designed not to exceed RENTD, and reasonable
efforts be made to sell or otherwise reduce the underwriting position
within a reasonable period, taking into account the liquidity,
maturity, and depth of the market for the relevant type of security;
The banking entity has established and implements,
maintains, and enforces an internal compliance program that is
reasonably designed to ensure the banking entity's compliance with the
requirements of the underwriting exemption, including reasonably
designed written policies and procedures, internal controls, analysis,
and independent testing identifying and addressing:
[cir] The products, instruments, or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
[cir] Limits for each trading desk, based on the nature and amount
of the trading
[[Page 61999]]
desk's underwriting activities, including RENTD, on the (1) amount,
types, and risk of the trading desk's underwriting position, (2) level
of exposures to relevant risk factors arising from the trading desk's
underwriting position, and (3) period of time a security may be held;
[cir] Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
[cir] Authorization procedures, including escalation procedures
that require review and approval of any trade that would exceed a
trading desk's limit(s), demonstrable analysis of the basis for any
temporary or permanent increase to a trading desk's limit(s), and
independent review of such demonstrable analysis and approval;
The compensation arrangements of persons performing the
banking entity's underwriting activities are designed not to reward or
incentivize prohibited proprietary trading; and
The banking entity is licensed or registered to engage in
the activity described in the underwriting exemption in accordance with
applicable law.
Similarly, section __.4(b) of the 2013 rule implements the
statutory exemption for market making-related activities and sets forth
the requirements that all banking entities must meet in order to rely
on the exemption. Among other things, the 2013 rule requires that:
The trading desk that establishes and manages the
financial exposure routinely stands ready to purchase and sell one or
more types of financial instruments related to its financial exposure
and is willing and available to quote, purchase and sell, or otherwise
enter into long and short positions in those types of financial
instruments for its own account, in commercially reasonable amounts and
throughout market cycles on a basis appropriate for the liquidity,
maturity, and depth of the market for the relevant types of financial
instruments;
The amount, types, and risks of the financial instruments
in the trading desk's market-maker inventory are designed not to
exceed, on an ongoing basis, RENTD, as required by the statute and
based on certain factors and analysis specified in the rule;
The banking entity has established and implements,
maintains, and enforces an internal compliance program that is
reasonably designed to ensure its compliance with the exemption for
market making-related activities, including reasonably designed written
policies and procedures, internal controls, analysis, and independent
testing identifying and assessing certain specified factors; \366\
---------------------------------------------------------------------------
\366\ See 2013 rule Sec. __.4(b)(2)(iii).
---------------------------------------------------------------------------
To the extent that any required limit \367\ established by
the trading desk is exceeded, the trading desk takes action to bring
the trading desk into compliance with the limits as promptly as
possible after the limit is exceeded;
---------------------------------------------------------------------------
\367\ See 79 FR at 5615.
---------------------------------------------------------------------------
The compensation arrangements of persons performing market
making-related activities are designed not to reward or incentivize
prohibited proprietary trading; and
The banking entity is licensed or registered to engage in
market making-related activities in accordance with applicable
law.\368\
---------------------------------------------------------------------------
\368\ 2013 rule Sec. __.4(b)(2). This provision was not
intended to expand the scope of licensing or registration
requirements under relevant U.S. or foreign law that are applicable
to a banking entity engaged in market-making activities, but rather
to recognize that compliance with applicable law is an essential
indicator that a banking entity is engaged in market-making
activities. See 79 FR at 5620.
---------------------------------------------------------------------------
In the several years since the adoption of the 2013 rule, public
commenters have observed that the significant and costly compliance
requirements in the existing exemptions may unnecessarily constrain
underwriting and market making without a corresponding reduction in the
type of trading activities that the rule was designed to prohibit.\369\
As the agencies noted in the proposal, implementation of the 2013 rule
has indicated that the existing approach to give effect to the
statutory standard of RENTD may be overly broad and complex, and also
may inhibit otherwise permissible activity.\370\
---------------------------------------------------------------------------
\369\ 83 FR at 33435, 33459.
\370\ 83 FR at 33445-46.
---------------------------------------------------------------------------
Accordingly, the proposal was intended to tailor, streamline, and
clarify the requirements that a banking entity must satisfy to avail
itself of either exemption for underwriting or market making-related
activities. In particular, the proposal intended to provide a clearer
way to determine if a trading desk's activities satisfy the statutory
requirement that underwriting or market making-related activity, as
applicable, be designed not to exceed RENTD. Specifically, the proposal
would have established a presumption, available to banking entities
both with and without significant trading assets and liabilities, that
trading within internally set limits satisfies the requirement that
permitted activities must be designed not to exceed RENTD.\371\ In
addition, the agencies also proposed to tailor the exemption for
underwriting and market making-related activities' compliance program
requirements to the size, complexity, and type of activity conducted by
the banking entity by making those requirements applicable only to
banking entities with significant trading assets and liabilities.\372\
---------------------------------------------------------------------------
\371\ Proposed rules Sec. __.4(a)(8) and Sec. __.4(b)(6).
\372\ 83 FR at 33438 and 33459.
---------------------------------------------------------------------------
b. Proposed Presumption of Compliance With the Statutory RENTD
Requirement
As described above, the statutory exemptions for underwriting and
market making-related activities in section 13(d)(1)(B) of the BHC Act
requires that such activities be designed not to exceed RENTD.\373\
Consistent with the statute, for the purposes of the exemption for
underwriting activities, section __.4(a)(2)(ii) of the 2013 rule
requires that the amount and type of the securities in the trading
desk's underwriting position be designed not to exceed RENTD, and
reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity, maturity, and depth of the market for the relevant type
of security.\374\
---------------------------------------------------------------------------
\373\ 12 U.S.C. 1851(d)(1)(B).
\374\ 2013 rule Sec. __.4(a)(2)(ii).
---------------------------------------------------------------------------
Similarly, for the purposes of the exemption for market making-
related activities, section __.4(b)(2)(ii) of the 2013 rule requires
that the amount, types, and risks of the financial instruments in the
trading desk's market-maker inventory are designed not to exceed, on an
ongoing basis, RENTD, based on certain factors and analysis.\375\
Specifically, these factors are: (i) The liquidity, maturity, and depth
of the market for the relevant type of financial instrument(s), and
(ii) demonstrable analysis of historical customer demand, current
inventory of financial instruments, and market and other factors
regarding the amount, types, and risks of or associated with positions
in financial instruments in which the trading desk makes a market,
including through block trades.\376\ Under Sec. __.4(b)(2)(iii)(C) of
the 2013 rule, a banking entity must account for these considerations
when establishing limits for each trading desk.\377\
---------------------------------------------------------------------------
\375\ 2013 rule Sec. __.4(b)(2)(ii).
\376\ Id.
\377\ 2013 rule Sec. __.4(b)(2)(iii)(C).
---------------------------------------------------------------------------
In the proposal, the agencies recognized that the prescriptive
standards for meeting the statutory RENTD requirements in the
exemptions for underwriting and market making-related activities were
complex, costly, and did not provide bright line conditions under which
trading activity
[[Page 62000]]
could be classified as permissible underwriting or market making-
related activity.\378\ Accordingly, the agencies sought comment on a
proposal to implement this key statutory factor--in connection with
both relevant exemptions--in a manner designed to provide banking
entities and the agencies with greater certainty and clarity about what
activity constitutes permissible underwriting or market making-related
activity pursuant to the applicable exemption.\379\
---------------------------------------------------------------------------
\378\ See 83 FR at 33455, 33459.
\379\ Id.
---------------------------------------------------------------------------
Instead of the approach taken in the 2013 rule, the agencies
proposed to establish the articulation and use of internal limits as a
key mechanism for conducting trading activity in accordance with the
rule's exemptions for underwriting and market making-related
activities.\380\ Specifically, the proposal would have provided that
the purchase or sale of a financial instrument by a banking entity
would be presumed to be designed not to exceed RENTD if the banking
entity establishes internal limits for each trading desk, subject to
certain conditions, and implements, maintains, and enforces those
limits, such that the risk of the financial instruments held by the
trading desk does not exceed such limits.\381\ As stated in the
proposal, the agencies believe that this approach would provide banking
entities with more flexibility and certainty in conducting permissible
underwriting and market making-related activities.\382\
---------------------------------------------------------------------------
\380\ As stated in the proposal, as a consequence of the changes
to focus on limits, many of the requirements of the 2013 rule
relating to limits associated with the exemptions for underwriting
and market making-related activities would be incorporated into this
requirement and modified or removed as appropriate in the proposal.
\381\ See proposed rule Sec. __.4(a)(8); proposed rule Sec.
__.4(b)(6).
\382\ 83 FR at 33438.
---------------------------------------------------------------------------
Under the proposal, all banking entities, regardless of their
volume of trading assets and liabilities, would have been able to
voluntarily avail themselves of the presumption of compliance with the
RENTD requirement by establishing and complying with these internal
limits. With respect to the underwriting exemption, the proposal would
have provided that a banking entity would establish internal limits for
each trading desk that are designed not to exceed RENTD, based on the
nature and amount of the trading desk's underwriting activities, on
the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.\383\
---------------------------------------------------------------------------
\383\ Proposed rule Sec. __.4(a)(8)(i).
---------------------------------------------------------------------------
With respect to the exemption for market making-related activities,
the proposal would have provided that all banking entities, regardless
of their volume of trading assets and liabilities, would be able to
voluntarily avail themselves of the presumption of compliance with the
RENTD requirement by establishing and complying with internal limits.
Specifically, the proposal would have provided that a banking entity
would establish internal limits for each trading desk that are designed
not to exceed RENTD, based on the nature and amount of the trading
desk's market making-related activities, on the:
(1) Amount, types, and risks of its market-maker positions;
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
(4) Period of time a financial instrument may be held.\384\
---------------------------------------------------------------------------
\384\ Proposed rule Sec. __.4(6)(i)(B).
---------------------------------------------------------------------------
In the case of both exemptions, the proposal provided that banking
entities utilizing the applicable presumption of compliance with the
RENTD requirement would have been required to maintain internal
policies and procedures for setting and reviewing desk-level risk
limits.\385\ The proposed approach would not have required that a
banking entity's limits be based on any specific or mandated analysis,
as required with respect to RENTD analysis under the 2013 rule. Rather,
a banking entity would have established the limits according to its own
internal analyses and processes around conducting its underwriting
activities and market making-related activities in accordance with
section 13(d)(1)(B).\386\ In addition, the proposal would have
required, for both the exemption for underwriting and market making-
related activities, a banking entity to promptly report to the
appropriate agency when a trading desk exceeds or increases its
internal limits.\387\
---------------------------------------------------------------------------
\385\ See 83 FR at 33456, 33460. Under the proposal, banking
entities with significant trading assets and liabilities would have
continued to be required to establish internal limits for each
trading desk as part of the underwriting compliance program
requirement in Sec. __.4(a)(2)(iii)(B), the elements of which would
cross-reference directly to the requirement in proposed Sec.
__.4(a)(8)(i). Similarly, banking entities with significant trading
assets and liabilities would have continued to be required to
establish internal limits for each trading desk as part of the
compliance program requirement for market making-related activity in
Sec. __.4(b)(2)(iii)(C), the elements of which would cross-
reference directly to the requirement in proposed Sec.
__.4(b)(6)(i). Banking entities without significant trading assets
and liabilities would have no longer been required to establish a
compliance program that is specific for the purposes of complying
with the either exemption, but would need to establish, implement,
maintain and enforce internal limits if they chose to utilize the
proposed presumption of compliance with respect to the statutory
RENTD requirement in section 13(d)(1)(B) of the BHC Act.
\386\ See 83 FR at 33456, 34460. In the proposal, the agencies
indicated that they expected that the risk and position limits
metric that is required for certain banking entities under the 2013
rule (and would continue to be required under the Appendix to the
proposal) would help banking entities and the agencies to manage and
monitor the underwriting and market making-related activities of
banking entities subject to the metrics reporting and recordkeeping
requirements of the Appendix.
\387\ Proposed rule Sec. __.4(a)(8)(iii); proposed rule Sec.
__.4(b)(6)(iii).
---------------------------------------------------------------------------
The proposal also provided that internal limits established by a
banking entity for the presumption of compliance with the statutory
RENTD requirement under both the exemption for underwriting and market
making-related activities would have been subject to review and
oversight by the appropriate agency on an ongoing basis. Any review of
such limits would have assessed whether or not those limits are
established based on the statutory standard--i.e., the trading desk's
RENTD, based on the nature and amount of the trading desk's
underwriting or market making-related activities.\388\
---------------------------------------------------------------------------
\388\ See 83 FR at 33456.
---------------------------------------------------------------------------
Finally, under the proposal, the presumption of compliance with the
statutory RENTD requirement for permissible underwriting and market
making-related activities could have been rebutted by the appropriate
agency if the agency determines, based on all relevant facts and
circumstances, that a trading desk is engaging in activity that is not
based on the trading desk's RENTD on an ongoing basis. The agency would
have provided notice of any such determination to the banking entity in
writing.\389\
---------------------------------------------------------------------------
\389\ See proposed rule Sec. __.4(a)(8)(iv); proposed rule
Sec. __.4(b)(6)(iv).
---------------------------------------------------------------------------
The agencies requested comment on the proposed addition of a
presumption that conducting underwriting or market making-related
activities within internally set limits satisfies the requirement that
permitted such activities be designed not to exceed RENTD.
[[Page 62001]]
c. Commenters' Views
General Approach of a Presumption of Compliance With the Statutory
RENTD Requirement
As discussed above, the agencies proposed to establish the
articulation and use of internal limits as a key mechanism for
conducting trading activity in accordance with the rule's exemptions
for underwriting and market making-related activities.\390\ A number of
commenters expressed support for the general approach of a presumption
of compliance to satisfy the RENTD standard.\391\ Claiming that the
2013 rule has chilled market making-related activities and is complex
and costly and does not provide bright line conditions under which
trading can clearly be classified as permissible market making-related
activities, one commenter asserted that the general approach would
significantly improve upon the approach of the 2013 rule.\392\
---------------------------------------------------------------------------
\390\ See proposed rule Sec. __.4(a)(8); proposed rule Sec.
__.4(b)(6).
\391\ See, e.g., Credit Suisse; SIFMA; State Street; Real Estate
Associations; and BOK.
\392\ See SIFMA.
---------------------------------------------------------------------------
One commenter supported the proposed approach on the basis that the
presumption would allow banking entities to estimate and manage
inventory limits in a more holistic manner to allow for greater and
more efficient liquidity and pricing for its clients.\393\ That
commenter argued that, in comparison to the 2013 rule, a presumption
will more effectively leverage existing industry practices and
reporting requirements related to managing market-making inventory,
such as maintaining daily VaR metrics by product and position limits
compared to relative levels of client activity.\394\ Another suggested
that because internally set limits are developed and applied by each
banking entity in light of capital requirements and risk management it
would be reasonable to provide a presumption of compliance tied to
internally set limits.\395\ Finally, one commenter said that the
approach would provide a more efficient use of compliance resources and
allow banking entities to tailor compliance requirements to its
specific underwriting and market making-related activities.\396\
---------------------------------------------------------------------------
\393\ See State Street.
\394\ Id.
\395\ See JBA.
\396\ See ABA.
---------------------------------------------------------------------------
Several commenters, however, expressed concerns about the creation
of a presumption of compliance to satisfy the statutory RENTD
standard.\397\ For example, commenters argued that the proposed
presumption is not consistent with the statute,\398\ with one commenter
claiming that the statutory requirement was intended to constrain bank
activities, not bank risks.\399\ Commenters expressed concerns that the
proposed presumption of compliance is too deferential to banking
entities \400\ and would reward aggressive banking entities that set
their risk limits too high.\401\ One commenter argued that the limits
would not constrain proprietary trading because the proposed
presumption of compliance with RENTD allows banking entities to raise
their limits and does not distinguish between permissible and
impermissible proprietary trades within risk limits.\402\ Another
commenter disagreed with a presumption of compliance for underwriting
activity, asserting that this approach would undermine well-established
principles of safety and soundness, particularly given what the
commenter referred to as a general lack of scrutiny over bank-developed
risk limits.\403\
---------------------------------------------------------------------------
\397\ See, e.g., Merkley; AFR; Bean; Better Markets; Center for
American Progress (CAP); Public Citizen; Volcker Alliance; and Data
Boiler.
\398\ See, e.g., Bean; Better Markets; CAP; and Public Citizen.
\399\ See AFR.
\400\ See, e.g., AFR; Bean; CAP; Public Citizen; Volcker
Alliance; and Data Boiler.
\401\ See, e.g., Bean and Volcker Alliance.
\402\ See Better Markets.
\403\ See NAFCU.
---------------------------------------------------------------------------
Required Analysis for Establishing Risk Limits
As discussed above, the agencies recognized in the proposal that
the prescriptive standards in the 2013 rule for meeting the RENTD
requirements were complex, costly, and did not provide bright line
conditions under which trading can clearly be classified as permissible
proprietary trading.\404\ As a result, the proposal would not have
required that a banking entity's limits be based on any specific or
mandated analysis, as was required under the 2013 rule. Rather, under
the presumption of compliance with the RENTD requirement in the
proposal, a banking entity would have established limits according to
its own internal analyses and processes around conducting its
underwriting and market making-related activities in accordance with
section 13(d)(1)(B) of the BHC Act.\405\ Several commenters provided
their views on this element of the proposal.
---------------------------------------------------------------------------
\404\ See 83 FR 33459.
\405\ See 83 FR at 33460. In the proposal, the agencies noted
that they expect that the risk and position limits metric that is
already required for certain banking entities under the 2013 rule
(and would continue to be required under the Appendix to the
proposal) would help banking entities and the agencies to manage and
monitor the market making-related activities of banking entities
subject to the metrics reporting and recordkeeping requirements of
the Appendix.
---------------------------------------------------------------------------
Two commenters supported the agencies' contention in the proposal
that the prescriptive standards in the 2013 rule were complex, costly,
and did not provide bright line conditions under which trading can
clearly be classified as permissible proprietary trading.\406\ Some
commenters said that removing certain conditions, such as the
demonstrable analysis of historical customer demand in Sec.
__.4(b)(2)(ii)(B) of the 2013 rule, would increase flexibility and
provide certainty for banking entities to engage in market making-
related activities since current or reasonably forecasted market demand
may be different than historical data may suggest.\407\
---------------------------------------------------------------------------
\406\ See, e.g., Capital One et al. and SIFMA.
\407\ See FSF; State Street and SIFMA.
---------------------------------------------------------------------------
Several commenters, however, expressed concerns about the proposed
removal of the demonstrable analysis requirement. Some commenters
argued that the removal of this requirement will make it harder to for
the agencies to rebut the presumption or determine when banking
entities have not properly set their RENTD limits.\408\ One commenter
argued that by not requiring a demonstrable analysis, the proposed rule
will allow banking entities to engage in trading activities only
superficially tied to customer demand.\409\ One commenter expressed a
belief that the demonstrable analysis cannot be effectively replaced by
other metrics in the proposal, such as the risk and position limits and
usage metric in the Appendix because this metric does not provide
information on customer demand relative to trading inventories.\410\
---------------------------------------------------------------------------
\408\ See Merkley; Volcker Alliance; and Data Boiler.
\409\ See Better Markets.
\410\ See AFR.
---------------------------------------------------------------------------
To increase flexibility and certainty for banking entities engaged
in permitted activities, several of the commenters that supported the
general approach of the presumption of compliance with the RENTD
requirement requested that this proposed requirement be modified in
certain ways. One commenter suggested that the presumption should be
available to trading desks that establish internal limits appropriate
for their risk appetite, risk capacity, and business strategy and hold
themselves out as a
[[Page 62002]]
market maker.\411\ A commenter requested that the agencies revise the
presumption to make it available to a banking entity that sets, in a
manner agreed to with its onsite prudential examiner and consistent
with the intent and purposes of section 13 of the BHC, internal RENTD
limits based on factors relevant to the reasonable near-term demand of
clients, customers and counterparties, which are calibrated with the
intention of not exceeding RENTD.\412\ One commenter suggested that,
instead of adhering to the more prescriptive aspects of the proposed
RENTD presumption, the trading desks of moderate and limited trading
assets and liabilities banking entities should be given discretion to
adopt internal risk limits appropriate to the activities of the desk
subject to other existing bank regulations, supervisory review, and
oversight by the appropriate agency and still be able to utilize the
presumption of compliance.\413\
---------------------------------------------------------------------------
\411\ See JBA.
\412\ See SIFMA (recommended that such factors might include,
for example, anticipated market volatility and current client
inquiries and other indications of client interest, among many
others); FSF.
\413\ See Capital One et al.
---------------------------------------------------------------------------
Some commenters requested that the agencies clarify aspects of the
proposal's RENTD presumption. Commenters asked the agencies to clarify
that supervisors and examiners will not impose a one-size fits all
approach given the differences in business models among banking
entities.\414\ While opposed to the general approach of a presumption
of compliance with the statutory RENTD requirement, one commenter
suggested that, if the agencies adopt the presumption of compliance,
additional guidance should be given to banking entities regarding the
factors to consider when setting the limits required to establish the
presumption of compliance, as the factors in the proposal were too
broad and malleable.\415\ Another commenter suggested that the agencies
clarify that the presumption of compliance should include activity-
based limits as a part of its risk-limit structure, such as financial
instrument holding periods, notional size and inventory turnover,
because activity-based limits are reflective of client demand and an
appropriate statutory substitute compared to risk-based limits, which
can be hedged.\416\
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\414\ See CCMR and JBA (In particular, this commenter argued
that the agencies should not compare banking entities as it would be
an impediment to banking entities that are not the most conservative
in its internal risk controls).
\415\ See Better Markets.
\416\ See BB&T.
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Specific to the underwriting exemption, one commenter asserted that
underwriting activity can be sporadic due to client demand or market
factors, which may result in low limit utilization and a rebuttal of
the presumption of compliance even when the underwriting position
itself is identifiable as part of a primary or follow-on offering of
securities.\417\ The commenter suggested that the agencies consider
corporate actions, such as a debt offering, as an appropriate
identifier of permissible underwriting.\418\ Another commenter
suggested that the agencies permit banking entities to set limits based
on the absolute value of profits and losses in the case of an
underwriting desk.\419\
---------------------------------------------------------------------------
\417\ Id.
\418\ Id.
\419\ See JBA.
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Prompt Notifications
As discussed above, the proposal would have required a banking
entity to promptly report to the appropriate agency when a trading desk
exceeds or increases the internal limits it sets to avail itself of the
RENTD presumption with respect to the exemptions for underwriting and
market making-related activities.\420\ With two exceptions,\421\
commenters strongly opposed the proposal's requirement that banking
entities promptly report limit breaches.\422\ For example, many of
these commenters stated that the notifications would be impractical and
burdensome to banking entities \423\ and would not enhance the
oversight capabilities of the agencies because the information is
already otherwise available through ordinary supervisory
processes,\424\ including the internal limits and usage metric.\425\
Two commenters asserted that the notices would provide little insight
into how risk is managed.\426\ Some commenters expressed concern that
complying with the requirement would be particularly challenging for
banking entities with parents that are FBOs because these banking
entities lack on-site examiners to receive notifications.\427\ A few
commenters claimed that the prompt notification requirement provides
incentives for banking entities to set their limits so high that they
have fewer breaches and changes to limits.\428\ Commenters also noted
that, when risk limits are appropriately calibrated, breaches are not
uncommon, and notifying the agencies of each breach could overwhelm the
agencies.\429\ Another commenter argued that the prompt notification
may chill traders' willingness to request changes to limits where it
would otherwise be appropriate to accommodate legitimate customer
demand.\430\
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\420\ See proposed rule Sec. __.4(a)(8)(iii); proposed rule
Sec. __.4(b)(6)(iii).
\421\ See, e.g., CFA at 7 (stating that, some small and mid-
sized institutions may not have strong internal controls and may be
susceptible to the activities of a rogue trader, so the prompt
notice requirements allow regulators to impose stricter controls if
necessary); Data Boiler at 36 (representing that the prompt
reporting requirement would decrease opportunities for evasion of
the rule's requirements).
\422\ See, e.g., CCMC; BOK; ISDA; Real Estate Associations;
Goldman Sachs; GFMA; CREFC; ABA; SIFMA; IIB; BB&T; JBA; FSF; Credit
Suisse; and Capital One et al.
\423\ See, e.g., CCMR; Credit Suisse; GFMA; FSF; and JBA.
\424\ See, e.g., Credit Suisse; ABA; GFMA; IIB; BOK; and SIFMA.
\425\ See, e.g., FSF; JBA; ABA; Goldman Sachs; CREFC; and CCMC.
\426\ See, e.g., BOK (stating that limit excesses do not, of
themselves, show that an institution has changed it strategy or risk
tolerance and that reporting by financial institutions might detract
from a focus on risk management and shift to a ``number of times
exceeded'' view which provides very little insight into how risk is
managed); MBA (stating that prompt reporting would encourage the
agencies to view events in isolation without consideration to facts
and circumstances and that it would be more appropriate to review
limit-events in the ordinary course of established supervisory
process).
\427\ See, e.g., JBA (stating that it would be operationally
difficult and costly for foreign headquarters to collect and report
data to US regulators); IIB (stating that foreign trading desks
would not have on-site examiners to receive reports and that the
requirement could intrude into local supervisory matters).
\428\ See, e.g., Better Markets; Capital One et al.; and State
Street.
\429\ See, e.g., GFMA and BOK (stating that limits that are
never exceeded ``may not be very useful limits.'').
\430\ See CCMC.
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As an alternative to the prompt notification requirement, many
commenters suggested that the agencies require banking entities to make
detailed records of limit changes and breaches.\431\ Other commenters
suggested that the agencies rely on existing supervisory processes to
monitor limit breaches and increases,\432\ including the internal
limits and usage metric.\433\
---------------------------------------------------------------------------
\431\ See, e.g., CCMR and BB&T.
\432\ See, e.g., FSF; GFMA; and Real Estate Associations.
\433\ See, e.g., FSF; JBA; and ABA.
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Rebutting the Presumption
As discussed above, under the proposal, the RENTD presumption could
have been rebutted by the appropriate agency if the agency determined,
based on all relevant facts and circumstances, that a trading desk is
engaging in activity that is not based
[[Page 62003]]
on the trading desk's RENTD on an ongoing basis.\434\
---------------------------------------------------------------------------
\434\ See proposed rule Sec. __.4(a)(8)(iv); proposed rule
Sec. __.4(b)(6)(iv).
---------------------------------------------------------------------------
A few commenters discussed the rebuttal process. For example, one
commenter requested that the agencies specify the procedures for an
agency to rebut the presumption of compliance.\435\ Another commenter
recommended that the agencies adopt a consistent procedure for
challenging the presumptions in the rule.\436\ Another commenter stated
that the proposal would only allow the agencies to challenge the risk
limit approval and exception process, not the nexus between RENTD and
the limits themselves.\437\
---------------------------------------------------------------------------
\435\ See MBA.
\436\ See IIB.
\437\ See Better Markets.
---------------------------------------------------------------------------
d. Final Presumption of Compliance With the Statutory RENTD Requirement
The agencies are adopting the presumption of compliance with the
RENTD requirement for both the exemptions for underwriting and market
making-related activities largely as proposed, but with modifications
intended to be responsive to commenters' concerns.\438\
---------------------------------------------------------------------------
\438\ In addition to the changes described in this section, the
presumption of compliance has been moved into a new paragraph (c) in
Sec. __.4, as opposed to including separate provisions under each
of the two relevant exemptions. That change was intended solely for
clarity and to avoid any unnecessary duplication in light of the
fact that the process for complying with the presumption of
compliance is identical for both exemptions. New paragraph (c) does,
however, recognize that the limits banking entities will be required
to implement, maintain, and enforce will differ as between the
exemptions for underwriting and market making-related activities.
See final rule Sec. Sec. __.4(c)(2)(A) and __.4(c)(2)(B).
---------------------------------------------------------------------------
The agencies are mindful of the concerns raised by commenters
regarding the general approach of relying on a banking entity's
internal limits to satisfy the statutory RENTD requirement.\439\ With
respect to the comments described above that the presumption would not
be consistent with the statute, the agencies note that the statute
permits underwriting and market making-related activities to the extent
that such activities are designed not to exceed RENTD. Accordingly,
under the final rule the presumption will be available to each trading
desk that establishes, implements, maintains, and enforces internal
limits that are designed not to exceed RENTD.\440\ In addition, with
respect to the commenter who expressed concern that the presumption
would undermine safety and soundness due to a perceived lack of general
scrutiny over banking entity-developed limits, the agencies note that
these internal limits will be subject to supervisory review and
oversight, which constrains banking entities' ability to set their
limits too high. Further, the agencies may review such limits to assess
whether or not those limits are consistent with the statutory RENTD
standard. This allows the supervisors and examiners to look to the
articulation and use of limits to distinguish between permissible and
impermissible proprietary trading. The agencies believe that the
presumption of compliance, along with the other requirements of the
final rule's exemptions for underwriting and market making-related
activities, create a framework that will allow banking entities and the
agencies to determine whether a trading activity has been designed not
to exceed RENTD.
---------------------------------------------------------------------------
\439\ As noted above, this includes commenters who argue that
such amendments will undermine the operation of the 2013 rule, lead
to increased risk taking among banking entities, and conflict with
the statutory requirements in section 13(d)(1)(B) of the BHC Act.
See supra notes 28, 36-41 and accompanying text.
\440\ For consistency with the final rule's RENTD requirement,
the sub-heading for Sec. __.4(c)(1) has been changed from ``risk
limits'' to ``limits.''
---------------------------------------------------------------------------
Further, the agencies are concerned that compliance with the 2013
rule's exemptions for underwriting and market making-related activities
may be unnecessarily complex and costly to achieve the intended goal of
compliance with these exemptions. For example, as noted in the
proposal, a number of banking entities have indicated that even after
conducting a number of complex and intensive analyses to meet the
``demonstrable analysis'' requirements for the exemption for market
making-related activities, they still may be unable to gain comfort
that their bona fide market making-related activity meets the
factors.\441\ Further, the absence of clear, bright-line standards for
assessing compliance with the statutory RENTD standard may be
unnecessarily constraining underwriting and market making, two critical
functions to the health and well-being of financial markets in the
United States.
---------------------------------------------------------------------------
\441\ 83 FR at 33459.
---------------------------------------------------------------------------
The agencies note commenters' concerns regarding the removal of
``demonstrable analysis'' requirement will make it harder for agencies
to rebut the presumption of compliance with the RENTD requirement or
determine when banking entities have not properly set their RENTD
limits. The agencies believe, however, that requiring a banking
entity's internal limits to be based on RENTD as a requirement for
utilizing the presumption of compliance should help to simplify
compliance with, and oversight of, that statutory standard by placing
the focus on how those limits are established, maintained, implemented,
and enforced.
Accordingly, under the rule, a banking entity will be presumed to
meet the RENTD requirements in Sec. __.4 (a)(2)(ii)(A) or Sec.
__.4(b)(2)(ii) with respect to the purchase or sale of a financial
instrument if the banking entity has established and implements,
maintains, and enforces the limits for the relevant trading desk as
described in the final rule.\442\ With respect to underwriting
activities, the presumption will be available to each trading desk that
establishes, implements, maintains, and enforces internal limits that
are designed not to exceed RENTD, based on the nature and amount of the
trading desk's underwriting activities, on the:
---------------------------------------------------------------------------
\442\ See final rule, Sec. __.4(c)(1)(i).
---------------------------------------------------------------------------
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.\443\
---------------------------------------------------------------------------
\443\ See final rule Sec. __.4(c)(1)(ii)(A). The language in
this paragraph of the rule has been modified slightly from the
proposal to clarify that such limits should take into account the
liquidity, maturity, and depth of the market for the relevant types
of financial instruments. As this language comes directly from the
RENTD requirement in Sec. __.4 (a)(2)(ii)(A), the agencies do not
view this as a substantive change. Rather, the agencies believe that
it is important to emphasize in the rule text that the limit used to
satisfy the presumption of compliance for one type of financial
instrument will not necessarily be the same for other types of
financial instruments and that the particular characteristics of the
relevant market should be taken into account throughout the process
of setting these limits.
---------------------------------------------------------------------------
With respect to market making-related activities, the presumption
will be available to each trading desk that establishes, implements,
maintains, and enforces risk and position limits that are designed not
to exceed RENTD, based on the nature and amount of the trading desk's
market making-related activities, that address the:
(1) Amount, types, and risks of its market-maker positions;
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
(4) Period of time a financial instrument may be held.\444\
---------------------------------------------------------------------------
\444\ See final rule Sec. __.4(c)(1)(ii)(B). For the reasons
described in connection with the limits required as satisfy the
presumption of compliance in connection with the underwriting
exemption, the language in this paragraph has been modified slightly
from the proposal to clarify that such limits must take into account
the liquidity, maturity, and depth of the market for the relevant
types of financial instruments. See id.
---------------------------------------------------------------------------
[[Page 62004]]
Some commenters also noted that the agencies should not take a
``one-size-fits-all'' approach to the limits that must be established
to satisfy the presumption of compliance with RENTD on the basis that
not all of the proposed limits may be applicable to every type of
financial instrument, particularly derivatives.\445\ In response to
these commenters, the agencies have modified the rule text to clarify
that the limits required to be established by a banking entity in order
to satisfy the presumption of compliance must address certain items.
The agencies recognize that certain of the enumerated items, which are
unchanged from the proposal, may be more easily applied for desks that
engage in market-making in securities rather than derivatives, and
emphasize that section __.4(b), both as currently in effect and as
amended, is intended to provide banking entities with the flexibility
to determine appropriate limits for market making-related activities
that are designed not to exceed RENTD, taking into account the
liquidity, maturity, and depth of the market for the relevant types of
financial instruments.
---------------------------------------------------------------------------
\445\ See e.g., FSF, SIFMA.
---------------------------------------------------------------------------
With respect to derivatives, certain of the enumerated items may
not be effective for designing market making-related activities not to
exceed RENTD, which is ultimately the primary purpose of adopting a
presumption of compliance based on the establishment and use of
internal limits.\446\ Under those circumstances, the agencies
acknowledge that it may be appropriate for banking entities to
establish limits based on specific conditions that would need to be
satisfied in order to utilize the presumption of compliance, rather
than a fixed number of market-maker positions.\447\
---------------------------------------------------------------------------
\446\ As previously noted, the final rule also replaces the
existing definition of ``market maker-inventory'' with a definition
of ``market-maker positions.'' This change was intended to reflect
the fact that requiring banking entities seeking to rely on the
presumption of compliance with the RENTD requirement to have limits
on market maker-inventory is generally unworkable in the context of
derivatives. See infra note 458 and accompanying text.
\447\ The agencies note that this discussion does not encompass
or impact the CFTC's or SEC's treatment of market-making in
derivatives for purposes other than section 13 of the BHC Act and
the rule.
---------------------------------------------------------------------------
For example, for a desk that engages in market making-related
activities only with respect to derivatives (or derivatives and non-
financial instruments), the requirement to establish, implement,
maintain, and enforce limits designed not to exceed RENTD could be
satisfied to the extent the banking entity establishes limits on the
market making desk's level of exposures to relevant risk factors
arising from its financial exposure and such limits are designed not to
exceed RENTD (including derivatives positions related to a request from
a client, customer, or counterparty), based on the nature and amount of
the trading desk's market making-related activities. Such limits would
be consistent with the underlying purpose of the exemption for market
making-related activities, which is to implement the restriction on a
banking entity's proprietary trading activities while still allowing
market makers to provide intermediation and liquidity services
necessary to the functioning of our financial markets.
Consistent with the proposal, the limits used to satisfy the
presumption of compliance under the final rule will be subject to
supervisory review and oversight by the applicable agency on an ongoing
basis.\448\ Moreover, the final rule provides that the presumption of
compliance may be rebutted by the applicable agency if such agency
determines, taking into account the liquidity, maturity, and depth of
the market for the relevant types of financial instruments and based on
all relevant facts and circumstances, that a trading desk is engaging
in activity that is not designed not to exceed RENTD.\449\ In a
modification from the proposed rule, the final rule contains additional
language that specifies that the agencies will take into account the
liquidity, maturity, and depth of the market for the relevant types of
financial instruments when determining whether to rebut the presumption
of compliance. This change is intended to provide additional clarity
regarding the factors the agencies will consider when making this
determination. In response to commenters' concerns about the rebuttal
process, the final rule specifies that any such rebuttal of the
presumption must be made in accordance with the notice and response
procedures in subpart D of the rule.\450\
---------------------------------------------------------------------------
\448\ See final rule Sec. __.4(c)(2). The supervisory review
provision in the proposed rule stated that ``any review of such
limits will include assessment of whether the limits are designed
not to exceed the reasonably expected near term demands of clients,
customers, or counterparties.'' Sections___.4(c)(1)(i)-(ii) of the
final rule clearly stipulate that such limits must be designed not
to exceed the reasonably expected near term demand of clients,
customers, or counterparties. To avoid redundancy, this language has
been omitted from Sec. __.4(c)(2) in the final rule.
\449\ See final rule Sec. __.4(c)(4).
\450\ See infra notes 655-58 and accompanying text (discussion
of the notice and response procedures in Sec. __.20(i)).
---------------------------------------------------------------------------
The agencies are, however, persuaded by the arguments raised by
some commenters with respect to the proposed requirement that a banking
entity promptly report to the appropriate agency when a trading desk
exceeds or increases its internal limits to avail itself of the RENTD
presumption with respect to the exemptions for underwriting and market
making-related activity.\451\ The agencies recognize that limits that
are set so high as to never be breached are not necessarily meaningful
limits. Thus, breaches of appropriately set limits may occur with a
frequency that does not justify notifying the agencies for every single
breach. The agencies recognize that the burdens associated with
preparing and reporting such information may not be justified in light
of the potential benefits of such requirement.
---------------------------------------------------------------------------
\451\ See proposed rule Sec. Sec. __.4(a)(8)(iii) and
__.4(b)(6)(iii). See also supra note 387 and accompanying text.
---------------------------------------------------------------------------
Accordingly, the final rule instead requires banking entities to
maintain and make available to the applicable agency, upon request,
records regarding (1) any limit that is exceeded and (2) any temporary
or permanent increase to any limit(s), in each case in the form and
manner as directed by the agency.\452\ Moreover, when a limit is
breached or increased, the presumption of compliance with RENTD will
continue to be available so long as the banking entity: (1) Takes
action as promptly as possible after a breach to bring the trading desk
into compliance; and
---------------------------------------------------------------------------
\452\ See final rule Sec. __.4(c)(3)(i).
---------------------------------------------------------------------------
(2) follows established written authorization procedures, including
escalation procedures that require review and approval of any trade
that exceeds a trading desk's limit(s), demonstrable analysis of the
basis for any temporary or permanent increase to a trading desk's
limit(s), and independent review of such demonstrable analysis and
approval.\453\ The agencies believe that this requirement will provide
the agencies with sufficient information to determine whether a banking
entity's existing limits are appropriately calibrated to comply with
the RENTD requirement for that particular financial instrument.\454\
---------------------------------------------------------------------------
\453\ See final rule Sec. __.4(c)(3)(i).
\454\ The agencies note that the final rule requires that
banking entities with significant trading assets and liabilities
must record and report the quantitative measurements contained in
the Appendix to the final rule. See infra Subpart E-- Metrics:
Appendix to Part []--Reporting and Recordkeeping
Requirements. The agencies believe that the risk and position limits
metric will also help banking entities and the agencies monitor the
underwriting and market making-related activities of banking
entities with significant trading assets and liabilities.
---------------------------------------------------------------------------
[[Page 62005]]
e. Additional Changes to the Final Rule's Underwriting and Market
Making-Related Activities Exemptions
In addition to the changes described above, the final rule's
exemptions for underwriting and market making-related activities
contain several other conforming and clarifying changes. Consistent
with the proposed rule, the structure of Sec. __.4(a)(ii) in the final
rule has been modified to clarify that the applicable paragraph
contains two separate and distinct requirements.\455\ In addition,
several definitions used in the final rule's exemptions for
underwriting and market making-related activities have also been
modified. Specifically, the phrase ``paragraph (b)'' has been replaced
with ``this section'' in the definition of ``underwriting position''
because the defined term is used in several places.\456\ The definition
of ``financial exposure'' has been similarly modified.\457\ Finally,
the final rule, however, replaces the existing definition of ``market
maker-inventory'' with a definition for ``market-maker positions'' to
correspond with the language in Sec. __.4(c)(ii)(B)(1), which is the
only place such definition is used.\458\
---------------------------------------------------------------------------
\455\ Unlike the 2013 rule, Sec. __.4(a)(ii) in the final rule
contains subparagraphs (A) and (B).
\456\ See Sec. __.4(a)(6).
\457\ See Sec. __.4(b)(4).
\458\ See Sec. __.4(c)(ii)(B)(1). With respect to the exemption
for market making-related activities, the rebuttable presumption of
compliance for the RENTD requirement in the final rule requires,
among other things, that a trading desk establish, implement, and
enforce limits on the amounts, types, and risks of its market-maker
positions.
---------------------------------------------------------------------------
f. Compliance Program and Other Requirements for Underwriting and
Market Making-Related Activities
2013 Rule Compliance Program Requirements
The underwriting exemption in Sec. __.4(a) of the 2013 rule
requires a banking entity to establish, implement, maintain, and
enforce an internal compliance program, as required by subpart D, that
is reasonably designed to ensure compliance with the requirements of
the exemption. Such compliance program is required to include
reasonably designed written policies and procedures, internal controls,
analysis and independent testing identifying and addressing: (i) The
products, instruments, or exposures each trading desk may purchase,
sell, or manage as part of its underwriting activities; (ii) certain
limits for each trading desk, based on the nature and amount of the
trading desk's underwriting activities, including the reasonably
expected near term demands of clients, customers, or counterparties;
\459\ (iii) internal controls and ongoing monitoring and analysis of
each trading desk's compliance with its limits; and (iv) authorization
procedures, including escalation procedures that require review and
approval of any trade that would exceed one or more of a trading desk's
limits, demonstrable analysis of the basis for any temporary or
permanent increase to one or more of a trading desk's limits, and
independent review (i.e., by risk managers and compliance officers at
the appropriate level independent of the trading desk) of such
demonstrable analysis and approval.
---------------------------------------------------------------------------
\459\ These factors include the: (1) Amount, types, and risk of
its underwriting position; (2) level of exposures to relevant risk
factors arising from its underwriting position; and (3) period of
time a security may be held.
---------------------------------------------------------------------------
The exemption for market making-related activities in the 2013 rule
contains similar requirements. Specifically, Sec. __.4(b) of the 2013
rule requires that a banking entity establish, implement, maintain, and
enforce an internal compliance program, as required by subpart D, that
is reasonably designed to ensure compliance with the requirements of
the exemption. Such a compliance program is required to include
reasonably designed written policies and procedures, internal controls,
analysis, and independent testing identifying and addressing: (i) The
financial instruments each trading desk stands ready to purchase and
sell in accordance with the exemption for market making-related
activities; (ii) the actions the trading desk will take to demonstrably
reduce or otherwise significantly mitigate the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C), and the products, instruments, and exposures each
trading desk may use for risk management purposes; the techniques and
strategies each trading desk may use to manage the risks of its market
making-related activities and inventory; and the process, strategies,
and personnel responsible for ensuring that the actions taken by the
trading desk to mitigate these risks are and continue to be effective;
(iii) the limits for each trading desk, based on the nature and amount
of the trading desk's market making-related activities, including the
reasonably expected near term demands of clients, customers, or
counterparties; \460\ (iv) internal controls and ongoing monitoring and
analysis of each trading desk's compliance with its limits; and (v)
authorization procedures, including escalation procedures that require
review and approval of any trade that would exceed one or more of a
trading desk's limits, demonstrable analysis of the basis for any
temporary or permanent increase to one or more of a trading desk's
limits, and independent review (i.e., by risk managers and compliance
officers at the appropriate level independent of the trading desk) of
such demonstrable analysis and approval.
---------------------------------------------------------------------------
\460\ Specifically, such limits include the: (1) Amount, types,
and risks of its market-maker inventory; (2) amount, types, and
risks of the products, instruments, and exposures the trading desk
may use for risk management purposes; (3) the level of exposures to
relevant risk factors arising from its financial exposure; and (4)
period of time a financial instrument may be held.
---------------------------------------------------------------------------
Proposed Compliance Program Requirement
Feedback from market participants and agency oversight have
indicated that the compliance program requirements of the existing
exemptions for underwriting and market making-related activities may be
unduly complex and burdensome for banking entities with smaller and
less active trading activities. In the proposed rule, the agencies
proposed a tiered approach to such compliance program requirements, to
make these requirements commensurate with the size, scope, and
complexity of the relevant banking entity's trading activities and
business structure. Under the proposed rule, a banking entity with
significant trading assets and liabilities would continue to be
required to establish, implement, maintain, and enforce a comprehensive
internal compliance program as a condition for relying on the
exemptions for underwriting and market making-related activities.
However, the agencies proposed to eliminate such compliance program
requirements for banking entities that have moderate or limited trading
assets and liabilities.\461\
---------------------------------------------------------------------------
\461\ Under the 2013 rule, the compliance program requirement in
Sec. __.4(a)(2)(iii) is part of the compliance program required by
subpart D but is specifically used for purposes of complying with
the exemption for underwriting activity.
---------------------------------------------------------------------------
Comments on the Proposed Compliance Program Requirement
Some commenters did not support the removal of the underwriting or
market making-specific compliance program
[[Page 62006]]
requirements for banking entities with limited and moderate trading
assets and liabilities under the proposal. For example, one commenter
urged the agencies to require all banking entities to establish,
implement, maintain, and enforce such compliance program, independent
of any presumption of compliance.\462\ This commenter indicated that
there are ``exceedingly low incremental costs'' associated with most
elements of the RENTD compliance and controls framework for the
exemptions for underwriting and market making-related activities, even
for those banking entities with limited or moderate trading assets and
liabilities.\463\ In the commenter's view, minimal incremental costs
support the retention of such requirements, which are further justified
by the increased stability of financial institutions and financial
markets as a result of the 2013 rule.\464\
---------------------------------------------------------------------------
\462\ See Better Markets.
\463\ Id.
\464\ Id.
---------------------------------------------------------------------------
Further, that same commenter asserted that the compliance
requirements under the 2013 rule permit too much discretion for banking
entities to implement policies, procedures, and controls, noting that
judgments on the effectiveness of implemented controls depend on the
methodologies used by banking entities' testing functions, and argued
that the agencies should consider additional capital and activities-
based requirements specifically tied to the reported inventory of
trading assets, taking into account the total size of those trading
assets, the overall capital position of the financial institution, and
the average holding period or aging of trading assets, which may
indicate that inventories are unrelated to underwriting and market
making activities.\465\ Similarly, another commenter indicated that a
tiered compliance approach would not be appropriate because it
considered the proposed categorization of entities in terms of trading
assets and liabilities to be flawed.\466\
---------------------------------------------------------------------------
\465\ Id.
\466\ See Data Boiler.
---------------------------------------------------------------------------
Other commenters supported the revisions under the proposed rule to
apply the market making-related activities' compliance program
requirements only to those banking entities with significant trading
assets and liabilities. For example, one commenter expressed concern
that the market making-related activities' compliance program
requirements under the 2013 rule have contributed to decreased market
making activities with, and increased costs for, banking entities'
commercial end-user counterparties.\467\ This commenter indicated that
applying the market making-related activities' compliance program
requirements only to banking entities with significant trading assets
and liabilities would allow banking entities to develop more efficient
compliance and liquidity risk management programs, which would
ultimately reduce transaction costs for commercial end users.\468\
---------------------------------------------------------------------------
\467\ See Coalition of Derivatives End Users.
\468\ Id.
---------------------------------------------------------------------------
Another commenter expressed the view that the proposed approach of
applying the compliance program requirements under the exemptions for
underwriting and market making-related activities only to those banking
entities with significant trading assets and liabilities was an
appropriate means of reducing the regulatory burdens on banks with
limited or moderate trading and underwriting exposures.\469\ That
commenter noted that such approach would continue to allow for the
appropriate monitoring of these activities to ensure compliance with
the provisions of the 2013 rule.\470\
---------------------------------------------------------------------------
\469\ See CFA.
\470\ Id.
---------------------------------------------------------------------------
Final Compliance Program Requirement
The agencies believe that the compliance program requirements that
apply specifically to the exemptions for underwriting and market
making-related activities play an important role in facilitating and
monitoring a banking entity's compliance with the requirements of those
exemptions. However, the agencies also believe that those requirements
can be appropriately tailored to the nature of the underwriting and
market making activities conducted by each banking entity. It also is
important to recognize that the removal of such compliance program
requirements for banking entities that do not have significant trading
assets and liabilities would not relieve those banking entities of the
obligation to comply with the other requirements of the exemptions for
underwriting and market making-related activities, including RENTD
requirements, under the final rule.
Accordingly, and after consideration of the comments, the agencies
continue to believe that removing the Sec. __.4 compliance program
requirements for banking entities that do not have significant trading
assets and liabilities as a condition to engaging in permitted
underwriting and market making-related activities should provide these
banking entities with additional flexibility to tailor their compliance
programs in a way that takes into account the risk profile and relevant
trading activities of each particular trading desk.
The agencies recognize that banking entities that do not have
significant trading assets and liabilities may incur costs to
establish, implement, maintain, and enforce the compliance program
requirements applicable to permitted underwriting activities under the
2013 rule. As the trading activities of banking entities that do not
have significant trading activities comprise approximately seven
percent of the total U.S. trading activity subject to the Volcker Rule,
the agencies believe the costs of the compliance program requirement
would be disproportionate to the banking entity's trading activity and
the risk posed to U.S. financial stability. Accordingly, eliminating
the Sec. __.4 compliance program requirements for permitted
underwriting and market making-related activities conducted by banking
entities that do not have significant trading assets and liabilities
may reduce compliance costs without materially impacting conformance
with the objectives set forth in section 13 of the BHC Act. Applying
these specific compliance requirements only to banking entities with
significant trading assets and liabilities also is consistent with the
modifications to the general compliance program requirements for these
banking entities under Sec. __.20 of the final rule, as discussed
below.
Accordingly, Sec. __.4(a)(2)(iii) of the final rule will require
banking entities with significant trading assets and liabilities, as a
condition to complying with the underwriting exemption, to establish
and implement, maintain, and enforce an internal compliance program
required by subpart D that is reasonably designed to ensure the banking
entity's compliance with the requirements of the exemption, including
reasonably designed written policies and procedures, internal controls,
analysis and independent testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, in accordance with Sec.
__.4(a)(2)(ii)(A); \471\
---------------------------------------------------------------------------
\471\ Final rule Sec. __.4(a)(2)(ii)(A) requires that the
amount and type of the securities in the trading desk's underwriting
position are designed not to exceed RENTD, taking into account the
liquidity, maturity, and depth of the market for the relevant type
of security; and (B) that reasonable efforts are made to sell or
otherwise reduce the underwriting position within a reasonable
period, taking into account the liquidity, maturity, and depth of
the market for the relevant type of security.
---------------------------------------------------------------------------
[[Page 62007]]
(C) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
(D) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
With respect to the exemption for market making-related activities,
Sec. __.4(a)(b)(iii) of the final rule will require banking entities
with significant trading assets and liabilities to establish and
implement, maintain, and enforce an internal compliance program
required by subpart D that is reasonably designed to ensure the banking
entity's compliance with the requirements of the exemption, including
reasonably designed written policies and procedures, internal controls,
analysis and independent testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with Sec. __.4(b)(2)(i); \472\
---------------------------------------------------------------------------
\472\ Final rule Sec. __.4(b)(2)(i) requires that the trading
desk that establishes and manages the financial exposure routinely
stands ready to purchase and sell one or more types of financial
instruments related to its financial exposure and is willing and
available to quote, purchase and sell, or otherwise enter into long
and short positions in those types of financial instruments for its
own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity,
and depth of the market for the relevant types of financial
instruments.
---------------------------------------------------------------------------
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under Sec. __.4
(b)(2)(iii)(C); the products, instruments, and exposures each trading
desk may use for risk management purposes; the techniques and
strategies each trading desk may use to manage the risks of its market
making-related activities and positions; and the process, strategies,
and personnel responsible for ensuring that the actions taken by the
trading desk to mitigate these risks are and continue to be effective;
(C) Limits for each trading desk, in accordance with Sec.
__.4(b)(2)(ii); \473\
---------------------------------------------------------------------------
\473\ Final rule Sec. __.4(b)(2)(ii) requires that the trading
desk's market making-related activities are designed not to exceed,
on an ongoing basis, RENTD, taking into account the liquidity,
maturity, and depth of the market for the relevant type of security.
---------------------------------------------------------------------------
(D) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
(E) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
The agencies are clarifying in the final rule that the
authorization procedures for banking entities with significant trading
assets and liabilities of proposed Sec. __.4(a)(2)(iii)(D) and Sec.
__.4(b)(2)(iii)(E) are to be in writing pursuant to Sec.
__.4(a)(2)(iii)(C) and Sec. __.4(b)(2)(iii)(D). Requiring that these
authorization procedures are written provides a basis for which banking
entities and supervisors can review for compliance with the
underwriting and market making exemption compliance requirements.
Sections __.4(a)(2)(iii) (which sets forth the compliance program
requirements for the underwriting exemption) and Sec. __.4(b)(2)(iii)
(which sets forth the compliance program requirements for the
exemptions for market making-related activities) further provide that a
banking entity with significant trading assets and liabilities may
satisfy the requirements pertaining to limits and written authorization
procedures by complying with the requirements pursuant to the
presumption of compliance with the statutory RENTD requirement in Sec.
__.4(c).\474\ As such, Sec. __.4(c)(1) provides for a rebuttable
presumption that a banking entity's purchase or sale of a financial
instrument complies with the RENTD requirements in Sec.
__.4(a)(2)(ii)(A) and Sec. __.4(b)(2)(ii) if the relevant trading desk
establishes, implements, maintains, and enforces internal limits that
are designed not to exceed the reasonably expected near term demands of
clients, customers, or counterparties, taking into account the
liquidity, maturity, and depth of the market for the relevant type of
security. In taking this approach, the agencies recognize that
requiring a banking entity to establish separate limits in accordance
with the statutory RENTD requirement would be unnecessary and may
reduce the benefit of relying on internal limits set pursuant to Sec.
__.4(c)(1).
---------------------------------------------------------------------------
\474\ See supra section IV.B.2.d (discussing the requirements in
the final rule associated with the presumption of compliance with
the statutory RENTD requirement).
---------------------------------------------------------------------------
Additionally, in the case of a banking entity with significant
trading assets and liabilities, the relevant exemption compliance
requirements pertaining to written authorization procedures in Sec.
__.4(a)(2)(iii)(C) are not required if the criteria in Sec. __.4(c)
are satisfied. Without the requirement to establish limits pursuant to
Sec. __.4(a)(iii)(B), such a requirement for written authorization
procedures would be unnecessary. Further, because Sec.
__.4(c)(3)(ii)(2) contains written authorization procedures, also
requiring written authorization procedures in Sec. __.4(a)(2)(iii)(C)
would be duplicative.
These revisions clarify that banking entities with significant
trading assets and liabilities that establish limits and written
authorization procedures pursuant to the rebuttable presumption of
compliance do not have to establish a second set of limits and written
authorization procedures pursuant to the compliance program
requirements of the underwriting or market making exemptions.
Regardless of whether a banking entity with significant trading assets
and liabilities relies on the presumption of compliance in Sec.
__.4(c), every banking entity with significant trading assets and
liabilities is required to maintain limits and written authorization
procedures for purposes of complying with the exemption for permitted
underwriting or market making-related activities under Sec. __.4.
The agencies are removing the proposed rule's requirement for a
banking entity with significant trading assets and liabilities that, to
the extent that any limit identified pursuant to Sec.
__.4(b)(2)(iii)(C) of the proposed rule is exceeded, the trading desk
takes action to bring the trading desk into compliance with the limits
as promptly as possible after the limit is exceeded. Instead, this
requirement is being moved to Sec. __.4(c), the rebuttable presumption
of compliance for banking entities that establish internal limits
pursuant to Sec. __.4(c)(1). Such requirements would be redundant for
a banking entity with significant trading assets and liabilities that
is required, on an ongoing basis, to ensure that its trading desk's
market making activities are designed not to exceed RENTD while also
establishing limits designed not to exceed RENTD.\475\ In addition, the
written authorization procedures \476\
[[Page 62008]]
require internal compliance processes to handle such limit breaches.
---------------------------------------------------------------------------
\475\ See final rule Sec. __.4(b)(2)(iii)(C).
\476\ See final rule Sec. __.4(b)(2)(iii)(D).
---------------------------------------------------------------------------
g. Other Comments
Finally, some commenters recommended changes to certain aspects of
the existing exemptions for underwriting and market making-related
activities in the 2013 rule that were not specifically proposed. For
example, one commenter suggested that the agencies eliminate the
limitations on treating banking entities with greater than $50 billion
in trading assets and liabilities as clients, customers, or
counterparties.\477\ As stated in the 2013 rule, the agencies believe
that removing this limitation could make it difficult to meaningfully
distinguish between permitted market making-related activity and
impermissible proprietary trading, and allow a trading desk to maintain
an outsized inventory and to justify such inventory levels as being
tangentially related to expected market-wide demand.\478\ The agencies
also believe that banking entities engaged in substantial trading
activity do not typically act as customers to other market makers.\479\
As a result, the agencies have retained the 2013 rule's definition of
client, customer, or counterparty. Another commenter suggested
broadening the scope of the exemption for underwriting activities to
encompass any activity that assists persons or entities in accessing
the capital markets or raising capital.\480\ The agencies believe the
final rule's changes provide additional clarity while maintaining
consistency with statutory objectives. Accordingly, after consideration
of these comments, the agencies have decided not to make any changes to
the exemptions for underwriting or market making-related activities
other than those discussed above.
---------------------------------------------------------------------------
\477\ See CCMC.
\478\ See 79 FR 5607.
\479\ See 79 FR 5606-5607.
\480\ See ISDA.
---------------------------------------------------------------------------
h. Market Making Hedging
As noted in the proposal, during implementation of the 2013 rule,
the agencies received a number of inquiries regarding the circumstances
under which banking entities could elect to comply with the market
making risk management provisions permitted in Sec. __.4(b) or
alternatively the risk-mitigating hedging requirements under Sec.
__.5. These inquiries generally related to whether a trading desk could
treat an affiliated trading desk as a client, customer, or counterparty
for purposes of the exemption market making-related activities' RENTD
requirement; and whether, and under what circumstances, one trading
desk could undertake market making risk management activities for one
or more other trading desks.\481\
---------------------------------------------------------------------------
\481\ 83 FR at 33464.
---------------------------------------------------------------------------
Each trading desk engaging in a transaction with an affiliated
trading desk that meets the definition of proprietary trading must rely
on an exemption or exclusion in order for the transaction to be
permissible. As noted in the proposal, in one example presented to the
agencies, one trading desk of a banking entity may make a market in a
certain financial instrument (e.g., interest rate swaps), and then
transfer some of the risk of that instrument (e.g., foreign exchange
(FX) risk) to a second trading desk (e.g., an FX swaps desk) that may
or may not separately engage in market making-related activity. In the
proposal, the agencies requested comment as to whether, in such a
scenario, the desk taking the risk (in the preceding example, the FX
swaps desk) and the market making desk (in the preceding example, the
interest rate desk) should be permitted to treat each other as a
client, customer, or counterparty for purposes of establishing internal
limits or RENTD levels under the exemption for market making-related
activities.\482\
---------------------------------------------------------------------------
\482\ Id.
---------------------------------------------------------------------------
The agencies also requested comment as to whether each desk should
be permitted to treat swaps executed between the desks as permitted
market making-related activities of one or both desks if the swap does
not cause the relevant desk to exceed its applicable limits and if the
swap is entered into and maintained in accordance with the compliance
requirements applicable to the desk, without treating the affiliated
desk as a client, customer, or counterparty for purposes of
establishing or increasing its limits. This approach was intended to
maintain appropriate limits on proprietary trading by not permitting an
expansion of a trading desk's market making limits based on internal
transactions. At the same time, this approach was intended to permit
efficient internal risk management strategies within the limits
established for each desk.\483\
---------------------------------------------------------------------------
\483\ Id.
---------------------------------------------------------------------------
The agencies also requested comment on the circumstances in which
an organizational unit of an affiliate (affiliated unit) of a trading
desk engaged in market making-related activities in compliance with
Sec. __.4(b) (market making desk) would be permitted to enter into a
transaction with the market making desk in reliance on the market
making desk's risk management policies and procedures. In this
scenario, to effect such reliance the market making desk would direct
the affiliated unit to execute a risk-mitigating transaction on the
market making desk's behalf. If the affiliated unit did not
independently satisfy the requirements of the exemption for market
making-related activities with respect to the transaction, it would be
permitted to rely on the exemption for market making-related activities
available to the market making desk for the transaction if: (i) The
affiliated unit acts in accordance with the market making desk's risk
management policies and procedures; and (ii) the resulting risk-
mitigating position is attributed to the market making desk's financial
exposure (and not the affiliated unit's financial exposure) and is
included in the market making desk's daily profit and loss calculation.
If the affiliated unit establishes a risk-mitigating position for the
market making desk on its own accord (i.e., not at the direction of the
market making desk) or if the risk-mitigating position is included in
the affiliated unit's financial exposure or daily profit and loss
calculation, then the affiliated unit may still be able to comply with
the requirements of the risk-mitigating hedging exemption pursuant to
Sec. __.5 for such activity.\484\
---------------------------------------------------------------------------
\484\ Id.
---------------------------------------------------------------------------
The commenters were generally in favor of permitting affiliated
trading desks to treat each other as a client, customer, or
counterparty for the purposes of establishing risk limits or RENTD
levels under the exemption for market making-related activities,\485\
particularly for banking entities that service customers in different
jurisdictions. One commenter, however, did not support this approach,
and expressed that it would be difficult to validate banking entities'
RENTD limits if affiliates could be considered as a client, customer,
or counterparty.\486\
---------------------------------------------------------------------------
\485\ See, e.g., HSBC; JBA; and IIB.
\486\ See Data Boiler.
---------------------------------------------------------------------------
One commenter argued that affiliated trading desks with different
mandates should be able to treat each other as a client, customer, or
counterparty as long as each desk stays within its limits, because such
an approach would allow banking entities to take an enterprise-wide
view of risk management.\487\
---------------------------------------------------------------------------
\487\ See IIB.
---------------------------------------------------------------------------
Two commenters explained that, to increase efficiencies, certain
internationally active banking entities employ a ``hub-and-spoke''
model, where trading desks at local entities
[[Page 62009]]
(spoke) enter into transactions with major affiliates (hub) that manage
the risks of, and source trading positions for, the local
entities.\488\ One of these commenters expressed that these trading
desks have trouble demonstrating they are indeed market making desks
without intra-entity and inter-affiliate transactions being treated as
transactions with a client, customer, or counterparty.\489\ The other
commenter expressed that, under the hub-and-spoke model, treating the
``spoke'' trading desk as a client, customer, or counterparty, would
allow the hub desk to look through to the customer of the local entity
since the hub is acting as the ultimate market maker.\490\
---------------------------------------------------------------------------
\488\ See HSBC and JBA.
\489\ See JBA.
\490\ See HSBC.
---------------------------------------------------------------------------
After consideration of comments, the agencies continue to recognize
that, under certain circumstances, a trading desk may undertake market
making risk management activities for one or more affiliated trading
desks \491\ and trading desks may rely on the exemption for market
making-related activities for its transactions with affiliated trading
desks. The agencies, however, are declining to permit banking entities
to treat affiliated trading desks as ``clients, customers, or
counterparties'' \492\ for the purposes of determining a trading desk's
RENTD pursuant to Sec. __.4(b)(2)(ii) of the exemption for market
making-related activities.
---------------------------------------------------------------------------
\491\ See 79 FR at 5594.
\492\ Sec. __.4(b)(3).
---------------------------------------------------------------------------
The agencies believe that, under the exemption for market making-
related activities, each trading desk must be able to independently tie
its activities to the RENTD of external customers that the trading desk
services. Allowing a desk to treat affiliated trading desks as
customers for purposes of RENTD would allow the desk to accumulate
financial instruments if it has a reason to believe that other internal
desks will be interested in acquiring the positions in the near term.
Those other desks could then acquire the positions from the first desk
at a later time when they have a reasonable expectation of near term
demand from external customers. The agencies also believe that
generally allowing a desk to treat other internal desks as customers
for purposes of RENTD could impede monitoring of market making-related
activity and detection of impermissible proprietary trading since a
banking entity could aggregate in a single trading desk the RENTD of
trading desks that engage in multiple different trading strategies and
aggregate a larger volume of trading activities.\493\
---------------------------------------------------------------------------
\493\ See 79 FR at 5590.
---------------------------------------------------------------------------
With respect to the arguments raised by these commenters that
permitting this treatment would facilitate efficient risk
management,\494\ the agencies believe that the amendments to the risk-
mitigating hedging exemption in the final rule \495\ and the amendments
to the liquidity management exemption in the final rule \496\ will
provide banking entities with additional flexibility to manage risks
more efficiently than the 2013 rule.
---------------------------------------------------------------------------
\494\ See HSBC; JBA; and IIB.
\495\ The agencies are streamlining several aspects of the risk-
mitigating hedging exemption for banking entities with and without
significant trading assets and liabilities. See final rule Sec.
__.5; See also section IV.B.3, infra.
\496\ The agencies have expanded the types of financial
instruments eligible for the exclusion to include for exchange
forwards and foreign exchange swaps. See final rule Sec. __.3(e);
See also section IV.B.1.b.i, supra.
---------------------------------------------------------------------------
Further, the agencies note that while affiliated trading desks may
not consider each other clients, customers, or counterparties,
transactions between affiliated trading desks may be permitted under
the exemption for market making-related activities in certain
circumstances that do not require the expansion of a trading desk's
market making limits based on internal transactions. Returning to the
example from the proposal and described above \497\ concerning an
interest rate swaps desk transferring some of the risk of a financial
instrument to an affiliated FX swaps desk, if the FX swaps desk acts as
a market maker in FX swaps, the FX swaps desk may be able to rely on
the exemption for market making-related activities for its transactions
with the interest rate swaps desk if those transactions are consistent
with the requirements of the exemption for market making-related
activities, including the FX swaps desk's RENTD.\498\ Further, if the
FX swaps desk does not independently satisfy the requirements of the
exemption for market making-related activities with respect to the
transaction, it would be permitted to rely on the exemption for market
making-related activities available to the market making desk for the
transaction under certain conditions. If the banking entity has
significant trading assets and liabilities, the FX swaps desk would be
permitted to rely on the exemption for market making-related activities
if: (i) The FX swaps desk acts in accordance with the interest rate
swaps desk's risk management policies and procedures established in
accordance with Sec. __.4(b)(2)(iii) and (ii) the resulting risk-
mitigating position is attributed to the interest rate swaps desk's
financial exposure (and not the FX swaps desk's financial exposure) and
is included in the interest rate swaps desk's daily profit and loss
calculation. If the banking entity does not have significant trading
assets and liabilities, the FX swaps desk would be permitted to rely on
the exemption for market making-related activities if the resulting
risk-mitigating position is attributed to the interest rate swaps
desk's financial exposure (and not the FX swaps desk's financial
exposure) and is included in the interest rate swaps desk's daily
profit and loss calculation. If the FX swaps desk cannot independently
satisfy the requirements of the exemption for market making-related
activities with respect to its transactions with the interest rate
swaps desk, the risk-mitigating hedging exemption would be available,
provided the conditions of that exemption are met.
---------------------------------------------------------------------------
\497\ See Part IV.B.2.h, supra; see also 83 FR 33463.
\498\ The interest rate market making desk can rely on the
exemption for market making-related activities for the FX swap it
enters into with the FX swaps desk provided the interest rate market
making desk enters into the FX swap to hedge its market making-
related position and otherwise complies with the requirements of the
exemption for market making-related activities.
---------------------------------------------------------------------------
3. Section __.5: Permitted Risk-Mitigating Hedging Activities
a. Section __.5 of the 2013 Rule
Section 13(d)(1)(C) of the BHC Act provides an exemption from the
prohibition on proprietary trading for risk-mitigating hedging
activities that are designed to reduce the specific risks to a banking
entity in connection with and related to individual or aggregated
positions, contracts, or other holdings. Section __.5 of the 2013 rule
implements section 13(d)(1)(C).
Section __.5 of the 2013 rule provides a multi-faceted approach to
implementing the hedging exemption to ensure that hedging activity is
designed to be risk-reducing and does not mask prohibited proprietary
trading. Under the 2013 rule, risk-mitigating hedging activities must
comply with certain conditions for those activities to qualify for the
exemption. Generally, a banking entity relying on the hedging exemption
must have in place an appropriate internal compliance program that
meets specific requirements, including the requirement to conduct
certain correlation analysis, to support its compliance with the terms
of the exemption, and the compensation arrangements of persons
performing risk-mitigating hedging activities must be designed not to
reward or incentivize
[[Page 62010]]
prohibited proprietary trading.\499\ In addition, the hedging activity
itself must meet specified conditions. For example, at inception, the
hedge must be designed to reduce or otherwise significantly mitigate,
and must demonstrably reduce or otherwise significantly mitigate, one
or more specific, identifiable risks arising in connection with and
related to identified positions, contracts, or other holdings of the
banking entity, and the activity must not give rise to any significant
new or additional risk that is not itself contemporaneously
hedged.\500\ Finally, Sec. __.5 establishes certain documentation
requirements with respect to the purchase or sale of financial
instruments made in reliance of the risk-mitigating exemption under
certain circumstances.\501\
---------------------------------------------------------------------------
\499\ See 2013 rule Sec. __.5(b)(1) and (3).
\500\ See 2013 rule Sec. __.5(b)(2).
\501\ See 2013 rule Sec. __.5(c).
---------------------------------------------------------------------------
b. Proposed Amendments to Section __.5
i. Correlation Analysis for Section __.5(b)(1)(iii)
The agencies proposed to remove the specific requirement to conduct
a correlation analysis for risk-mitigating hedging activities.\502\ In
particular, the agencies proposed to remove the words ``including
correlation analysis'' from the requirement that the banking entity
seeking to engage in risk-mitigating hedging activities conduct
``analysis, including correlation analysis, and independent testing''
designed to ensure that hedging activities may reasonably be expected
to reduce or mitigate the risks being hedged. Thus, the requirement to
conduct an analysis would have remained, but the banking entity would
have had flexibility to apply a type of analysis that was appropriate
to the facts and circumstances of the hedge and the underlying risks
targeted.\503\
---------------------------------------------------------------------------
\502\ See 83 FR at 33465.
\503\ See 83 FR at 33465.
---------------------------------------------------------------------------
The agencies noted that they have become aware of practical
difficulties with the correlation analysis requirement, which according
to banking entities can add delays, costs, and uncertainty to permitted
risk-mitigating hedging.\504\ The agencies anticipated that removing
the correlation analysis requirement would reduce uncertainties in
meeting the analysis requirement without significantly impacting the
conditions that risk-mitigating hedging activities must meet in order
to qualify for the exemption.\505\
---------------------------------------------------------------------------
\504\ See id.
\505\ See id.
---------------------------------------------------------------------------
The agencies also noted that section 13 of the BHC Act does not
specifically require this correlation analysis.\506\ Instead, the
statute only provides that a hedging position, technique, or strategy
is permitted so long as it is ``. . . designed to reduce the specific
risks to the banking entity . . . .'' \507\ The 2013 rule added the
correlation analysis requirement as a measure intended to ensure
compliance with this exemption.
---------------------------------------------------------------------------
\506\ See 83 FR at 33465.
\507\ 12 U.S.C. 1851(d)(1)(C).
---------------------------------------------------------------------------
ii. Hedge Demonstrably Reduces or Otherwise Significantly Mitigates
Specific Risks for Sections __.5(b)(1)(iii), __.5(b)(2)(ii), and
__.5(b)(2)(iv)(B)
The agencies stated in the proposal that the requirements in Sec.
__.5(b)(1)(iii), Sec. __.5(b)(2)(ii), and Sec. __.5(b)(2)(iv)(B),
that a risk-mitigating hedging activity demonstrably reduces or
otherwise significantly mitigates specific risks, is not directly
required by section 13(d)(1)(C) of the BHC Act.\508\ The statute
instead requires that the hedge be designed to reduce or otherwise
significantly mitigate specific risks.\509\ Thus, the agencies proposed
to remove the ``demonstrably reduces or otherwise significantly
mitigates'' specific risk requirement from Sec. __.5(b)(2)(ii) and
Sec. __.5(b)(2)(iv)(B). This change would retain the requirement that
the hedging activity be designed to reduce or otherwise significantly
mitigate one or more specific, identifiable risks, while providing
banking entities with the flexibility to apply a type of analysis that
was appropriate to the facts and circumstances of the hedge and the
underlying risks targeted.
---------------------------------------------------------------------------
\508\ See 83 FR at 33465.
\509\ See id.
---------------------------------------------------------------------------
The agencies also proposed to remove parallel provisions in Sec.
__.5(b)(1)(iii). In particular, the agencies proposed to delete the
word ``demonstrably'' from the requirement that ``the positions,
techniques and strategies that may be used for hedging may reasonably
be expected to demonstrably reduce or otherwise significantly mitigate
the specific, identifiable risk(s) being hedged'' in Sec.
__.5(b)(1)(iii). This change would have meant that the banking entity's
analysis and testing would have had to show that the hedging may be
expected to reduce or mitigate the risks being hedged, but without the
specific requirement that such reduction or mitigation be demonstrable.
The agencies also proposed to delete the requirement in Sec.
__.5(b)(1)(iii) that ``such correlation analysis demonstrates that the
hedging activity demonstrably reduces or otherwise significantly
mitigates the specific, identifiable risk(s) being hedged'' because
this requirement was not necessary if the ``correlation analysis'' and
``demonstrable'' requirements were deleted.
The agencies noted that, in practice, it appears that the
requirement to show that hedging activity demonstrably reduces or
otherwise significantly mitigates a specific, identifiable risk that
develops over time can be complex and could potentially reduce bona
fide risk-mitigating hedging activity. For example, in some
circumstances it would be very difficult, if not impossible, for a
banking entity to comply with the continuous requirement to
demonstrably reduce or significantly mitigate the identifiable risks,
and therefore the firm would not enter into what would otherwise be
effective hedges of foreseeable risks.\510\
---------------------------------------------------------------------------
\510\ See id.
---------------------------------------------------------------------------
iii. Reduced Compliance Requirements for Banking Entities That Do Not
Have Significant Trading Assets and Liabilities for Section __.5(b) and
(c)
For banking entities that do not have significant trading assets
and liabilities, the agencies proposed to eliminate the requirements
for a separate internal compliance program for risk-mitigating hedging
under Sec. __.5(b)(1); certain of the specific requirements of Sec.
__.5(b)(2); the limits on compensation arrangements for persons
performing risk-mitigating activities in Sec. __.5(b)(3); and the
documentation requirements for certain hedging activities in Sec.
__.5(c).\511\ In place of those requirements, the agencies proposed a
new Sec. __.5(b)(2) that would require that the risk-mitigating
hedging activities be: (i) At the inception of the hedging activity
(including any adjustments), designed to reduce or otherwise
significantly mitigate one or more specific, identifiable risks,
including the risks specifically enumerated in the proposal; and (ii)
subject to ongoing recalibration, as appropriate, to ensure that the
hedge remains designed to reduce or otherwise significantly mitigate
one or more specific, identifiable risks.\512\ The proposal also
included conforming changes to Sec. __.5(b)(1) and Sec. __.5(c) of
the 2013 rule to make the requirements of those sections
[[Page 62011]]
applicable only to banking entities that have significant trading
assets and liabilities.\513\
---------------------------------------------------------------------------
\511\ See 83 FR at 33466.
\512\ Id.
\513\ Id.
---------------------------------------------------------------------------
The agencies explained that these requirements are overly
burdensome and complex for banking entities that do not have
significant trading assets and liabilities, which are generally less
likely to engage in the types of trading activities and hedging
strategies that would necessitate these additional compliance
requirements. Given these considerations, the agencies believed that
removing the requirements for banking entities that do not have
significant trading assets and liabilities would be unlikely to
materially increase risks to the safety and soundness of the banking
entity or U.S. financial stability. The agencies also believed that the
proposed requirements for banking entities without significant trading
assets and liabilities would effectively implement the statutory
requirement that the hedging transactions be designed to reduce
specific risks the banking entity incurs.\514\
---------------------------------------------------------------------------
\514\ Id.
---------------------------------------------------------------------------
iv. Reduced Documentation Requirements for Banking Entities That Have
Significant Trading Assets and Liabilities for Section __.5(c)
For banking entities that have significant trading assets and
liabilities, the agencies proposed to retain the enhanced documentation
requirements for the hedging transactions identified in Sec.
__.5(c)(1) to permit evaluation of the activity.\515\ However, the
agencies proposed a new paragraph (c)(4) in Sec. __.5 that would
eliminate the enhanced documentation requirement for hedging activities
that meets certain conditions.\516\ Under new paragraph (c)(4) in Sec.
__.5, compliance with the enhanced documentation requirement would not
apply to purchases and sales of financial instruments for hedging
activities that are identified on a written list of financial
instruments pre-approved by the banking entity that are commonly used
by the trading desk for the specific types of hedging activity for
which the financial instrument is being purchased or sold.\517\ In
addition, at the time of the purchase or sale of the financial
instruments, the related hedging activity would need to comply with
written, pre-approved hedging limits for the trading desk purchasing or
selling the financial instrument, which would be required to be
appropriate for the size, types, and risks of the hedging activities
commonly undertaken by the trading desk; the financial instruments
purchased and sold by the trading desk for hedging activities; and the
levels and duration of the risk exposures being hedged.\518\
---------------------------------------------------------------------------
\515\ Id.
\516\ Id.
\517\ Id.
\518\ Id.
---------------------------------------------------------------------------
The agencies explained that certain of the regulatory purposes of
these documentation requirements, such as facilitating subsequent
evaluation of the hedging activity and prevention of evasion, are less
relevant in circumstances where common hedging strategies are used
repetitively. Therefore the agencies believed that the enhanced
documentation requirements were not necessary in such instances and
that reducing them would make beneficial risk-mitigating activity more
efficient and effective. The agencies intended that the conditions on
the pre-approved limits would provide clarity regarding the limits
needed to comply with requirements.\519\
---------------------------------------------------------------------------
\519\ See 83 FR at 33466-67.
---------------------------------------------------------------------------
c. Commenters' Views
One commenter argued that the requirements associated with the 2013
rule's risk-mitigating hedging exemption have been overly prescriptive,
cumbersome, and unnecessary for sound and efficient risk
management.\520\ Many commenters supported the agencies' efforts to
reduce costs and uncertainty and improve the utility of the risk-
mitigating hedging exemption.\521\ More specifically, commenters agreed
with the recommendations to remove the correlation analysis
requirement, remove the requirement that a hedge demonstrably reduce or
otherwise significantly mitigate one or more specific risks, and reduce
the enhanced documentation requirements.\522\
---------------------------------------------------------------------------
\520\ See SIFMA.
\521\ See, e.g., State Street; FSF; ABA; BPI; and SIFMA.
\522\ See, e.g., State Street; FSF; ABA; BPI; and SIFMA.
---------------------------------------------------------------------------
Although some commenters supported the agencies' effort to reduce
the compliance burden in the risk-mitigating hedging exemption, others
argued that the agencies did not go far enough. Several commenters
argued that the agencies should reduce the enhanced documentation
requirements and go further to remove these requirements for all
banking entities.\523\ Another commenter urged the agencies to
eliminate the enhanced documentation requirements altogether in light
of the proposed rule's robust compliance framework.\524\ In addition, a
commenter suggested targeted modifications to the provision, including
permitting certain types of hedging in line with internal risk limits,
allowing aggregate assessment of hedging, and clarifying how firms can
comply with the provision.\525\
---------------------------------------------------------------------------
\523\ See, e.g., SIFMA; JBA; ABA; BPI; FSF; and CREFC.
\524\ See BPI.
\525\ See Credit Suisse.
---------------------------------------------------------------------------
In contrast, other commenters did not support the agencies'
proposed changes to the compliance obligations associated with the
risk-mitigating hedging exemption.\526\ One commenter argued that
eliminating the correlation analysis requirement would eliminate the
primary means used by most banks today to ensure a hedging activity is,
in fact, offsetting risk.\527\ Moreover, the same commenter argued that
eliminating the existing regulatory requirement that banks show a hedge
``demonstrably reduces'' or ``significantly mitigates'' the risks
targeted by the hedge would be a direct repudiation of the statute,
because that type of demonstration is required by the statute.\528\
Another commenter argued that the various changes proposed by the
agencies would lead to uncontrollable speculations.\529\
---------------------------------------------------------------------------
\526\ See, e.g., Volcker Alliance; Bean; Data Boiler; CFA; AFR;
NAFCU; Merkley; Better Markets; CAP; Systemic Risk Council; and
Public Citizen.
\527\ See Bean.
\528\ See Bean.
\529\ See Data Boiler.
---------------------------------------------------------------------------
d. Final Rule
i. Correlation Analysis for Section __.5(b)(1)(i)(C)
The agencies are adopting Sec. __.5(b)(1)(iii) as proposed, but
renumbered as Sec. __.5(b)(1)(i)(C). Based on the agencies'
implementation experience of the 2013 rule and commenters' feedback on
the proposed changes, the agencies are removing the requirement that a
correlation analysis be the type of analysis used to assess risk-
mitigating hedging activities. The agencies continue to believe, as
stated in the proposal, that allowing banking entities to use the type
of analysis that is appropriate to the hedging activities in question
will avoid the uncertainties discussed in the proposal without
substantially impacting the conditions that risk-mitigating hedging
activities must meet in order to qualify for the exemption.\530\
---------------------------------------------------------------------------
\530\ See 83 FR at 33465.
---------------------------------------------------------------------------
Furthermore, section 13 of the BHC Act does not require that the
analysis used by the banking entity be a correlation analysis. Instead,
the statute only provides that a hedging position,
[[Page 62012]]
technique, or strategy is permitted so long as it is ``. . . designed
to reduce the specific risks to the banking entity . . . .'' \531\ The
agencies believe the continuing requirement that the banking entity
conduct ``analysis and independent testing designed to ensure that the
positions, techniques and strategies that may be used for hedging may
reasonably be expected to reduce or otherwise significantly mitigate
the specific, identifiable risk(s) being hedged'' will effectively
implement the statute.
---------------------------------------------------------------------------
\531\ 12 U.S.C. 1851(d)(1)(C).
---------------------------------------------------------------------------
The agencies anticipate that the banking entity's flexibility to
apply the type of analysis that is appropriate to assess the particular
hedging activity at issue will facilitate the appropriate use of risk-
mitigating hedging under the exemption. Regarding the comment asserting
that correlation analysis is the primary means used by banking entities
to test whether a hedging activity is offsetting risk, the agencies
note that if this is the case it would be reasonable to expect that the
banking entity would use correlation analysis to satisfy the regulatory
requirements with respect to that hedging activity. However, if another
type of analysis is more appropriate, the banking entity would have the
flexibility to use that form of analysis instead.
ii. Hedge Demonstrably Reduces or Otherwise Significantly Mitigates
Specific Risks for Sections __.5(b)(1)(i)(C), __.5(b)(1)(ii)(B) and
__.5(b)(1)(ii)(D)(2)
The agencies are adopting Sec. __.5(b)(1)(iii), Sec.
__.5(b)(2)(ii), and Sec. __.5(b)(2)(iv)(B) as proposed, but renumbered
as Sec. __.5(b)(1)(i)(C), Sec. __.5(b)(1)(ii)(B) and Sec.
__.5(b)(1)(ii)(D)(2). As stated in the proposal, the requirement that
the reduction or mitigation of specific risks resulting from a risk-
mitigating hedging activity be demonstrable is not directly required by
section 13(d)(1)(C) of the BHC Act.\532\ In practice, it appears that
the requirement to show that hedging activity demonstrably reduces or
otherwise significantly mitigates a specific, identifiable risk that
develops over time can be complex and could potentially reduce bona
fide risk-mitigating hedging activity. The agencies continue to believe
that in some circumstances, it may be difficult for banking entities to
know with sufficient certainty that a potential hedging activity that a
banking entity seeks to commence will continuously demonstrably reduce
or significantly mitigate an identifiable risk after it is implemented,
even if the banking entity is able to enter into a hedge reasonably
designed to reduce or significantly mitigate such a risk. As stated in
the proposal, unforeseeable changes in market conditions, event risk,
sovereign risk, and other factors that cannot be known with certainty
in advance of undertaking a hedging transaction could reduce or
eliminate the otherwise intended hedging benefits.\533\ In these
events, the requirement that a hedge ``demonstrably reduce'' or
``significantly mitigate'' the identifiable risks could create
uncertainty with respect to the hedge's continued eligibility for the
exemption. In such cases, a banking entity may determine not to enter
into what would otherwise be a reasonably designed hedge of foreseeable
risks out of concern that the banking entity may not be able to
effectively comply with the requirement that such a hedge demonstrably
reduces such risks due to the possibility of unforeseen risks occur.
Therefore, the final rule removes the ``demonstrably reduces or
otherwise significantly mitigates'' specific risk requirement from
Sec. __.5(b)(1)(i)(C), Sec. __.5(b)(1)(ii)(B) and Sec.
__.5(b)(1)(ii)(D)(2).
---------------------------------------------------------------------------
\532\ See 83 FR at 33465.
\533\ See id.
---------------------------------------------------------------------------
The agencies do not agree with a commenter's assertion that the
requirement that banking entities show that a hedge ``demonstrably''
reduces or significantly mitigates the risks is a core requirement
under section 13 of the BHC Act. Instead, the statute expressly permits
hedging activities that are ``designed to reduce the specific risks of
the banking entity.'' \534\ The final rule maintains the requirement
that hedging activity undertaken pursuant to Sec. __.5 be designed to
reduce or otherwise mitigate specific, identifiable risks. Hedging
activity must also be subject to ongoing recalibration by the banking
entity to ensure that the hedging activity satisfies the requirement
that the activity is designed to reduce or otherwise significantly
mitigate one or more specific, identifiable risks even after changes in
market conditions or other factors. In light of these requirements, the
agencies do not find it necessary to require that the hedge
``demonstrably reduce'' risk to the banking entity on an ongoing basis.
---------------------------------------------------------------------------
\534\ 12 U.S.C. 1851(d)(1)(C).
---------------------------------------------------------------------------
iii. Reduced Compliance Requirements for Banking Entities That Do Not
Have Significant Trading Assets and Liabilities for Section __.5(b)(2)
and Section __.5(c)
The agencies are adopting Sec. Sec. __.5(b)(2) and __.5(c) as
proposed. Consistent with the changes in the final rule relating to the
scope of the requirements for banking entities that do not have
significant trading assets and liabilities, the agencies are also
revising the requirements in Sec. Sec. __.5(b)(2) and __.5(c) for
banking entities that do not have significant trading assets and
liabilities. For these firms, the agencies are eliminating the
requirements for a separate internal compliance program for risk-
mitigating hedging under Sec. __.5(b)(1); certain of the specific
requirements of Sec. __.5(b)(2); the limits on compensation
arrangements for persons performing risk-mitigating activities in Sec.
__.5(b)(1)(iii); and the documentation requirements for those
activities in Sec. __.5(c). Based on comments received, the agencies
have determined that these requirements are overly burdensome and
complex for banking entities with moderate trading assets and
liabilities, in light of the reduced scale of their trading and hedging
activities.
In place of those requirements, new Sec. __.5(b)(2) requires that
risk-mitigating hedging activities for those banking entities be: (i)
At the inception of the hedging activity (including any adjustments),
designed to reduce or otherwise significantly mitigate one or more
specific, identifiable risks, including the risks specifically
enumerated in the proposal; and (ii) subject to ongoing recalibration,
as appropriate, to ensure that the hedge remains designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks. The agencies continue to believe that these tailored
requirements for banking entities without significant trading assets
and liabilities effectively implement the statutory requirement that
the hedging transactions be designed to reduce specific risks the
banking entity incurs. The agencies believe that the remaining
requirements for a firm with moderate trading assets and liabilities
would be effective in ensuring such banking entities engage only in
permissible risk-mitigating hedging activities. The agencies also note
that reducing these compliance requirements for banking entities that
do not have significant trading assets and liabilities is unlikely to
materially increase risks to the safety and soundness of the banking
entity or
[[Page 62013]]
U.S. financial stability. Therefore, the agencies are eliminating and
modifying these requirements for banking entities that do not have
significant trading assets and liabilities. In connection with these
changes, the final rule also includes conforming changes to Sec. Sec.
__.5(b)(1) and __.5(c) of the 2013 rule to make the requirements of
those sections applicable only to banking entities that have
significant trading assets and liabilities.
iv. Reduced Documentation Requirements for Banking Entities That Have
Significant Trading Assets and Liabilities for Section __.5(c)
The agencies are adopting Sec. __.5(c) as proposed. The final rule
retains the enhanced documentation requirements for banking entities
that have significant trading assets and liabilities for hedging
transactions identified in Sec. __.5(c)(1) to permit evaluation of the
activity. Although this documentation requirement results in more
extensive compliance efforts, the agencies continue to believe it
serves an important role to prevent evasion of the requirements of
section 13 of the BHC Act and the final rule.
The hedging transactions identified in Sec. __.5(c)(1) include
hedging activity that is not established by the specific trading desk
that creates or is responsible for the underlying positions, contracts,
or other holdings the risks of which the hedging activity is designed
to reduce; is effected through a financial instrument, exposure,
technique, or strategy that is not specifically identified in the
trading desk's written policies and procedures as a product,
instrument, exposure, technique, or strategy such trading desk may use
for hedging; or established to hedge aggregated positions across two or
more trading desks. The agencies believe that hedging transactions
established at a different trading desk, or which are not identified in
the relevant policies, may present or reflect heightened potential for
prohibited proprietary trading. In other words, the further removed
hedging activities are from the specific positions, contracts, or other
holdings the banking entity intends to hedge, the greater the danger
that such activity is not limited to hedging specific risks of
individual or aggregated positions, contracts, or other holdings of the
banking entity. For this reason, the agencies do not agree with
commenters who argued that the enhanced documentation requirements
should be removed for all banking entities.
However, based on the agencies' experience during the first several
years of implementation of the 2013 rule, it appears that many hedges
established by one trading desk for other affiliated desks are often
part of common hedging strategies that are used regularly and that do
not raise the concerns of those trades prohibited by the rule. In those
instances, the documentation requirements of Sec. __.5(c) of the 2013
rule are less necessary for purposes of evaluating the hedging activity
and preventing evasion. In weighing the significantly reduced
regulatory and supervisory utility of additional documentation of
common hedging trades against the complexity of complying with the
enhanced documentation requirements, the agencies have determined that
the documentation requirements are not necessary in those instances.
Reducing the documentation requirement for common hedging activity
undertaken in the normal course of business for the benefit of one or
more other trading desks would also make beneficial risk-mitigating
activity more efficient and potentially improve the timeliness of
important risk-mitigating hedging activity, the effectiveness of which
can be time sensitive.
Therefore, Sec. __.5(c)(4) of the final rule eliminates the
enhanced documentation requirement for hedging activities that meet
certain conditions. In excluding a trading desk's common hedging
instruments from the enhanced documentation requirements in Sec.
__.5(c), the final rule seeks to distinguish between those financial
instruments that are commonly used for a trading desk's ordinary
hedging activities and those that are not. The final rule requires the
banking entity to have in place appropriate limits so that less common
or more unusual levels of hedging activity would still be subject to
the enhanced documentation requirements. The final rule provides that
the enhanced documentation requirement does not apply to purchases and
sales of financial instruments for hedging activities that are
identified on a written list of financial instruments pre-approved by
the banking entity that are commonly used by the trading desk for the
specific types of hedging activity for which the financial instrument
is being purchased or sold. In addition, at the time of the purchase or
sale of the financial instruments, the related hedging activity would
need to comply with written, pre-approved hedging limits for the
trading desk purchasing or selling the financial instrument. These
hedging limits must be appropriate for the size, types, and risks of
the hedging activities commonly undertaken by the trading desk; the
financial instruments purchased and sold by the trading desk for
hedging activities; and the levels and duration of the risk exposures
being hedged. These conditions on the pre-approved limits are intended
to provide clarity as to the types and characteristics of the limits
needed to comply with the final rule. The pre-approved limits should be
reasonable and set to correspond to the type of hedging activity
commonly undertaken and at levels consistent with the hedging activity
undertaken by the trading desk in the normal course.
The agencies considered comments that suggested additional targeted
modifications to the risk-mitigating hedging requirements, but believe
that the suggested modifications would add additional complexity and
administrative burden without significantly changing the efficiency and
effectiveness of the final rule. Additionally, the agencies believe
that because the final rule maintains significant requirements for
hedging activities to qualify for the exemption, it should not lead to
uncontrollable speculation, as one commenter warned.
4. Section __.6(e): Permitted Trading Activities of a Foreign Banking
Entity
Section 13(d)(1)(H) of the BHC Act \535\ permits certain foreign
banking entities to engage in proprietary trading that occurs solely
outside of the United States (the foreign trading exemption); \536\
however, the statute does not define when a foreign banking entity's
trading occurs ``solely outside of the United States.'' The 2013 rule
includes several conditions on the availability of the foreign trading
exemption. Specifically, in addition to limiting the exemption to
foreign banking entities where the purchase or sale is made pursuant to
paragraph (9)
[[Page 62014]]
or (13) of Sec. __.4(c) of the BHC Act,\537\ the 2013 rule provides
that the foreign trading exemption is available only if: \538\
---------------------------------------------------------------------------
\535\ Section 13(d)(1)(H) of the BHC Act permits trading
conducted by a foreign banking entity pursuant to paragraph (9) or
(13) of section 4(c) of the BHC Act (12 U.S.C. 1843(c)), if the
trading occurs solely outside of the United States, and the banking
entity is not directly or indirectly controlled by a banking entity
that is organized under the laws of the United States or of one or
more States. See 12 U.S.C. 1851(d)(1)(H).
\536\ This section's discussion of the concept of ``solely
outside of the United States'' is provided solely for purposes of
the rule's implementation of section 13(d)(1)(H) of the BHC Act and
does not affect a banking entity's obligation to comply with
additional or different requirements under applicable securities,
banking, or other laws. Among other differences, section 13 of the
BHC Act does not necessarily include the customer protection,
transparency, anti-fraud, anti-manipulation, and market orderliness
goals of other statutes administered by the agencies. These other
goals or other aspects of those statutory provisions may require
different approaches to the concept of ``solely outside of the
United States'' in other contexts.
\537\ 12 U.S.C. 1843(c)(9), (13). See 2013 rule Sec.
__.6(e)(1)(i) and (ii).
\538\ See 2013 rule Sec. __.6(e).
---------------------------------------------------------------------------
(i) The banking entity engaging as principal in the purchase or
sale (including any personnel of the banking entity or its affiliate
that arrange, negotiate, or execute such purchase or sale) is not
located in the United States or organized under the laws of the United
States or of any State.
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State.
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
(iv) No financing for the banking entity's purchase or sale is
provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State (the financing prong).
(v) The purchase or sale is not conducted with or through any U.S.
entity,\539\ except if the purchase or sale is conducted:
---------------------------------------------------------------------------
\539\ ``U.S. entity'' is defined for purposes of this provision
as any entity that is, or is controlled by, or is acting on behalf
of, or at the direction of, any other entity that is, located in the
United States or organized under the laws of the United States or of
any State. See 2013 rule Sec. __.6(e)(4).
---------------------------------------------------------------------------
(A) With the foreign operations of a U.S. entity, if no personnel
of such U.S. entity that are located in the United States are involved
in the arrangement, negotiation or execution of such purchase or sale
(the counterparty prong); \540\
---------------------------------------------------------------------------
\540\ A foreign banking entity wishing to engage in trading
activities with a U.S. entity's foreign affiliate generally must
rely on the counterparty prong.
---------------------------------------------------------------------------
(B) with an unaffiliated market intermediary acting as principal,
provided the transaction is promptly cleared and settled through a
clearing agency or derivatives clearing organization acting as a
central counterparty; or
(C) through an unaffiliated market intermediary, provided the
transaction is conducted anonymously (i.e., each party to the
transaction is unaware of the identity of the other party(ies)) on an
exchange or similar trading facility and promptly cleared and settled
through a clearing agency or derivatives clearing organization acting
as a central counterparty.
Since the adoption of the 2013 rule, foreign banking entities have
asserted that certain of these criteria limit their ability to make use
of the statutory exemption for trading activity that occurs outside of
the United States, which has adversely impacted their foreign trading
operations. Additionally, many foreign banking entities have suggested
that the full set of eligibility criteria to rely on the exemption for
foreign trading activity are unnecessary to accomplish the policy
objectives of section 13 of the BHC Act. This information has raised
concerns that the current requirements for the exemption may be overly
restrictive and not effective in permitting foreign banks to engage in
foreign trading activities consistent with the policy objective of the
statute.
The proposal would have modified the requirements for the foreign
trading exemption so that it would be more usable by foreign banking
entities. Specifically, the proposal would have retained the first
three requirements of the 2013 rule, with a modification to the first
requirement, and would have removed the last two requirements of Sec.
__.6(e)(3). As a result, Sec. __.6(e)(3), as modified by the proposal,
would have required that for a foreign banking entity to be eligible
for this exemption:
(i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
The proposal would have maintained these three requirements in
order to ensure that the banking entity (including any relevant
personnel) that engages in the purchase or sale as principal or makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or any
State. Furthermore, the proposal would have retained the 2013 rule's
requirement that the purchase or sale, including any transaction
arising from a related risk-mitigating hedging transaction, may not be
accounted for as principal by the U.S. operations of the foreign
banking entity. However, the proposal would have replaced the first
requirement that any personnel of the banking entity that arrange,
negotiate, or execute such purchase or sale are not located in the
United States with one that would restrict only the relevant personnel
engaged in the banking entity's decision in the purchase or sale are
not located in the United States.
Under the proposed approach, the requirements for the foreign
trading exemption focused on whether the banking entity that engages in
or that decides to engage in the purchase or sale as principal
(including any relevant personnel) is located in the United States. The
proposed modifications recognized that some limited involvement by U.S.
personnel (e.g., arranging or negotiating) would be consistent with
this exemption so long as the principal risk and actions of the
purchase or sale do not take place in the United States for purposes of
section 13 of the BHC Act and the implementing regulations.
The proposal also would have eliminated the financing prong and the
counterparty prong. Under the proposal, these changes would have
focused the key requirements of the foreign trading exemption on the
principal actions and risk of the transaction. In addition, the
proposal would have removed the financing prong to address concerns
that the fungibility of financing has made this requirement in certain
circumstances difficult to apply in practice to determine whether a
particular financing is tied to a particular trade. Market participants
have raised a number of questions about the financing prong and have
indicated that identifying whether financing has been provided by a
U.S. affiliate or branch can be exceedingly complex, in particular with
respect to demonstrating that financing has not been provided by a U.S.
affiliate or branch with respect to a particular transaction. To
address the concerns raised by foreign banking entities and other
market participants, the proposal would have amended the exemption to
focus on the principal risk of a transaction and the location of the
actions as principal and trading decisions, so that a foreign banking
entity would be able to make use of the exemption so long as the risk
of the transaction is booked outside of the United States. While the
agencies
[[Page 62015]]
recognize that a U.S. branch or affiliate that extends financing could
bear some risks, the agencies note that the proposed modifications to
the foreign trading exemption were designed to require that the
principal risks of the transaction occur and remain solely outside of
the United States.
Similarly, foreign banking entities have communicated to the
agencies that the counterparty prong has been overly difficult and
costly for banking entities to monitor, track, and comply with in
practice. As a result, the agencies proposed to remove the requirement
that any transaction with a U.S. counterparty be executed solely with
the foreign operations of the U.S. counterparty (including the
requirement that no personnel of the counterparty involved in the
arrangement, negotiation, or execution may be located in the United
States) or through an unaffiliated intermediary and an anonymous
exchange. These changes were intended to materially reduce the reported
inefficiencies associated with rule compliance. In addition, market
participants have indicated that this requirement has in practice led
foreign banking entities to overly restrict the range of counterparties
with which transactions can be conducted, as well as disproportionately
burdened compliance resources associated with those transactions,
including with respect to counterparties seeking to do business with
the foreign banking entity in foreign jurisdictions.
The proposal would have removed the counterparty prong and focused
the requirements of the foreign trading exemption on the location of a
foreign banking entity's decision to trade, action as principal, and
principal risk of the purchase or sale. This proposed focus on the
location of actions and risk as principal in the United States was
intended to align with the statute's definition of ``proprietary
trading'' as ``engaging as principal for the trading account of the
banking entity.'' \541\ The proposal would have scaled back those
requirements that were not critical for this determination and thus
would not be needed in the final rule. Therefore, the proposal would
have removed the requirements of Sec. __.6(e)(3) since they are less
directly relevant to these considerations.
---------------------------------------------------------------------------
\541\ See 12 U.S.C. 1851(h)(4) (emphasis added).
---------------------------------------------------------------------------
Consistent with the 2013 rule, the exemption under the proposal
would not have exempted the U.S. or foreign operations of U.S. banking
entities from having to comply with the restrictions and limitations of
section 13 of the BHC Act. Thus, for example, the U.S. and foreign
operations of a U.S. banking entity that is engaged in permissible
market making-related activities or other permitted activities may
engage in those transactions with a foreign banking entity that is
engaged in proprietary trading in accordance with the exemption under
Sec. __.6(e) of the 2013 rule, so long as the U.S. banking entity
complies with the requirements of Sec. __.4(b), in the case of market
making-related activities, or other relevant exemption applicable to
the U.S. banking entity. The proposal, like the 2013 rule, would not
have imposed a duty on the foreign banking entity or the U.S. banking
entity to ensure that its counterparty is conducting its activity in
conformance with section 13 and the implementing regulations. Rather,
that obligation would have been on each party subject to section 13 to
ensure that it is conducting its activities in accordance with section
13 and the implementing regulations.
The proposal's exemption for trading of foreign banking entities
outside the United States potentially could have given foreign banking
entities a competitive advantage over U.S. banking entities with
respect to permitted activities of U.S. banking entities because
foreign banking entities could trade directly with U.S. counterparties
without being subject to the limitations associated with the market
making-related activities exemption or other exemptions under the rule.
This competitive disparity in turn could create a significant potential
for regulatory arbitrage. In this respect, the agencies sought to
mitigate this concern through other changes in the proposal; for
example, U.S. banking entities would have continued to be able to
engage in all of the activities permitted under the 2013 rule and the
proposal, including the simplified and streamlined requirements for
market making and risk-mitigating hedging and other types of trading
activities.
In general, commenters supported the proposed changes.\542\
However, a number of commenters requested further modifications to the
foreign trading exemption. For example, some commenters requested that
the agencies clarify the definition of ``relevant personnel'' to mean
employees that conduct risk management, and not the traders or others
associated with executing the transaction.\543\ One commenter requested
clarification that the proposed changes not constrain foreign banking
entities from delegating investment authority to non-affiliated U.S.
investment advisers.\544\ Another commenter supported eliminating the
conduct restriction.\545\ One commenter proposed several additional
modifications, including further simplifying the exemption to only
focus on where the transaction is booked, clarifying certain terms
(e.g., sub-servicing, dark pools, engaging in), and including inter-
affiliate or intra-bank transactions in the exemption.\546\ This
commenter also requested that the agencies include execution as one of
the examples of limited involvement.\547\
---------------------------------------------------------------------------
\542\ See, e.g., ISDA; IIB; ABA; New England Council; BVI; HSBC;
EBF; Credit Suisse; JBA FSF; and EFAMA.
\543\ See, e.g., HSBC and JBA.
\544\ See EFAMA.
\545\ See HSBC.
\546\ See JBA.
\547\ See JBA.
---------------------------------------------------------------------------
A few commenters opposed the proposed changes to eliminate the
financing and counterparty requirements.\548\ These commenters argued
that the proposed changes might provide foreign entities with a
competitive advantage over domestic entities.\549\ One commenter
asserted that the proposed changes would increase uncertainty and could
increase the exposure of U.S. institutions to foreign proprietary
trading losses.\550\ This commenter also argued that the agencies did
not provide factual data to support the change and that the proposal
was contrary to law.\551\
---------------------------------------------------------------------------
\548\ See, e.g., Bean; Data Boiler; and Better Markets.
\549\ See, e.g., Better Markets and FSF.
\550\ See Bean.
\551\ See Bean.
---------------------------------------------------------------------------
After consideration of these comments, the agencies are adopting
the changes to the foreign trading exemption as proposed. The
proposal's modifications in general sought to balance concerns
regarding competitive impact while mitigating the concern that an
overly narrow approach to the foreign trading exemption may cause
market bifurcations, reduce the efficiency and liquidity of markets,
make the exemption overly restrictive to foreign banking entities, and
harm U.S. market participants. The agencies believe that this approach
appropriately balances one of the key objectives of section 13 of the
BHC Act by limiting the risks that proprietary trading poses to the
U.S. financial system, while also modifying the application of section
13 as it applies to foreign banking entities, as required by section
13(d)(1)(H).
As noted in the preamble to the proposal, the statute contains an
exemption that allows foreign banking entities to engage in trading
activity that is, only for purposes of the prohibitions of the statute,
solely outside the United
[[Page 62016]]
States. The statute also contains a prohibition on proprietary trading
for U.S. banking entities regardless of where their activity is
conducted. The statute generally prohibits U.S. banking entities from
engaging in proprietary trading because of the perceived risks of those
activities to U.S. banking entities and the U.S. financial system. The
modified foreign trading exemption excludes from the statutory
prohibitions transactions where the principal risk is booked outside of
the United States and the actions and decisions as principal occur
outside of the United States by foreign operations of foreign banking
entities. The agencies also are confirming that the foreign trading
exemption does not preclude a foreign banking entity from engaging a
non-affiliated U.S. investment adviser as long as the actions and
decisions of the banking entity as principal occur outside of the
United States. By continuing to limit the risks of foreign banking
entities' proprietary trading activities to the U.S. financial system,
the agencies believe that the rule continues to protect and promote the
safety and soundness of banking entities and the financial stability of
the United States, while also allowing U.S. markets to continue to
operate efficiently in conjunction with foreign markets.
C. Subpart C--Covered Fund Activities and Investments
1. Overview of Agencies' Approach to the Covered Fund Provisions
The proposal included several proposed revisions to subpart C (the
covered fund provisions). The proposal also sought comments on other
aspects of the covered fund provisions beyond those changes for which
specific rule text was proposed. As described further below, the
agencies have determined to adopt, as proposed, the changes to subpart
C for which specific rule text was proposed. The agencies continue to
consider other aspects of the covered fund provisions on which the
agencies sought comment in the proposal and intend to issue a separate
proposed rulemaking that specifically addresses those areas.
The proposal sought comment on the 2013 rule's general approach to
defining the term ``covered fund,'' as well as the existing exclusions
from the covered fund definition and potential new exclusions from this
definition. The agencies received numerous comments on these aspects of
the covered fund provisions. Some commenters encouraged the agencies to
make significant revisions to these provisions, such as narrowing the
covered fund ``base definition'' \552\ or providing additional
exclusions from this definition.\553\ Other commenters argued that the
agencies should not narrow the covered fund definition or should retain
the definition in section 13 of the BHC Act.\554\ Some commenters
raised concerns about the agencies' ability to finalize changes to the
covered fund provisions for which the proposal did not provide specific
rule text.\555\ In light of the number and complexity of issues under
consideration, the agencies intend to address these and other comments
received on the covered fund provisions in a subsequent proposed
rulemaking.
---------------------------------------------------------------------------
\552\ See, e.g., ABA; AIC; Center for American Entrepreneurship;
Goldman Sachs; and JBA.
\553\ See, e.g., Capital One et al.; Credit Suisse; and SIFMA.
\554\ See, e.g., AFR and Occupy the SEC.
\555\ See, e.g., AFR; Bean; and Volcker Alliance.
---------------------------------------------------------------------------
In this final rule, the agencies are adopting only those changes to
the covered fund provisions for which specific rule text was
proposed.\556\ Those changes are being adopted as final without change
from the proposal for the reasons described below. While the agencies
are not including any other changes to subpart C in this final rule,
this approach does not reflect any final determination with respect to
the comments received on other aspects of the covered fund provisions.
The agencies continue to consider comments received and intend to
address additional aspects of the covered funds provisions in the
future covered funds proposal.
---------------------------------------------------------------------------
\556\ In addition, consistent with changes described in Part
IV.B.1.b.i of this Supplementary Information, the final rule removes
references to ``guidance'' from subpart C.
---------------------------------------------------------------------------
2. Section __.11: Permitted Organizing and Offering, Underwriting, and
Market Making With Respect to a Covered Fund
Section 13(d)(1)(B) of the BHC Act permits a banking entity to
purchase and sell securities and other instruments described in section
13(h)(4) of the BHC Act in connection with the banking entity's
underwriting or market making-related activities.\557\ The 2013 rule
provides that the prohibition against acquiring or retaining an
ownership interest in or sponsoring a covered fund does not apply to a
banking entity's underwriting or market making-related activities
involving a covered fund as long as:
---------------------------------------------------------------------------
\557\ 12 U.S.C. 1851(d)(1)(B).
---------------------------------------------------------------------------
The banking entity conducts the activities in accordance
with the requirements of the underwriting exemption in Sec. __.4(a) of
the 2013 rule or market making exemption in Sec. __.4(b) of the 2013
rule, respectively.
The banking entity includes the aggregate value of all
ownership interests of the covered fund acquired or retained by the
banking entity and its affiliates for purposes of the limitation on
aggregate investments in covered funds (the aggregate-fund limit) \558\
and capital deduction requirement; \559\ and
---------------------------------------------------------------------------
\558\ 2013 rule Sec. __.12(a)(2)(iii).
\559\ 2013 rule Sec. __.12(d).
---------------------------------------------------------------------------
The banking entity includes any ownership interest that it
acquires or retains for purposes of the limitation on investments in a
single covered fund (the per-fund limit) if the banking entity (i) acts
as a sponsor, investment adviser or commodity trading adviser to the
covered fund; (ii) otherwise acquires and retains an ownership interest
in the covered fund in reliance on the exemption for organizing and
offering a covered fund in Sec. __.11(a) of the 2013 rule; (iii)
acquires and retains an ownership interest in such covered fund and is
either a securitizer, as that term is used in section 15G(a)(3) of the
Exchange Act, or is acquiring and retaining an ownership interest in
such covered fund in compliance with section 15G of that Act and the
implementing regulations issued thereunder, each as permitted by Sec.
__.11(b) of the 2013 rule; or (iv) directly or indirectly, guarantees,
assumes, or otherwise insures the obligations or performance of the
covered fund or of any covered fund in which such fund invests.\560\
---------------------------------------------------------------------------
\560\ See 2013 rule Sec. __.11(c).
---------------------------------------------------------------------------
The proposal would have removed the requirement that the banking
entity include for purposes of the aggregate fund limit and capital
deduction the value of any ownership interests of a third-party covered
fund (i.e., covered funds that the banking entity does not advise or
organize and offer pursuant to Sec. __.11 of the final rule) acquired
or retained in accordance with the underwriting or market-making
exemptions in Sec. __.4. Under the proposal, these limits, as well as
the per-fund limit, would have applied only to a covered fund that the
banking entity organizes or offers and in which the banking entity
acquires or retains an ownership interest pursuant to Sec. __.11(a) or
(b) of the 2013 rule. The agencies proposed this change to more closely
align the requirements for engaging in underwriting or market-making-
related activities with respect to ownership interests in a covered
fund with the requirements for engaging in these activities with
respect to other financial instruments.
[[Page 62017]]
Several commenters supported eliminating these requirements for
underwriting and market making in ownership interests in covered
funds.\561\ Many of these commenters said this proposal would reduce
the compliance burden for banking entities engaged in client-facing
underwriting and market making activities and would facilitate these
permitted activities.\562\ One of these commenters noted in particular
the difficulties for banking entities to determine whether a third-
party fund is a covered fund subject to the limits of the 2013 rule and
to determine with certainty whether certain non-U.S. securities may be
issued by covered funds.\563\ Some of these commenters argued that
providing underwriting and market making in the interests in such funds
increases liquidity and benefits the marketplace generally.\564\ One of
these commenters also stated that this would facilitate capital-raising
activities of covered funds and other issuers.\565\ Other commenters
opposed this change because they believed that it would greatly expand
banking entities' ability to hold ownership interests in covered
funds,\566\ and is contrary to section 13 of the BHC Act.\567\
---------------------------------------------------------------------------
\561\ See, e.g., ABA; BPI; FSF; Goldman Sachs; IIB; ISDA; and
SIFMA.
\562\ See, e.g., BPI; FSF; ISDA; and SIFMA.
\563\ See SIFMA.
\564\ See ISDA.
\565\ See SIFMA.
\566\ See, e.g., AFR; Bean; and Volcker Alliance.
\567\ See Bean.
---------------------------------------------------------------------------
Several commenters supported making additional revisions to Sec.
__.11 by eliminating the aggregate fund limit and capital deduction for
other funds, such as affiliated funds or sponsored funds \568\ and
advised funds.\569\ Certain of these commenters argued that
underwriting and market making in interests in these covered funds
would not expose banking entities to greater risk because ownership
interests in such funds acquired in accordance with the risk-mitigating
hedging, market-making or underwriting exemptions would nevertheless be
subject to the restrictions contained in those exemptions.\570\
---------------------------------------------------------------------------
\568\ See ISDA.
\569\ See, e.g., BPI; ISDA; and SIFMA.
\570\ See, e.g., BPI and ISDA.
---------------------------------------------------------------------------
The agencies are eliminating the aggregate fund limit and the
capital deduction requirement for the value of ownership interests in
third-party covered funds acquired or retained in accordance with the
underwriting or market-making exemption (i.e., covered funds that the
banking entity does not advise or organize and offer pursuant to Sec.
__.11(a) or (b) of the final rule).\571\ The agencies believe this
change will better align the compliance requirements for underwriting
and market making involving covered funds with the risks those
activities entail. In particular, the agencies understand that it has
been difficult for banking entities to determine whether ownership
interests in covered funds are being acquired or retained in the
context of trading activities, especially for non-U.S. issuers. Banking
entities have had to undertake an often time-consuming process to
determine whether an issuer is a covered fund and the security issued
is an ownership interest, all for the purpose of ensuring compliance
with the aggregate fund limit and capital deduction requirement for the
period of time that the banking entity holds the ownership interest as
part of its otherwise permissible underwriting and market making
activities.\572\ These compliance challenges are heightened in the case
of third-party funds. However, a banking entity can more readily
determine whether a fund is a covered fund if the banking entity
advises or organizes and offers the fund. Thus, the agencies are not
eliminating the aggregate fund limit and capital deduction requirement
for advised covered funds or covered funds that the banking entity
organizes or offers. The agencies continue to consider whether the
approach being adopted in the final rule may be extended to other
issuers, such as funds advised by the banking entity, and intend to
address and request additional comment on this issue in the future
proposed rulemaking.
---------------------------------------------------------------------------
\571\ As in the proposal, this requirement is also eliminated
for underwriting and market-making activities involving funds with
respect to which the banking entity directly or indirectly,
guarantees, assumes, or otherwise insures the obligations or
performance of the covered fund or of any covered fund in which such
fund invests. Such funds are not organized and offered pursuant to
Sec. __.11(a) or (b) of the final rule and thus treatment as a
third-party fund is more appropriate for purposes of the
underwriting and market-making exemption for covered funds. The
agencies note, however, that other provisions of section 13 of the
BHC Act, as well as other laws and regulations, limit banking
entities' ability to guarantee, assume, or otherwise insure the
obligations or performance of covered funds. See 12 U.S.C. 1851(f);
12 U.S.C. 1851(d)(2); Sec. Sec. __.14 and __.15 of the final rule.
See also 12 CFR 7.1017 (limiting authority of national bank to act
as a guarantor).
\572\ See SIFMA.
---------------------------------------------------------------------------
The agencies disagree with the commenter who argued that
eliminating the aggregate fund limit and capital deduction is contrary
to section 13 of the BHC Act.\573\ An exemption from the prohibition on
acquiring or retaining an ownership interest in a covered fund for
underwriting and market making involving covered fund ownership
interests is consistent with and supported by section 13 of the BHC
Act.\574\ Section 13(d)(1)(B) provides a statutory exemption for
underwriting and market making activities and, by its terms, applies to
both prohibitions in section 13(a), whether on proprietary trading or
covered fund activities. Section 13 does not require any per-fund or
aggregate limits, or capital deduction, with respect to covered fund
ownership interests acquired pursuant to the underwriting and market
making exemption in section 13(d)(1)(B), and eliminating these
requirements with respect to third-party funds will improve the
effectiveness of the statutory exemption for these activities.\575\
---------------------------------------------------------------------------
\573\ See Bean.
\574\ See 79 FR 5535, 5722.
\575\ The quantitative limits and capital deduction requirements
in 12 U.S.C. 1851(d)(4)(B) are required to apply only in the case of
seeding investments and other de minimis investments made pursuant
to 12 U.S.C. 1851(d)(4)(B).
---------------------------------------------------------------------------
The agencies also disagree with commenters who asserted that this
change will greatly expand banking entities' ability to hold ownership
interests in covered funds.\576\ This exemption for underwriting and
market making involving ownership interests in covered funds applies
only to underwriting and market making activities conducted pursuant to
the requirements in section 13(d)(1)(B) of the BHC Act and Sec. __.4
of the final rule. This exemption is intended to allow banking entities
to engage in permissible underwriting and market making involving
covered fund ownership interests to the same extent as other financial
instruments. It is also intended to increase the effectiveness of the
underwriting and market making exemptions in Sec. __.4 by
appropriately limiting the covered fund determinations a banking entity
must make in the course of these permissible activities. For these
reasons, and to limit the potential for evasion, the exemption for
underwriting and market making involving ownership interests in covered
funds continues to apply only to activities that satisfy the
requirements of the underwriting or market making exemptions in Sec.
__.4.
---------------------------------------------------------------------------
\576\ See, e.g., AFR; Bean; and Volcker Alliance.
---------------------------------------------------------------------------
One commenter argued that the aggregate fund limit should apply
only at the global consolidated level for all firms.\577\ This
commenter argued that measuring aggregate covered fund ownership at the
parent-level is a better test of immateriality than measuring covered
fund investments at a lower level, such as at the level of an
[[Page 62018]]
intermediate holding company.\578\ This commenter also said the
agencies should expand the per-fund limit to allow bank-affiliated
securitization investment managers to rely on applicable foreign risk
retention regulations as a basis for exceeding the three percent per-
fund limitation, provided that those foreign regulations are generally
comparable to U.S. requirements.\579\ Another commenter asserted that
the preamble to the 2013 rule indicated that direct investments made
alongside a covered fund should be aggregated for purposes of the per-
fund limit in certain circumstances.\580\ This commenter asked the
agencies to clarify that the 2013 rule does not prohibit banking
entities from making direct investments alongside covered funds,
regardless of whether the fund is sponsored or the investments are
coordinated, so long as such investments are otherwise authorized for
such banking entities (e.g., under merchant banking authority). The
agencies continue to consider these issues. As noted above, the
agencies expect to address and request additional comments on these and
other covered fund provisions in the future proposed rulemaking.
---------------------------------------------------------------------------
\577\ See Credit Suisse.
\578\ Id.
\579\ Id.
\580\ See Goldman Sachs.
---------------------------------------------------------------------------
3. Section __.13: Other Permitted Covered Fund Activities
a. Permitted Risk-Mitigating Hedging
Section 13(d)(1)(C) of the BHC Act provides an exemption for risk-
mitigating hedging activities in connection with and related to
individual or aggregated positions, contracts, or other holdings of a
banking entity that are designed to reduce the specific risks to the
banking entity in connection with and related to such positions,
contracts, or other holdings.\581\ As described in the preamble to the
proposal, the 2013 rule implemented this authority narrowly in the
context of covered fund activities. Specifically, the 2013 rule
permitted only limited risk-mitigating hedging activities involving
ownership interests in covered funds for hedging employee compensation
arrangements.
---------------------------------------------------------------------------
\581\ 12 U.S.C. 1851(d)(1)(C).
---------------------------------------------------------------------------
Like the proposal, the final rule allows a banking entity to
acquire or retain an ownership interest in a covered fund as a hedge
when acting as intermediary on behalf of a customer that is not itself
a banking entity to facilitate the exposure by the customer to the
profits and losses of the covered fund. This provision is consistent
with the agencies' original 2011 proposal.\582\
---------------------------------------------------------------------------
\582\ See 83 FR at 33483-84.
---------------------------------------------------------------------------
The proposal also would have amended Sec. __.13(a) to align with
the proposed modifications to Sec. __.5. In particular, the proposal
would have required that a risk-mitigating hedging transaction pursuant
to Sec. __.13(a) be designed to reduce or otherwise significantly
mitigate one or more specific, identifiable risks to the banking
entity. It would have removed the requirement that the hedging
transaction ``demonstrably'' reduces or otherwise significantly
mitigates the relevant risks, consistent with the proposed
modifications to Sec. __.5.\583\
---------------------------------------------------------------------------
\583\ See supra Part IV.B.3.b.ii.
---------------------------------------------------------------------------
Several commenters supported permitting banking entities to acquire
and retain ownership interests in covered funds as a hedge when acting
as intermediary on behalf of a customer.\584\ Certain of these
commenters argued that acquiring or retaining ownership interests in
covered funds for this purpose (fund-linked products) is beneficial
because it accommodates banking entities' client facilitation and
related risk management activities.\585\ Two commenters noted that
restricting institutions' ability to find the best hedge for a
transaction may increase risks to safety and soundness and, conversely,
permitting banking entities to use the best available hedge for risks
arising from customer facilitation activities would promote safety and
soundness and reduce risk.\586\ Several of these commenters also argued
that fund-linked products are not a high-risk trading strategy.\587\
For example, one commenter argued that the magnitude of counterparty
default risk that banking entities would face in acquiring or retaining
a covered fund ownership interest under these circumstances (i.e., to
hedge a position by the banking entity when acting as intermediary on
behalf of a customer that is not itself a banking entity to facilitate
exposure by the customer to a covered fund) is no different than any
other counterparty default risk that banking entities face when
entering into other risk-mitigating hedges.\588\ Other commenters
opposed this change and noted that, at the time the 2013 rule was
adopted, the agencies considered acting as principal in providing
exposure to the profits and losses of a covered fund for a customer,
even if hedged by the banking entity with ownership interests of the
covered fund, to constitute a high-risk trading strategy.\589\ One
commenter stated that the proposal did not offer specific examples or
explain why such fund-linked products are necessary.\590\ Another
commenter argued that the exemption for risk-mitigating hedging
involving ownership interests in covered funds should be further
restricted or completely removed from the rule.\591\
---------------------------------------------------------------------------
\584\ See, e.g., ABA; BPI; FSF; Goldman Sachs; IIB; ISDA; SIFMA;
and IIB.
\585\ See, e.g., BPI and FSF.
\586\ See, e.g., FSF and SIFMA.
\587\ See, e.g., FSF; ISDA; and SIFMA.
\588\ See FSF.
\589\ See, e.g., AFR and Volcker Alliance.
\590\ See AFR.
\591\ See Occupy the SEC.
---------------------------------------------------------------------------
The final rule adopts the proposed revision without change. This
exemption is tailored to permit bona fide customer facilitation
activities and to limit the risk incurred directly by the banking
entity. The new exemption in Sec. __.13(a) extends only to a position
taken by the banking entity when acting as intermediary on behalf of a
customer that is not itself a banking entity to facilitate the
customer's exposure to the profits and losses of the covered fund. The
banking entity's acquisition or retention of the ownership interest as
a hedge must be designed to reduce or otherwise significantly mitigate
one or more specific, identifiable risks arising out of a transaction
conducted solely to accommodate a specific customer request with
respect to the covered fund. As a result, a transaction conducted in
reliance on this exemption must be customer-driven. A banking entity
cannot rely on this exemption to solicit customer transactions in order
to facilitate the banking entity's own exposure to a covered fund.
As some commenters noted, in the preamble to the 2013 rule, the
agencies stated that they were not adopting an exemption for customer
facilitation activities and related hedging activities involving
ownership interests in covered funds because these activities could
potentially expose a banking entity to the types of risks that section
13 of the BHC Act sought to address. However, in light of other
comments received,\592\ the agencies do not believe that a banking
entity's customer facilitation activities and related hedging
activities involving ownership interests in covered funds necessarily
constitute high-risk trading strategies that could threaten the safety
and soundness of the banking entity. The agencies believe that,
properly monitored and managed, these activities can be conducted
without creating a greater degree of risk to the banking entity than
the other customer facilitation activities permitted by the
[[Page 62019]]
final rule.\593\ In particular, these activities remain subject to all
of the final rule's requirements for risk-mitigating hedging
transactions, including requirements that such transactions must:
---------------------------------------------------------------------------
\592\ See, e.g., FSF; ISDA; and SIFMA.
\593\ See, e.g., final rule Sec. __.3(d)(11).
---------------------------------------------------------------------------
Be designed to reduce or otherwise significantly mitigate
the specific, identifiable risks to the banking entity;
be made in accordance with the banking entity's written
policies, procedures and internal controls;
not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with the risk-mitigating hedging
requirements; and
be subject to continuing review, monitoring and management
by the banking entity.\594\
---------------------------------------------------------------------------
\594\ See final rule Sec. __.13.
---------------------------------------------------------------------------
In addition, these activities remain subject to Sec. __.15 of the
final rule and, therefore, to the extent they would in practice
significantly increase the likelihood that the banking entity would
incur a substantial financial loss or would pose a threat to the
financial stability of the United States, they would not be
permissible. The agencies are also adopting without change the
amendment to align Sec. __.13(a) with Sec. __.5 by eliminating the
requirement that a risk-mitigating hedging transaction ``demonstrably''
reduces or otherwise significantly mitigates the relevant risks. The
agencies are adopting this amendment to Sec. __.13(a) for the same
reason the agencies are adopting the amendment to Sec. __.5.
b. Permitted Covered Fund Activities and Investments Outside of the
United States
Section 13(d)(1)(I) of the BHC Act permits foreign banking entities
to acquire or retain an ownership interest in, or act as sponsor to, a
covered fund, so long as those activities and investments occur solely
outside the United States and certain other conditions are met (the
foreign fund exemption).\595\ Section 13 of the BHC Act does not
further define ``solely outside of the United States'' (SOTUS).
---------------------------------------------------------------------------
\595\ Section 13(d)(1)(I) of the BHC Act permits a banking
entity to acquire or retain an ownership interest in, or have
certain relationships with, a covered fund notwithstanding the
restrictions on investments in, and relationships with, a covered
fund, if: (i) Such activity or investment is conducted by a banking
entity pursuant to paragraph (9) or (13) of section 4(c) of the BHC
Act; (ii) the activity occurs solely outside of the United States;
(iii) no ownership interest in such fund is offered for sale or sold
to a resident of the United States; and (iv) the banking entity is
not directly or indirectly controlled by a banking entity that is
organized under the laws of the United States or of one or more
States. See 12 U.S.C. 1851(d)(1)(I).
---------------------------------------------------------------------------
The 2013 rule established several conditions on the availability of
the foreign fund exemption. Specifically, the 2013 rule provided that
an activity or investment occurs solely outside the United States for
purposes of the foreign fund exemption only if:
The banking entity acting as sponsor, or engaging as
principal in the acquisition or retention of an ownership interest in
the covered fund, is not itself, and is not controlled directly or
indirectly by, a banking entity that is located in the United States or
organized under the laws of the United States or of any State;
The banking entity (including relevant personnel) that
makes the decision to acquire or retain the ownership interest or act
as sponsor to the covered fund is not located in the United States or
organized under the laws of the United States or of any State;
The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State; and
No financing for the banking entity's ownership or
sponsorship is provided, directly or indirectly, by any branch or
affiliate that is located in the United States or organized under the
laws of the United States or of any State (the ``financing
prong'').\596\
---------------------------------------------------------------------------
\596\ See final rule Sec. __.13(b)(4).
---------------------------------------------------------------------------
Much like the similar requirement under the exemption for permitted
trading activities of a foreign banking entity, the proposal would have
removed the financing prong of the foreign fund exemption, while
leaving in place the other requirements for an activity or investment
to be considered ``solely outside of the United States.'' Removing the
financing prong was intended to streamline the requirements of the
foreign fund exemption with the intention of improving implementation
of the statutory exemption.
Several commenters supported removing the financing prong from the
foreign fund exemption.\597\ One commenter argued that this change
would appropriately refocus the foreign fund exemption on the location
of the activities of the banking entity as principal.\598\ Another
commenter argued that the proposed changes to the foreign fund
exemption, including removal of the financing prong, could promote
international regulatory cooperation.\599\ Other commenters argued
against eliminating the financing prong because it could result in a
U.S. branch or affiliate that extends financing to bear some
risks.\600\
---------------------------------------------------------------------------
\597\ See, e.g., BPI; BVI; EBF; IIB; JBA; and New England
Council.
\598\ See EBF.
\599\ See BPI.
\600\ See, e.g., Better Markets and CAP.
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The agencies are adopting the proposal to remove the financing
prong for the same reasons described above in section IV.B.4 for the
trading outside of the United States exemption. This change focuses one
of the key requirements of the foreign fund exemption on the principal
actions and risk of the transaction. Removing the financing prong would
also address concerns that the fungibility of financing has made this
requirement in certain circumstances difficult to apply in practice to
determine whether a particular financing is tied to a particular
activity or investment. Eliminating the financing prong, while
retaining the other prongs of the foreign fund exemption, strikes a
better balance between the risks posed to U.S. banking entities and the
U.S. financial system, on the one hand, and effectuating the statutory
exemption for activities conducted solely outside of the United States,
on the other. The agencies note that a U.S. banking entity's affiliate
lending activities remain subject to other laws and regulations--
including sections 23A and 23B of the Federal Reserve Act and
prudential safety and soundness standards, as applicable.
One of the restrictions of the statutory exemption for covered fund
activities conducted by foreign banking entities solely outside the
United States is the restriction that ``no ownership interest in such
hedge fund or private equity fund is be offered for sale or sold to a
resident of the United States.\601\ To implement this restriction,
Sec. __.13(b) of the 2013 rule requires, as one condition of the
foreign fund exemption, that ``no ownership interest in the covered
fund is offered for sale or sold to a resident of the United States''
(the ``marketing restriction'').\602\
---------------------------------------------------------------------------
\601\ See 12 U.S.C. 1851(d)(1)(I).
\602\ See final rule Sec. __.13(b)(1)(iii).
---------------------------------------------------------------------------
The final rule, like the proposal, clarifies that an ownership
interest in a covered fund is not offered for sale or sold to a
resident of the United States for purposes of the marketing restriction
only if it is not sold and has not been sold pursuant to an offering
that targets residents of the United States in which the banking entity
or any affiliate of the banking entity participates. The final
[[Page 62020]]
rule, like the proposal, also clarifies that if the banking entity or
an affiliate sponsors or serves, directly or indirectly, as the
investment manager, investment adviser, commodity pool operator, or
commodity trading advisor to a covered fund, then the banking entity or
affiliate will be deemed for purposes of the marketing restriction to
participate in any offer or sale by the covered fund of ownership
interests in the covered fund.\603\ This revision adopts existing staff
guidance addressing this issue.\604\ Several commenters supported this
clarification.\605\ Some commenters argued that this clarification
appropriately excludes from the marketing restriction those activities
where the risk occurs and remains outside of the United States and
reflects the intended extraterritorial limitations of the section 13 of
the BHC Act.\606\ In addition, commenters stated that codifying the
previously issued staff guidance will provide greater clarity and
certainty for non-U.S. banking entities making investments in third
party funds (i.e., covered funds that the banking entity does not
advise or organize and offer pursuant to Sec. __.11(a) or (b) of the
final rule) and will enable long-term strategies in reliance on this
provision.\607\
---------------------------------------------------------------------------
\603\ See proposal Sec. __.13(b)(3).
\604\ See supra note 59, FAQ 13.
\605\ See, e.g., AIC; BPI; BVI; IIB; and EBF.
\606\ See, e.g., EBF and IIB.
\607\ See, e.g., AIC; BPI; and BVI.
---------------------------------------------------------------------------
The agencies are adopting this clarification as proposed to
formally incorporate the existing staff guidance. As staff noted in the
previous staff guidance, the marketing restriction constrains the
foreign banking entity in connection with its own activities with
respect to covered funds rather than the activities of unaffiliated
third parties.\608\ This ensures that the foreign banking entity
seeking to rely on the foreign fund exemption does not engage in an
offering of ownership interests that targets residents of the United
States. This clarification limits the extraterritorial application of
section 13 to foreign banking entities while seeking to ensure that the
risks of covered fund investments by foreign banking entities occur and
remain solely outside of the United States. If the marketing
restriction were applied to the activities of third parties, such as
the sponsor of a third-party covered fund (rather than the foreign
banking entity investing in a third-party covered fund), the foreign
fund exemption may not be available in certain circumstances even
though the risks and activities of a foreign banking entity with
respect to its investment in the covered fund are solely outside the
United States.
---------------------------------------------------------------------------
\608\ See supra note 59, FAQ 13.
---------------------------------------------------------------------------
One commenter asked the agencies to clarify that the requirement
that the banking entity (including the relevant personnel) that makes
the decision ``to acquire or retain the ownership interest or act as
sponsor to the covered fund'' must not be located in the United States
does not prohibit non-U.S. investment funds from utilizing the
expertise of U.S. investment advisers under delegation agreements.\609\
This commenter noted that a foreign investment fund may appoint a
qualified U.S. investment adviser for providing investment management
or investment advisory services under delegation but that the ultimate
responsibility for the investment decisions and compliance with
statutory and contractual investment limits remains with the foreign
management company that manages the foreign investment fund. As stated
in the preamble to the 2013 rule, the foreign fund exemption permits
the U.S. personnel and operations of a foreign banking entity to act as
investment adviser to a covered fund in certain circumstances. For
example, the U.S. personnel of a foreign banking entity may provide
investment advice and recommend investment selections to the manager or
general partner of a covered fund so long as the investment advisory
activity in the United States does not result in U.S. personnel
participating in the control of the covered fund or offering or selling
an ownership interest to a resident of the United States.\610\
Consistent with the foreign trading exemption, as discussed above,\611\
the agencies also are confirming that under the final rule, the foreign
fund exemption does not preclude a foreign banking entity from engaging
a non-affiliated U.S. investment adviser as long as the actions and
decisions of the banking entity as principal occur outside of the
United States. The agencies intend to address and request further
comment on additional covered fund issues in a future proposed
rulemaking.
---------------------------------------------------------------------------
\609\ See BVI.
\610\ 79 FR at 5741.
\611\ See supra Part IV.B.4.
---------------------------------------------------------------------------
4. Section __.14: Limitations on Relationships With a Covered Fund
a. Relationships With a Covered Fund
Section 13(f) of the BHC Act provides that, with limited
exceptions, no banking entity that serves, directly or indirectly, as
the investment manager, investment adviser, or sponsor to a hedge fund
or private equity fund, or that organizes and offers a hedge fund or
private equity fund pursuant to section 13(d)(1)(G), and no affiliate
of such entity, may enter into a transaction with the fund, or with any
other hedge fund or private equity fund that is controlled by such
fund, that would be a ``covered transaction,'' as defined in section
23A of the Federal Reserve Act, as if such banking entity and the
affiliate thereof were a member bank and the hedge fund or private
equity fund were an affiliate thereof.\612\ The 2013 rule includes this
prohibition as well.\613\ The proposal included a request for comment
regarding the restrictions in section 13(f) of the BHC Act and Sec.
__.14 of the 2013 rule. As with the other covered fund issues for which
no specific rule text was proposed, the agencies continue to consider
the prohibition in section 13(f) of the BHC Act and intend to issue a
separate proposed rulemaking that addresses this issue.
---------------------------------------------------------------------------
\612\ See U.S.C. 1851(f)(1).
\613\ See final rule Sec. __.14(a)(1).
---------------------------------------------------------------------------
b. Prime Brokerage Transactions
Section 13(f) of the BHC Act provides an exemption from the
prohibition on covered transactions with a hedge fund or private equity
fund for any prime brokerage transaction with a hedge fund or private
equity fund in which a hedge fund or private equity fund managed,
sponsored, or advised by a banking entity has taken an ownership
interest (a second-tier fund).\614\ The statute by its terms permits a
banking entity with a relationship to a hedge fund or private equity
fund described in section 13(f) of the BHC Act to engage in prime
brokerage transactions (that are covered transactions) only with
second-tier funds and does not extend to hedge funds or private equity
funds more generally.\615\ Under the statute, the exemption for prime
brokerage transactions is available only so long as certain enumerated
conditions are satisfied.\616\ The 2013 rule included this exemption as
well and similarly required satisfaction of certain enumerated
conditions in order for a banking entity to engage in permissible prime
brokerage transactions.\617\ The
[[Page 62021]]
2013 rule's conditions are that (i) the banking entity is in compliance
with each of the limitations set forth in[thinsp]Sec. __.11 of the
2013 rule with respect to a covered fund organized and offered by the
banking entity or any of its affiliates; (ii) the CEO (or equivalent
officer) of the banking entity certifies in writing annually that the
banking entity does not, directly or indirectly, guarantee, assume, or
otherwise insure the obligations or performance of the covered fund or
of any covered fund in which such covered fund invests; and (iii) the
Board has not determined that such transaction is inconsistent with the
safe and sound operation and condition of the banking entity.
---------------------------------------------------------------------------
\614\ See U.S.C. 1851(f)(3).
\615\ Neither the statute nor the proposal limits covered
transactions between a banking entity and a covered fund for which
the banking entity does not serve as investment manager, investment
adviser, or sponsor (as defined in section 13 of the BHC Act) or
have an interest in reliance on section 13(d)(1)(G) of the BHC Act.
Similarly, the final rule does not limit such covered transactions.
\616\ See 12 U.S.C. 1851(f)(3).
\617\ See final rule Sec. __.14(a)(2)(ii).
---------------------------------------------------------------------------
The proposal retained each of the 2013 rule's conditions for the
prime brokerage exemption described above, including the requirement
that certification be made to the appropriate agency for the banking
entity.\618\ Staffs of the agencies previously issued guidance
explaining when a banking entity was required to provide this
certification during the conformance period.\619\ The proposal
incorporated this guidance into the rule text by requiring banking
entities to provide the CEO certification annually no later than March
31 of the relevant year.\620\ This change was intended to provide
banking entities with certainty about when the required certification
must be provided to the appropriate agency in order to comply with the
prime brokerage exemption. As under the 2013 rule, under the proposal,
the CEO would have a duty to update the certification if the
information in the certification materially changes at any time during
the year when he or she becomes aware of the material change.\621\
---------------------------------------------------------------------------
\618\ See 83 FR at 33486-87.
\619\ See supra note 59, FAQ 18.
\620\ See 83 FR at 33487.
\621\ This duty to update the certification is required as a
condition of the statutory exemption. See 12 U.S.C.
1851(f)(3)(A)(ii).
---------------------------------------------------------------------------
One commenter recommended that the agencies expressly state that
the CEO certification for purposes of the prime brokerage exemption is
based on a reasonable review by the CEO and is made based on the
knowledge and reasonable belief of the CEO.\622\ That commenter also
requested that the agencies clarify that the term ``prime brokerage
transaction'' includes transactions and services commonly provided in
connection with prime brokerage transactions, as described under the
2013 rule, including: (1) Lending and borrowing of financial assets,
(2) provision of secured financing collateralized by financial assets,
(3) repurchase and reverse repurchase of financial assets, (4)
derivatives, (5) clearance and settlement of transactions, (6) ``give-
up'' agreements, and (7) purchase and sale of financial assets from
inventory.\623\ Similarly, another commenter requested that the
agencies clarify that the term ``prime brokerage transaction'' applies
to any transaction provided in connection with custody, clearance and
settlement, securities borrowing or lending services, trade execution,
financing, or data, operational, and administrative support regardless
of which business line within the banking entity conducts the
business.\624\ The same commenter suggested that any prime brokerage
transaction with a second-tier covered fund should be presumed to
comply with section __.14 of the rule and the prime brokerage exemption
as long as it is executed in compliance with the requirements of
Section 23B of the Federal Reserve Act.\625\ In addition, one commenter
recommended limiting the prime brokerage exemption by, for instance,
excluding financing and securities lending and borrowing from the prime
brokerage exemption.\626\
---------------------------------------------------------------------------
\622\ See SIFMA.
\623\ See id.
\624\ See ABA.
\625\ See id.
\626\ See Occupy the SEC.
---------------------------------------------------------------------------
The final rule adopts the proposed revision to the prime brokerage
exemption with no changes. The agencies believe that codifying a
deadline for CEO certification with respect to prime brokerage
transactions will provide banking entities with greater certainty and
facilitate supervision and review of the prime brokerage exemption.
With respect to the other issues raised by commenters regarding the
prime brokerage exemption in section 13(f) of the BHC Act, the agencies
continue to consider these issues and intend to issue a separate
proposed rulemaking that specifically addresses these issues.
D. Subpart D--Compliance Program Requirement; Violations
1. Section __.20: Program for Compliance; Reporting
Section __.20 of the 2013 rule contains compliance program and
metrics collection and reporting requirements. The 2013 rule was
intended to focus the most significant compliance obligations on the
largest and most complex organizations, while minimizing the economic
impact on small banking entities.\627\ To this end, the 2013 rule
included a simplified compliance program for small banking entities and
banking entities that did not engage in extensive trading
activity.\628\ However, as the agencies noted in the proposal, public
feedback has indicated that even determining whether a banking entity
is eligible for the simplified compliance program could require
significant analysis for small banking entities. In addition, certain
traditional banking activities of small banks fall within the scope of
the proprietary trading and covered fund prohibitions and exemptions,
making banks engaging in these activities ineligible for the simplified
compliance program. As the agencies noted in the proposal, public
feedback has also indicated that the compliance program requirements
are unduly burdensome for larger banking entities that must implement
the rule's enhanced compliance program, metrics, and CEO attestation
requirements. Accordingly, the agencies proposed to revise the
compliance program requirements to allow greater flexibility for
banking entities in integrating the Volcker compliance and exemption
requirements into existing compliance programs and to focus the
requirements on the banking entities with the most significant and
complex activities.
---------------------------------------------------------------------------
\627\ See 79 FR 5753.
\628\ Banking entities did not have any compliance program
obligations under the 2013 rule if they do not engage in any covered
activities other than trading in certain government, agency, State
or municipal obligations. Sec. __20(f)(1). Additionally, banking
entities with $10 billion or less in total consolidated assets could
satisfy the compliance program requirements under the 2013 rule by
including appropriate references to the requirements of section 13
of the BHC Act and the implementing regulations in their existing
policies and procedures. Sec. __.20(f)(2).
---------------------------------------------------------------------------
Specifically, the agencies proposed applying the compliance program
requirement to banking entities as follows:
Banking entities with significant trading assets and
liabilities. Banking entities with significant trading assets and
liabilities would have been subject to the six-pillar compliance
program requirement (Sec. __.20(b) of the 2013 rule), the metrics
reporting requirements (Sec. __.20(d) of the 2013 rule),\629\ the
covered fund documentation requirements (Sec. __.20(e) of the 2013
rule), and the CEO attestation
[[Page 62022]]
requirement (Appendix B of the 2013 rule).\630\
---------------------------------------------------------------------------
\629\ As discussed below, the proposal would have amended the
Appendix A metrics requirements to reduce compliance-related
inefficiencies while allowing for the collection of data to permit
the agencies to better monitor compliance with section 13 of the BHC
Act. In addition, the proposal would have eliminated Appendix B of
the 2013 rule, which would have resulted in Appendix A being re-
designated as the ``Appendix.''
\630\ Although the proposal would have eliminated Appendix B, as
noted above, it would have continued to apply a modified version of
the CEO attestation to banking entities without limited trading
assets and liabilities.
---------------------------------------------------------------------------
Banking entities with moderate trading assets and
liabilities. Banking entities with moderate trading assets and
liabilities would have been required to establish the simplified
compliance program (described in Sec. __.20(f)(2) of the 2013 rule)
and comply with the CEO attestation requirement.
Banking entities with limited trading assets and
liabilities. Banking entities with limited trading assets and
liabilities would have been presumed to be in compliance with the
proposal and would have had no obligation to demonstrate compliance
with subpart B and subpart C of the implementing regulations on an
ongoing basis. These banking entities would not have been required to
demonstrate compliance with the rule unless and until the appropriate
agency, based upon a review of the banking entity's activities,
determined that the banking entity should have been treated as if it
did not have limited trading assets and liabilities.
After reviewing all of the comments to this section, the agencies
are finalizing these changes largely as proposed, except for further
tailoring application of the CEO attestation requirement to only
banking entities with significant trading assets and liabilities and
revising the notice and response procedures in subpart D to be more
broadly applicable.
a. Compliance Program Requirements for Banking Entities With
Significant Trading Assets and Liabilities
i. Section 20(b)--Six-Pillar Compliance Program
Section __.20(b) of the 2013 rule specifies six elements that each
compliance program required under that section must at a minimum
contain.
The six elements specified in Sec. __.20(b) are:
Written policies and procedures reasonably designed to
document, describe, monitor and limit trading activities and covered
fund activities and investments conducted by the banking entity to
ensure that all activities and investments that are subject to section
13 of the BHC Act and the rule comply with section 13 of the BHC Act
and the 2013 rule;
A system of internal controls reasonably designed to
monitor compliance with section 13 of the BHC Act and the rule and to
prevent the occurrence of activities or investments that are prohibited
by section 13 of the BHC Act and the 2013 rule;
A management framework that clearly delineates
responsibility and accountability for compliance with section 13 of the
BHC Act and the 2013 rule and includes appropriate management review of
trading limits, strategies, hedging activities, investments, incentive
compensation and other matters identified in the rule or by management
as requiring attention;
Independent testing and audit of the effectiveness of the
compliance program conducted periodically by qualified personnel of the
banking entity or by a qualified outside party;
Training for trading personnel and managers, as well as
other appropriate personnel, to effectively implement and enforce the
compliance program; and
Records sufficient to demonstrate compliance with section
13 of the BHC Act and the 2013 rule, which a banking entity must
promptly provide to the relevant agency upon request and retain for a
period of no less than 5 years.
Under the 2013 rule, these six elements have to be part of the
required compliance program of each banking entity with total
consolidated assets greater than $10 billion that engages in covered
trading activities and investments subject to section 13 of the BHC Act
and the implementing regulations (excluding trading permitted under
Sec. __.6(a) of the 2013 rule).
The agencies proposed further tailoring the compliance program
requirements to make the scale of compliance activity required by the
rule commensurate with a banking entity's size and level of trading
activity. Specifically, the proposal would have applied the six-pillar
compliance program requirements to banking entities with significant
trading assets and liabilities and would have afforded flexibility to
integrate the Sec. __.20 compliance program requirements into other
compliance programs of the banking entity. The proposal also would have
eliminated the enhanced compliance program requirements found in
Appendix B of the 2013 rule,\631\ except for the CEO attestation
requirement discussed below. The proposal also would have revised the
covered fund documentation requirements in Sec. __.20(e), which
applied to all banking entities with greater than $10 billion in total
consolidated assets under the 2013 rule, to only apply to firms with
significant trading assets and liabilities.
---------------------------------------------------------------------------
\631\ The enhanced minimum standards in Appendix B of the 2013
rule required that the firm's compliance program: (1) Be reasonably
designed to identify, document, monitor, and report the trading and
covered fund activities and investments of the banking entity;
identify, monitor and promptly address the risks of these activities
and investments and potential areas of noncompliance; and prevent
activities or investments prohibited by, or that do not comply with,
section 13 of the BHC Act and the 2013 rule; (2) establish and
enforce appropriate limits on the activities and investments of the
banking entity, including limits on the size, scope, complexity, and
risks of the individual activities or investments consistent with
the requirements of section 13 of the BHC Act and the 2013 rule; (3)
subject the effectiveness of the compliance program to periodic
independent review and testing, and ensure that the entity's
internal audit, corporate compliance and internal control functions
involved in review and testing are effective and independent; (4)
make senior management, and others as appropriate, accountable for
the effective implementation of the compliance program, and ensure
that the board of directors and CEO (or equivalent) of the banking
entity review the effectiveness of the compliance program; and (5)
facilitate supervision and examination by the agencies of the
banking entity's trading and covered fund activities and
investments.
---------------------------------------------------------------------------
Several commenters expressed support for the elimination of the
enhanced compliance program requirements in Appendix B of the 2013
rule.\632\ One commenter requested that the agencies provide greater
discretion to banking entities with significant trading assets and
liabilities to tailor their compliance programs to the size and
complexity of their activities and structure of their business.\633\ A
few commenters opposed the elimination of Appendix B of the 2013
rule.\634\ One asserted that firms have already made investments in
their compliance programs, so there was no justification for the
change.\635\ Another commenter argued that the remaining controls are
not sufficient to ensure compliance with the rule because they lack
specificity.\636\ This commenter also asserted that merging the Volcker
Rule requirements with the safety and soundness compliance framework
would be problematic as the Volcker Rule considers market supply and
demand dynamics while the safety and soundness compliance framework
generally only considers risks.\637\ The concern was that a combined
program might not adequately consider the activities restrictions of
the Volcker Rule.
---------------------------------------------------------------------------
\632\ See, e.g., Insurance Coalition; Real Estate Associations;
CREFC; Credit Suisse; JBA; FSF; and ABA.
\633\ See Credit Suisse.
\634\ See, e.g., Bean; Data Boiler; and AFR.
\635\ See Bean.
\636\ See AFR.
\637\ Id.
---------------------------------------------------------------------------
The agencies are adopting the six-pillar compliance program
requirements and retaining the covered fund
[[Page 62023]]
documentation requirements for banking entities with significant
trading assets and liabilities as proposed. The agencies continue to
believe that these banking entities are engaged in activities at a
scale that warrants the costs of establishing and maintaining the
detailed and comprehensive compliance program elements described in
Sec. Sec. __.20(b) and __.20(e) of the rule. Accordingly, the agencies
believe it is appropriate to require banking entities with significant
trading assets and liabilities to maintain a six-pillar compliance
program to ensure that banking entities' activities are conducted in
compliance with section 13 of the BHC Act and the implementing
regulations. Based on experience with the six-pillar compliance program
requirements under the 2013 rule, the agencies believe that such
requirements are appropriate and effective for firms with significant
trading assets and liabilities; these standards impose certain minimum
standards, but permit the banking entity flexibility to reasonably
design the program in light of the banking entity's activities. The
agencies also believe that the prescribed six-pillar compliance
requirements are consistent with the standards banking entities use in
their traditional risk management and compliance processes.
The agencies believe that banking entities should have discretion
to tailor their compliance programs to the structure and activities of
their organizations. The flexibility to build on compliance programs
that already exist at banking entities, including internal limits, risk
management systems, board-level governance protocols, and the level at
which compliance is monitored, may reduce the costs and complexity of
compliance while also enabling a robust compliance mechanism for the
final rule.
The agencies therefore believe that removal of the specific,
enhanced minimum standards in Appendix B will afford a banking entity
considerable flexibility to satisfy the elements of Sec. __.20 in a
manner that it determines to be most appropriate given its existing
compliance regimes, organizational structure, and activities. Allowing
banking entities the flexibility to integrate Volcker Rule compliance
requirements into existing compliance programs should increase the
effectiveness of the Sec. __.20 requirements by eliminating
duplicative governance and oversight structures arising from the
Appendix B requirement for a stand-alone compliance program.
ii. CEO Attestation Requirement
The 2013 rule included a requirement in its Appendix B that a
banking entity's CEO must review and annually attest in writing to the
appropriate agency that the banking entity has in place processes to
establish, maintain, enforce, review, test, and modify the compliance
program established pursuant to Appendix B and Sec. __.20 of the 2013
rule in a manner reasonably designed to achieve compliance with section
13 of the BHC Act and the implementing regulations.
Under the proposal, Appendix B would have been eliminated, and a
modified CEO attestation requirement would have applied to banking
entities with significant trading assets and liabilities or moderate
trading assets and liabilities. The agencies believed that, while the
revisions to the compliance program requirements under the proposal
generally would simplify the compliance program requirements, this
simplification should be balanced against the requirement for all
banking entities to maintain compliance with section 13 of the BHC Act
and the implementing regulations. Accordingly, the agencies believed
that applying the CEO attestation requirement to banking entities with
meaningful trading activities would ensure that the compliance programs
established by these banking entities pursuant to Sec. __.20(b) or
Sec. __.20(f)(2) of the proposal would be reasonably designed to
achieve compliance with section 13 of the BHC Act and the implementing
regulations as proposed. The agencies proposed limiting the CEO
attestation requirement to banking entities with moderate trading
assets and liabilities or significant trading assets and liabilities
because, under the proposal, banking entities with limited trading
assets and liabilities would have been subject to a rebuttable
presumption of compliance. Thus, the agencies did not believe it
necessary to require a CEO attestation for banking entities with
limited trading assets and liabilities as those banking entities would
not be subject to the express requirement to maintain a compliance
program pursuant to Sec. __.20 under the proposal. Further, the
agencies proposed retaining the 2013 rule's language concerning how the
CEO attestation requirement applies to the U.S. operations of a foreign
banking entity. This language states that, in the case of the U.S.
operations of a foreign banking entity, including a U.S. branch or
agency of a foreign banking entity, the attestation may be provided for
the entire U.S. operations of the foreign banking entity by the senior
management officer of the U.S. operations of the foreign banking entity
who is located in the United States.
Several commenters expressed support for the CEO attestation
requirement and recommended that the agencies make no changes to the
requirement or apply it to all banking entities.\638\ Other commenters
believed that the CEO attestation requirement should not apply to
banking entities with moderate trading assets and liabilities,\639\ as
requiring the development of costly and burdensome internal compliance
efforts would not be consistent with the activities or risks of such
firms.\640\ One commenter argued that the CEO attestation requirement
duplicates existing quarterly reporting process,\641\ and another
commenter asserted that imposing such a requirement for firms with
moderate trading assets and liabilities would negate the tailoring the
agencies proposed for those banking entities.\642\ One commenter urged
the agencies to limit the application of the compliance program and
reporting requirements to only the U.S. operations of foreign banking
entities.\643\ Other requests for modification included streamlining
the CEO attestation requirement,\644\ adding a knowledge
qualifier,\645\ and limiting the scope to only U.S. operations.\646\ A
few commenters requested that the CEO attestation be completely
eliminated.\647\
---------------------------------------------------------------------------
\638\ See, e.g., AFR; Merkley; Better Markets; and Data Boiler.
\639\ See, e.g., Capital One et al.; ABA; Arvest; BB&T; State
Street; BPI; and IIB.
\640\ See Capital One et al.
\641\ See BOK.
\642\ See Capital One et al.
\643\ See IIB.
\644\ See, e.g., ABA and JBA.
\645\ See, e.g., ABA and FSF.
\646\ See JBA.
\647\ See BOK and Capital One et al.
---------------------------------------------------------------------------
After reviewing the comments, the agencies have decided to retain
the CEO attestation requirement but only for banking entities with
significant trading assets and liabilities. The agencies continue to
believe that incorporating the CEO attestation requirement (which was
previously in Appendix B of the 2013 rule) into Sec. __.20(c) will
help to ensure that the compliance program established pursuant to that
section is reasonably designed to achieve compliance with section 13 of
the BHC Act and the implementing regulations.
However, the agencies have decided not to apply the CEO attestation
requirement to banking entities without significant trading assets and
liabilities. Such banking entities will still need to comply with
section 13 of the BHC Act and the implementing regulations;
[[Page 62024]]
however, they will not need to provide CEO attestations. This means
that the CEO attestation requirement will not be expanded to cover
banking entities that did not need to provide CEO attestations under
the 2013 rule.\648\ The agencies believe that requiring a CEO
attestation from banking entities with limited or moderate trading
assets and liabilities would result in additional costs and burdens
that would not be commensurate with the type of activities or risks of
these firms.
---------------------------------------------------------------------------
\648\ The 2013 rule applied the CEO attestation requirement to
all banking entities with total consolidated assets of $50 billion
or more (or, in the case of a foreign banking entity, total U.S.
assets of $50 billion or more). By applying the CEO attestation
requirement to banking entities with moderate trading assets and
liabilities, the proposal would have expanded its applicability to
certain banking entities with less than $50 billion in total U.S.
assets that were not subject to the requirement under the 2013 rule.
---------------------------------------------------------------------------
b. Compliance Program Requirements for Banking Entities With Moderate
Trading Assets and Liabilities
The 2013 rule provided that a banking entity with total
consolidated assets of $10 billion or less as measured on December 31
of the previous two years that engages in covered activities or
investments pursuant to subpart B or subpart C of the 2013 rule (other
than trading activities permitted under Sec. __.6(a) of the 2013 rule)
may satisfy the compliance program requirements by including in its
existing compliance policies and procedures appropriate references to
the requirements of section 13 of the BHC Act and subpart D of the
implementing regulations and adjustments as appropriate given the
activities, size, scope, and complexity of the banking entity.\649\
---------------------------------------------------------------------------
\649\ 2013 rule Sec. __.20(f)(2).
---------------------------------------------------------------------------
The agencies proposed extending the availability of this simplified
compliance program to banking entities with moderate trading assets and
liabilities. The agencies believed that streamlining the compliance
program requirements for banking entities with moderate trading assets
and liabilities would be appropriate because the scale and nature of
the activities and investments in which these banking entities are
engaged may not justify the additional costs associated with
establishing the compliance program elements under Sec. Sec. __.20(b)
and (e) of the 2013 rule. Such activities may be appropriately managed
through an appropriately tailored simplified compliance program. The
agencies noted that banking entities with moderate trading assets and
liabilities would be able to incorporate their simplified compliance
program into existing compliance policies and procedures and tailor
their compliance programs to the size and nature of their activities,
consistent with the approach for banking entities with significant
trading assets and liabilities.
Other commenters expressed support for a tailored compliance
program for banking entities with moderate trading assets and
liabilities.\650\ The agencies are adopting the compliance program
requirements, as proposed, for banking entities with moderate trading
assets and liabilities, for the aforementioned reasons. Thus, a banking
entity with moderate trading assets and liabilities qualifies for the
simplified compliance program under Sec. __.20(f)(2) of the final
rule.
---------------------------------------------------------------------------
\650\ See, e.g., BB&T and JBA.
---------------------------------------------------------------------------
c. Compliance Program Requirements for Banking Entities With Limited
Trading Assets and Liabilities
Under the proposal, a banking entity with limited trading assets
and liabilities would have been presumed to be in compliance with the
rule. Banking entities with limited trading assets and liabilities
would have had no obligation to demonstrate compliance with subpart B
and subpart C of the implementing regulations on an ongoing basis,
given the limited scale of their trading operations. The agencies
believed, based on experience implementing and supervising compliance
with the 2013 rule, that these banking entities generally engage in
minimal trading and investment activities subject to section 13 of the
BHC Act. Thus, the agencies believed that the limited trading assets
and liabilities of the banking entities qualifying for the presumption
of compliance would be unlikely to warrant the costs of establishing a
compliance program under Sec. __.20 of the 2013 rule.
Under the proposed approach, the agencies would not have expected a
banking entity with limited trading assets and liabilities that
qualified for the presumption of compliance to demonstrate compliance
with the proposal on an ongoing basis in conjunction with the agencies'
normal supervisory and examination processes. However, the appropriate
agency would have been able to exercise its authority to treat the
banking entity as if it did not have limited trading assets and
liabilities if, upon review of the banking entity's activities, the
relevant agency determined that the banking entity engaged in
proprietary trading or covered fund activities that were otherwise
prohibited under subpart B or subpart C. A banking entity would have
been expected to remediate any impermissible activity upon being
notified of such determination by the agency within a period of time
deemed appropriate by the agency.
In addition, irrespective of whether a banking entity had engaged
in activities in violation of subpart B or C, the relevant agency would
have retained its authority to require a banking entity to apply the
compliance program requirements that would otherwise apply if the
banking entity had significant or moderate trading assets and
liabilities if the relevant agency determined that the size or
complexity of the banking entity's trading or investment activities, or
the risk of evasion, did not warrant a presumption of compliance.
One commenter expressed support for the rebuttable presumption of
compliance for banking entities with limited trading assets and
liabilities.\651\ Another commenter suggested completely exempting
banking entities with limited trading assets and liabilities from
section 13 of the BHC Act.\652\ One commenter requested that the
evidence that an agency would require in response to its attempt to
rebut a presumption should not be greater than what is required of the
banking entity under the presumption.\653\ Another commenter
recommended that the agencies treat inadvertent violations of the rule
as supervisory matters and not as violations.\654\
---------------------------------------------------------------------------
\651\ See B&F.
\652\ See JBA.
\653\ See SIFMA.
\654\ See ABA.
---------------------------------------------------------------------------
The final rule adopts the compliance program requirements for
banking entities with limited trading assets and liabilities as
proposed. The agencies note that the removal of the standard compliance
program requirements in Sec. __.20 for banking entities with limited
trading assets and liabilities does not relieve those banking entities
of the obligation to comply with the prohibitions and other
requirements of the permitted trading activity exemptions, to the
extent that the banking entity engages in such activities, including
RENTD requirements for permitted underwriting and market making, under
the final rule. The agencies believe the presumption of compliance for
banking entities with limited trading assets and liabilities will allow
flexibility for these banking entities to take appropriate actions,
tailored to the individual activities in which the banking entities
engage, to comply with the rule. Such
[[Page 62025]]
actions may include, for example, integrating the requirements for
permitted trading activities under the exemptions in Sec. __.4, __.5,
and __.6 into existing internal policies and procedures (to the extent
the banking entity engages in such activities), or taking other steps
to satisfy the criteria to engage in such activities under the final
rule. Regarding one commenter's proposal that the agencies completely
exempt banking entities with limited trading activities, the agencies
note that section 13 of the BHC Act does not give the agencies
authority to completely exempt banking entities from the requirements
of the Volcker Rule.
d. Notice and Response Procedures
The proposed rule included notice and response procedures that an
agency would follow when determining whether to treat a banking entity
with limited trading assets and liabilities as if it did not have
limited trading assets and liabilities.\655\ The notice and response
procedures required the relevant agency to provide a written
explanation of its determination and allowed the banking entity the
opportunity to respond to the agency with any matters that the banking
entity would have the agency consider in reaching its determination.
The response procedures would have required the banking entity to
respond within 30 days unless the agency extended the time period for
good cause or if the agency shortened the time period either with the
consent of the banking entity or because the conditions or activities
of the banking entity so required. Failure to respond within the
applicable timeframe would have constituted a waiver of objection to
the agency's determination. After the close of the response period, the
agency would have decided, based on a review of the banking entity's
response and other information concerning the banking entity, whether
to maintain the agency's determination and would have notified the
banking entity of its decision in writing. These notice and response
procedures were similar, but not identical to, notice and response
procedures found elsewhere in the proposed rule.\656\
---------------------------------------------------------------------------
\655\ See proposed rule Sec. __.20(g)(2)(ii).
\656\ See proposed rule Sec. Sec. __.3(c), __.3(g)(2),
__.4(a)(8)(iv), __.4(b)(6)(iv).
---------------------------------------------------------------------------
One commenter suggested that there should be a consistent notice
and response process regarding all presumptions in the final rule.\657\
The agencies agree and have modified the notice and response procedures
in subpart D to apply more broadly to several types of determinations
under the final rule, including determinations and rebuttals made under
Sec. Sec. __.3, __.4, and __.20.\658\ This change will provide
consistency and enhance transparency with respect to the processes that
an agency will follow for certain determinations throughout the final
rule.
---------------------------------------------------------------------------
\657\ See IIB.
\658\ See final rule Sec. __.20(i).
---------------------------------------------------------------------------
E. Subpart E--Metrics: Appendix to Part []--Reporting and
Recordkeeping Requirements
Under the 2013 rule, a banking entity with substantial trading
activity \659\ must furnish the following quantitative measurements for
each of its trading desks engaged in covered trading activity,
calculated in accordance with Appendix A:
---------------------------------------------------------------------------
\659\ Appendix A of the 2013 rule applies to U.S. banking
entities with trading assets and liabilities the average gross sum
of which equals or exceeds $10 billion on a worldwide consolidated
basis over the previous four calendar quarters (excluding trading
assets and liabilities involving obligations of or guaranteed by the
United States or any agency of the United States), and to foreign
banking entities with combined U.S. trading assets and liabilities
the average gross sum of which equals or exceeds $10 billion over
the previous four calendar quarters (excluding trading assets and
liabilities involving obligations of or guaranteed by the United
States or any agency of the United States). 2013 rule Sec.
__.20(d)(1).
---------------------------------------------------------------------------
Risk and position limits and usage;
Risk factor sensitivities;
Value-at-risk and stressed VaR;
Comprehensive profit and loss attribution;
Inventory turnover;
Inventory aging; and
Customer-facing trade ratio.
The proposal explained that, based on the agencies' evaluation of
the effectiveness of the metrics data in monitoring covered trading
activities for compliance with section 13 of the BHC Act and the
associated reporting costs,\660\ the proposed rule would have amended
Appendix A requirements to reduce compliance-related inefficiencies
while allowing for the collection of data to permit the agencies to
better monitor compliance with section 13 of the BHC Act.\661\
Specifically, the proposed rule would have made the following
modifications to the reporting requirements in Appendix A:
---------------------------------------------------------------------------
\660\ See 79 FR at 5772.
\661\ As previously noted in the section entitled ``Enhanced
Minimum Standards for Compliance Programs,'' the Agencies are
proposing to eliminate Appendix B of the 2013 rule. Current Appendix
A is therefore re-designated as the ``Appendix'' in the final rule.
---------------------------------------------------------------------------
Limit the applicability of certain metrics only to market
making and underwriting desks.
Replace the Customer-Facing Trade Ratio with a new
Transaction Volumes metric to more precisely cover types of trading
desk transactions with counterparties.
Replace Inventory Turnover with a new Positions metric,
which measures the value of all securities and derivatives positions.
Remove the requirement to separately report values that
can be easily calculated from other reported quantitative measurements.
Streamline and make consistent value calculations for
different product types, using both notional value and market value to
facilitate better comparison of metrics across trading desks and
banking entities.
Eliminate inventory aging data for derivatives because
aging, as applied to derivatives, does not appear to provide a
meaningful indicator of potential impermissible trading activity or
excessive risk-taking.
Require banking entities to provide qualitative
information specifying for each trading desk the types of financial
instruments traded, the types of covered trading activity the desk
conducts, and the legal entities into which the trading desk books
trades.
Require a Narrative Statement describing changes in
calculation methods, trading desk structure, or trading desk
strategies.
Remove the paragraphs labeled ``General Calculation
Guidance'' from the regulation. The Instructions generally would
provide calculation guidance.\662\
---------------------------------------------------------------------------
\662\ The Instructions will be available on each agency's
respective website at the addresses specified in the Paperwork
Reduction Act section of this Supplementary Information. For the SEC
and CFTC, this document represents the views of SEC staff and CFTC
staff; neither Commission has approved nor disapproved them. The
Instructions are not a rule, regulation, or statement of the SEC or
the CFTC; and like all SEC or CFTC staff guidance, it has no legal
force or effect, does not alter or amend applicable law, and creates
no new or additional SEC or CFTC obligations for any person.
Consistent with changes elsewhere in the final rule and with the
Federal banking agencies' Interagency Statement Clarifying the Role
of Supervisory Guidance (Sept. 11, 2018; https://www.federalreserve.gov/supervisionreg/srletters/sr1805.htm, https://www.occ.gov/news-issuances/news-releases/2018/nr-ia-2018-97a.pdf,
https://www.fdic.gov/news/news/financial/2018/fil18049.html), the
agencies are removing references to guidance and expectations from
the regulatory text of the metrics reporting requirements.
---------------------------------------------------------------------------
Remove the requirement that banking entities establish and
report limits on Stressed Value-at-Risk at the trading desk-level
because trading desks do not typically use such limits to manage and
control risk-taking.
Require banking entities to provide descriptive
information about their reported metrics, including information
uniquely identifying and describing
[[Page 62026]]
certain risk measurements and information identifying the relationships
of these measurements within a trading desk and across trading desks.
Require electronic submission of the Trading Desk
Information, Quantitative Measurements Identifying Information, and
each applicable quantitative measurement in accordance with the XML
Schema specified and published on each agency's website.\663\
---------------------------------------------------------------------------
\663\ The staff-level Technical Specifications Guidance
describes the XML Schema. The Technical Specifications Guidance and
the XML Schema are available on each agency's respective website at
the addresses specified in the Paperwork Reduction Act section of
this Supplementary Information.
---------------------------------------------------------------------------
Several commenters objected to the proposed rule's modification of
the metrics. Some commenters suggested that the proposed amendments to
metrics reporting were inappropriate in light of the lack of public
disclosure of previously reported metrics information, and in some
cases recommended that the agencies expand metrics reporting
requirements.\664\ Other commenters recommended that the agencies
simplify or eliminate the metrics.\665\ As described in detail below,
the final rule streamlines the reporting requirements in Appendix A of
the 2013 rule and adopts a limited set of the new requirements
introduced in the proposal. Among other changes, the final rule
entirely eliminates the stressed value-at-risk, risk factor
sensitivities, and inventory aging. Taken together, the agencies
estimate that the revised metrics in the final rule would result in a
67 percent reduction in the number of data items and approximately 94
percent reduction in the total volume of data, relative to the 2013
rule's reporting requirement. The agencies believe the remaining
metrics are generally useful to help firms demonstrate that their
covered trading activities are conducted appropriately, and to enable
the agencies to identify activities that potentially involve
impermissible proprietary trading. Moreover, the agencies believe that
these items do not pose a special calculation burden because firms
generally already record these values in the regular course of
business. The agencies expect that the changes in the final rule will
enable banking entities to leverage calculations from their market risk
capital programs to meet the requirements for the Volcker Rule
quantitative measurements, which will reduce complexity and cost for
banking entities, and improve the effectiveness of the final rule.\666\
As discussed above, in order to give banking entities a sufficient
amount of time to comply with the changes adopted, banking entities
will not be required to comply with the final amendments until January
1, 2021 (although banking entities may voluntarily comply, in whole or
in part, with the amendments adopted in this release prior to the
compliance date, subject to the agencies' completion of necessary
technological changes). By providing an extended compliance period, the
final amendments also should facilitate firms in integrating these
requirements into existing or planned compliance programs.
---------------------------------------------------------------------------
\664\ See, e.g., AFR; Better Markets; Occupy the SEC; Public
Citizen; and Volcker Alliance.
\665\ See, e.g., ABA; FSF; IIB; New England Council; and SIFMA.
\666\ The agencies anticipate the market risk capital
calculations and the Volcker Rule quantitative measurements will
align particularly closely when the banking agencies adopt a rule
implementing the Basel Committee's market risk capital standard in
the United States. However, the agencies note that certain
anticipated changes resulting from the Basel market risk capital
standards may still result in a mismatch between metrics required
under the market risk capital rule and the final rule. The agencies
are aware of this potential issue and intend to address any such
discrepancies at a future date.
---------------------------------------------------------------------------
1. Purpose
Paragraph I.c of Appendix A of the 2013 rule provides that the
quantitative measurements that are required to be reported under the
rule are not intended to serve as a dispositive tool for identifying
permissible or impermissible activities. The proposal would have
expanded the qualifying language in paragraph I.c of Appendix A to
apply to all of the information required to be reported pursuant to the
appendix, rather than only to the quantitative measurements themselves.
In addition, the proposed rule would have also removed paragraph I.d.
in Appendix A of the 2013 rule, which provides that the agencies would
review the metrics data and revise the metrics collection requirements
based on that review.
The agencies received no comments on these proposed changes. The
final rule adopts the changes, as proposed. The agencies believe that
the trading desk information and quantitative measurements identifying
information, coupled with the quantitative measurements, should assist
the agencies in monitoring compliance. This information will be used to
monitor patterns and identify activity that may warrant further review.
Additionally, the final rule removes paragraph I.d. Appendix A of the
2013 rule, as the agencies have conducted this preliminary evaluation
of the effectiveness of the quantitative measurements collected to date
and have adopted modifications based on that review.
2. Definitions
The proposed rule would have clarified the definition of ``covered
trading activity'' by adding the phrase ``in its covered trading
activity'' to clarify that the term ``covered trading activity,'' as
used in the proposed appendix, may include trading conducted under
Sec. __.3(d), __.6(c), __.6(d), or __.6(e) of the proposal.\667\ In
addition, the proposed rule defined two additional terms for purposes
of the appendix, ``applicability'' and ``trading day,'' that were not
defined in the 2013 rule. The proposal defined ``applicability'' to
clarify when certain metrics are required to be reported for specific
trading desks and thus make several metrics applicable only to desks
engaged in market making or underwriting. Finally, the proposal defined
``trading day,'' a term used throughout Appendix A of the 2013
rule,\668\ to mean a calendar day on which a trading desk is open for
trading.
---------------------------------------------------------------------------
\667\ The proposed change would clarify that banking entities
would have the discretion (but not the obligation) to report metrics
with respect to a broader range of activities.
\668\ Appendix A of the 2013 rule provides that the calculation
period for each quantitative measurement is one trading day, but
does not define ``trading day''.
---------------------------------------------------------------------------
Commenters supported the proposal to define ``applicability'' in
order to clarify that certain metrics are only applicable to desks
engaged in market making or underwriting.\669\ One commenter suggested
defining the scope of ``covered trading activity'' to align with
activity covered under the Basel Committee's revised standard for
market risk capital.\670\ While the agencies received no comments on
the proposed definition of ``trading day'' in the regulation, several
comments expressed serious concerns with the proposed ``trading day''
definition in the 2018 Instructions,\671\ specifically requiring
banking entities to report metrics for trading days when U.S. markets
are closed but non-U.S. locations may be open.\672\ These commenters
argued that this would impose significant operational costs with no
commensurate benefit to the agencies' oversight ability. However, the
Agencies feel the definition of trading day is appropriate because the
potential for impermissible
[[Page 62027]]
trading activity on a desk exists on any day when the desk is open for
trading, regardless of which markets are open. The final rule retains
the definition.
---------------------------------------------------------------------------
\669\ See, e.g., Credit Suisse; FSF; and JBA.
\670\ See JBA.
\671\ The definition in the Instructions require banking
entities to calculate each metric for each calendar day on which a
trading desk is open for trading, even if the desk is closed for
trading in one jurisdiction (for example, due to a national
holiday).
\672\ See, e.g., ABA; CCMR; FSF; and SIFMA.
---------------------------------------------------------------------------
The agencies believe that the scope of ``covered trading activity''
in the final rule is appropriate, and note that, due to changes in the
definition of trading account, the scope of ``covered trading
activity'' will align more closely with the scope of activities covered
under the Basel Committee's market risk capital standards for certain
banking entities. Therefore, the final rule adopts these definitions as
proposed.
3. Reporting and Recordkeeping
Paragraph III.a of Appendix A of the 2013 rule required banking
entities subject to the appendix to furnish seven quantitative metrics
for all trading desks engaged in trading activity conducted pursuant to
Sec. __.4, Sec. __.5, or Sec. __.6(a) (i.e., permitted underwriting,
market making, and risk-mitigating hedging activity and trading in
certain government obligations).\673\
---------------------------------------------------------------------------
\673\ In addition, the 2013 rule permits banking entities to
optionally include trading under Sec. __.3(d), Sec. __.6(c), Sec.
__.6(d), or Sec. __.6(e).
---------------------------------------------------------------------------
The proposal would have made several modifications to streamline
the reporting requirements in paragraph III.a of Appendix A of the 2013
rule. Specifically, the proposal would have: (1) Replaced the Inventory
Turnover and Customer-Facing Trade Ratio metrics with the Positions and
Transaction Volumes quantitative measurements, respectively; (2)
limited the Inventory Aging metric to only apply to securities \674\
and changed the name of the quantitative measurement to the Securities
Inventory Aging; (3) added the phrase ``as applicable'' to paragraph
III.a in order to limit application of the Positions, Transaction
Volumes, and Securities Inventory Aging quantitative measurements to
only trading desks that rely on Sec. __.4(a) or Sec. __.4(b) to
conduct underwriting activity or market making-related activity,
respectively; and (4) inserted references in paragraph III.a to the new
qualitative information requirements added to the appendix (i.e.,
Trading Desk Information, Quantitative Measurements Identifying
Information, and Narrative Statement requirements).\675\
---------------------------------------------------------------------------
\674\ Including derivatives or securities that also meet the
2013 rule's definition of a derivative See infra Part III.E.2.i.v
(discussing the Securities Inventory Aging quantitative
measurement). The definition of ``security'' and ``derivative'' are
set forth in Sec. __.2 of the 2013 rule. See 2013 rule Sec. Sec.
__.2 (h), (y).
\675\ In addition, the proposed rule would have added to
paragraph III.a. a requirement that banking entities include file
identifying information in each submission to the relevant agency
pursuant to Appendix A of the 2013 rule. Specifically, the proposal
would have required the file identifying information to include the
name of the banking entity, the RSSD ID assigned to the top-tier
banking entity by the Board, the reporting period, and the creation
date and time.
---------------------------------------------------------------------------
A number of commenters supported the proposed changes to remove or
tailor certain of the metrics provided in Appendix A of the 2013 rule,
but opposed the addition of new metrics reporting requirements (i.e.,
Trading Day definition, Trading Desk Information, Quantitative
Measurements Identifying Information, Narrative Statement).\676\ These
commenters argued that, contrary to the proposal's objective to
streamline compliance requirements, the new reporting requirements
would significantly increase the overall compliance burden and impose
substantial compliance costs on firms.\677\ Three commenters argued
that the agencies did not provide reasoned cost benefit analysis to
justify the inclusion of the new metrics.\678\ A few commenters
recommended that the agencies should further streamline the current
metrics to permit individual supervisors and banking entities to
collaborate on determining which metrics are appropriate for that
specific institution.\679\ One commenter expressed concern that the
agencies intended for the newly added metrics to replace onsite
supervision and review, as the new qualitative information requirements
often duplicate the existing compliance program requirements.\680\
---------------------------------------------------------------------------
\676\ See, e.g., ABA; CCMR; Credit Suisse; FSF; and Goldman
Sachs.
\677\ See, e.g., ABA; Credit Suisse; CCMR; and FSF.
\678\ See, e.g., CCMR; Public Citizen; and SIFMA.
\679\ See, e.g., Goldman Sachs; JBA; and States Street (on
leveraging current industry practices for FX).
\680\ See SIFMA.
---------------------------------------------------------------------------
Other commenters opposed all of the proposed revisions to the
metrics, with certain limited exceptions (e.g., limiting Inventory
Aging to securities).\681\ Some of these commenters argued that the
agencies should adopt an approach focused on further streamlining the
metrics requirements included in Appendix A of the 2013 rule.\682\ A
few of these commenters argued that the proposed changes to the
existing metrics would in effect create entirely new metrics and that
the new metrics would not provide new information that cannot be
obtained through the existing metrics.\683\ Other commenters supported
only retaining the Comprehensive Profit and Loss Attribution and Risk
Management metrics.\684\ Another commenter supported retaining the
current requirements, as any revisions would necessitate changes to
firms' current systems and thus impose considerable operational burdens
and costs.\685\ One commenter stressed the inability of the general
public to provide informed comment on the proposed changes as the
agencies have not publically disclosed any data related to firms'
metrics submissions.\686\ Another commenter noted that disclosing
firms' metrics submissions on an aggregated and/or time-delayed basis
would enable the general public to understand the impact of the Volcker
Rule.\687\ In contrast, other commenters urged the agencies not to
publicly disclose the metrics data because the data is confidential
supervisory information that could be used by competitors and could
create distortions in the capital markets.\688\ Another commenter
recommended replacing the metrics with a utility platform that would
automate and perform trade surveillance in real time.\689\
---------------------------------------------------------------------------
\681\ See, e.g., Data Boiler; IIB; JBA; SIFMA; and State Street.
\682\ See, e.g., IIB; New England Council; SIFMA; and State
Street.
\683\ See, e.g., IIB and SIFMA.
\684\ See, e.g., New England Council and State Street.
\685\ See JBA.
\686\ See Public Citizen.
\687\ See AFR.
\688\ See, e.g., SIFMA and IIB.
\689\ See Data Boiler.
---------------------------------------------------------------------------
As described in detail below, the final rule focuses on
streamlining the 2013 rule's reporting requirements and only adopts a
limited set of the new qualitative requirements introduced in the
proposal. The agencies believe the remaining metrics are generally
useful tools to help both firms and supervisors identify activities
that potentially involve impermissible proprietary trading. Moreover,
the agencies believe that these items do not pose a special calculation
burden because firms already record these values in the regular course
of business.
Finally, although the agencies are not including any changes
related to public disclosure of the quantitative measurements in this
final rule, the agencies will continue to consider whether some or all
of the quantitative measurements should be publicly disclosed, taking
into account the need to protect sensitive, confidential information,
as well as restrictions on the agencies relating to the disclosure of
sensitive, confidential business and supervisory information on a firm-
specific basis.
4. Trading Desk Information
The proposed rule added a new paragraph III.b to Appendix A to
require
[[Page 62028]]
banking entities to report certain descriptive information for each
trading desk engaged in covered trading activity, including the trading
desk name and identifier, the type of covered activity conducted by the
desk, a brief description of the trading desk's general strategy (i.e.,
the method for conducting authorized trading activities), the types of
financial instruments purchased and sold by the trading desk, and the
list of legal entities used to book trades including which were the
main booking entities. The proposal also would have required firms to
indicate for each trading desk whether each calendar date is a trading
day or not a trading day and to specify the currency used by a trading
desk as well as the conversion rate to U.S. dollars, if applicable.
In general, most commenters opposed requiring banking entities to
report any new information outside the scope of the 2013 rule
requirements, including qualitative information for each trading
desk.\690\ These commenters argued that the de minimis benefit to the
agencies' oversight ability did not justify the significant operational
costs associated with the new requirements, in particular identifying
the legal entities used as booking entities by the trading desk as well
as the financial instruments and other products traded by the
desk.\691\
---------------------------------------------------------------------------
\690\ See, e.g., ABA; Credit Suisse; CCMR; FSF; IIB; JBA; and
SIFMA.
\691\ See, e.g., ABA; CCMR; and SIFMA.
---------------------------------------------------------------------------
After considering these comments, the final rule retains a modified
version of the Trading Desk Information. The final rule eliminates the
requirement for each trading desk to identify the financial instruments
and other products traded by the desk. The final rule also replaces the
requirement to identify the legal entities that serve as booking
entities for each trading desk with the simpler requirement that the
banking entity's submission for each trading desk list: (1) Each agency
receiving the submission for the desk; and (2) the exemptions or
exclusions under which the desk conducts trading activity. The
exemption/exclusion identification is particularly necessary in light
of the fact that some of the quantitative measurements identified below
(i.e., the customer-facing activity measurements) are only required for
desks operating under the underwriting or market making exemptions. The
list of the agencies that have received the submission for a desk
should facilitate inter-agency coordination, as generally trading desks
encompass multiple legal entities, for which more than one agency may
be the primary federal regulator. The agencies believe that this
approach appropriately balances the benefit to the agencies and the
cost to firms from the new reporting obligations.
5. Quantitative Measurements Identifying Information
The proposed rule added a new paragraph III.c. to Appendix A to
require banking entities to prepare and provide five schedules: (i)
Risk and Position Limits Information Schedule; (ii) Risk Factor
Sensitivities Information Schedule; (iii) Risk Factor Attribution
Information Schedule; (iv) Limit/Sensitivity Cross-Reference Schedule;
and (v) Risk factor Sensitivity/Attribution Schedule. The proposed
schedules would have provided descriptive information on the
quantitative measurements on a collective basis for all relevant
trading desks. The new proposed Schedules would have required banking
entities to provide detailed information regarding each limit and risk
factor sensitivity reported in quantitative measurements as well as on
the attribution of existing position profit and loss to the risk factor
reported in the quantitative measurements. In addition, the new Limit/
Sensitivity Cross-Reference Schedule would have required banking
entities to cross-reference, by unique identification label, a limit
reported in the Risk and Position Limits Information Schedule to any
associated risk factor sensitivity reported in the Risk Factor
Sensitivities Information Schedule.
Many commenters generally opposed requiring banking entities to
report any new information outside the scope of the 2013 rule
requirements, including quantitative measurements identifying
information.\692\ One commenter argued that these new requirements
impose undue costs on firms without providing any new supervisory
benefit as they duplicate existing requirements in Sec. __.20, which
information the agencies can obtain through the normal supervisory and
examination process.\693\ This commenter further noted that increasing
the scope of the appendix submission may harm the agencies' ability to
effectively supervise Volcker compliance, by increasing the supervisory
resources necessary to review the data at the detriment of performing
normal supervision.
---------------------------------------------------------------------------
\692\ See, e.g., ABA; CCMR; Credit Suisse; Data Boiler; JBA; and
SIFMA.
\693\ See SIFMA.
---------------------------------------------------------------------------
After considering these comments, the final rule retains a modified
version of the Quantitative Measurements Identifying Information that
eliminates the Risk Factor Sensitivities Information Schedule, the
Limit/Sensitivity Cross-Reference Schedule and the Risk-Factor
Sensitivity/Attribution Cross-Reference Schedule. Despite the potential
benefit to the agencies from having a deeper understanding of the
relationship between firms' limits and the risk factor sensitivities,
the agencies agree that the proposed requirements could significantly
increase firms' reporting burden in a way not commensurate with the
potential benefits. The final rule retains the Risk Factor Attribution
Information Schedule and a modified version of the Risk and Position
Limits Information Schedule that includes identification of the
corresponding risk factor attribution for certain limits (``Internal
Limits Information Schedule''). While together these schedules add two
new reporting elements relative to the 2013 Appendix A (i.e., a
description of the limit/risk factor sensitivities and risk factor
attribution for certain limits), the agencies generally expect firms to
realize a net reduction in reporting burden from the elimination of the
duplicative reporting requirements in the current framework. The 2013
rule requires firms report internal limits, including but not limited
to risk and position limits, and risk factor sensitivities established
for each trading desk on a daily basis. As in practice, firms often use
the same limits and risk factors for multiple desks, the 2013 rule
results in firms reporting the same limit on a daily basis for multiple
desks. These two new schedules reduce reporting burden by allowing
firms to submit a comprehensive list of all the internal limits and the
risk factor sensitivities that account for a preponderance of the
profit or loss for the trading desks. Additionally, the final rule
eliminates the requirement to report Risk Factor Sensitivities for each
trading desk on a daily basis. Based on the submissions received to
date, the agencies expect this change alone will reduce the total
volume of data submitted by more than half relative to the 2013 rule.
6. Narrative Statement
The proposed rule would have added a new paragraph III.d. to
require banking entities to submit a Narrative Statement in a separate
electronic document to the relevant agency that describes any changes
in calculation methods used for its quantitative measurements, or the
trading desk structure (e.g., adding, terminating, or merging pre-
existing desks) or strategies. In addition, in its Narrative Statement,
a banking entity, if applicable, would
[[Page 62029]]
have to explain its inability to report a particular quantitative
measurement and to provide notice if a trading desk changes its
approach to including or excluding products that are not financial
instruments in its metrics. The proposed rule would have required that
banking entities that do not have any information to report in a
Narrative Statement to submit an electronic document stating that the
firm does not have any information to report in a Narrative Statement.
Most commenters generally opposed requiring banking entities to
report any new information outside the scope of the 2013 rule
requirements, including the Narrative Statement.\694\ While recognizing
that currently banking entities voluntarily provide additional
information about their metrics submissions, one commenter argued that
requiring the Narrative Statement would impose undue costs on banking
entities, as the agencies can already obtain this information through
the normal supervisory process.\695\
---------------------------------------------------------------------------
\694\ See, e.g., ABA; CCMR; Credit Suisse; Data Boiler; JBA; and
SIFMA.
\695\ See SIFMA.
---------------------------------------------------------------------------
After considering all comments received, the agencies are not
adopting the narrative statement requirement in the final rule. Rather,
the final rule retains the provision from the 2013 rule's reporting
instructions that permits, but does not require, firms to provide a
narrative statement describing any additional information they believe
would be helpful to the agencies in identifying material events or
changes. Narrative statements may permit the agencies to understand
aspects of the metrics without going back to the banking entities to
ask questions. While the agencies anticipate that many banking entities
will continue to voluntarily provide clarifying information, the
agencies agree that the compliance costs associated with requiring a
separate document are not commensurate with the potential benefit to
the agencies of receiving information in this format from banking
entities that do not wish to provide it.
7. Frequency and Method of Required Calculation and Reporting
The 2013 rule established a reporting schedule in Sec. __.20 that
required banking entities with $50 billion or more in trading assets
and liabilities to report the information required by Appendix A of the
2013 rule within 10 days of the end of each calendar month. The
proposed rule would have extended this reporting schedule for firms
with significant trading activities, as defined in the final rule, to
be within 20 days of the end of each calendar month.\696\
---------------------------------------------------------------------------
\696\ See Sec. __.20(d) of the proposal.
---------------------------------------------------------------------------
In general, commenters supported extending the reporting schedule
to be within 20 days of the end of each calendar month.\697\ Two
commenters suggested further extending this to 30 days.\698\ Of these,
one commenter recommended reducing the frequency from monthly to
quarterly in order to better align the metrics reporting with other
regulatory reporting regimes.\699\
---------------------------------------------------------------------------
\697\ See, e.g., FSF and Goldman Sachs.
\698\ See, e.g., Credit Suisse and SIFMA.
\699\ See SIFMA.
---------------------------------------------------------------------------
Under the final rule, metrics filers must submit metrics on a
quarterly basis. In addition, the final rule retains the reporting
schedule of 30 days after the end of each quarter, consistent with the
reporting schedule for quarterly filers under the 2013 rule.
Supervisory experience has indicated that this will reduce the
incidence of errors and improve the quality of the data in the metrics
submissions.
Appendix A of the 2013 rule did not specify a format in which
metrics should be reported. To clarify the formatting requirements for
the data submissions and to help ensure the quality and consistency of
data submissions across banking entities, the proposed rule would have
required banking entities to report all the information contained
within the proposed appendix in accordance with an XML Schema to be
specified and published on the relevant agency's website.\700\
---------------------------------------------------------------------------
\700\ To the extent the XML Schema is updated, the version of
the XML Schema that must be used by banking entities would be
specified on the relevant agency's website. A banking entity must
not use an outdated version of the XML Schema to report the Trading
Desk Information, Quantitative Measurements Identifying Information,
and applicable quantitative measurements to the relevant agency.
---------------------------------------------------------------------------
Two commenters opposed transitioning to XML format for reporting
due to the costs of changing reporting software to switch formats.\701\
One commenter fully supported the use of XML as a standardized
format.\702\ Another commenter supported XML and estimated the cost of
switching formats to be low compared to other costs involved in
reporting.\703\ Finally, one commenter asserted that reporting in XML
could be useful in certain cases but that it was not clear that
requiring metrics reporting in XML would be useful. The commenter
recommended deferring the decision to adopt the XML until after a final
rule is adopted. The commenter stated that the decision of whether to
adopt the XML Schema requirement should be subject to separate notice
and comment.\704\
---------------------------------------------------------------------------
\701\ See, e.g., Credit Suisse and JBA.
\702\ See Goldman Sachs.
\703\ See Data Boiler.
\704\ See SIFMA.
---------------------------------------------------------------------------
The final rule adopts the use of XML for reporting metrics,
following the format specified in XML Schema to be posted on the
relevant agency's website. The agencies acknowledge that any changes to
the metrics will impose some switching costs on banking entities. As a
very common standard for data transmission, XML is expected to be a
less costly format to employ than a bespoke format. Moreover, the XML
Schema allows for clearer specification, which should reduce
miscommunication, errors, inconsistencies, and the need for data
resubmissions. The agencies believe the benefits of standardization
outweigh the one-time switching costs.
8. Recordkeeping
Under paragraph III.c. of Appendix A of the 2013 rule, a banking
entity's reported quantitative measurements are subject to the record
retention requirements provided in Appendix A. Under the proposed rule,
this provision would have been moved to paragraph III.f. and expanded
to include the new qualitative information requirements added to the
appendix (i.e., Trading Desk Information, Quantitative Measurements
Identifying Information, and Narrative Statement requirements). The
agencies received no comments on these proposed changes. The final
rule's recordkeeping requirement is being adopted largely as
proposed.\705\
---------------------------------------------------------------------------
\705\ The recordkeeping requirement in the final rule does not
require that banking entities retain a copy of the Narrative
Statement.
---------------------------------------------------------------------------
9. Quantitative Measurements
Section IV of Appendix A of the 2013 rule sets forth the individual
quantitative measurements required by the appendix. The proposed rule
would have added an ``Applicability'' paragraph to each quantitative
measurement to identify the trading desks for which a banking entity
would be required to calculate and report a particular metric based on
the type of covered trading activity conducted by the desk. The
proposed rule also would have removed the ``General Calculation
Guidance'' paragraphs in section IV of Appendix A of the 2013 rule for
each quantitative measurement, and provided such guidance in the
Instructions.
As noted above, commenters generally supported the proposal to
define ``applicability'' in order to clarify that certain metrics are
only applicable
[[Page 62030]]
to desks engaged in market making or underwriting.\706\ The agencies'
received no comments on providing the metrics calculation guidance in
an Instructions document and removing this guidance from the appendix.
The metrics are not intended to serve as a dispositive tool for
identifying permissible or impermissible activities. Thus, the agencies
believe that providing the metrics calculation guidance in the
Instructions and not within the regulation is more appropriate.\707\
Therefore, the agencies are adopting these changes as proposed.
---------------------------------------------------------------------------
\706\ See, e.g., Credit Suisse; FSF; and JBA.
\707\ See supra note 662.
---------------------------------------------------------------------------
a. Risk-Management Measurements
i. Internal Limits and Usage
Like the 2013 rule, the proposed rule would have applied the Risk
and Position Limits and Usage metric to all trading desks engaged in
covered trading activities. Additionally, the proposed rule would have
removed references to Stressed Value-at-Risk (Stressed VaR) in the Risk
and Position Limits and Usage metric and required banking entities to
report the unique identification label for each limit as listed in the
Risk and Position Limits Information Schedule, the limit size
(distinguishing between the upper bound and lower bound of the limit,
where applicable), and the value of usage of the limit.\708\
---------------------------------------------------------------------------
\708\ If a limit is introduced or discontinued during a calendar
month, the banking entity must report this information for each
trading day that the trading desk used the limit during the calendar
month.
---------------------------------------------------------------------------
In general, most commenters supported eliminating requirements to
establish limits on Stressed VaR.\709\ One commenter did not support
this change, as any revisions would necessitate changes to firms'
current systems and thus impose considerable operational burdens and
costs.\710\ Another commenter supported further requiring full
reporting of upper and lower bounds of risk and position limits
usage.\711\
---------------------------------------------------------------------------
\709\ See, e.g., FSF and Data Boiler.
\710\ See JBA.
\711\ See Data Boiler.
---------------------------------------------------------------------------
The final rule largely adopts these changes as proposed. As noted
above, the agencies believe requiring firms to submit one consolidated
Internal Limits Information Schedule for the entire banking entity's
covered trading activity, rather than multiple times in the Risk and
Position Limits and Usage metric for different trading desks, will
alleviate inefficiencies associated with reporting redundant
information and reduce electronic file submission sizes. The unique
identification label should allow the agencies to efficiently obtain
the descriptive information regarding the limit that is separately
reported in the Internal Limits Information Schedule.\712\ Recognizing
that firms may establish internal limits other than risk and position
limits (e.g., inventory aging limits), the final rule adopts an
Internal Limits Information Schedule and daily Internal Limits and
Usage quantitative metric.
---------------------------------------------------------------------------
\712\ Such information includes the name of the limit, a
description of the limit, the unit of measurement for the limit, the
type of limit, and identification of the corresponding risk factor
attribution in the particular case that the limit type is a limit on
a risk factor sensitivity and profit and loss attribution to the
same risk factor is reported.
---------------------------------------------------------------------------
As discussed in more detail below, the final rule removes the
metrics for Risk Factor Sensitivities. Accordingly, the final rule also
removes the cross reference between Risk and Position Limits and Risk
Factor Sensitivities, and the cross-reference between Risk Factor
Sensitivities and Profit and Loss Risk Factor Attributions. These
cross-references would have provided an essential link between the
limits on exposures to risk factors and the factors that are
demonstrably important sources of revenue. In place of these two cross-
references, the final rule adopts an identifier within the Internal
Limits Information Schedule indicating the corresponding Risk Factor
Attribution when a desk measures and imposes a limit on exposure to
that risk factor. This identifier facilitates the agencies' review of
the Internal Limits metric and its relation to gains and losses on the
positions measured by that metric.
ii. Risk Factor Sensitivities
Like the 2013 rule, the proposed rule would have applied the Risk
Factor Sensitivities metric to all trading desks engaged in covered
trading activities. Under the proposal, a banking entity would have to
report for each trading desk the unique identification label associated
with each risk factor sensitivity of the desk, the magnitude of the
change in the risk factor, and the aggregate change in value across all
positions of the desk given the change in risk factor.
As discussed above in Quantitative Measurements Identifying
Information, to reduce firms' reporting burden the final rule
eliminates the Risk Factor Sensitivities quantitative measurement.
iii. Value-at-Risk and Stressed Value-at-Risk
The 2013 rule applies the Value-at-Risk and Stressed Value-at-Risk
metric to all trading desks engaged in covered trading activities. The
proposed rule would have modified the description of Stressed VaR to
align its calculation with that of Value-at-Risk and clarified that
Stressed VaR is not required to be reported for trading desks whose
covered trading activity is conducted exclusively to hedge products
excluded from the definition of financial instrument in Sec.
__.3(d)(2) of the proposal. The proposal would have also revised the
definition of Value-at-Risk to provide that Value-at-Risk is the
measurement of the risk of future financial loss in the value of a
trading desk's aggregated positions at the ninety-nine percent
confidence level over a one-day period, based on current market
conditions.\713\
---------------------------------------------------------------------------
\713\ Banking entities may base their calculations of Value-at-
Risk on historical observations consistent with other applicable
regulatory requirements relating to the calculation of Value-at-
Risk. See, e.g., 12 CFR part 3 subpart F; 12 CFR part 217 subpart F;
12 CFR part 324 subpart F.
---------------------------------------------------------------------------
In general, a few commenters supported eliminating Stressed VaR,
including for non-financial instrument hedging.\714\ One commenter did
not support this change, as any revisions would necessitate changes to
firms' current systems and thus impose considerable operational burdens
and costs.\715\ One commenter stated that Stressed VaR was not a
helpful metric because it bears an attenuated relationship to
proprietary trading.\716\
---------------------------------------------------------------------------
\714\ See, e.g., FSF and Data Boiler.
\715\ See JBA.
\716\ See Goldman Sachs.
---------------------------------------------------------------------------
After considering the comments received, the agencies believe that
eliminating the Stressed VaR metric altogether will reduce burden
without affecting the ability of the agencies to monitor for prohibited
proprietary trading. The agencies believe that the other metrics
retained or adopted in the final rule provide appropriate data to
monitor for prohibited proprietary trading. To avoid duplicative or
unnecessary metrics, the final rule eliminates the Stressed VaR metric.
b. Source-of-Revenue Measurements
i. Comprehensive Profit and Loss Attribution
The 2013 rule requires banking entities to calculate and report
volatility of comprehensive profit and loss. The proposed rule would
have eliminated this requirement as the measurement can be calculated
from the profit and loss amounts reported under the Comprehensive
Profit and Loss Attribution metric. Additionally, the proposed rule
would have required banking entities to provide, for one or more
factors that explain the
[[Page 62031]]
preponderance of the profit or loss changes due to risk factor changes,
a unique identification label for the factor and the profit or loss due
to the factor change. The proposed rule also would have required
banking entities to report a unique identification label for the factor
so the agencies can efficiently obtain the descriptive information
regarding the factor that is separately reported in the Risk Factor
Attribution Information Schedule.\717\
---------------------------------------------------------------------------
\717\ Such information includes the name of the risk factor or
other factor, a description of the risk factor or other factor, and
the change unit of the risk factor or other factor.
---------------------------------------------------------------------------
In general, commenters did not support requiring firms to attribute
profit and loss to specific risk factors.\718\ One commenter expressed
concern that this could disrupt firms' current infrastructure projects
to comply with the Basel Committee's revised market risk capital
standards, which also require specific alignment of risk factor
attribution and risk factor sensitivity hierarchies.\719\ This
commenter also noted the limited utility of this information for
horizontal comparisons across firms as each banking organization
defines these metrics at different levels of granularity. Two
commenters supported eliminating the volatility calculation, as
proposed.\720\
---------------------------------------------------------------------------
\718\ See SIFMA.
\719\ See SIFMA.
\720\ See, e.g., Goldman Sachs and FSF.
---------------------------------------------------------------------------
After considering these comments, the final rule adopts these
changes as proposed. Under the final rule, banking entities will no
longer be required to report volatility for the Comprehensive Profit
and Loss metric. Banking entities will be required to provide certain
information regarding the factors that explain the preponderance of the
profit or loss changes due to risk factor changes when sub-attributing
comprehensive profit and loss from existing positions to specific and
other factors.
As in the 2013 rule and the proposal, the final rule requires
trading desks to attribute profit and loss into: (i) Profit and loss
attributable to a trading desk's existing positions, and (ii) profit
and loss attributable to new positions. The final rule retains the
category for residual profit and loss,\721\ but clarifies that this is
a sub-category of profit and loss attributable to existing positions.
---------------------------------------------------------------------------
\721\ As under the 2013 rule, significant unexplained profit and
loss must be escalated for further investigation and analysis under
the final rule.
---------------------------------------------------------------------------
c. Customer-Facing Activity Metrics
i. Replacement of Inventory Turnover With Positions Metric
The 2013 rule required banking entities to calculate and report
inventory turnover, or the turnover of a trading desk's inventory, over
a 30-day, 60-day, and 90-day reporting period. The proposed rule would
have replaced the Inventory Turnover metric with the daily data
underlying that metric, rather than proposing specific calculation
periods. The proposal would have replaced Inventory Turnover with the
daily Positions quantitative measurement. As noted in the Supplemental
Information to the proposed rule, positions information that is a
component of the Inventory Turnover metric would be more useful to the
agencies, and is already tracked by banking entities as a component of
the Inventory Turnover metric. The proposal would have limited the
scope of applicability of the Positions metric to trading desks that
rely on Sec. __.4(a) or Sec. __.4(b) to conduct underwriting activity
or market making-related activity, respectively. As a result, a trading
desk that did not rely on Sec. __.4(a) or Sec. __.4(b) would not have
been subject to the proposed Positions metric.\722\
---------------------------------------------------------------------------
\722\ For example, a trading desk that relies solely on Sec.
__.5 to conduct risk-mitigating hedging activity would not have been
subject to the Positions metric under the proposed rule.
---------------------------------------------------------------------------
The proposal would have also required banking entities subject to
the appendix to separately report the market value of all long
securities positions, the market value of all short securities
positions, the market value of all derivatives receivables, the market
value of all derivatives payables, the notional value of all
derivatives receivables, and the notional value of all derivatives
payables.\723\ Finally, the proposal also would have clarified that
positions reported as ``derivatives'' need not be reported as
``securities,'' thereby clarifying the treatment of certain positions
that may have met both definitions. This technical change would have
addressed the possibility that a position could have been reported in
both the ``securities'' and ``derivatives'' positions, and thus been
double-counted.
---------------------------------------------------------------------------
\723\ Under the proposal, banking entities would have been
required to report the effective notional value of derivatives
receivables and derivatives payables for those derivatives whose
stated notional amount is leveraged.
---------------------------------------------------------------------------
A few commenters recommended that the agencies eliminate the
Positions metric, but retain the inventory turnover metric.\724\ These
commenters expressed concern that the new ``Positions'' metric would
be, in effect, a ``new'' metric that would require reporting banking
entities to modify their systems to generate as a standalone metric and
noted that this metric could create ``false positives'' due to daily
changes in inventory that may be driven by fluctuations in the
expectation of customer demand. Other commenters recommended that the
agencies eliminate inventory turnover metrics reporting requirements
for derivatives, including foreign exchange derivatives.\725\ One
commenter supported the positions metric, but recommended removing the
requirement to report market values for derivative positions--as
notional value measures are sufficient to assess the size of a trading
desk's derivative inventory.\726\
---------------------------------------------------------------------------
\724\ See, e.g., GFMA and SIFMA.
\725\ See, e.g., GFMA; Goldman Sachs; and State Street.
\726\ See e.g., Credit Suisse.
---------------------------------------------------------------------------
The final rule adopts the ``Positions'' metric and eliminates the
``Inventory Turnover'' metric consistent with the proposal. The
``Positions'' metric is itself a necessary component firms already must
calculate to generate the ``Inventory Turnover'' metric. Therefore,
producing the ``Positions'' metric as a standalone figure would not
require firms to generate additional data not produced internally
today, but will result in a more effective metrics reporting framework.
The agencies are aware that all changes to the metrics reporting
requirements require changes to the underlying systems required to
generate and report metrics to the agencies. However, the Positions
metric will allow both the agencies and the firms themselves to analyze
firms' trading activities over different time horizons, as appropriate;
the Inventory Turnover metric, by contrast, relied on the same
underlying positions data as the final rule requires to be reported,
but aggregated it in a manner (with 30-day, 60-day, and 90-day rolling
averages) that is more complicated than a direct reporting of positions
metrics, and is less effective. The final rule differs from the
proposal in that it eliminates the requirement to report the notional
value of derivatives. Removing the requirement to report notional value
of derivative positions will avoid potential complexity arising from
using different calculation methods for determining the notional value
for different types of derivatives. Additionally, as the definition of
financial instrument in section __.3 lists securities, derivatives and
futures as distinct types of financial instruments, the agencies are
clarifying that futures positions
[[Page 62032]]
should be reported as ``derivatives,'' and are not expected to be
broken out separately. The agencies are making this technical change to
avoid confusion as to whether or how to classify futures for this
metric.\727\
---------------------------------------------------------------------------
\727\ See final rule Sec. __.3(c)(1) (defining ``financial
instrument'' to mean (i) a security, including an option on a
security; (ii) a derivative, including an option on a derivative; or
(iii) a contract of sale of a commodity for future delivery, or
option on a contract of sale of a commodity for future delivery).
---------------------------------------------------------------------------
ii. Transaction Volumes and the Customer-Facing Trade Ratio
Paragraph IV.c.3. of Appendix A of the 2013 rule requires banking
entities to calculate and report a Customer-Facing Trade Ratio
comparing transactions involving a counterparty that is a customer of
the trading desk to transactions with a counterparty that is not a
customer of the desk. Appendix A of the 2013 rule requires the
Customer-Facing Trade Ratio to be computed by measuring trades on both
a trade count basis and value basis. In addition, Appendix A of the
2013 rule provides that the term ``customer'' for purposes of the
Customer-Facing Trade Ratio is defined in the same manner as the terms
``client, customer, and counterparty'' used in Sec. __.4(b) of the
2013 rule describing the permitted activity exemption for market
making-related activities. This metric is required to be calculated on
a daily basis for 30-day, 60-day, and 90-day calculation periods.
The proposed rule would have replaced the Customer-Facing Trade
Ratio with a daily Transaction Volumes quantitative measurement that
would allow the agencies to calculate customer-facing trade ratios over
any period of time and to conduct more meaningful analysis of trading
desks' customer-facing activity.\728\ The proposed Transaction Volumes
metric would measure the number and value \729\ of all securities and
derivatives transactions \730\ conducted by a trading desk engaged in
permitted underwriting activity or market making-related activity under
the 2013 rule with four categories of counterparties: (i) Customers
(excluding internal transactions); (ii) non-customers (excluding
internal transactions); (iii) trading desks and other organizational
units where the transaction is booked into the same banking entity; and
(iv) trading desks and other organizational units where the transaction
is booked into an affiliated banking entity.\731\ The proposed rule
would have clarified that the term ``customer'' for purposes of this
metric has the same meaning as ``client, customer, and counterparty''
in Sec. __.4(a) for underwriting desks and in Sec. __.4(b) for
market-making desks. To reduce reporting inefficiencies, the proposed
rule would have only required trading desks engaged in underwriting or
market making-related activity under Sec. __.4(a) or Sec. __.4(b) to
calculate this quantitative measurement for each trading day. As with
the Positions metric, the proposed rule would also have further reduced
reporting volume by replacing the 30-day, 60-day, and 90-day
calculation periods for each transaction with a single daily
transaction value and count for each type.
---------------------------------------------------------------------------
\728\ As noted in the proposal the current Customer-Facing Trade
Ratio metric does not provide meaningful information when a trading
desk only conducts customer-facing trading activity. The numerator
of the ratio represents transactions with counterparties that are
customers, while the denominator represents transactions with
counterparties that are not customers. If a trading desk only trades
with customers, it will not be able to calculate this ratio because
the denominator will be zero.
\729\ The proposal defined value to mean gross market value with
respect to securities, gross notional value (i.e., the current
dollar market value of the quantity of the commodity underlying the
derivative) for commodity derivatives, and gross notional value for
all other derivatives.
\730\ As noted in the Positions metric preamble, in calculating
the Transactions Volume quantitative metric, futures positions
should be reported as ``derivatives.''
\731\ The proposal noted that in order to avoid double-counting
transactions, these four categories would be exclusive of each other
(i.e., a transaction could only be reported in one category).
---------------------------------------------------------------------------
The proposed rule would have required banking entities to
separately report the value and number of securities and derivatives
transactions conducted by a trading desk with the four categories of
counterparties described above. The proposed classification of
securities and derivatives described above for Positions would have
also applied to Transaction Volumes.
A few commenters opposed the replacing the Customer-Facing Trade
Ratio with the new Transactions Volume quantitative metric.\732\ These
commenters argued that the proposed changes would effectively create an
entirely new metric, in particular by requiring firms to classify
inter-affiliate transactions within the prescribed categories. One
commenter also asserted that distinguishing trades that occur across
banking entities from those within a single banking entity would not
provide any informational value to the agencies in monitoring
compliance with section 13 of the BHC Act.\733\ One commenter supported
the proposal, but also recommended excluding inter-affiliate
transactions.\734\
---------------------------------------------------------------------------
\732\ See, e.g., IIB and SIFMA.
\733\ See SIFMA.
\734\ See, e.g., Credit Suisse.
---------------------------------------------------------------------------
The final rule adopts the proposed change to add a category of
counterparty for desk-to-desk transactions within the same legal entity
and transactions between affiliates (collectively, Internal
Transactions). In order to connect the transactions metric with the
other quantitate measurements, for example risk, profit and loss, and
positions, it is important for transactions metrics to include all
transactions conducted by the desk, including: (i) Desk-to-desk
transfers within the same legal entity; (ii) transactions between
affiliates; and (iii) transactions with non-affiliated external
counterparties. It is also important for supervisors to be able to
distinguish Internal Transactions from transactions with external non-
affiliated counterparties because, based on supervisory experience
under the 2013 rule, firms report these transactions inconsistently
depending on a desk's purpose and business model.\735\ Considering the
trading activities of a desk without Internal Transactions may not give
a complete picture of the desk's positions, risk exposure or trading
strategies. To understand the activity of the desk the agencies need to
observe its Internal Transactions.
---------------------------------------------------------------------------
\735\ Internal Transactions are used for a number of reasons,
including to transfer risk to a desk better equipped to manage the
position's risk; to allow a desk with better market access or
specialized market knowledge to facilitate another desk better
equipped to face customers; or to allocate funding costs via
transfer pricing, in which case one desk treats other internal desks
or affiliate desks in much the same way as external clients.
Supervisory experience has shown that, depending on the purpose of
the internal transaction, banking entities sometimes report these
internal transactions as transactions with customers, sometimes as
transactions with non-customers, and sometimes do not report them at
all.
---------------------------------------------------------------------------
Transactions between one trading desk and another trading desk in
which the second desk books the position in the same banking entity as
the first are not purchases or sales of financial instruments subject
to the rule, including the prohibition on proprietary trading in Sec.
__.3. However, in practice many trading desks book positions into
multiple affiliated banking entities and also engage in desk-to-desk
transactions within the same legal entity. Distinguishing Internal
Transactions that move positions to new legal entities from desk-to-
desk transactions that occur purely within the same legal entity would
require an additional layer of recordkeeping. The agencies agree that
the benefit of distinguishing trades across affiliated banking entities
from desk-to-desk transactions within the same legal entity does not
justify the
[[Page 62033]]
extra record-keeping costs. The final rule consolidates these two
proposed categories into one category, transactions with trading desks
and other organizational units where the transaction is booked into
either the same banking entity or an affiliated banking entity.
d. Securities Inventory Aging
The 2013 rule requires all trading desks engaged in covered trading
activities to report Inventory Aging metrics for their securities and
derivative positions. The proposed rule would have only required
trading desks that relied on Sec. __.4(a) or Sec. __.4(b) to conduct
underwriting or market making-related activity to report Inventory
Aging and limited the scope of this metric to only securities
positions.\736\ To reflect the revised scope, the proposed rule would
have revised the name of this metric to be Securities Inventory Aging.
Finally, the proposal would have required a banking entity to calculate
and report the Securities Inventory Aging metric according to a
specific set of age ranges. Specifically, banking entities would have
to calculate and report the market value of security assets and
security liabilities over the following holding periods: 0-30 calendar
days; 31-60 calendar days; 61-90 calendar days; 91-180 calendar days;
181-360 calendar days; and greater than 360 calendar days.
---------------------------------------------------------------------------
\736\ The proposed Securities Inventory Aging metric would not
require banking entities to prepare an aging schedule for
derivatives or include in its securities aging schedules those
``securities'' that are also ``derivatives,'' as those terms are
defined under the 2013 rule. See 2013 rule Sec. Sec. __.2(h), (y).
See also supra Part III.E.2.i (discussing the classification of
securities and derivatives for purposes of the proposed Positions
quantitative measurement).
---------------------------------------------------------------------------
In general, commenters supported reducing the Inventory Aging
metric, as inventory aging data is not readily available or
particularly useful for derivative positions.\737\ After consideration
of comments and in light of the general desire to reduce reporting
burden, the agencies believe that the Inventory Aging metric may be
overly prescriptive as an indicator of compliance with the rule.
Therefore, the final rule no longer requires the Inventory Aging metric
for all desks and position types. For those desks where banking
entities identify inventory aging as a meaningful control, the entities
should report their internal limits on inventory aging under the
Internal Limits and Usage metric and consequently ``Inventory Aging''
has been added as a potential type of limit under the Internal Limits
Information Schedule.
---------------------------------------------------------------------------
\737\ See, e.g., Data Boiler; Credit Suisse; FSF; Goldman Sachs,
GFMA; and State Street.
---------------------------------------------------------------------------
V. Administrative Law Matters
A. Use of Plain Language
Section 722 of the Gramm-Leach-Bliley Act \738\ requires the OCC,
Board, and FDIC (Federal banking agencies) to use plain language in all
proposed and final rules published after January 1, 2000. The Federal
banking agencies have sought to present the proposed rule in a simple
and straightforward manner and did not receive any comments on plain
language.
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\738\ Public Law 106-102, section 722, 113 Stat. 1338, 1471
(1999).
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B. Paperwork Reduction Act
Certain provisions of the final rule contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act (PRA) of 1995 (44 U.S.C. 3501-3521). In accordance with
the requirements of the PRA, the agencies may not conduct or sponsor,
and a respondent is not required to respond to, an information
collection unless it displays a currently valid Office of Management
and Budget (OMB) control number. The agencies reviewed the final rule
and determined that the final rule revises certain reporting and
recordkeeping requirements that have been previously cleared under
various OMB control numbers. The agencies did not receive any specific
comments on the PRA. The agencies are extending for three years, with
revision, these information collections. The information collection
requirements contained in this final rule have been submitted by the
OCC and FDIC to OMB for review and approval under section 3507(d) of
the PRA (44 U.S.C. 3507(d)) and section 1320.11 of the OMB's
implementing regulations (5 CFR 1320). The Board reviewed the final
rule under the authority delegated to the Board by OMB. The Board will
submit information collection burden estimates to OMB and the
submission will include burden for Federal Reserve-supervised
institutions, as well as burden for OCC-, FDIC-, SEC-, and CFTC-
supervised institutions under a holding company. The OCC and the FDIC
will take burden for banking entities that are not under a holding
company.
Abstract
Section 13 to the BHC Act generally prohibits any banking entity
from engaging in proprietary trading or from acquiring or retaining an
ownership interest in, sponsoring, or having certain relationships with
a covered fund, subject to certain exemptions. The exemptions allow
certain types of permissible trading activities such as underwriting,
market making, and risk-mitigating hedging, among others. The 2013 rule
implementing section 13 became effective on April 1, 2014. Section
__.20(d) and Appendix A of the 2013 final rule require certain of the
largest banking entities to report to the appropriate agency certain
quantitative measurements.
Current Actions
This final rule contains requirements subject to the PRA and the
changes relative to the 2013 rule are discussed herein. The new and
modified reporting requirements are found in sections __.4(c)(3)(i),
__.20(d), __.20(i), and the Appendix. The new and modified
recordkeeping requirements are found in sections, __.3(d)(3),
__.4(c)(3)(i), __.5(c), __.20(b), __.20(c), __.20 (d), __.20(e),
__.20(f), and the Appendix. The modified information collection
requirements \739\ would implement section 13 of the BHC Act. The
respondents are for-profit financial institutions, including small
businesses. A covered entity must retain these records for a period
that is no less than 5 years in a form that allows it to promptly
produce such records to the relevant agency on request.
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\739\ In an effort to provide transparency, the total cumulative
burden for each agency is shown. In addition to the changes
resulting from this final rule, the agencies are also applying a
conforming methodology for calculating the burden estimates in order
to be consistent across the agencies.
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Reporting Requirements
Section __.4(c)(3)(i) requires a banking entity to make available
to the agency upon request records regarding (1) any limit that is
exceeded and (2) any temporary or permanent increase to any limit(s),
in each case in the form and manner as directed by the primary
financial regulatory agency. The agencies estimate that the average
time per response would be 15 minutes.
Section __.20(d) is modified by extending the reporting period for
certain banking entities from within 10 days of the end of each
calendar month to 30 days of the end of each calendar quarter. The
threshold for reporting under section __.20(d) is modified from $10
billion or more in trading assets and liabilities to $20 billion or
more in trading assets and liabilities. The metrics reporting changes
to the Appendix would impact the reporting burden under section
___.20(d). The agencies estimate that the current average hours per
response will
[[Page 62034]]
decrease by 14 hours (decrease 40 hours for initial set-up).
Sections __.3(b)(4), __.4(c)(4), __.20(g)(2), and __.20(h) would
implicate the notice and response procedures pursuant to section
__.20(i) that an agency would follow when rebutting a presumption or
exercising a reservation of authority. The agencies estimate that the
average hours per response would be 20 hours.
Recordkeeping Requirements
Section __.3(d)(3) would expand the scope of the recordkeeping to
include foreign exchange forward (as that term is defined in section
1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)), foreign
exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25)), or cross-currency swap. The
agencies estimate that the current average hour per response will not
change.
Section __.4(c)(3)(i) requires a banking entity to maintain records
regarding (1) any limit that is exceeded and (2) any temporary or
permanent increase to any limit(s), in each case in the form and manner
as directed by the primary financial regulatory agency. The agencies
estimate that the average time per response would be 15 minutes.
Section __.5(c) is modified by reducing the requirements for
banking entities that do not have significant trading assets and
liabilities and eliminating documentation requirements for certain
hedging activities. The agencies estimate that the current average
hours per response will decrease by 20 hours (decrease 10 hours for
initial set-up).
Section __.20(b) is modified by limiting the requirement only to
banking entities with significant trading assets and liabilities. The
agencies estimate that the current average hour per response will not
change.
Section __.20(c) is modified by limiting the CEO attestation
requirement to a banking entity that has significant trading assets and
liabilities. The agencies estimate that the current average hours per
response will decrease by 1,100 hours (decrease 3,300 hours for initial
set-up).
Section __.20(d) is modified by extending the time period for
reporting for certain banking entities from within 10 days of the end
of each calendar month to 30 days of the end of each calendar quarter.
The agencies estimate that the current average hours per response will
decrease by 3 hours.
Section __.20(e) is modified by limiting the requirement to banking
entities with significant trading assets and liabilities. The agencies
estimate that the current average hours per response will not change.
Section __.20(f)(2) is modified by limiting the requirement to
banking entities with moderate trading assets and liabilities. The
agencies estimate that the current average hours per response will not
change.
The Instructions for Preparing and Submitting Quantitative
Measurement Information, Technical Specifications Guidance, and XML
Schema will be available on each agency's public website:
OCC: https://www.occ.treas.gov/topics/capital-markets/financial-markets/trading/volcker-rule-implementation/index-volcker-rule-implementation.html;
Board: https://www.federalreserve.gov/apps/reportforms/review.aspx;
FDIC: https://www.fdic.gov/regulations/reform/volcker/;
CFTC: https://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_28_VolckerRule/index.htm; and
SEC: https://www.sec.gov/structureddata/dera_taxonomies.
Proposed Revision, With Extension, of the Following Information
Collections
Estimated average hours per response:
Reporting
Section __.4(c)(3)(i)--0.25 hours for an average of 20 times per
year.
Section __.12(e)--20 hours (Initial set-up 50 hours) for an average
of 10 times per year.
Section __.20(d)--41 hours (Initial set-up 125 hours) quarterly.
Section __.20(i)--20 hours.
Recordkeeping
Section __.3(d)(3)--1 hour (Initial set-up 3 hours).
Section __.4(b)(3)(i)(A)--2 hours quarterly.
Section __.4(c)(3)(i)--0.25 hours for an average of 40 times per
year.
Section __.5(c)--80 hours (Initial setup 40 hours).
Section __.11(a)(2)--10 hours.
Section __.20(b)--265 hours (Initial set-up 795 hours).
Section __.20(c)--100 hours (Initial set-up 300 hours).
Section __.20(d)- 10 hours.
Section __.20(e)--200 hours.
Section __.20(f)(1)--8 hours.
Section __.20(f)(2)--40 hours (Initial set-up 100 hours).
Disclosure
Section __.11(a)(8)(i)--0.1 hours for an average of 26 times per
year.
OCC
Title of Information Collection: Reporting, Recordkeeping, and
Disclosure Requirements Associated with Restrictions on Proprietary
Trading and Certain Relationships with Hedge Funds and Private Equity
Funds.
Frequency: Annual, quarterly, and event driven.
Affected Public: Businesses or other for-profit.
Respondents: National banks, state member banks, state nonmember
banks, and state and federal savings associations.
OMB control number: 1557-0309.
Estimated number of respondents: 39.
Proposed revisions estimated annual burden: -3,503 hours.
Estimated annual burden hours: 19,823 hours (3,482 hours for
initial set-up and 16,341 hours for ongoing).
Board
Title of Information Collection: Reporting, Recordkeeping, and
Disclosure Requirements Associated with Regulation VV.
Frequency: Annual, quarterly, and event driven.
Affected Public: Businesses or other for-profit.
Respondents: State member banks, bank holding companies, savings
and loan holding companies, foreign banking organizations, U.S. State
branches or agencies of foreign banks, and other holding companies that
control an insured depository institution and any subsidiary of the
foregoing other than a subsidiary for which the OCC, FDIC, CFTC, or SEC
is the primary financial regulatory agency. The Board will take burden
for all institutions under a holding company including:
OCC-supervised institutions,
FDIC-supervised institutions,
Banking entities for which the CFTC is the primary
financial regulatory agency, as defined in section 2(12)(C) of the
Dodd-Frank Act, and
Banking entities for which the SEC is the primary
financial regulatory agency, as defined in section 2(12)(B) of the
Dodd-Frank Act.
Legal authorization and confidentiality: This information
collection is authorized by section 13 of the BHC Act (12 U.S.C.
1851(b)(2) and 12 U.S.C. 1851(e)(1)). The information collection is
required in order for covered entities to obtain the benefit of
engaging in certain types of proprietary trading or investing in,
sponsoring, or having certain relationships with a hedge fund or
private equity fund, under the restrictions set forth in
[[Page 62035]]
section 13 and the final rule. If a respondent considers the
information to be trade secrets and/or privileged such information
could be withheld from the public under the authority of the Freedom of
Information Act (5 U.S.C. 552(b)(4)). Additionally, to the extent that
such information may be contained in an examination report such
information could also be withheld from the public (5 U.S.C. 552
(b)(8)).
Agency form number: FR VV.
OMB control number: 7100-0360.
Estimated number of respondents: 255.
Proposed revisions estimated annual burden: -169,466 hours.
Estimated annual burden hours: 31,044 hours (4,035 hours for
initial set-up and 27,009 hours for ongoing).
FDIC
Title of Information Collection: Volcker Rule Restrictions on
Proprietary Trading and Relationships with Hedge Funds and Private
Equity Funds.
Frequency: Annual, quarterly, and event driven.
Affected Public: Businesses or other for-profit.
Respondents: State nonmember banks, state savings associations, and
certain subsidiaries of those entities.
OMB control number: 3064-0184.
Estimated number of respondents: 13.
Proposed revisions estimated annual burden: -15,172 hours.
Estimated annual burden hours: 3,115 hours (1,656 hours for initial
set-up and 1,459 hours for ongoing).
C. Regulatory Flexibility Act Analysis
OCC: The Regulatory Flexibility Act, 5 U.S.C. 601 et seq., (RFA),
requires an agency, in connection with a final rule, to prepare a Final
Regulatory Flexibility Analysis describing the impact of the rule on
small entities (defined by the SBA for purposes of the RFA to include
commercial banks and savings institutions with total assets of $600
million or less and trust companies with total assets of $41.5 million
or less) or to certify that the rule will not have a significant
economic impact on a substantial number of small entities.
The OCC currently supervises approximately 782 small entities.\740\
Under the EGRRCPA, banking entities with total consolidated assets of
$10 billion or less generally are not ``banking entities'' within the
scope of Section 13 of the BHCA if their trading assets and trading
liabilities do not exceed 5 percent of their total consolidated assets.
Thus, the final rule will not impact any OCC-supervised small entities.
Therefore, the OCC certifies that the final rule will not have a
significant impact on a substantial number of OCC-supervised small
entities.
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\740\ The number of small entities supervised by the OCC is
determined using the SBA's size thresholds for commercial banks and
savings institutions, and trust companies, which are $600 million
and $41.5 million, respectively. Consistent with the General
Principles of Affiliation 13 CFR 121.103(a), the OCC counts the
assets of affiliated financial institutions when determining if the
OCC should classify an OCC-supervised institution a small entity.
The OCC used December 31, 2018, to determine size because a
``financial institution's assets are determined by averaging the
assets reported on its four quarterly financial statements for the
preceding year.'' See footnote 8 of the U.S. Small Business
Administration's Table of Size Standards.
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Board: The RFA requires an agency to either provide a regulatory
flexibility analysis with a rule or certify that the rule will not have
a significant economic impact on a substantial number of small
entities. The U.S. Small Business Administration (SBA) establishes size
standards that define which entities are small businesses for purposes
of the RFA.\741\ Except as otherwise specified below, the size standard
to be considered a small business for banking entities subject to the
proposal is $600 million or less in consolidated assets.\742\
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\741\ U.S. SBA, Table of Small Business Size Standards Matched
to North American Industry Classification System Codes, available at
https://www.sba.gov/sites/default/files/files/Size_Standards_Table.pdf.
\742\ See id. Pursuant to SBA regulations, the asset size of a
concern includes the assets of the concern whose size is at issue
and all of its domestic and foreign affiliates. 13 CFR 121.103(6).
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The Board has considered the potential impact of the proposed rule
on small entities in accordance with the RFA. Based on the Board's
analysis, and for the reasons stated below, the Board believes that
this proposed rule will not have a significant economic impact on a
substantial of number of small entities. No comments were received
related to the Board's initial RFA analysis, which was published with
the proposal.
As discussed in the Supplementary Information, the agencies are
revising the 2013 rule in order to provide clarity to banking entities
about what activities are prohibited, reduce compliance costs, and
improve the ability of the agencies to make supervisory assessments
regarding compliance relative to the 2013 rule. The agencies are
explicitly authorized under section 13(b)(2) of the BHC Act to adopt
rules implementing section 13.\743\
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\743\ 12 U.S.C. 1851(b)(2).
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The Board's rule generally applies to state-chartered banks that
are members of the Federal Reserve System, bank holding companies,
foreign banking organizations, and nonbank financial companies
supervised by the Board (collectively, Board-regulated entities).
However, EGRRCPA, which was enacted on May 24, 2018, amended section 13
of the BHC Act and modified the scope of the definition of banking
entity by amending the term ``insured depository institution'' to
exclude certain community banks.\744\ The Board is not aware of any
Board-regulated entities that meet the SBA's definition of ``small
entity'' that are subject to section 13 of the BHC Act and the rule
following the enactment of EGRRCPA. Furthermore, to the extent that any
Board-regulated entities that meet the definition of ``small entity''
are or become subject to section 13 of the BHC Act and the rule, the
Board does not expect the total number of such entities to be
substantial. Accordingly, the Board's rule is not expected to have a
significant economic impact on a substantial number of small entities.
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\744\ Under EGRRCPA, a community bank and its affiliates are
generally excluded from the definition of banking entity, and thus
section 13 of the BHC Act, if the bank and all companies that
control the bank have total consolidated assets equal to $10 billion
or less and trading assets and liabilities equal to 5 percent or
less of total consolidated assets.
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The Board has not identified any federal statutes or regulations
that would duplicate, overlap, or conflict with the proposed revisions,
and the Board is not aware of any significant alternatives to the rule
that would reduce the economic impact on Board-regulated small
entities.
FDIC
(a) Regulatory Flexibility Analysis
The RFA generally requires an agency, in connection with a final
rule, to prepare and make available for public comment a final
regulatory flexibility analysis that describes the impact of a rule on
small entities.\745\ However, a regulatory flexibility analysis is not
required if the agency certifies that the rule will not have a
significant economic impact on a substantial number of small entities.
The SBA has defined ``small entities'' to include banking organizations
with total assets of less than or equal to $600 million.\746\
[[Page 62036]]
Generally, the FDIC considers a significant effect to be a quantified
effect in excess of 5 percent of total annual salaries and benefits per
institution, or 2.5 percent of total noninterest expenses. The FDIC
believes that effects in excess of these thresholds typically represent
significant effects for FDIC-supervised institutions. As discussed
further below, the FDIC certifies that this final rule will not have a
significant economic impact on a substantial number of FDIC-supervised
small entities.
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\745\ 5 U.S.C. 601 et seq.
\746\ The SBA defines a small banking organization as having
$600 million or less in assets, where an organization's ``assets are
determined by averaging the assets reported on its four quarterly
financial statements for the preceding year.'' See 13 CFR 121.201
(as amended by 84 FR 34261, effective August 19, 2019). In its
determination, the ``SBA counts the receipts, employees, or other
measure of size of the concern whose size is at issue and all of its
domestic and foreign affiliates.'' See 13 CFR 121.103. Following
these regulations, the FDIC uses a covered entity's affiliated and
acquired assets, averaged over the preceding four quarters, to
determine whether the covered entity is ``small'' for the purposes
of RFA.
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(b) Reasons for and Policy Objectives of the Final Rule
The agencies are issuing this final rule to amend the 2013 rule in
order to provide banking entities with additional clarity and certainty
about what activities are prohibited and seek to improve the efficacy
of the regulations where possible. The agencies acknowledge that many
banking entities have found certain aspects of the 2013 rule to be
complex or difficult to apply in practice. This final rule amends the
2013 rule to make its requirements more efficient.
(c) Description of the Rule
First, the FDIC is amending its regulations to tailor the
application of the final rule based on the size and scope of a banking
entity's trading activities. In particular, the FDIC aims to further
reduce compliance obligations for firms that do not have large trading
operations and therefore reduce costs and uncertainty faced by firms in
complying with the final rule, relative to their amount of trading
activity. In addition to tailoring the application of the final rule,
the FDIC is also streamlining and clarifying for all banking entities
certain definitions and requirements related to the proprietary trading
prohibition and limitations on covered fund activities and investments.
Finally, the FDIC is reducing reporting, recordkeeping, and compliance
program requirements for all banking entities and expanding tailoring
to make the scale of compliance activity required by the rule
commensurate with a banking entity's size and level of trading
activity.
(d) Other Statutes and Federal Rules
On May 24, 2018, EGRRCPA was enacted, which, among other things,
amends section 13 of the BHC Act. As a result, section 13 excludes from
the definition of ``banking entity'' any institution that, together
with their affiliates and subsidiaries, has: (1) Total assets of $10
billion or less, and (2) trading assets and liabilities that comprise 5
percent or less of total assets.
The FDIC has not otherwise identified any likely duplication,
overlap, and/or potential conflict between this final rule and any
other federal rule.
(e) Small Entities Affected
The FDIC supervises 3,465 depository institutions,\747\ of which,
2,705 are defined as small banking organizations according to the
RFA.\748\ Almost all FDIC-supervised small banking entities are exempt
from the requirements of section 13 of the BHC Act, pursuant to
EGRRCPA, and hence the final rule does not affect them.
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\747\ Categories of FDIC-supervised depository institutions are
set forth in 12 U.S.C. 1813(q)(2).
\748\ FDIC Call Report, March 31, 2019.
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Only one FDIC-supervised small banking entity is not exempt from
the requirements of section 13 of the BHC Act under EGRRCPA because it
has trading assets and liabilities greater than five percent of total
consolidated assets. This bank has trading activity at levels that
would place it in the final rule's limited trading assets and
liabilities compliance category, and it thus could benefit from the
final rule which contains a rebuttable presumption of compliance for
such banking entities. The FDIC estimates that banks with limited
trading will save, on average, $115,233 from the reduced burden of this
rule. This amount is far less than 5 percent of total salaries and 2.5
percent of total non-interest expenses for this one institution.
Consequently, the FDIC does not believe that this rule will have a
significant economic impact on a substantial number of small entities.
(f) Certification Statement
Section 13 of the BHC Act, as amended by EGRRCPA, exempts all but
one of the 2,705 FDIC-supervised small banking entities from compliance
with section 13 of the BHC Act. Therefore, the FDIC certifies that this
final rule will not have a significant economic impact on a substantial
number of FDIC-supervised small banking entities.
CFTC: Pursuant to 5 U.S.C. 605(b), the CFTC hereby certifies that
the amendments to the 2013 final rule will not have a significant
economic impact on a substantial number of small entities for which the
CFTC is the primary financial regulatory agency.
As discussed in this SUPPLEMENTARY INFORMATION, the Agencies are
revising the 2013 final rule in order to provide clarity to banking
entities about what activities are prohibited, reduce compliance costs,
and improve the ability of the Agencies to make assessments regarding
compliance relative to the 2013 final rule. To minimize the costs
associated with the 2013 final rule, the Agencies are simplifying and
tailoring the rule to allow banking entities to more efficiently
provide financial services in a manner that is consistent with the
requirements of section 13 of the BHC Act.
The revisions will generally apply to banking entities, including
certain CFTC-registered entities. These entities include bank-
affiliated CFTC-registered swap dealers, futures commission merchants,
commodity trading advisors and commodity pool operators.\749\ The CFTC
has previously determined that swap dealers, futures commission
merchants and commodity pool operators are not small entities for
purposes of the RFA and, therefore, the requirements of the RFA do not
apply to those entities.\750\ As for commodity trading advisors, the
CFTC has found it appropriate to consider whether such registrants
should be deemed small entities for purposes of the RFA on a case-by-
case basis, in the context of the particular regulation at issue.\751\
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\749\ The revisions may also apply to other types of CFTC
registrants that are banking entities, such as introducing brokers,
but the CFTC believes it is unlikely that such other registrants
will have significant activities that would implicate the revisions.
See 2013 final rule (CFTC), 79 FR 5808 at 5813 (Jan. 31, 2014).
\750\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618 (Apr. 30, 1982) (futures commission merchants and
commodity pool operators); and Registration of Swap Dealers and
Major Swap Participants, 77 FR 2613, 2620 (Jan. 19, 2012) (swap
dealers and major swap participants).
\751\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18620 (Apr. 30, 1982).
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In the context of the revisions to the 2013 final rule, the CFTC
believes it is unlikely that a substantial number of the commodity
trading advisors that are potentially affected are small entities for
purposes of the RFA. In this regard, the CFTC notes that only commodity
trading advisors that are registered with the CFTC are covered by the
2013 final rule, and generally those that are registered have larger
businesses. Similarly, the 2013 final rule applies to only those
commodity trading advisors that are affiliated with banks that are
within the scope of the Volcker Rule, which the CFTC expects are larger
businesses.\752\
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\752\ In this regard, the CFTC notes that the agencies recently
revised the 2013 final rule in order to be consistent with statutory
amendments made by EGRRCPA to section 13 of the BHC Act. The general
result of one of these statutory revisions was to exclude community
banks and their affiliates and subsidiaries from the scope of the
Volcker Rule. See 84 FR 35008. The CFTC believes this exclusion
lessens the likelihood that any commodity trading advisors that
remain within the scope of the Volcker Rule are small entities.
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[[Page 62037]]
The CFTC requested that commenters address whether any CFTC
registrants covered by the proposed revisions to the 2013 final rule
are small entities for purposes of the RFA. The CFTC did not receive
any public comments on this or any other aspect of the RFA as it
relates to the rule.
Because the CFTC believes there are not a substantial number of
commodity trading advisors within the scope of the Volcker Rule that
are small entities for purposes of the RFA, and the other CFTC
registrants that may be affected by the proposed revisions have been
determined not to be small entities, the CFTC believes that the
revisions to the 2013 final rule will not have a significant economic
impact on a substantial number of small entities for which the CFTC is
the primary financial regulatory agency.
SEC: In the proposal, the SEC certified that, pursuant to 5 U.S.C.
605(b), the proposal would not, if adopted, have a significant economic
impact on a substantial number of small entities. Although the SEC
solicited written comments regarding this certification, no commenters
responded to this request.
As discussed in the Supplementary Information, the Agencies are
adopting revisions to the 2013 rule that are intended to provide
banking entities with clarity about what activities are prohibited and
improve supervision and implementation of section 13 of the BHC Act.
The revisions the agencies are adopting today will generally apply
to banking entities, including certain SEC-registered entities.\753\
These entities include SEC-registered broker-dealers, investment
advisers, security-based swap dealers, and major security-based swap
participants that are affiliates or subsidiaries of an insured
depository institution.\754\ Based on information in filings submitted
by these entities, the SEC believes that there are no banking entity
registered investment advisers,\755\ broker-dealers,\756\ security-
based swap dealers, or major security-based swap participants that are
small entities for purposes of the RFA.\757\ For this reason, the SEC
certifies that the rule, as adopted, will not have a significant
economic impact on a substantial number of small entities.
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\753\ The SEC's Economic Analysis, below, discusses the economic
effects of the final amendments. See SEC Economic Analysis, supra
Part V.F.
\754\ See 2013 rule Sec. _.2(c) (definition of banking entity);
2013 rule Sec. _.2(r) as amended (definition of insured depository
institution).
\755\ For the purposes of an SEC rulemaking in connection with
the RFA, an investment adviser generally is a small entity if it:
(1) Has assets under management having a total value of less than
$25 million; (2) did not have total assets of $5 million or more on
the last day of the most recent fiscal year; and (3) does not
control, is not controlled by, and is not under common control with
another investment adviser that has assets under management of $25
million or more, or any person (other than a natural person) that
had total assets of $5 million or more on the last day of its most
recent fiscal year. See 17 CFR 275.0-7.
\756\ For the purposes of an SEC rulemaking in connection with
the RFA, a broker-dealer will be deemed a small entity if it: (1)
Had total capital (net worth plus subordinated liabilities) of less
than $500,000 on the date in the prior fiscal year as of which its
audited financial statements were prepared pursuant to 17 CFR
240.17a-5(d), or, if not required to file such statements, had total
capital (net worth plus subordinated liabilities) of less than
$500,000 on the last day of the preceding fiscal year (or in the
time that it has been in business, if shorter); and (2) is not
affiliated with any person (other than a natural person) that is not
a small business or small organization. See 17 CFR 240.0-10(c).
Under the standards adopted by the SBA, small entities also include
entities engaged in financial investments and related activities
with $38.5 million or less in annual receipts. See 13 CFR 121.201
(Subsector 523).
\757\ Based on SEC analysis of Form ADV data, the SEC believes
that there are not a substantial number of registered investment
advisers affected by the proposal that qualify as small entities
under RFA. Based on SEC analysis of broker-dealer FOCUS filings and
NIC relationship data, the SEC believes that there are no SEC-
registered broker-dealers affected by the proposal that qualify as
small entities under RFA. With respect to security-based swap
dealers and major security-based swap participants, based on
feedback from market participants and information about the
security-based swap markets, the Commission believes that the types
of entities that would engage in more than a de minimis amount of
dealing activity involving security-based swaps--which generally
would be large financial institutions--would not be ``small
entities'' for purposes of the RFA. See Regulation SBSR--Reporting
and Dissemination of Security-Based Swap Information, 81 FR 53546,
53553 (Aug. 12, 2016).
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D. Riegle Community Development and Regulatory Improvement Act
Section 302(a) of the Riegle Community Development and Regulatory
Improvement Act of 1994 (RCDRIA) \758\ requires that each Federal
banking agency, in determining the effective date and administrative
compliance requirements for new regulations that impose additional
reporting, disclosure, or other requirements on insured depository
institutions, consider, consistent with principles of safety and
soundness and the public interest, any administrative burdens that such
regulations would place on depository institutions, including small
depository institutions, and customers of depository institutions, as
well as the benefits of such regulations. The agencies have considered
comment on these matters in other parts of this Supplementary
Information.
---------------------------------------------------------------------------
\758\ 12 U.S.C. 4802(a).
---------------------------------------------------------------------------
In addition, under section 302(b) of the RCDRIA, new regulations
that impose additional reporting, disclosures, or other new
requirements on insured depository institutions generally must take
effect on the first day of a calendar quarter that begins on or after
the date on which the regulations are published in final form.\759\
Therefore, the effective date for the OCC, Board, and FDIC is January
1, 2020, the first day of the calendar quarter.\760\
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\759\ 12 U.S.C. 4802(b).
\760\ Additionally, the Administrative Procedure Act generally
requires that the effective date of a rule be no less than 30 days
after publication in the Federal Register. 5 U.S.C. 553(d)(1). The
effective date, January 1, 2020, will be more than 30 days after
publication in the Federal Register.
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E. OCC Unfunded Mandates Reform Act Determination
The OCC has analyzed the rule under the factors set forth in the
Unfunded Mandates Reform Act of 1995 (UMRA) (2 U.S.C. 1532). Under this
analysis, the OCC considered whether the rule includes a Federal
mandate that may result in the expenditure by State, local, and Tribal
governments, in the aggregate, or by the private sector, of $100
million or more in any one year (adjusted for inflation). The cost
estimate for the final rule is approximately $4.1 million in the first
year. Therefore, the OCC finds that the final rule does not trigger the
UMRA cost threshold. Accordingly, the OCC has not prepared the written
statement described in section 202 of the UMRA.
F. SEC Economic Analysis
1. Broad Economic Considerations
a. Scope
As discussed above, section 13 of the Bank Holding Company (BHC)
Act generally prohibits banking entities from engaging in proprietary
trading and from acquiring or retaining an ownership interest in,
sponsoring, or having certain relationships with a hedge fund or
private equity fund (covered funds), subject to certain exemptions.
Section 13(h)(1) of the BHC Act defines the term ``banking entity'' to
include (i) any insured depository institution (as defined by statute),
(ii) any company that controls an insured depository institution, (iii)
any company that is treated as a bank holding company for purposes of
section 8 of the
[[Page 62038]]
International Banking Act of 1978, and (iv) any affiliate or subsidiary
of such an entity.\761\ In addition, as discussed above, the Economic
Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA),
enacted on May 24, 2018, amended section 13 of the BHC Act to exclude
from the definition of ``insured depository institution'' any
institution that does not have and is not controlled by a company that
has (1) more than $10 billion in total consolidated assets; and (2)
total trading assets and trading liabilities, as reported on the most
recent applicable regulatory filing filed by the institution, that are
more than 5% of total consolidated assets.\762\
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\761\ See 12 U.S.C. 1851(h)(1).
\762\ These and other aspects of the regulatory baseline against
which the SEC is assessing the economic effects of the final rule on
SEC banking entities are discussed in the economic baseline. On July
22, 2019, the agencies adopted a final rule amending the definition
of ``insured depository institution'' in a manner consistent with
EGRRCPA.
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Certain SEC-regulated entities, such as broker-dealers, security-
based swap dealers (SBSDs), and registered investment advisers (RIAs)
affiliated with a banking entity, fall under the definition of
``banking entity'' and are subject to the prohibitions of section 13 of
the BHC Act.\763\ This economic analysis is limited to areas within the
scope of the SEC's function as the primary securities markets regulator
in the United States. In particular, the SEC's economic analysis is
focused on the potential effects of the final rule on SEC registrants,
in their capacity as such, the functioning and efficiency of the
securities markets, investor protection, and capital formation. SEC
registrants affected by the final rule include SEC-registered broker-
dealers, SBSDs, and RIAs. Thus, the below analysis does not consider
broker-dealers, SBSDs, and investment advisers that are not banking
entities, or banking entities that are not SEC registrants, in either
case for purposes of section 13 of the BHC Act, beyond the potential
spillover effects on these entities and effects on efficiency,
competition, investor protection, and capital formation in securities
markets. Other sections of this Supplementary Information discuss the
effects of the final rule on banking entities not overseen by the SEC
for purposes of section 13 of the BHC Act.
---------------------------------------------------------------------------
\763\ Throughout this economic analysis, the term ``banking
entity'' generally refers only to banking entities for which the SEC
is the primary financial regulatory agency unless otherwise noted.
While section 13 of the BHC Act and its associated rules apply to a
broader set of banking entities, this economic analysis is limited
to those banking entities for which the SEC is the primary financial
regulatory agency as defined in Section 2(12)(B) of the Dodd-Frank
Act. See 12 U.S.C. 1851(b)(2); 12 U.S.C. 5301(12)(B).
Compliance with SBSD registration requirements is not yet
required and there are currently no registered SBSDs. However, the
SEC has previously estimated that as many as 50 entities may
potentially register as SBSDs and that as many as 16 of these
entities may already be SEC-registered broker-dealers. See Capital,
Margin, and Segregation Requirements for Security-Based Swap Dealers
and Major Security-Based Swap Participants and Capital and
Segregation Requirements for Broker-Dealers, Exchange Act Release
No. 86175 (June 21, 2019), 84 FR at 43872 (Aug. 22, 2019),
(henceforth ``Capital, Margin, and Segregation Adopting Release'').
For the purposes of this economic analysis, the term ``dealer''
generally refers to SEC-registered broker-dealers and SBSDs.
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In the proposal, the SEC solicited comment on all aspects of the
costs and benefits associated with the proposed amendments for SEC
registrants, including any spillover effects the proposed amendments
may have on efficiency, competition, and capital formation in
securities markets. The SEC has considered these comments, as discussed
in greater detail in the sections that follow.
b. Economic Effects and Justification
As stated in the proposal, in implementing section 13 of the BHC
Act, the agencies sought to increase the safety and soundness of
banking entities, promote financial stability, and reduce conflicts of
interest between banking entities and their customers.
In the proposal, the SEC recognized a number of effects of the 2013
rule.\764\ The SEC continues to recognize that distinguishing between
permissible and prohibited activities may be complex and costly for
some firms,\765\ which may impede the conduct of permissible
activities.\766\ The SEC continues to believe that the 2013 rule may
have resulted in a complex and costly compliance regime that is unduly
restrictive and burdensome for some banking entities, particularly
smaller firms that do not qualify for the simplified compliance
regime.\767\ Since the 2013 rule became effective, new estimates
regarding compliance burdens and new information about the various
effects of the 2013 rule have become available.\768\ The passage of
time has also enabled an assessment of the value of individual
requirements that enable SEC oversight, such as the requirement to
report certain quantitative metrics, relative to reporting and other
compliance burdens.\769\
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\764\ See 83 FR at 33520-33552.
\765\ See, e.g., 83 FR at 33521.
\766\ See, e.g., 83 FR at 33532.
\767\ Id.
\768\ See, e.g., 83 FR at 33522.
\769\ Id.
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As discussed below, a number of commenters have indicated that the
proposed amendments would have altered the scope of permissible
activities and compliance requirements of the 2013 rule in a way that
significantly affects the economic costs and benefits of the 2013 rule.
In addition, commenters offered a variety of views on the baseline
economic effects, which include section 13 of the BHC Act, the 2013
rule, sections 203 and 204 of EGRRCPA and conforming amendments, and
current practices of banking entities aimed at compliance with these
regulations.\770\ As part of the proposal's economic baseline, the SEC
discussed the effects of the agencies' 2013 rule.\771\ The economic
baseline section below discusses these effects in greater detail.
---------------------------------------------------------------------------
\770\ See, e.g., Occupy the SEC; Better Markets; SIFMA and
Center for American Entrepreneurship.
\771\ See 83 FR at 33520-33521.
---------------------------------------------------------------------------
The final rule includes amendments that impact the scope of
permitted activities for all or a subset of banking entities (e.g.,
trading account definition, underwriting and market making, and trading
and investing activities by foreign banking entities), and amendments
that simplify, tailor, or eliminate the application of certain aspects
of the 2013 rule intended to reduce compliance and reporting burdens
while preserving and, in some cases, enhancing the effectiveness of the
2013 rule. Many of the final amendments seek to provide greater clarity
and certainty about which activities are permitted under the 2013 rule,
which may increase the ability and willingness of banking entities to
engage in permitted activities, and to promote the effective allocation
of compliance resources.
Broadly, the SEC believes that a greater ability and willingness to
engage in permitted activities would benefit the parties to those
transactions and capital markets as a whole. Reduced compliance costs
may translate into increased willingness of banking entities to engage
in activities that facilitate risk-sharing and capital formation, such
as underwriting securities and making markets. Accordingly, the rule
may also benefit clients, customers, and counterparties in the form of
an increased ability to transact with banking entities.
The SEC continues to recognize that some of these changes may also,
in certain circumstances, increase activities involving risk exposure
or increase the incidence of conflicts of interest among some market
participants. The returns and risks from
[[Page 62039]]
the activities of banking entities may flow through to their investors.
In general, to the extent that the final rule increases or decreases
the scope of permissible activities, the final rule may dampen or
magnify some of the economic tensions inherent in this rulemaking. As
discussed above, various aspects of the final rule are designed to
ensure that the prudential objectives of the rule are not diminished.
Moreover, amendments adopted as part of the final rule that redefine
the scope of entities subject to certain provisions of the 2013 rule
may have an effect on competition, allocative efficiency, and capital
formation. Where the final rule reduces burdens on some groups of
market participants (e.g., on banking entities without significant
trading assets and liabilities and certain foreign banking entities),
the final rule is expected to increase competition and trading activity
in related market segments.
Other amendments to the 2013 rule reduce compliance program,
reporting, and documentation requirements for some banking entities.
The SEC believes that these amendments may reduce the compliance
burdens of SEC-regulated banking entities, which may enhance
competition, trading activity, and capital formation. The SEC
recognizes that these amendments may alter the mix of tools available
for regulatory oversight and supervision. However, the SEC believes
that the final rule as a whole is unlikely to reduce the efficacy of
the agencies' regulatory oversight.\772\ Further, under the final rule,
banking entities (other than banking entities with limited trading
assets and liabilities for which the presumption of compliance has not
been rebutted) are still required to develop and provide for the
continued administration of a compliance program that is reasonably
designed to ensure and monitor compliance with the prohibitions and
restrictions set forth in section 13 of the BHC Act. Finally, the final
rule does not change the scope of entities subject to the statutory
obligations and prohibitions of section 13 of the BHC Act.
---------------------------------------------------------------------------
\772\ See, e.g., sections IV.B.2 and IV.D.1.
---------------------------------------------------------------------------
c. Analytical Approach
The SEC's economic analysis is informed by research on the effects
of section 13 of the BHC Act and the 2013 rule and on related
incentives conflicts, by comments received by the agencies from a
variety of interested parties, and by the agencies' experience
administering the 2013 rule since its adoption. Throughout this
economic analysis, the SEC discusses how different market participants
may respond to various aspects of the final rule and considers the
potential effects of the final rule on activities by banking entities
that involve risk, on their willingness and ability to engage in
client-facilitation activities, and on competition, market quality, and
capital formation, as informed, among other things, by research and
comment letters. The SEC's analysis also recognizes that the overall
risk exposure of banking entities may arise out of a combination of
activities, including proprietary trading, market making, and
traditional banking, as well as the volume and structure of hedging and
other risk-mitigating activities. As discussed further below, the SEC
recognizes the complex baseline effects of section 13 of the BHC Act,
as amended by sections 203 and 204 of EGRRCPA, and implementing rules,
on overall levels and structure of banking entity risk exposures.
The SEC also considered the investor protection implications of the
final rule. Broadly, the SEC notes that market liquidity can be
important to investors as it may enable investors to exit (in a timely
manner and at an acceptable price) from their positions in instruments,
products, and portfolios. At the same time, excessive risk exposures of
banking entities can adversely affect markets and, therefore,
investors.
The final rule tailors, removes, or alters the scope of various
requirements in the 2013 rule and adds certain new requirements. Since
section 13 of the BHC Act and the 2013 rule combined a number of
different requirements, and, as discussed above, the type and level of
risk exposure of a banking entity is the result of a combination of
activities,\773\ it is difficult to attribute the observed effects to a
specific provision or set of requirements. In addition, analysis of the
effects of the implementation of the 2013 rule is confounded by
macroeconomic factors, other policy interventions, and post-crisis
changes to market participants' risk aversion and return expectations.
Because of the extended timeline of implementation of section 13 of the
BHC Act and the overlap of the 2013 rule period with other post-crisis
changes affecting the same group or certain sub-groups of SEC
registrants, the SEC cannot rely on typical quantitative methods that
might otherwise enable causal attribution and quantification of the
effects of section 13 of the BHC Act and the 2013 rule on measures of
capital formation, liquidity, competition, and informational or
allocative efficiency. Moreover, empirical measures of capital
formation or liquidity do not reflect issuance and transaction activity
that does not occur as a result of the 2013 rule. Accordingly, it is
difficult to quantify the primary issuance and secondary market
liquidity that would have been observed following the financial crisis
absent various provisions of Section 13 of the BHC Act and the 2013
final rule.
---------------------------------------------------------------------------
\773\ See, e.g., 79 FR 5541.
---------------------------------------------------------------------------
Importantly, the existing securities markets--including market
participants, their business models, market structure, etc.--differ in
significant ways from the securities markets that existed prior to
enactment of Section 13 of the BHC Act and the implementation of the
2013 rule. For example, the role of dealers in intermediating trading
activity has changed in important ways, including the following: In
recent years, on both an absolute and relative basis bank-dealers
generally committed less capital to intermediation activities while
nonbanking dealers generally committed more; the volume and
profitability of certain trading activities after the financial crisis
may have decreased for bank-dealers while it may have increased for
other intermediaries, including nonbanking entities that provide
intraday liquidity using sophisticated electronic trading algorithms
and high speed access to data and trading venues; and the introduction
of alternative credit markets may have contributed to liquidity
fragmentation across markets while potentially increasing access to
capital.\774\
---------------------------------------------------------------------------
\774\ See Sec. & Exch. Comm'n, Access To Capital And Market
Liquidity, (2017) [hereinafter SEC Report 2017].
---------------------------------------------------------------------------
Where possible, this analysis attempts to quantify the costs and
benefits expected to result from the final rule. In many cases,
however, the SEC is unable to quantify these potential economic
effects. Some of the primary economic effects, such as the effect on
incentives that may give rise to conflicts of interest in various
regulated entities and the efficacy of regulatory oversight under
various compliance regimes, are inherently difficult to quantify.
Moreover, some of the benefits of the 2013 rule's prohibitions that are
being amended here, such as potential benefits for resilience during a
crisis, are less readily observable under strong economic conditions
and cannot be isolated from the effects of other post-crisis regulatory
efforts intended to enhance resilience. Lastly, because of overlapping
implementation periods of various post-crisis regulations affecting
[[Page 62040]]
the same group or certain sub-groups of SEC registrants, the long
implementation timeline of the 2013 rule, and the fact that many market
participants changed their behavior in anticipation of future changes
in regulation, it is difficult to quantify the net economic effects of
individual amendments to the 2013 rule adopted here.
In some instances, the SEC lacks the information or data necessary
to provide reasonable estimates for the economic effects of the final
rule. For example, the SEC lacks information and data, and commenters
have not provided such information or data, to allow a quantification
of (1) the volume of trading activity that does not occur because of
uncertainty about how to demonstrate that underwriting or market making
activities satisfy the reasonably expected near-term demand (RENTD)
requirement; (2) the extent to which internal limits may capture
expected customer demand; (3) how accurately correlation analysis
reflects underlying exposures of banking entities with, and without,
significant trading assets and liabilities in normal times and in times
of market stress; (4) the feasibility and costs of reorganization that
may enable some U.S. banking entities to become foreign banking
entities for the purposes of relying on the foreign trading exemption;
and (5) the extent of the overall risk reduction (if any) caused by the
2013 rule. Where the SEC cannot quantify the relevant economic effects,
the SEC discusses them in qualitative terms.
2. Baseline
The baseline against which the SEC is assessing the economic
effects of the final rule includes the legal and regulatory framework
as it exists at the time of this release and current practices aimed at
compliance with these regulations.
a. Regulation
The regulatory baseline includes section 13 of the BHC Act, as
amended by EGRRCPA, and the 2013 rule, as amended by the agencies'
amendments conforming to EGRRCPA. Further, the baseline accounts for
the fact that since the adoption of the 2013 rule, the staffs of the
agencies have provided FAQ responses to questions about the 2013
rule.\775\ In addition, the federal banking agencies released a 2019
policy statement with respect to foreign excluded funds.\776\
---------------------------------------------------------------------------
\775\ See https://www.sec.gov/divisions/marketreg/faq-volcker-rule-section13.htm, originally published on June 10, 2014, and most
recently updated on March 4, 2016.
\776\ See Statement regarding Treatment of Certain Foreign Funds
under the Rules Implementing Section 13 of the Bank Holding Company
Act (July 17, 2019), available at https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20190717a1.pdf. This policy
statement continued the position of the Federal banking agencies
that was released on July 21, 2017, and the position that the
agencies expressed in the proposal. See 83 FR 33444.
---------------------------------------------------------------------------
The subsections below discuss in greater detail the legal and
regulatory baseline applicable to entities that are registered with the
SEC and that the SEC oversees for purposes of section 13 of the BHC
Act. In particular, the SEC discusses the exemptions for permissible
underwriting and market making-related activities, risk-mitigating
hedging, and foreign trading; requirements and exemptions related to
covered funds; compliance and metrics reporting requirements; and
sections of EGRRCPA and conforming amendments that exempt certain
banking entities from section 13 of the BHC Act and the 2013 rule.
i. The 2013 Rule
(1) Definition of the Trading Account
The scope of prohibited proprietary trading activity is determined
by the definition of ``trading account'' and related exclusions.\777\
As discussed in detail in section IV.B.1.a, the 2013 rule's definition
of trading account includes three prongs: The short-term intent prong,
the market risk capital rule prong, and the dealer prong. In addition,
the 2013 rule includes a rebuttable presumption, under which a purchase
(or sale) of a financial instrument is presumed to be for the trading
account under the short-term intent prong if the banking entity holds
the financial instrument for fewer than 60 days or substantially
transfers the risk of the financial instrument within 60 days of the
purchase (or sale).
---------------------------------------------------------------------------
\777\ This aspect of the baseline is discussed in section
V.F.3.b.
---------------------------------------------------------------------------
The 2013 rule provides several exclusions from the definition of
proprietary trading in section Sec. __.3(d). In particular, under
certain conditions, the 2013 rule excludes from the definition of
proprietary trading any purchases or sales that arise under a
repurchase or reverse repurchase agreement or under a transaction in
which the banking entity lends or borrows a security temporarily, any
purchase or sale of a security for the purpose of liquidity management
in accordance with a documented liquidity management plan,\778\ any
purchase or sale by a banking entity that is a derivatives clearing
organization or a clearing agency in connection with clearing financial
instruments, any excluded clearing activities, any purchase or sale
that satisfies an existing delivery obligation or an obligation in
connection with a judicial, administrative, self-regulatory
organization, or arbitration proceeding, any purchase or sale by a
banking entity that is acting solely as agent, broker, or custodian,
any purchase or sale through a deferred compensation, stock-bonus,
profit-sharing, or pension plan, and any purchase or sale in the
ordinary course of collecting a debt previously contracted in good
faith.
---------------------------------------------------------------------------
\778\ This aspect of the baseline is discussed in section
IV.B.1.b.i.
---------------------------------------------------------------------------
In addition, section Sec. __.3(e)(13) of the 2013 rule defines
``trading desk'' as the smallest discrete unit of organization of a
banking entity that purchases or sells financial instruments for the
trading account of the banking entity or an affiliate thereof, and
applies certain requirements at the ``trading desk''-level of
organization.\779\
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\779\ See 2013 rule Sec. Sec. __.4, __.5, App. A., App. B;
final rule Sec. Sec. __.4, __.5, App. A.
---------------------------------------------------------------------------
(2) Exemption for Underwriting and Market Making-Related Activity
Section 13(d)(1)(B) of the BHC Act contains an exemption from the
prohibition on proprietary trading for underwriting and market making-
related activities. Under the 2013 rule, all banking entities with
covered activities must satisfy several requirements with respect to
their underwriting activities to qualify for the exemption for
underwriting activities, discussed in detail in section IV.B.2.a
above.\780\ In addition, under the current baseline, all banking
entities with covered activities must satisfy six requirements with
respect to their market making-related activities to qualify for the
exemption for market making-related activities, as discussed in section
IV.B.2.a.\781\
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\780\ See 2013 rule Sec. __.4 (a).
\781\ See 2013 rule Sec. __.4 (b).
---------------------------------------------------------------------------
The SEC also notes that, under the baseline, an organizational unit
or a trading desk of another banking entity that has consolidated
trading assets and liabilities of $50 billion or more is generally not
considered a client, customer, or counterparty for the purposes of the
RENTD requirement.\782\ Thus, such demand does not contribute to RENTD
unless such demand is affected through an anonymous trading facility or
unless the trading desk documents how and why the organizational unit
of said large banking entity should be treated as a client,
[[Page 62041]]
customer, or counterparty. To the extent that such documentation
requirements increase the cost of intermediating interdealer
transactions, this requirement may affect the volume and cost of
interdealer trading.
---------------------------------------------------------------------------
\782\ See 2013 rule Sec. __.4 (b)(3)(i).
---------------------------------------------------------------------------
(3) Exemption for Risk-Mitigating Hedging
Under the baseline, certain risk-mitigating hedging activities may
be exempt from the restriction on proprietary trading under the risk-
mitigating hedging exemption. To make use of this exemption, the 2013
rule requires all banking entities to comply with a comprehensive and
multi-faceted set of requirements, including (1) the establishment,
implementation, and maintenance of an internal compliance program; (2)
satisfaction of various criteria for hedging activities; and (3) the
existence of compensation arrangements for persons performing risk-
mitigating hedging activities that are designed not to reward or
incentivize prohibited proprietary trading. In addition, certain
activities under the exemption for risk-mitigating hedging are subject
to documentation requirements.\783\
---------------------------------------------------------------------------
\783\ See 2013 rule Sec. __.5.
---------------------------------------------------------------------------
Specifically, the 2013 rule requires that a banking entity seeking
to rely on the exemption for risk-mitigating hedging must establish,
implement, maintain, and enforce an internal compliance program that
includes reasonably designed written policies and procedures regarding
the positions, techniques, and strategies that may be used for hedging,
including documentation indicating what positions, contracts, or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts, or other holdings. The compliance program
must also provide for internal controls and ongoing monitoring,
management, and authorization procedures, including relevant escalation
procedures. In addition, the 2013 rule requires that all banking
entities, as part of their compliance program, must conduct analysis,
including correlation analysis, and independent testing designed to
ensure that the positions, techniques, and strategies that may be used
for hedging are designed to reduce or otherwise significantly mitigate
and demonstrably reduce or otherwise significantly mitigate the
specific, identifiable risk(s) being hedged.
The 2013 rule does not require a banking entity to prove
correlation mathematically--rather, the nature and extent of the
correlation analysis should be dependent on the facts and circumstances
of the hedge and the underlying risks targeted. Moreover, if
correlation cannot be demonstrated, the analysis needs to state the
reason and explain how the proposed hedging position, technique, or
strategy is designed to reduce or significantly mitigate risk and how
that reduction or mitigation can be demonstrated without
correlation.\784\ In the proposal, the SEC referenced market
participants' estimate that the inability to perform correlation
analysis, for instance, for non-trading assets such as mortgage
servicing assets, can add as much as 2% of the asset value to the cost
of hedging.\785\
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\784\ See 79 FR 5631.
\785\ See 83 FR at 33534 citing to note 18 regarding Notice
Seeking Public Input on the Volcker Rule (August 2017), available at
https://www.occ.gov/news-issuances/news-releases/2017/nr-occ-2017-89a.pdf. Corresponding comment letters are available at https://www.regulations.gov/docketBrowser?rpp=25&so=DESC&sb=commentDueDate&po=0&dct=PS&D=OCC-2017-0014. Letter from BOK Financial can be accessed directly at
https://www.regulations.gov/document?D=OCC-2017-0014-0016.
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To qualify for the exemption for risk-mitigating hedging, the
hedging activity, both at inception and at the time of any adjustment
to the hedging activity, must be designed to reduce or otherwise
significantly mitigate and demonstrably reduce or significantly
mitigate one or more specific identifiable risks.\786\ Hedging
activities also must not give rise, at the inception of the hedge, to
any significant new or additional risk that is not itself hedged
contemporaneously. Additionally, the hedging activity must be subject
to continuing review, monitoring, and management by the banking entity,
including ongoing recalibration of the hedging activity to ensure that
the hedging activity satisfies the requirements for the exemption and
does not constitute prohibited proprietary trading.
---------------------------------------------------------------------------
\786\ See 2013 rule Sec. __.5(b)(2)(ii).
---------------------------------------------------------------------------
Finally, the 2013 rule requires banking entities to document and
retain information related to the purchase or sale of hedging
instruments that are either (1) established by a trading desk that is
different from the trading desk establishing or responsible for the
risks being hedged; (2) established by the specific trading desk
establishing or responsible for the risks being hedged but that are
effected through means not specifically identified in the trading
desk's written policies and procedures; or (3) established to hedge
aggregate positions across two or more trading desks. \787\ The
documentation must include the specific identifiable risks being
hedged, the specific risk-mitigating strategy that is being
implemented, and the trading desk that is establishing and responsible
for the hedge. These records must be retained for a period of not less
than 5 years in a form that allows them to be promptly produced if
requested.\788\
---------------------------------------------------------------------------
\787\ See 2013 rule Sec. __.5(c)(1).
\788\ See 2013 rule Sec. __.5(c)(3). See also 2013 rule Sec.
__.20(b)(6).
---------------------------------------------------------------------------
(4) Exemption for Foreign Trading
Under the 2013 rule, a foreign banking entity that has a branch,
agency, or subsidiary located in the United States (and is not itself
located in the United States) is subject to the proprietary trading
prohibitions and related compliance requirements unless the transaction
meets five criteria.\789\ First, a branch, agency, or subsidiary of a
foreign banking organization that is located in the United States or
organized under the laws of the United States or of any state may not
engage as principal in the purchase or sale of financial instruments
(including any personnel that arrange, negotiate, or execute a purchase
or sale). Second, the banking entity (including relevant personnel)
that makes the decision to engage in the transaction must not be
located in the United States or organized under the laws of the United
States or of any state. Third, the transaction, including any
transaction arising from risk-mitigating hedging related to the
transaction, must not be accounted for as principal directly or on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any state. Fourth, no financing for the transaction can be provided by
any branch or affiliate of a foreign banking entity that is located in
the United States or organized under the laws of the United States or
of any state (the financing prong). Fifth, the transaction must
generally not be conducted with or through any U.S. entity (the
counterparty prong), unless (1) no personnel of a U.S. entity that are
located in the United States are involved in the arrangement,
negotiation, or execution of such transaction; (2) the transaction is
with an unaffiliated U.S. market intermediary acting as principal and
is promptly cleared and settled through a central counterparty; or (3)
the transaction is executed through an unaffiliated U.S. market
intermediary acting as agent, conducted anonymously through an
[[Page 62042]]
exchange or similar trading facility, and is promptly cleared and
settled through a central counterparty.\790\
---------------------------------------------------------------------------
\789\ See 2013 rule Sec. __.6(e).
\790\ See 2013 rule Sec. __.6(e)(3).
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(5) Covered Funds
The 2013 rule generally defines covered funds as issuers that would
be investment companies but for section 3(c)(1) or 3(c)(7) of the
Investment Company Act of 1940 and then excludes specific types of
entities from the definition. As described above, the 2013 rule
provides for market making and hedging exemptions to the prohibition on
proprietary trading. However, the 2013 rule places additional
restrictions on the amount of underwriting, market making, and hedging
a banking entity can engage in when those transactions involve covered
funds. For underwriting and market making transactions in covered
funds, if the banking entity sponsors or advises a covered fund, or
acts in any of the other capacities specified in Sec. __.11(c)(2) of
the 2013 rule, then any ownership interests acquired or retained by the
banking entity and its affiliates in connection with underwriting and
market making-related activities for that particular covered fund must
be included in the per-fund and aggregate covered fund investment
limits in Sec. __.12 of the 2013 rule and is subject to the capital
deduction provided in Sec. __.12(d) of the 2013 rule.\791\
Additionally, a banking entity's aggregate investment in all covered
funds is limited to 3% of a banking entity's tier 1 capital, and
banking entities must include all ownership interests in covered funds
acquired or retained in connection with underwriting and market making-
related activities for purposes of this calculation.\792\ Moreover,
under the 2013 rule, the exemption for risk-mitigating hedging
activities related to covered funds is available only for transactions
that mitigate risks associated with the compensation of a banking
entity employee or an affiliate that provides advisory or other
services to the covered fund.\793\
---------------------------------------------------------------------------
\791\ See 2013 rule Sec. __.12(a)(2)(ii); see also Sec.
__.11(c)(2).
\792\ See 2013 rule Sec. __.12(a)(2)(iii); see also Sec.
__.11(c)(3).
\793\ See 2013 rule Sec. __.13(a).
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Under the 2013 rule, foreign banking entities can acquire or retain
an ownership interest in, or act as sponsor to, a covered fund, so long
as those activities and investments occur solely outside of the United
States, no ownership interest in such fund is offered for sale or sold
to a resident of the United States (the marketing restriction), and
certain other conditions are met. Under the 2013 rule, an activity or
investment occurs solely outside of the United States if (1) the
banking entity is not itself, and is not controlled directly or
indirectly by, a banking entity that is located in the United States or
established under the laws of the United States or of any state; (2)
the banking entity (and relevant personnel) that makes the decision to
acquire or retain the ownership interest or act as sponsor to the
covered fund is not located in the United States or organized under the
laws of the United States or of any state; (3) the investment or
sponsorship, including any risk-mitigating hedging transaction related
to an ownership interest, is not accounted for as principal by any U.S.
branch or affiliate; and (4) no financing is provided, directly or
indirectly, by any U.S. branch or affiliate. In addition, the staffs of
the agencies have issued FAQs concerning the requirement that no
ownership interest in such fund is offered for sale or sold to a
resident of the United States.\794\
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\794\ See Responses to Frequently Asked Questions Regarding the
Commission's Rule under Section 13 of the Bank Holding Company Act,
June 10, 2014, updated March 4, 2016, available at https://www.sec.gov/divisions/marketreg/faq-volcker-rule-section13.htm.
---------------------------------------------------------------------------
(6) Compliance Program
For compliance purposes, the 2013 rule differentiates banking
entities on the basis of certain thresholds, including the amount of
the banking entity's consolidated trading assets and liabilities and
total consolidated assets. More specifically, U.S. banking entities
that have, together with affiliates and subsidiaries, trading assets
and liabilities (excluding trading assets and liabilities involving
obligations of or guaranteed by the United States or any agency of the
United States) the average gross sum of which--on a worldwide
consolidated basis, over the previous consecutive four quarters, as
measured as of the last day of each of the four prior calendar
quarters--equals $10 billion or more are subject to reporting
requirements of Appendix A under the 2013 rule. Banking entities that
have $50 billion or more in total consolidated assets as of the
previous calendar year end and banking entities with over $10 billion
in consolidated trading assets and liabilities are subject to the
requirement to adopt an enhanced compliance program pursuant to
Appendix B of the 2013 rule. Additionally, banking entities that engage
in covered activities and that have total consolidated assets of $10
billion or less as reported on December 31 of the previous 2 calendar
years qualify for the simplified compliance regime.
The 2013 rule emphasized the importance of a strong compliance
program and sought to tailor the compliance program to the size of
banking entities and the size of their trading activity. As noted in
the preamble to the 2013 rule, the agencies believed it was necessary
to balance compliance burdens posed on smaller banking entities with
specificity and rigor necessary for large and complex banking
organizations facing high compliance risks. As a result, the compliance
regime under the 2013 rule is progressively more stringent with the
size of covered activities and/or balance sheet of banking entities.
Under the 2013 rule, all banking entities with covered activities
must develop and maintain a compliance program that is reasonably
designed to ensure and monitor compliance with section 13 of the BHC
Act and the implementing regulations. The terms, scope, and detail of
the compliance program depend on the types, size, scope, and complexity
of activities and business structure of the banking entity.\795\
---------------------------------------------------------------------------
\795\ See 2013 rule Sec. __.20(a).
---------------------------------------------------------------------------
Under the 2013 rule, banking entities that qualify for the
simplified compliance program (banking entities that have total
consolidated assets of less than $10 billion) are able to incorporate
compliance with the 2013 rule into their regular compliance policies
and procedures by reference, adjusting as appropriate given the
entities' activities, size, scope, and complexity.\796\
---------------------------------------------------------------------------
\796\ See 2013 rule Sec. __.20(f). Note that if an entity does
not have any covered activities, it is not required to establish a
compliance program until it begins to engage in covered activity.
---------------------------------------------------------------------------
All other banking entities with covered activities are, at a
minimum, required to implement a six-pillar compliance program. The six
pillars include (1) written policies and procedures reasonably designed
to document, describe, monitor and limit proprietary trading and
covered fund activities and investments for compliance; (2) a system of
internal controls reasonably designed to monitor compliance; (3) a
management framework that clearly delineates responsibility and
accountability for compliance, including management review of trading
limits, strategies, hedging activities, investments, and incentive
compensation; (4) independent testing and audit of the effectiveness of
the compliance program; (5) training for personnel to
[[Page 62043]]
effectively implement and enforce the compliance program; and (6)
recordkeeping sufficient to demonstrate compliance.\797\
---------------------------------------------------------------------------
\797\ See 2013 rule Sec. __.20(b).
---------------------------------------------------------------------------
In addition, under the 2013 rule, banking entities with covered
activities that do not qualify as those with modest activity (banking
entities that have total consolidated assets in excess of $10 billion)
and that are either subject to the reporting requirements of Appendix A
or have more than $50 billion in total consolidated total assets as of
the previous calendar year end are required to comply with the enhanced
minimum standards for compliance as specified in Appendix B of the 2013
rule.\798\
---------------------------------------------------------------------------
\798\ See 2013 rule Sec. __.20(c) and Appendix B.
---------------------------------------------------------------------------
Appendix B requires the compliance program of the banking entities
that are subject to it to (1) be reasonably designed to supervise the
permitted trading and covered fund activities and investments, identify
and monitor the risks of those activities and potential areas of
noncompliance, and prevent prohibited activities and investments; (2)
establish and enforce appropriate limits on the covered activities and
investments, including limits on the size, scope, complexity, and risks
of the individual activities or investments consistent with the
requirements of section 13 of the BHC Act and the 2013 rule; (3)
subject the compliance program to periodic independent review and
testing and ensure the entity's internal audit, compliance, and
internal control functions are effective and independent; (4) make
senior management and others accountable for the effective
implementation of the compliance program, and ensure that the chief
executive officer and board of directors review the program; and (5)
facilitate supervision and examination by the agencies.
Additionally, under the 2013 rule, any banking entity that has more
than $10 billion in total consolidated assets as reported in the
previous 2 calendar years is required to maintain additional records
related to covered funds. In particular, a banking entity must document
the exclusions or exemptions relied on by each fund sponsored by the
banking entity (including all subsidiaries and affiliates) in
determining that such fund is not a covered fund, including
documentation that supports such determination; for each seeding
vehicle that will become a registered investment company or SEC-
regulated business development company, a written plan documenting the
banking entity's determination that the seeding vehicle will become a
registered investment company or SEC-regulated business development
company, the period of time during which the vehicle will operate as a
seeding vehicle, and the banking entity's plan to market the vehicle to
third-party investors and convert it into a registered investment
company or SEC-regulated business development company within the time
period specified.\799\
---------------------------------------------------------------------------
\799\ See 2013 rule Sec. __.20(e).
---------------------------------------------------------------------------
(7) Metrics
Under Appendix A of the 2013 rule, banking entities with trading
assets and liabilities (excluding trading assets and liabilities
involving obligations of or guaranteed by the United States or any
agency of the United States) the average gross sum of which--on a
worldwide consolidated basis, over the four previous quarters, as
measured by the last day of each of the four prior calendar quarters--
equals or exceeds $10 billion to meet requirements concerning recording
and reporting certain measurements for each trading desk engaged in
covered trading activity.\800\ Banking entities subject to Appendix A
are required to record and report the following quantitative
measurements for each trading day and for each trading desk engaged in
covered trading activities: (i) Risk and Position Limits and Usage;
(ii) Risk Factor Sensitivities; (iii) Value-at-Risk and Stress Value-
at-Risk; (iv) Comprehensive Profit and Loss Attribution; (v) Inventory
Turnover; (vi) Inventory Aging; and (vii) Customer-Facing Trade Ratio.
---------------------------------------------------------------------------
\800\ See 2013 rule Sec. __.20(d) and Appendix A.
---------------------------------------------------------------------------
The metrics reporting requirements are intended to assist banking
entities, the SEC, and other regulators in achieving the following: A
better understanding of the scope, type, and profile of covered trading
activities; identification of covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the rule's proprietary trading restrictions; evaluation
of whether the covered trading activities of trading desks engaged in
permitted activities are consistent with the provisions of the
permitted activity exemptions; evaluation of whether the covered
trading activities of trading desks that are engaged in permitted
trading activities (i.e., underwriting and market making-related
activity, risk-mitigating hedging, or trading in certain government
obligations) are consistent with the requirement that such activity not
result, directly or indirectly, in a material exposure to high-risk
assets or high-risk trading strategies; identification of the profile
of particular covered trading activities of the banking entity, and its
individual trading desks, to help establish the appropriate frequency
and scope of the SEC's examinations of such activity; and the
assessment and addressing of the risks associated with the banking
entity's covered trading activities.\801\
---------------------------------------------------------------------------
\801\ See 2013 rule Sec. __.20 and Appendix A.
---------------------------------------------------------------------------
Under the 2013 rule, banking entities with significant trading
assets and liabilities (Group A entities) and with moderate trading
assets and liabilities (Group B entities) that have less than $50
billion in consolidated trading assets and liabilities are required to
report metrics for each quarter within 30 days of the end of that
quarter. In contrast, Group A and Group B banking entities with total
trading assets and liabilities equal to or above $50 billion are
required to report metrics more frequently--each month within 10 days
of the end of that month.\802\
---------------------------------------------------------------------------
\802\ See 2013 rule Sec. __.20(d)(3).
---------------------------------------------------------------------------
ii. EGRRCPA and Conforming Amendments
In accordance with section 203 of EGRRCPA,\803\ the agencies
amended the definition of ``insured depository institution'' in Sec.
__.2(r) of the 2013 rule to exclude an institution if it, and every
entity that controls it, has both (1) $10 billion or less in total
consolidated assets and (2) total consolidated trading assets and
liabilities that are 5% or less of its total consolidated assets. The
agencies also amended the 2013 rule to reflect the changes made by
section 204 of EGRRCPA. That provision modified section 13 of the BHC
Act to permit, in certain circumstances, bank-affiliated investment
advisers to share their name with the hedge funds or private equity
funds they organize and offer.
---------------------------------------------------------------------------
\803\ Specifically, section 203 of EGRRCPA provides that the
term ``insured depository institution,'' for purposes of the
definition of ``banking entity'' in section 13(h)(1) of the BHC Act
(12 U.S.C. 1851(h)(1)), does not include an insured depository
institution that does not have, and is not controlled by a company
that has (1) more than $10 billion in total consolidated assets; and
(2) total trading assets and trading liabilities, as reported on the
most recent applicable regulatory filing filed by the institution,
that are more than 5% of total consolidated assets.
---------------------------------------------------------------------------
As discussed elsewhere,\804\ certain SEC-regulated entities, such
as dealers and RIAs, fell under the definition of ``banking entity''
for the purposes of section 13 of the BHC Act before the enactment of
EGRRCPA and qualified for the final amendments implementing
[[Page 62044]]
sections 203 and 204 of EGRRCPA.\805\ Therefore, the economic baseline
against which the SEC is assessing the final rule incorporates the
economic effects of sections 203 and 204 of EGRRCPA, as analyzed in the
agencies' release adopting the conforming amendments.\806\
---------------------------------------------------------------------------
\804\ See EGRRCPA Conforming Amendments Adopting Release, 84 FR
at 35008.
\805\ The SEC continues to believe that all bank-affiliated
entities that may register with the SEC as security-based swap
dealers and major security-based swap participants were unaffected
by section 203 of EGRRCPA or the conforming amendments because of
the size of their balance sheets and the amount of trading activity
of their affiliated banking entities. The SEC's analysis was based
on DTCC Derivatives Repository Limited Trade Information Warehouse
(TIW) data on single-name credit-default swaps.
\806\ See EGRRCPA Conforming Amendments Adopting Release, 84 FR
at 35008.
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b. Response to Commenters Regarding Economic Baseline and Effects of
Section 13 of the BHC Act and the 2013 Rule
In the proposal, the SEC described the baseline effects of the 2013
rule \807\ and recognized that amendments that increase or decrease the
scope of permissible activities may magnify or attenuate the baseline
economic effects of the 2013 rule.\808\ The SEC also noted that
amendments that decrease (or increase) compliance program and reporting
obligations could alter the economic effects toward (or away from)
competition, trading activity, and capital formation on the one hand,
and against (or in favor of) regulatory and internal oversight on the
other. However, the SEC noted that the proposed amendments may enhance
trading liquidity and capital formation and that some of the proposed
changes need not reduce the efficacy of the regulation or the agencies'
regulatory oversight.\809\
---------------------------------------------------------------------------
\807\ See 83 FR at 33520-33521.
\808\ See 83 FR at 33521.
\809\ Id.
---------------------------------------------------------------------------
A number of commenters, however, have indicated that the proposed
amendments would have changed the scope of permissible activities and
the compliance regime in the 2013 rule in a manner that significantly
alters the costs and benefits of that rule and offered a variety of
assessments of the baseline economic effects of section 13 of the BHC
Act and the 2013 rule.\810\ In response to those comments, this section
expands the discussion of the baseline and supplements the analysis in
the proposal with a discussion of the comments received by the agencies
and, in response to comments, recent research on that topic. In the
2013 rule, the agencies sought to increase the safety and soundness of
banking entities and to promote financial stability,\811\ and to reduce
conflicts of interest between banking entities and their customers,
clients, and counterparties,\812\ while preserving the provision of
valuable client-oriented services \813\ and mitigating unnecessary
compliance burdens and related competitive effects.\814\ Accordingly,
the sections that follow address the SEC's understanding of the
baseline effects of section 13 of the BHC Act and the 2013 rule on (a)
risk exposures, (b) conflicts of interest between banking entities and
their customers and counterparties, (c) client-oriented financial
services and market quality, and (d) compliance burdens and
competition.
---------------------------------------------------------------------------
\810\ See, e.g., Occupy the SEC, Better Markets, SIFMA, Center
for American Entrepreneurship.
\811\ See, e.g., 79 FR at 5666, 79 FR at 5574, 79 FR at 5541.
\812\ See, e.g., 79 FR at 5659.
\813\ See, e.g., 79 FR at 5541.
\814\ See, e.g., 79 FR at 5541, 79 FR at 5584, 79 FR at 5616, 79
FR at 5671, 79 FR at 5673, 79 FR at 5675, 79 FR at 5713.
---------------------------------------------------------------------------
The SEC's analysis of these various effects reflects comments
received, academic research, and the SEC's experience overseeing
registered entities for purposes of section 13 of the BHC Act.
Importantly, research studies cited below are limited to their specific
settings and are subject to various methodological and measurement
limitations, as discussed in the sections that follow. Moreover, as
described below, some studies empirically examine the relevant effects
around the implementation of the 2013 rule, while others focus on the
anticipatory response of market participants around the enactment of
section 13 of the BHC Act and prior to the effective date of the 2013
rule. As a result, the SEC recognizes that these findings may have
limited generalizability and may or may not extend to various groups of
SEC registrants.
As discussed below, some research suggests that section 13 of the
BHC Act and the 2013 rule may have reduced risk exposures of banking
entities related to trading, but may not have reduced the overall
exposure to risk of some banking entities. Other research suggests that
the 2013 rule may have partly mitigated certain conflicts of interest
between banking entities and clients in a limited set of banking
entity-client relationships. Moreover, some research suggests that the
2013 rule imposed large compliance costs that may have
disproportionately affected smaller banking entities and may have
decreased the willingness and ability of banking entities to engage in
certain client facilitation activities.
In addition, commenters suggested that the agencies must consider
the effects of the 2013 rule and proposed amendments in light of the
overall effects of new requirements on banking entities, including
Basel III, regulations of systemically important financial
institutions, the SEC's money market reform, and the liquidity coverage
ratio.\815\ Where relevant, the analysis that follows discusses the
direct effects of section 13 of the BHC Act, the 2013 rule, sections
203 and 204 of EGRRCPA and conforming amendments, and the final rule,
as well as how they may interact with the effects of other related
financial regulations.
---------------------------------------------------------------------------
\815\ See CCMC; Oonagh McDonald; JBA; Occupy the SEC and
Systemic Risk Council.
---------------------------------------------------------------------------
i. Risk Exposure
As discussed in the proposal, in implementing section 13 of the BHC
Act, the agencies sought to increase the safety and soundness of
banking entities and to promote financial stability, among other
things.\816\ The regulatory regime created by the 2013 rule was
intended to enhance regulatory oversight and compliance with the
substantive prohibitions in section 13 of the BHC Act.\817\
---------------------------------------------------------------------------
\816\ See, e.g., 79 FR at 5666, 79 FR at 5574, 79 FR at 5541, 79
FR at 5659. See also Senators Merkley et al.
\817\ See, e.g., 83 FR at 33520.
---------------------------------------------------------------------------
In response to the proposal, some commenters indicated that the
benefits from the statutory prohibition in section 13 of the BHC Act
and implementing rules on proprietary trading include reduced banking
profits resulting from proprietary trading and corresponding reductions
in the costs associated with bailouts; \818\ prudent risk management
that makes job-creating functions of banks more viable; \819\ greater
financial stability; \820\ dampened bubbles in products such as
synthetic collateralized debt obligations,\821\ and reduced highly
risky bank trading activities and hedge fund and private equity
investments that can threaten financial stability.\822\ Other
commenters stated that proprietary trading was not the cause of the
2007-2008 financial crisis and that almost every financial crisis in
history has been driven by classic extensions of credit; \823\ that
rather than reducing systemic risk, section 13 of the BHC Act and the
implementing rules harm the healthy functioning of the financial
services
[[Page 62045]]
industry; \824\ and that section 13 of the BHC Act and the implementing
rules are no longer necessary given Basel III capital requirements,
stress testing, and liquidity coverage ratio rules that promote short-
term resilience of bank risk profiles.\825\
---------------------------------------------------------------------------
\818\ See, e.g., Occupy the SEC.
\819\ Id.
\820\ See, e.g., Better Markets and NAFCU.
\821\ See, e.g., Volcker Alliance.
\822\ See, e.g., CAP.
\823\ See, e.g., American Action Forum.
\824\ See, e.g., American Action Forum and CAP.
\825\ See Oonagh McDonald. See also infra note 849.
---------------------------------------------------------------------------
In response to the comments discussed above, the SEC has analyzed
relevant academic research on these issues. Most existing qualitative
analysis and quantitative research on moral hazard,\826\ incentives to
increase risk exposures that arise out of deposit insurance \827\ and
implicit bailout guarantees,\828\ and systemic risk implications of
proprietary trading do not explicitly analyze the effects of section 13
of the BHC Act or of the 2013 rule.\829\
---------------------------------------------------------------------------
\826\ A classic definition of moral hazard is ``the loss
exposure of an insurer (the FDIC) that results from the character or
circumstances of the insured'' (here, the banking entity). See
Anthony Saunders & Marcia Cornett, Financial Institutions
Management: A Risk Management Approach, 573 (8th ed. 2014) p. 573.
\827\ Saunders and Cornett (2014) discusses how deposit
insurance reduces the risks of depositors or other liability holders
engaging in a run on a banking entity and the related costs of a
banking entity's failure. However, if the risk of bank failure is
not adequately priced in the insurance premium paid by the banking
entity, deposit insurance can create incentives to engage in more
risky activities. Moreover, even absent deposit insurance, the
limited liability of a banking entity's shareholders still creates
incentives to risk shift at the expense of depositors, bondholders,
and other fixed claimants. See Saunders and Cornett (2014), ch. 19.
\828\ Deposit insurance and implicit bailout guarantees may give
rise to risk taking incentives that are not specific to proprietary
trading. In other words, even in the absence of proprietary trading,
both deposit insurance and implicit bailout guarantees may create
incentives for banking entities to increase risk exposures from
permissible activities such as lending, underwriting, and market
making. Thus, a prohibition of proprietary trading need not by
itself reduce moral hazard or overall risk exposures of banking
entities if banking entities increase risk exposures from other
activities during the same time.
\829\ For a literature review, see, e.g., Sylvain, Benoit et
al., Where the Risks Lie: A Survey on Systemic Risk, 21 Rev. Fin.
109 (2017). See also 83 FR 33533 note 350.
---------------------------------------------------------------------------
Several recent academic studies examined the baseline effects of
section 13 of the BHC Act and implementing regulations on activities by
banking entities that involve market risk. As discussed in detail
below, this research suggests that, although section 13 of the BHC Act
and the 2013 rule may have reduced risk exposure related to trading, it
is not clear that the 2013 rule reduced the overall risk of individual
banking entities and potentially of banking entities as a whole.
For example, one study \830\ compares changes in equity returns and
CDS spreads of 93 U.S. listed banks affected by post-crisis financial
reforms and of those that were not. Specifically, the study finds that
news concerning the potential enactment of substantive prohibitions in
section 13 of the BHC Act \831\ led to a rise in credit default swap
(CDS) spreads (by as much as 17-18 basis points) and to a decrease in
equity prices (statistically significant in most specifications). The
paper interprets the results as an indication that the proprietary
trading prohibition reduced bank profitability because of the spinoffs
of profitable trading and swap desks. In an additional analysis, the
paper finds that these effects were more significant for investment
banks, for banks that are more likely to be systemically
important,\832\ and for banks that are closer to default. Notably, the
paper does not examine changes in specific types of risky activities,
so it is possible that the observed effects may have occurred for
reasons unrelated to the proprietary trading prohibitions.\833\ While
the paper concludes that the reforms reduced bail-out expectations, the
rise in CDS spreads and the decrease in equity prices are also
consistent with the interpretation that market participants reacted to
the event as a change increasing the risk to banking entities, for
instance because of the expected shift to risk taking through lending
or reduced hedging of lending activities with trading activities. For
instance, a shift away from trading activity and toward more illiquid
and potentially less diversified lending or trading activities may have
increased banking entities' exposure to liquidity and counterparty
risks, and this risk may have been priced in higher CDS spreads of
banking entities.
---------------------------------------------------------------------------
\830\ See Alexander Sch[auml]fer et al., Financial Sector Reform
after the Subprime Crisis: Has Anything Happened?, 20 Rev. Fin. 77
(2016).
\831\ Specifically, the paper performs an event study around
January 21, 2010, when President Obama announced support for Volcker
Rule-type restrictions on proprietary trading by banking entities.
See Remarks by the President on Financial Reform, Office of the
Press Secretary, The White House, January 21, 2010, available at
https://obamawhitehouse.archives.gov/the-press-office/remarks-president-financial-reform, last accessed 6/27/2019.
\832\ Specifically, the paper measured systemic importance on
the basis of the Financial Stability Board's list of 29 global
systemically important financial institutions published on November
4, 2011. See Financial Stability Board Identifies 29 Global SIFIs
and Announces Agreed Policy Measures, Mondaq, November 4, 2011, last
accessed 7/9/2013.
\833\ Another study by Gropp et al. (2011) finds that government
guarantees can increase risk-taking incentives in competitor, but
not in protected, banks. See Reint Gropp et al., Competition, Risk-
Shifting, and Public Bailout Policies, 24 Rev. Fin. Stud. 2084
(2011).
---------------------------------------------------------------------------
In contrast, another paper \834\ examines the cumulative market
reaction to 15 events related to section 13 of the BHC Act using a
sample of 784 listed banks and seeks to distinguish the events from
announcements surrounding Orderly Liquidation Authority events. The
paper finds significant negative cumulative abnormal equity returns (-
11.97%) for targeted banks,\835\ consistent with targeted banks losing
out on profitable opportunities, and positive cumulative abnormal
returns (7.1%) for non-targeted banks. Similarly, the paper estimates
that targeted banks experienced a 0.021% increase in CDS spreads,
consistent with the changes making targeted banks riskier, whereas non-
targeted banks experienced a decline in CDS spreads of -0.049%. In
addition, banks with a higher measure of systemic risk (marginal
expected shortfall), higher illiquidity (Amihud (2002) \836\ measure
and the bid-ask spread), and worse reporting quality (abnormal loan
loss provisions) experienced more negative market reactions to events
surrounding section 13 of the BHC Act and the 2013 rule. On aggregate,
the paper finds that equity returns rose and CDS spreads declined for
sample banks, and concludes that the rule targeted larger institutions
and enhanced the relative position of smaller banks.
---------------------------------------------------------------------------
\834\ See Fayez Elayan et al., The Impact of the Volcker Rule on
Targeted Banks, Systemic Risk, Liquidity, and Financial Reporting
Quality, 96 J. Econ. & Bus. 69 (2018).
\835\ The paper defines targeted banks as banks that issued or
had exposure to mortgage-backed securities or other securitized
products or had other asset write-downs reported in news sources.
\836\ See Amihud Yakov, Illiquidity and Stock Returns: Cross-
section and Time Series Effects, 5 J. Fin Markets 31 (2002).
---------------------------------------------------------------------------
Four factors limit the interpretation of this paper's results.
First, the validity of inference from event studies is affected by the
presence of confounding events on announcement days. While a study of a
greater number of event days may provide a more complete picture of
market responses to even minor announcements concerning the reform of
interest, it increases the likelihood of confounding events occurring
on event days, ceteris paribus. Second, the proprietary trading
prohibitions scoped in all, not just a subset of, banking entities,
while the paper hypothesizes differential effects of the proprietary
trading prohibition on targeted and non-targeted banks. As a result,
the measurement of targeted banks may simply be capturing prior
performance of an institution during times of severe
[[Page 62046]]
stress or the likelihood of an institution being affected by other
regulatory restrictions or sanctions and not necessarily the degree of
exposure to the proprietary trading prohibition. Third, since the
management of bank balance sheets and risk exposures can take several
quarters, narrow event windows may reflect market participants'
expectations but may not be informative about ex-post changes in risky
bank activities in response to the event.\837\ Finally, all but one
event considered in this study relate to the substantive prohibitions
in section 13 of the BHC Act (and not the agencies' implementing
rules), and all of the events examined in this study precede the
adoption of the 2013 rule.
---------------------------------------------------------------------------
\837\ For example, see the below discussion of a study by Keppo
and Korte (2018) examining changes in bank risk taking over a 10
quarter period and finding that banks did not decrease risk-taking.
---------------------------------------------------------------------------
A recent paper uses regulatory data on net trading profits reported
by bank holding companies to the Federal Reserve under the Market Risk
Capital Rule and examines the risk-taking of U.S. banks via trading
books before and after the 2013 rule.\838\ The paper finds that, prior
to 2014, U.S. banks had significant exposures to equity risk factors
through their trading books, but that such trading exposures declined
after the implementing regulations. The paper also finds that, in
response to the 2013 rule, the trading desks of U.S. banks have
decreased their exposures to interest rate risk but not to credit risk.
Consistent with bank reliance on certain exemptions with respect to
commodities, foreign exchange, and currency trading, U.S. banks also
continue to be exposed to currency risk. Importantly, post-2013 rule
credit and dollar risk exposures are far less significant in magnitude
compared to pre-2013 rule exposure to equity risk factors. The paper
concludes that the ban on proprietary trading was effective in
curtailing large exposures. These results seem to suggest that holding
companies significantly reduced their exposure to risk from trading
activities.
---------------------------------------------------------------------------
\838\ See Antonio Falato et al., ``Banks as Regulated Traders,''
Finance Fin. & Econ. Discussion Series 2019-005, Washington: Board
of Governors of the Fed. Reserve System (2019), available at https://doi.org/10.17016/FEDS.2019.005, last accessed 5/20/2019.
---------------------------------------------------------------------------
Four considerations limit the interpretation of these results.
First, the paper's tests focus on data aggregated to the weekly
frequency, and it is not clear if the results would continue to hold
using daily, monthly, or quarterly frequencies. For example, the
results appear inconsistent with other research analyzing FR Y-9C data
on trends in quarterly trading positions and trading revenues, which
does not find significant changes in equity profits and losses after
the 2013 rule.\839\ Second, anticipatory compliance and confounding
regulatory and macroeconomic events (unaccounted for in the paper)
complicate definitive causal inference. Third, the paper does not
examine the possibility that, since higher risk is generally
compensated with higher expected returns,\840\ banking entities may
have offset risk reductions in their trading books by shifting risk
into illiquid banking books. Fourth, the paper also does not test
changes in the total amount of risk on bank balance sheets before and
after the relevant regulatory shocks or consider the effects of the
implementing regulations on the overall risk of U.S. banking entities.
---------------------------------------------------------------------------
\839\ See Begenau, 2019, Discussion of ``Banks as Regulated
Traders,'' NBER CF Spring meeting, April 12, available at https://begenau.people.stanford.edu/sites/g/files/sbiybj1926/f/nber_cfspring2019_begenau_disc.pdf, last accessed 07/15/2019. See
also Juliane Begenau et al., Banks' Risk Exposures, (Nat'l Bureau of
Econ. Research, Working Paper No. 21334, 2015) available at https://www.nber.org/papers/w21334, last accessed 07/15/2019.
\840\ This effect is commonly known as the ``risk-return
tradeoff'': If an investor is willing to take on risk, there is a
reward of higher expected returns. See ZVI Bodie et al.,
Investments, G-11 (9th ed. 2011).
---------------------------------------------------------------------------
Another study empirically examines the effects of the substantive
prohibitions of section 13 of the BHC Act on the returns and overall
risk of publicly traded U.S. bank holding companies before and after
the third quarter of 2010.\841\ Consistent with the papers discussed
above, this paper finds that most affected bank holding companies, i.e.
those with the largest trading books before 2010, reduced trading books
relative to total assets by 2.34% more than other bank holding
companies. However, this result is generally consistent with mean
reversion in trading activity by banks that may have suffered the
greatest trading losses during the crisis. In addition, the paper does
not directly distinguish between proprietary trading and client
facilitation trading or hedging trading. Although the paper finds a
decline in trading activity and a general decline in overall bank risk
(measured by the z-score),\842\ the paper does not find a pronounced
effect on most affected bank holding companies; in fact, some of the
results suggest that most affected banks became riskier than less
affected banks. The paper finds that the channel for this effect on
overall risk is an increase in asset return volatility of affected bank
holding companies. In addition, the paper finds no significant
differences in the volatility of bank stock prices and liquidity ratios
of affected and unaffected entities. The paper concludes that the risk
taking incentives of banking entities have not changed and that
affected banks have been able to maintain their levels of risk taking
by becoming less likely to use remaining trading assets to hedge
banking book returns.\843\ The SEC notes that the sample period of the
paper ends prior to the full effective date of the 2013 final rule,
which may partly limit the interpretation of these results.
---------------------------------------------------------------------------
\841\ See Jussi Keppo & Josef Korte, Risk Targeting and Policy
Illusions--Evidence from the Announcement of the Volcker Rule, 64
Mgmt. Sci. 215 (2018). Also cited as an example of ``pathbreaking
work assessing the many costs and benefits of the Rule'' in Robert
J. Jackson Jr., ``Proposed Amendments to the Volcker Rule,''
Securities and Exchange Commission, June 5, 2018, note 21 available
at https://www.sec.gov/news/public-statement/jackson-statement-proposed-amendments-volcker-rule.
\842\ The z-score is one of the most popular multiple
discriminant analysis models of bankruptcy, originally developed by
Altman (1968) and updated frequently since. Multiple discriminant
analysis consists of identifying a linear combination of accounting
measures that provides the best fit for the observed default and
non-default outcomes in a particular sample of firms. The variables
that enter into the z-score include: The ratio of working capital to
total assets; retained earnings to total assets; earnings before
interest and taxes to total assets; market value of equity to total
liabilities; and net sales to total assets. While the weights on
these components of the z-score are periodically recalibrated using
more recent samples, all components enter with a positive sign, such
that an increase in each of the variables decreases the probability
of bankruptcy. See Phillippe Jorion, GARP Financial Risk Manager
Handbook: Frm Part I/Part II, 475 (2011).
\843\ In another context, Keppo and Korte (2018) also find that,
after the passage of the Gramm-Leach-Bliley Act that repealed the
Glass-Steagall Act, the overall risk (measured by the z-score) of
affected banks relative to unaffected banks did not change. In that
context, the paper finds that affected banks did significantly
increase their trading risk and decrease the risk of their banking
book.
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Another recent paper \844\ uses structural methods to isolate and
estimate the effects of the limitation of bank proprietary trading in
section 13 of the BHC Act on the probability of bank defaults,
earnings, and the value of their equity. Using a model calibrated to
the data from a sample of 34 of the most affected U.S. banks, this
paper finds that banks--and particularly banks most affected by section
13 of the BHC Act--
[[Page 62047]]
may have become riskier after the statutory change. In the model, the
key mechanism behind this effect is the banks' ability to respond to
shocks: Since the rule leads to a reduction in the size of the trading
book and increases the relative weight of an illiquid banking book,
banks face greater difficulties scaling down the bank book when faced
with negative earnings shocks after the rule. The model assumes no
implementation costs, as the costs were sunk when the statutory
prohibition came into effect and yields an estimate of between -0.72%
and 56.72% increase in average bank default probability after the law.
This estimate range may suggest that the overall risk of some banks may
have increased, in some cases, after the law. In the model, banks for
which a small trading book is optimal, banks with a profitable and low-
risk bank book, and banks that take more risk through leverage, do not
experience this rise in the default risk after the proprietary trading
prohibition. Because the banking book is more profitable and volatile
than the trading book for most affected banks, the paper actually
estimates no significant decrease and, in some cases, an increase in
banks' expected earnings and earnings volatility (a range of -0.04% to
0.73% depending on calibration).\845\ An important caveat for the
interpretation of these results is the sensitivity of the estimates to
modeling assumptions, the limited sample used in model calibration, and
the extremely broad range of estimates of an increase in average bank
default probability after the law.
---------------------------------------------------------------------------
\844\ See Sohhyun Chung et al., The Impact of Volcker Rule on
Bank Profits and Default Probabilities, (SSRN Working Paper, Feb.
27, 2019), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2167773, last accessed 4/23/2019
Also cited in Robert J. Jackson Jr., ``Proposed Amendments to
the Volcker Rule,'' Securities and Exchange Commission, June 5,
2018, note 22 available at https://www.sec.gov/news/public-statement/jackson-statement-proposed-amendments-volcker-rule.
\845\ The estimate of -0.04% was obtained using parameters for
``median hedge fund banks,'' calculated as the median of the 34
sample banks, for which the drift and volatility of the trading
earnings were estimated from Credit Suisse Long/Short Equity Hedge
Fund Index data for 2000 through the beginning of 2010. The estimate
of 0.73% was obtained using drift and trading earnings volatility
for an asset-weighted mean of sample banks.
---------------------------------------------------------------------------
Finally, a recent paper \846\ identified three potential channels
behind the effects of section 13 of the BHC Act and the 2013 rule on
risky activities of bank holding companies: (i) Risks from proprietary
trading activity itself, (ii) risk from a lack of diversification of
bank revenue (trading and non-trading revenue), and (iii) risk from
similarity among banks. The paper measures overall risk with the z-
score (as well as volatility in returns, revenues, and returns on
assets) and systemic risk with marginal expected shortfall (average
stock return of each bank holding company during bottom 5th percentile
shocks to 1-year market returns; it also measures marginal expected
shortfall for the financial industry, and tail beta) \847\ and
documents two main results. First, an index of bank revenue
diversification reduces measures of bank and systemic risk, while
similarity across banks increases systemic risk, and trading activity
increases both. Second, the 2013 rule reduced risks from trading
activity of affected banks, reduced the diversification of bank revenue
of affected banks, and increased similarity across banks.
---------------------------------------------------------------------------
\846\ See Christina Bui and Talis Putnins, The Intended and
Unintended Effects of the Volcker Rule, (Aug. 31, 2018) (working
paper), available at https://fmaconferences.org/SanDiego/Papers/Volcker_SubmissionFMA.pdf, last accessed 4/23/2019.
\847\ Acharya et al. (2017) finds that a bank's impact on
systemic expected shortfall is affected by its marginal expected
shortfall and leverage. See Viral Acharya et al., Measuring Systemic
Risk, 30 Rev. Fin. Stud. 2 (2017).
---------------------------------------------------------------------------
The interpretation of these results may be limited because of
respective methodologies, measurement, identifying assumptions, and
residual confounding, as well as the general limitations noted at the
outset. However, these results are broadly consistent with other
research that finds that banking entities can respond to regulations by
risk shifting within an asset class while remaining in compliance \848\
and that the implementation of other financial reforms can create
effects inconsistent with the regulators' intentions.\849\
---------------------------------------------------------------------------
\848\ See Ran Duchin and Denis Sosyura, Safer Ratios, Riskier
Portfolios: Banks' Response to Government Aid, 113 J. Fin. Econ. 1
(2014).
\849\ For example, Sundaresan and Xiao (2019) show that the
interaction of liquidity requirements of Basel III and the money
market fund reform may have increased the reliance of private
financial institutions on liquidity provided by Federal Home Loan
Banks that enjoy an implicit government guarantee. The paper
concludes that the rules increased the role of a government-
sponsored enterprise in the aggregate liquidity transformation and
the reliance of private institutions on public liquidity backstops.
In another context, Baghai et al. (2019) finds that following the
money market fund reforms, safer funds exited the industry, the
remaining funds increased their portfolio risk, and issuers with
lower credit risk experienced a reduced access to money market
funding. See Suresh Sundaresan and Kairong Xiao, Unintended
Consequences of Post-Crisis Liquidity Regulation (Aug. 9, 2019)
(working paper) last accessed 8/29/2019. See also Ramin Baghai et
al., Liability Structure and Risk-Taking: Evidence from the Money
Market Fund Industry, (Aug. 18, 2019) (working paper) last accessed
8/29/2019.
---------------------------------------------------------------------------
Some commenters indicated that restricting pay practices of banking
entities may effectively reduce proprietary trading cross-subsidized by
taxpayers and accordingly lower the risks of banking entities.\850\
While the final rule does not amend existing requirements or impose new
requirements related to compensation practices of banking entities, the
SEC notes two incentive effects relevant for the consideration of these
issues. First, as discussed above, proprietary trading is one of many
activities through which a banking entity can take risk. Both deposit
insurance and implicit government bailout guarantees incentivize risk
taking that is not specific to proprietary trading. Even in the absence
of proprietary trading, deposit insurance and implicit bailout
guarantees may lead banking entities to take greater risks through
lending and permitted underwriting and market making, among other
things. As a result, a prohibition on proprietary trading need not by
itself reduce the overall risk of banking entities if banking entities
increase risk through other activities during the same time.
---------------------------------------------------------------------------
\850\ See, e.g., CAP and Public Citizen, citing Robert J.
Jackson Jr., ``Proposed Amendments to the Volcker Rule,'' Securities
and Exchange Commission, June 5, 2018, available at https://www.sec.gov/news/public-statement/jackson-statement-proposed-amendments-volcker-rule on potential effects of pay practices on
proprietary trading.
---------------------------------------------------------------------------
Second, the incentives to take on greater risks described above are
those of both a banking entity's shareholders who are residual
claimants on the banking entity's assets and management. Under limited
liability, all shareholders enjoy a limited downside (at worst,
shareholders stand to lose their investment) and an unlimited upside if
the firm performs well (the value of shareholders' equity depends on
the value of the assets net of the value of fixed claims, such as
claims of debtholders, depositors, and employees).\851\ Thus, the
incentives of banking entities to take on greater risks discussed above
may persist so long as any restrictions on pay practices leave the
incentives of a banking entity's management and employees even partly
aligned with those of shareholders.
---------------------------------------------------------------------------
\851\ See, e.g., Jonathan Berk & Peter DeMarzo, Corporate
Finance, 552-53 (3rd ed. 2014), discussing how leverage can (1)
incentivize shareholders to shift from lower-risk to higher-risk
assets (the ``asset substitution'' problem); and (2) induce
shareholders to undertake negative net present value, but
sufficiently risky projects (the ``over-investment'' problem). See
also Michael Jensen and William Meckling, Theory of the Firm:
Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin.
Econ. 305 (1976).
---------------------------------------------------------------------------
ii. Conflicts of Interest
As discussed in the proposal, in implementing section 13 of the BHC
Act, the agencies also sought to reduce conflicts of interest between
banking entities and their customers.\852\ Some commenters indicated
that bank trading activities and interests in hedge funds and private
equity funds resulted in
[[Page 62048]]
significant conflicts of interest between banks and their
customers.\853\ One commenter also indicated that the agencies should
amend the provisions concerning material conflicts of interest by
permitting banking entities to rely on information barriers under
certain circumstances.\854\
---------------------------------------------------------------------------
\852\ See, e.g., 79 FR at 5659.
\853\ See, e.g., CAP.
\854\ See SIFMA.
---------------------------------------------------------------------------
In response to these comments, the SEC reviewed relevant research
on conflicts of interest between banking entities and their customers.
As discussed below, related research generally examines trading of
banking entities in stocks, bonds, or options of their advisory and
underwriting clients. While the findings are somewhat mixed and limited
to their specific empirical settings, this research is consistent with
the presence of such conflicts in certain groups of merger and
acquisition (M&A) deals. In addition, one study finds that a narrow
type of conflicts of interest between banking entities and their
clients may have decreased after the implementation of the 2013 rule.
Specifically, a recent study \855\ examines both the presence of
conflicts of interest between advisor banks and their customers based
on banks' options holdings, and changes in such trading activity around
the implementation of the Volcker Rule. The paper documents three main
results. First, the paper finds that merger advisors tend to increase
their holdings in call options relative to put options in merger
targets during the quarter before the announcement. Second, merger
advisors are significantly more likely to increase put option holdings
in the acquirer firm.\856\ In combination with the literature's general
finding of average negative announcement returns in acquirer firms and
positive announcement returns in target firms, the paper argues that
these results are suggestive of informed trading by advisor banks on
client firms. Third, within the subsample of affected deals (deals in
which one or more advisor banks ceased proprietary trading operations
around the enactment of section 13 of the BHC Act) after 2011, the
paper finds that advisors did not increase their net call option
holdings on target firms before merger announcements. The paper
concludes that, in this narrow setting, the Volcker Rule may have
decreased banks' options trading on client information. Importantly,
the paper finds that some of this bank activity was replaced by hedge
fund activity: Specifically, hedge funds increased their informed
trading in options of M&A client firms around the same time in the same
subsample of deals.
---------------------------------------------------------------------------
\855\ See Michelle Lowry et al., Informed Trading By Advisor
Banks: Evidence from Options Holdings, 32 Rev. Fin. Stud 605 (2018).
\856\ To the degree that some advisor banks may have an
underlying (long) risk exposure to acquirer firms' equity, buying
put options is also consistent with risk-mitigating hedging.
---------------------------------------------------------------------------
The SEC is also aware of a broader body of research that
empirically tests the existence and magnitude of conflicts of interest
between banks and their customers in the context of advising and
underwriting relationships and that does not directly empirically test
the effects of section 13 of the BHC Act or the 2013 rule on the
presence or magnitude of such conflicts. One article in the legal
literature \857\ empirically measures the profitability of trading by
banks that have advisory clients and are subject to reporting
requirements as temporary insiders. They document that such trading by
banks in the stocks of advisory clients is profitable (with an
estimated average 25% return on their trades), that the trading centers
around adverse events, and that the elimination of Glass-Steagall
restrictions in 2002 was associated with more frequent and more
profitable trading. However, the paper does not empirically test the
effects of section 13 of the BHC Act or of the 2013 rule.
---------------------------------------------------------------------------
\857\ See Sureyya Avci et al., Eliminating Conflicts of
Interests in Banks: The Significance of the Volcker Rule, 35 Yale J.
Reg. 343 (2017). Also cited in Robert J. Jackson Jr., ``Proposed
Amendments to the Volcker Rule,'' Securities and Exchange
Commission, June 5, 2018, note 20, available at https://www.sec.gov/news/public-statement/jackson-statement-proposed-amendments-volcker-rule.
---------------------------------------------------------------------------
Finance research on this type of conflict of interest between banks
and their customers finds mixed effects. One of the earlier papers
\858\ examines trading in M&A target firms by the advisor banks of
bidders and links advisor pre-announcement stakes in target firms with
the probability of deal success and with the target premium. They
document positive returns of this trading strategy and conclude that
advisors acquire positions in deals of their advisory clients, as well
as influence deal outcomes. Since such advisor behavior benefits the
bidder, the authors recognize that they cannot rule out the alternative
explanation that the bidder's board retains the advisor with strong
incentives for deal completion. Outside of the M&A context, other work
\859\ explores the trading activity of IPO underwriters and finds that
lead underwriter trades in IPO firms are associated with subsequent IPO
abnormal returns.
---------------------------------------------------------------------------
\858\ See Andriy Bodnaruk et al., Investment Banks as Insiders
and the Market for Corporate Control, 22 Rev. Fin. Stud. 4989
(2009).
\859\ See Yao-Min Chiang et al., The Information Advantage of
Underwriters in IPOs, Mgmt. Sci. (forthcoming 2019).
---------------------------------------------------------------------------
Another study \860\ focuses on bond trading and uses a sample
covering 1994 through 2006 to examine the trading of bond dealers
affiliated with M&A advisory banks with insurance companies. The study
finds weak evidence that when affiliated dealers are one side of a bond
transaction, they earn higher bond returns than unaffiliated dealers,
and that affiliated dealers sell more of the bonds that may lose value
ahead of bad news than unaffiliated dealers. The paper observes only a
subset of such dealer trades with insurance companies and is unable to
evaluate whether affiliated dealers are net buyers or sellers of
affected bonds before bad news. The study concludes that there is weak
and suggestive evidence that transfer of information within financial
institutions is one of the potential information sources before public
announcements.
---------------------------------------------------------------------------
\860\ See Semi Kedia and Xing Zhou, Informed Trading Around
Acquisitions: Evidence From Corporate Bonds, 18 J. Fin. Mkt. 182
(2014).
---------------------------------------------------------------------------
Similarly, another paper \861\ finds no evidence of information
leakage because of investment bank M&A advisory, underwriting, or
lending relationships from 1997 through 2002. Specifically, the paper
finds no evidence that investment bank clients buy shares in takeover
targets in advised deals. Similarly, bank clients with previous
underwriter or lending relationships do not trade or earn abnormal
returns before earnings announcements. The paper also examines market
making imbalances and investment returns by connected brokerage houses
and finds that they do not trade profitably ahead of earnings
announcements by their IPO, SEO, M&A client, or borrower firms. The
paper concludes that neither brokerage houses nor their clients trade
on inside information available to the brokerage because of their
market making or advising roles.
---------------------------------------------------------------------------
\861\ See John M. Griffin et al., Examining the Dark Side of
Financial Markets: Do Institutions Trade on Information from
Investment Bank Connections, 25 J. Fin. Econ. 2155 (2012).
---------------------------------------------------------------------------
The SEC continues to note that the above studies are limited to
their specific empirical settings and, as can be seen above, different
empirical design, measurement, and identification approaches limit
inference in each of the papers discussed above. Moreover, the SEC
continues to note that the scope of this economic analysis is limited
to SEC registrants, investors in securities markets, and the
functioning of securities markets. While the research discussed above
does not focus
[[Page 62049]]
specifically on banking entities that are SEC registrants, some of the
incentive effects and conflicts of interest discussed above may extend
to banking entities overseen by the SEC.
iii. Client-Oriented Services and Market Quality
In the 2013 rule, the agencies recognized that client-oriented
financial services, such as underwriting and market making, are
critical to capital formation and can facilitate the provision of
market liquidity and that the ability to hedge is fundamental to
prudent risk management as well as capital formation.\862\
---------------------------------------------------------------------------
\862\ See, e.g., 79 FR at 5541, 79 FR at 5546, 79 FR at 5561.
---------------------------------------------------------------------------
In the proposal, the agencies stated that compliance with the
conditions of the underwriting and market making exemptions under the
2013 rule, such as RENTD, creates ambiguity for some market
participants, is over-reliant on historical demand, and necessitates an
accurate calibration of RENTD for different asset classes, time
periods, and market conditions.\863\ Since forecasting future customer
demand involves uncertainty, particularly in less liquid and more
volatile instruments and products, banking entity affiliated dealers
face uncertainty about the ability to rely on the underwriting and
market making exemptions. This uncertainty can reduce a banking
entity's willingness to engage in principal transactions \864\ with
customers, which, along with reducing profits, may reduce the volume of
transactions intermediated by banking entities.\865\
---------------------------------------------------------------------------
\863\ See, e.g., 83 FR at 33532.
\864\ Dealers can trade as agents, matching customer buys to
customer sells, or as principals, absorbing customer buys and
customer sells into inventory and committing the necessary capital.
\865\ See, e.g., 83 FR at 33532.
---------------------------------------------------------------------------
Moreover, consistent with the views of some commenters,\866\ the
SEC believes that, as a baseline matter, the 2013 rule creates
significant uncertainty among market participants regarding their
ability to rely on the risk-mitigating hedging exemption. For example,
there may be considerable uncertainty regarding whether a potential
hedging activity will continue to demonstrably reduce or significantly
mitigate an identifiable risk after it is implemented.\867\
Unforeseeable changes in market conditions and other factors could
reduce or eliminate the intended risk-mitigating effect of the hedging
activity, making it difficult for a banking entity to comply with the
continuous requirement that the hedging activity demonstrably reduce or
significantly mitigate specific, identifiable risks.\868\ According to
commenters, uncertainty and compliance burdens related to the risk-
mitigating hedging exemption are leading to less timely, less flexible,
and less efficient hedging.\869\
---------------------------------------------------------------------------
\866\ See, e.g., ABA.
\867\ See, e.g., 83 FR at 33465.
\868\ Id.
\869\ See, e.g., JBA and SIFMA.
---------------------------------------------------------------------------
The SEC continues to recognize that SEC-regulated entities
routinely engage in both static and dynamic hedging at the portfolio
(not the transaction) level and monitor and reevaluate on an ongoing
basis aggregate portfolio risk exposures, rather than the risk exposure
of individual transactions.\870\ Dynamic hedging may be particularly
common among dealers with large derivative portfolios, especially when
the values of these portfolios are nonlinear functions of the prices of
the underlying assets (e.g., gamma hedging of options).\871\ As a
baseline matter, the SEC notes that the 2013 rule permits dynamic
hedging. However, the 2013 rule requires the banking entity to document
and support its decisions regarding individual hedging transactions,
strategies, and techniques for ongoing activity in the same manner as
for its initial activities, rather than permitting a banking entity to
provide documentation for the hedging decisions regarding a portfolio
as a whole.
---------------------------------------------------------------------------
\870\ See, e.g., 83 FR at 33535.
\871\ Id.
---------------------------------------------------------------------------
The agencies have received a number of comments concerning the
baseline effects of section 13 of the BHC Act and the 2013 rule on
client facilitation activities, hedging, and market quality. The
agencies received comments that the 2013 rule maintains the depth and
liquidity of U.S. capital markets and that market liquidity remains
within historical norms; \872\ that there is no clear evidence that the
2013 rule has affected liquidity at a level that should cause concern;
\873\ and that liquidity may signal a bubble and should not be a key or
even a major metric in assessing the effects of reforms.\874\ Other
commenters stated that the 2013 rule has imperiled valuable market
making and risk-mitigating hedging and reduced market liquidity; \875\
that the prescriptive nature of the 2013 rule has raised costs of
providing liquidity, which has been passed along to investors and may
have exacerbated dislocations,\876\ and that less liquid capital
markets have made it difficult for derivative end-users to raise
capital in times of stress.\877\
---------------------------------------------------------------------------
\872\ See, e.g., NAFCU and CAP.
\873\ See, e.g., AFR and Occupy the SEC.
\874\ See, e.g., Public Citizen.
\875\ See, e.g., SIFMA and American Action Forum.
\876\ See, e.g., FSF and SIFMA.
\877\ See, e.g., Coalition for Derivative End Users.
---------------------------------------------------------------------------
The role of dealers in market making and client facilitation may be
more significant in dealer markets, such as derivative and corporate
bond markets. The SEC has elsewhere discussed several key changes in
liquidity in bond markets and security-based swaps after the financial
crisis. For example, the SEC found that, in corporate bond markets,
although estimated average transaction costs have decreased, trading
activity has become more concentrated in less complex bonds and bonds
with large issue sizes; that transaction costs have increased for some
subgroups of corporate bonds; and that dealers have, in aggregate,
reduced their capital commitment since its 2007 peak, consistent with
the claim that the Volcker Rule and other reforms potentially reduced
the liquidity provision in corporate bonds.\878\ The SEC recognizes
difficulties in causal attribution of the various provisions of section
13 of the BHC Act and the 2013 rule and notes that some studies do not
find significant structural breaks associated with post-crisis
financial regulations in several measures of market liquidity.\879\
However, the SEC continues to be informed by both comments discussed
above and a body of research drawing causal inference concerning the
adverse effects of section 13 of the BHC Act and the 2013 rule on
dealer provision of liquidity and on the risk of market dislocations in
times of stress.\880\
---------------------------------------------------------------------------
\878\ See SEC Report 2017, supra note 774, for a detailed data
analysis and literature survey.
\879\ See, e.g., Francesco Trebbi and Kairong Xiao, 2018,
Regulation and Market Liquidity, 6 Mgmt. Sci. 1949 (2019). The
generalizability of the paper's result is limited by the sample
period, which ends in December 2014 and before the full
implementation of the 2013 rule. For more methodological limitations
of this paper, such as heuristic choices of parameters, and crucial
assumptions, as well as other issues, see SEC Report 2017, supra
note 774, at 118-119. See also Tobias Adrian et al., Liquidity,
Leverage, and Regulation 10 Years After the Global Financial Crisis,
10 Ann. Rev. Fin. Econ. 1 (2018).
\880\ Id. See also 83 FR at 33520-33522, 33532-33533.
---------------------------------------------------------------------------
Importantly, the 2013 rule included a large number of requirements
and provisions, and aspects of the 2013 rule most likely to affect
banking entities' client facilitation activity (such as the RENTD
requirement for the underwriting and market making exemptions) are not
quantifiable or subject to public or regulatory reporting. As a result,
existing research primarily seeks to document trends in various aspects
of market liquidity in general and the effects of section 13 of the BHC
[[Page 62050]]
Act and the 2013 rule on dimensions of market liquidity in particular.
However, the most likely channels for the below effects of section 13
of the BHC Act and the 2013 rule on client facilitation activities are
the requirements for the exemptions (such as RENTD) and uncertainty
around the ability to rely on exemptions for client facilitation
activities.
As discussed below, several studies show significant declines in
various measures of liquidity after the financial crisis and post-
crisis reforms, including a recent study that ties the effects to the
underwriting exemption of the 2013 rule. In addition, some research
that reconciles the deterioration in dealer liquidity provision with
improvements in price-based measures of liquidity attributes those
effects to the reduced willingness of dealers to provide liquidity on a
principal basis after implementation of the 2013 rule. Further,
existing research suggests that the 2013 rule resulted in reduced
liquidity during times of stress, with an increase in liquidity
provision by dealers unaffiliated with banks failing to fully offset
the reduction in liquidity provision by bank-affiliated dealers.
Moreover, some research suggests that post-crisis financial reforms led
to persistent deviations from no-arbitrage conditions across markets,
with the effect driven by banking entities and levered nonbanking
entities that rely on systemically important banking entities for
funding liquidity. Finally, new evidence indicates that post-crisis
financial regulations may also be having effects on the co-movement in
liquidity metrics across markets. Though the research discussed below
is unable to attribute observed trends to specific provisions of the
2013 rule, these findings are largely consistent with the claim that
the 2013 rule had adverse effects on certain aspects of client
facilitation activity by banking entities, as discussed below.
A number of studies documented declines in several dimensions of
liquidity after the financial crisis and post-crisis reforms. For
example, one study \881\ finds that the willingness of dealers to
commit capital overnight, turnover, the frequency of block trades, and
average trade size have all declined after the financial crisis.
Importantly, the paper finds that the shift away from market-makers
absorbing customer imbalances and toward agency trading was most acute
when banks were required to comply with the proprietary trading
prohibition. Further, the paper finds that these declines in dealer
provision of liquidity stem from bank-affiliated dealers. The paper
concludes that post-crisis banking regulations, including the 2013
rule, contributed to the reductions in turnover, trade size, frequency
of block trades, and the willingness of dealers to commit capital.
---------------------------------------------------------------------------
\881\ See Hendrik Bessembinder et al., Capital Commitment and
Illiquidity in Corporate Bonds, 73 J. Fin. 1615 (2018). For a more
detailed discussion of the paper's limitations and caveats, see SEC
Report 2017, supra note 774, at 101-104.
---------------------------------------------------------------------------
Another paper \882\ examines the cost of immediacy in corporate
bonds, using index exclusions as a setting in which uninformed traders
exogenously demand immediacy. The paper finds that the cost of
immediacy has more than doubled and that dealers revert back to target
inventory far more quickly after the 2007-2008 financial crisis. The
paper finds that this post-crisis dealer behavior is most severe for
bank dealers and concludes that such changes are consistent with the
effects of the Volcker Rule.
---------------------------------------------------------------------------
\882\ See Jens Dick-Nielsen and Marco Rossi, The Cost of
Immediacy for Corporate Bonds, 32 Rev. Fin. Stud 1 (2019). For a
more detailed discussion, see SEC Report 2017, supra note 774, at
112-13.
---------------------------------------------------------------------------
Research on changes in liquidity around the post-crisis reforms,
including the 2013 rule, presents two seemingly contradictory results:
On the one hand, price-based measures of liquidity (such as the bid-ask
spread) have improved; on the other hand, measures of dealer liquidity
supply have significantly worsened.\883\ A few studies seek to
reconcile these two effects. One paper \884\ focuses on dealers'
willingness to provide liquidity in certain types of bonds out of
inventory. The paper finds that, when transacting in riskier and less
liquid bonds, dealers are significantly more likely to offset trades on
the same day instead of committing capital overnight. Specifically, the
paper documents that dealers offset approximately 75% of trades in the
lowest-rated, least-actively-traded bonds, but only 55% of trades in
the highest-credit-quality, most-actively-traded bonds. In addition,
liquidity provision out of inventory involves risk to the dealer--a
risk that is priced in higher transaction costs. As a result, a decline
in transaction costs in observed trades may be a reflection of the
decline in dealers' willingness to take certain groups of bonds into
inventory.
---------------------------------------------------------------------------
\883\ See, e.g., SEC Report 2017, supra note 774, at 100-105.
\884\ See Michael Goldstein and Edith Hotchkiss, Providing
Liquidity in an Illiquid Market: Dealer Behavior in U.S. Corporate
Bonds, J. Fin. Econ. (2019) (in press) (accepted manuscript). See
also, e.g., SEC Report 2017, supra note 774, at 106-107.
---------------------------------------------------------------------------
Another study \885\ finds that, after the post-crisis banking
regulations, including the 2013 rule, customer provision of liquidity
has increased and, as a result, the paper posits that bid-ask spread
measures will necessarily underestimate the cost of dealer liquidity
provision. The paper estimates that, for a subset of large liquidity
demanding customer trades in which dealers provide liquidity from their
inventory, customers pay between 35% and 65% higher spreads after the
crisis than before the crisis.\886\ The paper concludes that a large
portion of liquidity provision has moved from dealers to large asset
managers and that the effect is consistent with the effects of tighter
banking regulations.
---------------------------------------------------------------------------
\885\ See Jaewon Choi and Yesol Huh, Customer Liquidity
Provision: Implications for Corporate Bond Transaction Costs, (Aug.
1, 2019) (working paper), last accessed 8/27/2019). For a more
detailed discussion, see, e.g., SEC Report 2017, supra note 774, at
117.
\886\ In contrast, Bessembinder et al. (2016) focuses on dealer-
to-customer principal trades and finds the average transaction cost,
particularly for small trades (less than $100,000) and large trades
(over $1,000,000), is lowest in the pre-crisis and regulation
periods. As the SEC stated elsewhere, the difference between these
two results may stem from different proxies for transaction costs
and the measurement of principal trading activity.
---------------------------------------------------------------------------
A recent paper \887\ focuses on the effects of the underwriting
exemption of the 2013 rule on trading by affected dealers.
Specifically, the paper examines changes in the trading and liquidity
of newly issued bonds that affected dealers have underwritten relative
to bonds that the dealers have not underwritten around the
implementation and conformance of the 2013 rule. This empirical design
accounts for potentially confounding dealer effects (as dealers trade
in bonds that they both underwrite and bonds that they do not) and bond
effects (as both underwriters and non-underwriters trade in a given
bond), and isolates the effects of the underwriting exemption in the
2013 rule from the effects of other bank regulations during the
implementation period of the 2013 rule. The paper estimates that dealer
markups have increased by between 42 and 43 basis points for fast
roundtrip trades (15 minutes or less) after April 2014, but finds that
the effect is transitional and disappears after August of 2015.
However, the paper estimates that the adverse effects on dealer markups
for slower roundtrip trades of between 15 minutes and 1 day--trades
that involve dealers absorbing trades into inventory--are both
economically significant and persist past the
[[Page 62051]]
implementation period (a range of 27-43 bps increase between April 2014
and July 2015, and a range of 18-35 basis point effect after July
2015).\888\ To rule out the selection explanation (that dealers post-
2013 rule simply pre-arrange more trades so the non-prearranged trades
become costlier), the paper tests changes in short-term, non-inventory
trades. The paper finds an increase in such trades around the effective
date of the 2013 rule, but no differences when conditioning on dealer
underwriting activity, and concludes that endogenous selection of time
in inventory cannot explain the above results. Moreover, the paper
finds that nonbanking dealers enjoy a significant increase in market
share after the conformance period, while bank-affiliated dealers lose
market share. Finally, the paper concludes that the 2013 rule increased
dealer trading risk on short round-trip trades (15 minutes or less),
estimating that the standard deviation of covered dealers' markups on
corporate bonds has risen by between 0.09 and 0.1.
---------------------------------------------------------------------------
\887\ See Meraj Allahrakha et al., The Effects of the Volcker
Rule on Corporate Bond Trading: Evidence from the Underwriting
Exemption (Off. of Fin. Research Working Paper 19-02, 2019)
available at https://www.financialresearch.gov/working-papers/files/OFRwp-19-02_the-effects-of-the-volcker-rule-on-corporate-bond-trading.pdf, last accessed 8/9/2019.
\888\ The paper also finds an increase of between 8% and 14% in
dealer markups on trades around the 60-day cutoff for the rebuttable
presumption in the 2013 rule. The paper acknowledges that this
result could be consistent with dealers conducting profitable
proprietary trades and holding positions past the 60-day rebuttable
presumption window but is cautious in interpreting the result given
the methodological limitations of its empirical design and very
small sample size that does not allow conclusive inference.
---------------------------------------------------------------------------
These results are subject to three primary caveats. First, the
paper relies on a relatively narrow measure of risk (the standard
deviation of dealer profits at the bond-month level). Unlike other
research discussed in this section, the paper does not examine changes
in the overall volume of trading activity, measures of downside risk at
the individual banking entity level, or commonality of risk exposures
among affected and unaffected dealers. Second, some of the paper's
tests are affected by small sample sizes, limiting inference related to
transitional and permanent effects of the 2013 rule in certain trades
(including the 15 minute-1 day subsample and the 60-90 day subsample).
Third, the paper recognizes that these results are specific to dealer
provision of liquidity in the corporate bond market, and may not extend
to trading by affected firms in other asset classes.
Other research helps inform the SEC's understanding of the effects
of section 13 of the BHC Act and the 2013 rule on liquidity in times of
stress. Specifically, there is growing evidence that liquidity
provision in times of stress may be adversely affected by post-crisis
reforms in general and the Volcker Rule in particular. Two studies
directly test the effects of the Volcker Rule on market making by
dealers in times of stress. One of the papers \889\ examines liquidity
during corporate bond downgrades that result in selling by certain
institutions. The paper suggests that dealers affected by the Volcker
Rule decreased market making in newly downgraded bonds, and that
unaffected dealers have not fully offset this decline. Moreover, the
paper rules out the alternative explanation that these changes are
attributable to other financial reforms, finding that the same effects
are present for dealers affected by the Volcker Rule but not
constrained by Basel III and Comprehensive Capital Analysis and Review
(CCAR) regulations. The paper isolates the effect in a relatively small
sample of bonds experiencing relatively large stress events (under
normal aggregate conditions). This methodological design reflects the
common tradeoff between a narrower empirical setting that enables
causal inference, and a larger sample that is less amenable to causal
interpretations.\890\
---------------------------------------------------------------------------
\889\ See Jack Bao et al., The Volcker Rule and Corporate Bond
Market Making in Times of Stress, 130 J. Fin. Econ. 95 (2018).
\890\ For a fulsome discussion of this and other issues and
limitations, see SEC Report 2017, supra note 774, at 109-11.
---------------------------------------------------------------------------
A related study \891\ compares liquidity during times of stress
before and after the crisis, and defines times of stress on the basis
of extreme increases in market-wide volatility (measured by the VIX
index), bond yield drops, and credit rating downgrades from investment
grade to speculative grade. While the study does not find that price-
based liquidity measures decreased around idiosyncratic shocks, the
study does find that the price impact of large trades surrounding
market-wide shocks has increased after the post-crisis financial
reforms relative to the pre-crisis period.\892\
---------------------------------------------------------------------------
\891\ See Mike Anderson & Ren[eacute] Stulz, Is Post-Crisis Bond
Liquidity Lower? (Dice Ctr. Working Paper 2017-09, 2017) last
accessed 6/3/2019.
\892\ Consistent with these results, Goldstein and Hotchkiss
(2019) finds that on days with large VIX increases, dealers tend to
offset trades more quickly even for highly rated bonds that they
normally would take into inventory. For a more detailed discussion,
see SEC Report 2017, supra note 774, at 114-15.
---------------------------------------------------------------------------
A recent report by the International Organization of Securities
Commissions (IOSCO)'s Committee on Emerging Risks examined changes in
bond market liquidity focusing on stressed conditions.\893\ The report
notes that the most significant effect of post-crisis financial reforms
and reduction in dealer risk appetite is the decline in the capacity of
dealers to intermediate transactions on a principal basis, combined
with a drastic increase in the size of the market. The report concludes
that such effects mean the lack of liquidity in times of stress is
likely to be more acute than in past episodes of stressed conditions.
---------------------------------------------------------------------------
\893\ See OICU-IOSCO, 2019, Liquidity in Corporate Bond Markets
Under Stressed Conditions, FR079/2019, May. Available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD634.pdf, last accessed 7/1/
2019.
---------------------------------------------------------------------------
One of the important results identified in this literature is the
finding that nonbank dealers may step in but may not fully offset the
decline in the liquidity provision of bank dealers caused by section 13
of the BHC Act and the 2013 rule.\894\ New research suggests that the
fundamental mechanism behind this result may be the effect of other
post-crisis regulations on the ability of bank dealers to provide
funding liquidity to nonbank intermediaries.\895\ Specifically, the
paper examines the interplay between post-crisis bank regulations,
including the Volcker Rule, the supplementary leverage ratio, the
liquidity coverage ratio, and the net stable funding ratio, and their
effects on the ability of nonbank intermediaries to arbitrage away
mispricing. The paper finds that the profitability of classic arbitrage
trades (on-the-run/off-the-run, Treasury-interest swap, CDS-bond basis,
and single name-index CDS arbitrage trades) is significantly lower
under the supplementary leverage ratio, liquidity coverage ratio, and
net stable funding ratio components of Basel III compared with Basel
II. In addition, using a differences-in-differences estimation, the
paper finds that levered hedge funds relying on prime brokers that are
identified in the paper as globally systemically important banks
experience lower abnormal returns and a decline in assets under
management. The paper concludes that the effects of post-crisis
regulations affect not only bank intermediation but also the ability of
private funds to rely on banks for funding liquidity supporting
arbitrage strategies. The paper notes that the supplementary leverage
ratio and the net stable funding ratio disincentivize
[[Page 62052]]
low margin activities and a reliance on short-term funding, such as
repo, and that the liquidity coverage ratio incentivizes holdings of
more liquid securities. The paper concludes that Basel III is the
regulation with the biggest effect on the profitability of trades
exploiting arbitrage opportunities.\896\
---------------------------------------------------------------------------
\894\ As discussed above, when examining informed trading of
advisor banks in options on the stocks of client firms, Lowry et al.
(2018) finds that informed trading by hedge funds increases
simultaneously with a decrease in informed trading by banks around
the enactment of section 13 of the BHC Act. See Michelle Lowry et
al., Informed Trading By Advisor Banks: Evidence from Options
Holdings, 32 Rev. Fin. Stud 605 (2018).
\895\ See Boyarchenko, Eisenbach, Gupta, Shachar, and Van
Tassel, 2018, ``Bank Intermediated Arbitrage,'' Federal Reserve Bank
of New York Staff Report No. 858, last accessed 6/3/2019.
\896\ These findings are also consistent with another paper that
finds an exogenous increase in the leverage ratio constraint in the
UK to have reduced repo market liquidity--an effect especially
pronounced in transactions between dealers and small customers. See
Antonis Kotidis and Neeltje Horen, Repo Market Functioning: The Role
of Capital Regulation (2018) (working paper) last accessed June 3,
2019.
---------------------------------------------------------------------------
Post-crisis regulations may also be having effects on the co-
movement \897\ in liquidity metrics across markets. A recent paper
\898\ exploring this issue posits two channels for this increased co-
movement in liquidity. First, liquidity supply is capital intensive,
and absorbing trades into inventory in one risky asset class may use up
the capital capacity of a dealer to provide liquidity in other assets.
Basel III and liquidity requirements for banks may aggravate this
effect. Second, bank dealers may face uncertainty about their ability
to rely on the market making exemption in the 2013 rule, as the
distinctions between prohibited proprietary trading and permissible
market making may often be unclear. As discussed above, prior studies
suggest that the 2013 rule may have reduced the inventory capacity of
bank dealers. Empirically, the paper documents that co-movement among
measures of illiquidity of stock, bond, and CDS markets has risen
significantly after the 2007-2008 financial crisis, particularly during
the regulatory implementation period. For example, the regulatory
period is characterized by a much larger fraction of firms exhibiting
positive pairwise correlations between measures of illiquidity. The
paper concludes that the 2013 rule and the tightening of capital and
liquidity regulations reduced the inventory capacity of market makers,
resulting in higher co-movement in liquidity across various financial
markets. Importantly, the paper argues that these results are not
consistent with increased electronic trading as that would have
resulted in a reduced reliance on market makers and an increased
reliance on customers, which should have reduced (instead of increased)
co-movement in liquidity across markets.
---------------------------------------------------------------------------
\897\ Co-movement in two variables generally refers to a
positive correlation of changes in the two variables over time. For
example, co-movement in returns refers to a pattern of positive
correlation in returns among different securities or asset classes.
Similarly, co-movement in liquidity metrics suggests a positive
correlation of changes in liquidity metrics. See, e.g., Nicholas
Barberis et al., Co-movement, 75 J. Fin. Econ. 283 (2005).
\898\ See Xinjie Wang et al., Do Post-Crisis Regulations Affect
Market Liquidity? Evidence from the Co-Movement of Stock, Bond, and
CDS Illiquidity (2018) (working paper) last accessed 6/3/2019.
---------------------------------------------------------------------------
With respect to liquidity in the dealer-centric, single-name CDS
market, the SEC elsewhere found that, while dealer-customer activity
and various trading activity metrics have generally remained stable,
interdealer trading, trade sizes, number of quotes, and quoted spreads
for certain illiquid borrowers have worsened since 2010.\899\ In
addition, a recent paper \900\ seeks to tie financial reforms to trends
in liquidity in the single-name CDS markets. Specifically, the paper
finds that the sample period (2010 through 2016) saw a decline in
interdealer trading, a decrease in net dealer inventories, and a
decline in customer transaction volume. In addition, bid-ask spreads in
later years are more heavily dependent on individual dealer inventories
rather than aggregate inventories of all dealers. Notably, the paper
does not estimate the optimal volume of trading activity. Overall, the
paper concludes that increased costs of market making have affected
liquidity provision in the single-name CDS market.
---------------------------------------------------------------------------
\899\ See SEC Report 2017, supra note 774.
\900\ See Mark Paddrik and Stathis Tompaidis, Market Making
Costs and Liquidity: Evidence from CDS Markets (Off. of Fin.
Research Working Paper 19-01, 2019) available at https://www.financialresearch.gov/working-papers/files/OFRwp-19-01_Market-Making-Costs-and-Liquidity-Evidence-from-CDS-Markets.pdf, last
accessed 7/5/2019.
---------------------------------------------------------------------------
While these studies are necessarily limited in scope, methodology,
and measurement, their results may indicate that section 13 of the BHC
Act and the 2013 rule may have reduced dealer provision of liquidity,
particularly in times of stress.\901\ There is little empirical
evidence concerning whether customers will continue to provide
liquidity in times of severe market stress, possibly since such
empirical settings are scarce in the post-crisis period. One recent
paper builds a theoretical model \902\ that suggests that constraints
on dealer balance sheets may benefit customers and reduce transaction
costs as they can induce dealers to invest in technology designed to
match customers to each other. However, this model does not explicitly
examine dealer behavior in times of stress. In addition, the results
rely on strong modeling assumptions. The model assumes that only bank
dealers are able to develop technology to match customers and assumes
away the role of an inter-dealer market or competition among dealers in
the interdealer market. If these assumptions are violated, it is
unclear whether the results will continue to hold. For example, if
nonbank dealers (as well as bank dealers) can develop customer matching
technology, constraining dealer balance sheets may not be necessary for
the development of technology matching customers to other customers or
the disintermediation of trading, with its resulting welfare
improvements. Similarly, in the presence of an interdealer market,
constraining dealer balance sheets may benefit customers by
facilitating customer-to-customer trading but may also reduce the
ability of dealers to demand liquidity from other dealers.
---------------------------------------------------------------------------
\901\ See, e.g., supra notes 881, 887, 889, and 891.
\902\ See Gideon Saar et al., From Market Making to Matchmaking:
Does Bank Regulation Harm Market Liquidity? (May 22, 2019) (working
paper) last accessed June 3, 2019.
---------------------------------------------------------------------------
Moreover, as discussed above, existing research suggests that non-
dealer institutions may be constrained in their ability to secure
funding from prime brokers that are affected by post-crisis
regulations, limiting the ability of non-dealers to arbitrage away
mispricings. It is even less clear whether customers would be willing
and able to secure funding liquidity and stand on the buy side of
customer sells during severe market stress across asset markets.
Finally, the agencies also received comment that end-users are
increasingly finding that their bank counterparties have reduced short-
term lending and repo activity, while other end-users are experiencing
higher discounts to posted collateral as a result of the 2013
rule.\903\ The SEC is informed by research on the effects of the
constraints dealers face as a result of post-crisis regulations and
liquidity provision.\904\ One particular study on this issue \905\
finds that dealer balance sheet constraints have broad market-wide
effects on bond liquidity beyond the liquidity of bonds with a
particular credit rating, sector, or issue size. The paper finds that,
prior to the crisis, bonds were more liquid when they were traded by
more levered dealers, dealers with higher return on assets and lower
vulnerability
[[Page 62053]]
(measured by conditional value-at-risk),\906\ dealers with lower risk-
weighted assets, and dealers with relatively low reliance on repo.
However, during the rule implementation period (post-2014) these
results have reversed, and bonds are more liquid when they are traded
by less-levered dealers, dealers with lower return on assets, dealers
with higher risk-weighted assets, and dealers with more reliance on
repo funding. Finally, unlike the pre-crisis period, during the rule
implementation period (post-2014), dealers with more reliance on repo
funding, with higher trading revenues, with larger maturity mismatches,
with higher measures of vulnerability, and with fewer assets held as
loans are less likely to accommodate customer order flow and are more
likely to access the interdealer market instead. Though these results
do not speak to dealer behavior in times of stress, they are based on a
substantially larger sample compared with the discussed above work
showing liquidity declines in times of stress. Overall, while the paper
does not delineate the effects of the Volcker Rule from other post-
crisis regulations (such as the supplemental leverage ratio), the
paper's findings indicate that tightening of dealer balance sheet
constraints due to the package of post-crisis financial regulations may
adversely affect the ability of affected dealers to intermediate
customer trading in bond markets.
---------------------------------------------------------------------------
\903\ See Coalition for Derivatives End Users.
\904\ For a more general model of the links between repo market
frictions and liquidity in underlying cash markets see, e.g., Yesol
Huh and Sebastian Infante, Bond Market Intermediation and the Role
of Repo (Oct. 22, 2018) (working paper) last accessed 6/3/2019.
\905\ See Tobias Adrian et al., Dealer Balance Sheets and Bond
Liquidity Provision, 89 J. Monetary Econ. 92 (2017).
See also SEC Report 2017, supra note 774, at 115-16.
\906\ See Tobias Adrian and Markus Brunnermeier, CoVar, 106 Am.
Econ. Rev. 1705 (2016).
---------------------------------------------------------------------------
The SEC also recognizes that the effects of the 2013 rule on the
ability and willingness of banks to engage in repo activity may be
compounded by other post-crisis reforms. For example, one study \907\
focuses on the effects of the liquidity coverage ratio, exploiting
cross-country differences in the implementation of the rule. The paper
finds that, as a result of the liquidity coverage ratio, U.S. dealers
reduced their reliance on repo in funding high-quality liquid assets by
more, and increased the maturity of lower-quality-collateral repos by
more, than did foreign dealers.
---------------------------------------------------------------------------
\907\ See Marco Macchiavelli and Luke Pettit, Liquidity
Regulation and Financial Intermediaries (Jul. 29, 2019) (working
paper) last accessed 8/29/2019.
---------------------------------------------------------------------------
Importantly, reduced ability and willingness to engage in repo
activity are likely to have downstream effects on customers and market
quality. For example, a paper \908\ recently showed that dealers'
ability to rely on repos to finance bond inventory has an effect on
bid-ask spreads and bond transaction costs; that dealers with less
access to funding liquidity are less likely to provide liquidity on a
principal basis and are more likely to trade on an agency basis
instead; and that funding liquidity has causal effects on bond market
liquidity.
---------------------------------------------------------------------------
\908\ See Marco Macchiavelli and Xing Zhou, Funding Liquidity
and Market Liquidity: The Broker-Dealer Perspective (Jul. 17, 2019)
(working paper) last accessed 8/29/2019.
---------------------------------------------------------------------------
As discussed above, corporate bond dealers, particularly bank-
affiliated dealers, may have, on aggregate, reduced their capital
commitment post-crisis--a result that is consistent with a reduction in
liquidity provision in corporate bonds because of the 2013 rule. In
addition, the 2013 rule may have resulted in many corporate bond
dealers shifting from trading in a principal capacity to agency
trading. Moreover, corporate bond dealers may decrease liquidity
provision during certain times of stress in general (e.g., during a
financial crisis) \909\ and after the 2013 rule in particular, as
discussed above. Nonbank dealers and non-dealer intermediaries may not
have fully offset the shortfall in liquidity provision, partly because
of their reliance on funding from financial institutions affected by
post-crisis financial reforms.
---------------------------------------------------------------------------
\909\ Dealers provide less liquidity to clients and peripheral
dealers during stress times; during the peak of the crisis, core
dealers charged higher spreads to peripheral dealers and clients but
lower spreads to dealers with whom they had strong ties. See Marco
Di Maggio et al., The Value of Trading Relationships in Turbulent
Times, 124 J. Fin. Econ. 266 (2017). See also Jaewon Choi and Or
Shachar, Did Liquidity Providers Become Liquidity Seekers? (Oct.,
2013), New York Fed Staff Report No. 650.
---------------------------------------------------------------------------
The SEC recognizes that the effects of the 2013 rule on the
activities of banking entities and conflicts of interest may flow
through to SEC-registered dealers and investment advisers affiliated
with banks and bank holding companies directly (if banks and holding
companies transact through their dealer affiliates) and indirectly
(e.g., through effects on capital requirements, profitability,
compliance systems, and policies and procedures), and may have an
effect on securities markets. As discussed in the proposal,\910\ the
presence and magnitude of spillover effects across different types of
financial institutions vary over time and may be more significant in
times of stress.\911\
---------------------------------------------------------------------------
\910\ See 83 FR at 33534.
\911\ See, e.g., Monica Billio et al., Econometric Measures of
Connectedness and Systemic Risk in the Finance and Insurance
Sectors, 104 J. Fin. Econ. 535 (2012). See also Zeno Adams et al.,
Spillover Effects Among Financial Institutions: A State-Dependent
Sensitivity Value at Risk Approach (SDSVar), 49 J. Fin. &
Quantitative Analysis 575 (2014). See also Adrian and Brunnermeier
(2016) supra note 906.
---------------------------------------------------------------------------
iv. Compliance Burdens, Profitability, and Competitive Effects
In the proposal, the SEC recognized that the scope and breadth of
the compliance obligations impose costs on banking entities, which may
be particularly important for smaller entities.\912\ The SEC noted
commenters' estimates that banking entities may have added as many as
2,500 pages of policies, procedures, mandates, and controls per
institution for the purposes of compliance with the 2013 rule, which
need to be monitored and updated on an ongoing basis, and that some
banking entities may spend, on average, more than 10,000 hours on
training each year. In terms of ongoing costs, in the proposal the SEC
noted a market participant's estimate that some banking entities may
have 15 regularly meeting committees and forums, with as many as 50
participants per institution dedicated to compliance with the 2013
rule.
---------------------------------------------------------------------------
\912\ See, e.g., 83 FR at 33550.
---------------------------------------------------------------------------
In connection with the proposal, the agencies have received a
number of comments on the compliance burdens of the 2013 rule. Some
commenters presented trends in bank profitability, trading revenue, and
loan growth, arguing that the proposed amendments are unnecessary.\913\
Others indicated that the Volcker Rule may reduce bank profits due to
the elimination of proprietary trading but that lost profits are not
costs but intended regulatory effects of section 13 of the BHC
Act.\914\
---------------------------------------------------------------------------
\913\ See, e.g., Volcker Alliance and AFR.
\914\ See, e.g., Occupy the SEC.
---------------------------------------------------------------------------
[[Page 62054]]
In response to those comments, the SEC continues to note that the
scope of this economic analysis is limited to SEC registrants, and
securities markets and their participants. Importantly, trends in
profitability are not informative of the direct causal effect on
profitability or compliance burdens of section 13 of the BHC Act or of
the 2013 rule, since there is no data about the amount of revenue or
compliance burdens that would have occurred in the absence of the 2013
rule. Moreover, the agencies have received a number of comments
pointing to large and significant burdens of section 13 of the BHC Act
and various components of the agencies' 2013 rule. For example, one
commenter estimated that proprietary trading requirements related to
RENTD involved annual costs of as much as about $513 million; that the
metrics-related policies and procedures requirements involved initial
burdens of approximately $41.5 million; that total compliance
expenditures of affected entities (including with respect to covered
funds) totaled between $402 million and $541 million; and that covered
funds requirements involved a cost of between $152 million and $690
million.\915\ Another commenter estimated that, for at least one
banking entity, sorting counterparties into customers and non-customers
for the purposes of calculating RENTD requires dozens of employees
spending thousands of hours in initial and ongoing burdens.\916\
Another commenter stated that simplifying covered funds requirements
would eliminate thousands of unnecessary hours in compliance burdens
related to activities that do not raise the concerns intended to be
addressed by section 13 of the BHC Act.\917\ One trade organization
indicated that duplicative examinations drastically increase burdens on
registrants, estimating that in 2016 members of the organization spent
in aggregate over 50,000 hours responding to inquiries and examinations
related to section 13 of the BHC Act.\918\
---------------------------------------------------------------------------
\915\ See Data Boiler, citing its own analysis as well as SIA
Partners Briefing Note, July 2015, ``Volcker Implementation,''
available at https://en.finance.sia-partners.com/sites/default/files/post/sia_partners_-_briefing_note_volcker_coveredfunds_blog_version.pdf, last accessed
6/4/2019.
\916\ See CCMC.
\917\ See SFIG.
\918\ See SIFMA.
---------------------------------------------------------------------------
Moreover, the SEC notes that risk-averse market participants are
compensated for bearing greater systematic \919\ risks with higher
expected returns.\920\ If capital markets have a high degree of
efficiency and arbitrage opportunities are generally scarce, greater
profitability may simply be indicative of greater risks taken on by
banking entities. Setting aside the challenges of causal inference
discussed above, trends in bank profitability may reflect not only
compliance burdens of the 2013 rule, but also the effects of the 2013
rule on banking entity risk exposures from permissible activities. That
is, banking entities may have become more willing to take risk through
engaging in activities permitted by the 2013 rule. For more discussion
of the existing evidence on the effects of the 2013 rule on the
activities of banking entities, see the preceding sections of the
economic baseline.
---------------------------------------------------------------------------
\919\ The term ``systematic risk'' generally refers to the
variability of returns due to macroeconomic factors that affect all
risky assets and, thus, cannot be eliminated by diversification. See
Frank Reilly & Keith Brown, Investment Analysis & Portfolio
Management, 1025 (9th ed. 2009). See also Bodie, supra note 840, at
G-12.
\920\ See supra note 840.
---------------------------------------------------------------------------
The agencies also received a number of comments concerning the need
to tailor regulations to banking entities on the basis of risk profile
in order to balance the intended regulatory goals with compliance
burdens and competitive effects. Specifically, a number of commenters
supported tailoring the 2013 rule to more effectively accomplish the
underlying goals of section 13 of the BHC Act, reduce unnecessary
compliance burdens, particularly on smaller and mid-sized banking
entities and entities with small trading books, and more effectively
allocate supervisory resources to prudential goals.\921\
---------------------------------------------------------------------------
\921\ See, e.g., IIB; CCMC; CREFC; CCMR; Covington; Capital One
et al. and Credit Suisse.
---------------------------------------------------------------------------
The SEC continues to believe that the compliance regime under the
2013 rule and related burdens reduce the profitability of permissible
activities by bank-affiliated dealers and investment advisers and may
be passed along to customers or clients in the form of reduced
provision of services or higher service costs.\922\ Moreover, the SEC
continues to believe that the extensive compliance program under the
2013 rule detracts resources of some banking entities and their
compliance departments and supervisors from other compliance matters,
risk management, and supervision. Finally, the SEC continues to believe
that prescriptive compliance requirements may not optimally reflect the
organizational structures, governance mechanisms, or risk management
practices of complex, innovative, and global banking entities.
---------------------------------------------------------------------------
\922\ See 83 FR at 33550.
---------------------------------------------------------------------------
In the sections that follow the SEC discusses rule provisions of
the 2013 rule, how each amendment in the final rule changes the
economic effects of the regulatory requirements, and the anticipated
costs and benefits of the amendments.
c. Affected Participants
The SEC-regulated entities directly affected by the final rule
include broker-dealers, security-based swap dealers, and investment
advisers.
i. Broker-Dealers \923\
---------------------------------------------------------------------------
\923\ These estimates differ from the estimates in the proposal
and in the EGRRCPA Conforming Amendments Adopting Release, as these
estimates rely on more recent data and information about both U.S.
and global trading assets and liabilities of bank holding companies.
This analysis is based on data from Reporting Form FR Y-9C for
domestic holding companies on a consolidated basis and Report of
Condition and Income for banks regulated by the Board, FDIC, and OCC
for the most recent available four-quarter average, as well as data
from S&P Market Intelligence LLC on the estimated amount of global
trading activity of U.S. and non-U.S. bank holding companies.
Broker-dealer bank affiliations were obtained from the Federal
Financial Institutions Examination Council's (FFIEC) National
Information Center (NIC). Broker-dealer assets and holdings were
obtained from FOCUS Report data for Q4 2018.
---------------------------------------------------------------------------
Under the 2013 rule, some of the largest SEC-regulated broker-
dealers are banking entities because they are affiliated with banks or
bank holding companies. Table 1 reports the number, total assets, and
holdings of broker-dealers by the broker-dealer's bank affiliation.
[[Page 62055]]
While the 199 bank-affiliated broker-dealers subject to the 2013
rule (affected broker-dealers) are greatly outnumbered by the 3,595
broker-dealers that are either bank broker-dealers exempt under section
203 of EGRRCPA or nonbank broker-dealers, the affected broker-dealers
dominate other broker-dealers in terms of total assets (72.7% of total
broker-dealer assets) and aggregate holdings (66.5% of total broker-
dealer holdings).
Table 1--Broker-Dealer Count, Assets, and Holdings by Affiliation
----------------------------------------------------------------------------------------------------------------
Holdings
Broker-dealer bank affiliation Number Total assets, Holdings, $mln (altern.),
$mln \924\ \925\ $mln \926\
----------------------------------------------------------------------------------------------------------------
Bank broker-dealers affected by the final rule 199 3,142,780 761,532 567,387
\927\..........................................
All other broker-dealers \928\.................. 3,595 1,179,805 382,451 225,675
---------------------------------------------------------------
Total....................................... 3,794 4,322,586 1,143,983 793,062
----------------------------------------------------------------------------------------------------------------
Some of the amendments to the 2013 rule that the agencies are
adopting differentiate banking entities on the basis of their
consolidated trading assets and liabilities.\929\ Table 2 reports
affected broker-dealer counts, assets, and holdings by consolidated
trading assets and liabilities of the (top-level) parent firm. The SEC
estimates that 163 broker-dealer affiliates of firms with less than $20
billion in consolidated trading assets and liabilities account for
20.4% of bank-affiliated broker-dealer assets and 17.8% of holdings (or
7% using the alternative measure of holdings).\930\
---------------------------------------------------------------------------
\924\ Broker-dealer total assets are based on FOCUS report data
for ``Total Assets.''
\925\ Broker-dealer holdings are based on FOCUS report data for
securities and spot commodities owned at market value, including
bankers' acceptances, certificates of deposit and commercial paper,
state and municipal government obligations, corporate obligations,
stocks and warrants, options, arbitrage, other securities, U.S. and
Canadian government obligations, and spot commodities.
\926\ This alternative measure excludes U.S. and Canadian
government obligations and spot commodities.
\927\ This category includes all bank-affiliated broker-dealers
except those exempted by section 203 of EGRRCPA.
\928\ This category includes both bank affiliated broker-dealers
subject to section 203 of EGRRCPA and broker-dealers that are not
affiliated with banks or holding companies.
\929\ See, e.g., 2013 rule Sec. __.20(d)(1).
\930\ See supra note 926.
\931\ This analysis excludes SEC-registered broker-dealers
subject to section 203 of EGRRCPA.
\932\ Consolidated trading assets and liabilities are estimated
using information reported in form FR Y-9C data and from S&P Market
Intelligence LLC on the estimated amount of global trading activity
provided for U.S. and non-U.S. firms. These estimates exclude from
the definition of consolidated trading assets and liabilities
government, agency, and GSE securities. U.S. trading assets and
liabilities are calculated on the basis of the most recent four-
quarter average, except for foreign firms without an intermediate
holding company, for which the amount of trading activity for the
nonbank and edge subsidiaries does not exclude securities of
government-sponsored enterprises. For top-tier bank holding
companies, top-tier independent depositary institutions, and foreign
parents with U.S. activity, Ginnie Mae securities are included in
the calculation of trading assets and liabilities because of data
limitations. (It is not possible to exclude Ginnie Mae securities
without also excluding Fannie Mae and Freddie Mac securities.)
Table 2--Broker-Dealer Counts, Assets, and Holdings by Consolidated Trading Assets and Liabilities of the Banking Entity \931\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total assets, Holdings
Consolidated trading assets and liabilities \932\ Number $mln Percent Holdings, $mln Percent (altern.), $mln Percent
--------------------------------------------------------------------------------------------------------------------------------------------------------
>=50bln............................................ 28 2,152,225 68 555,787 73 510,325 90
20bln-50bln........................................ 8 349,716 11 70,054 9 17,611 3
10bln-20bln........................................ 9 198,895 6 49,797 7 13,301 2
5bln-10bln......................................... 24 261,622 8 55,316 7 14,295 3
1bln-5bln.......................................... 33 66,583 2 18,319 2 4,998 1
<=1bln............................................. 97 113,740 4 12,259 2 6,857 1
----------------------------------------------------------------------------------------------------
Total.......................................... 199 3,142,780 100 761,532 100 567,387 100
--------------------------------------------------------------------------------------------------------------------------------------------------------
ii. Security-Based Swap Dealers
The final rule may also affect bank-affiliated SBSDs. As compliance
with SBSD registration requirements is not yet required, there are
currently no registered SBSDs. However, the SEC has previously
estimated that as many as 50 entities may potentially register as
security-based swap dealers and that as many as 16 of these entities
may already be SEC-registered broker-dealers.\933\ Similarly, the SEC
previously estimated that between 0 and 5 entities may register as
Major Security-Based Swap Participants (MSBSPs).\934\ On the basis of
the analysis of TIW transaction and positions data on single-name
credit-default swaps, the SEC believes that all entities that may
register with the SEC as SBSDs are bank-affiliated firms, including
those that are SEC-registered broker-dealers. Therefore, the SEC
estimates that, in addition to the bank-affiliated SBSDs that are
already registered as broker-dealers and included in the discussion
above, as many as 34 other bank-affiliated SBSDs may be affected by
these amendments. Similarly, on the basis of the analysis of TIW data,
the SEC estimates that none of the entities that may register with the
SEC as MSBSPs are affected by the final rule.
---------------------------------------------------------------------------
\933\ See Capital, Margin, Segregation Adopting Release, 84 FR
at 43960.
\934\ Id.
---------------------------------------------------------------------------
Importantly, compliance with capital and other substantive
requirements for SBSDs under Title VII of the Dodd-Frank Act is not yet
required.\935\ The SEC recognizes that firms may choose to move
security-based swap trading activity into (or out of) an affiliated
bank or an affiliated broker-dealer instead of registering as a
standalone SBSD, if bank or broker-dealer capital and other regulatory
requirements are less (or more) costly than those that may be imposed
on SBSDs under Title VII. As a result, the above figures may
[[Page 62056]]
overestimate or underestimate the number of SBSDs that are not broker-
dealers and that may become SEC-registered entities affected by the
final rule. Quantitative cost estimates are provided separately for
affected broker-dealers and potential SBSDs.
---------------------------------------------------------------------------
\935\ Id.
---------------------------------------------------------------------------
iii. Private Funds and Private Fund Advisers \936\
---------------------------------------------------------------------------
\936\ These estimates are calculated from Form ADV data as of
March 31, 2019. An investment adviser is defined as a ``private fund
adviser'' if it indicates that it is an adviser to any private fund
on Form ADV Item 7.B. An investment adviser is defined as a ``bank-
affiliated RIA'' if it indicates on Form ADV Item 6.A.(7) that it is
actively engaged in business as a bank, or it indicates on Form ADV
Item 7.A.(8) that it has a ``related person'' that is a banking or
thrift institution. For purposes of Form ADV, a ``related person''
is any advisory affiliate and any person that is under common
control with the adviser. The definition of ``control'' for purposes
of Form ADV, which is used in identifying related persons on the
form, differs from the definition of ``control'' under the BHC Act.
In addition, this analysis does not exclude SEC-registered
investment advisers affiliated with banks that have consolidated
total assets less than or equal to $10 billion and trading assets
and liabilities less than or equal to 5% of total assets. Thus,
these figures may overestimate or underestimate the number of bank-
affiliated RIAs.
---------------------------------------------------------------------------
This section focuses on RIAs advising private funds. Using Form ADV
data, Table 3 reports the number of RIAs advising private funds by fund
types, as those types are defined in Form ADV. Table 4 reports the
number and gross assets of private funds advised by RIAs and separately
reports these statistics for bank-affiliated RIAs. As can be seen from
Table 3, the two largest categories of private funds advised by RIAs
are hedge funds and private equity funds.
Bank-affiliated RIAs advise a total of 4,316 private funds with
approximately $2 trillion in gross assets. Per Form ADV data, bank-
affiliated RIAs' gross private fund assets under management are
concentrated in hedge funds and private equity funds. On the basis of
this data, bank-affiliated RIAs advise 929 hedge funds with
approximately $668 billion in gross assets and 1,420 private equity
funds with approximately $395 billion in assets. While bank-affiliated
RIAs are subject to all of section 13's restrictions, because RIAs do
not typically engage in proprietary trading, the SEC continues to
believe that they will not be affected by the final rule as it relates
to proprietary trading.
Table 3--SEC-Registered Investment Advisers Advising Private Funds, by
Fund Type \937\
------------------------------------------------------------------------
Bank-
Fund type All RIA affiliated
RIA
------------------------------------------------------------------------
Hedge Funds............................. 2,656 154
Private Equity Funds.................... 1,644 98
Real Estate Funds....................... 526 52
Securitized Asset Funds................. 220 45
Liquidity Funds......................... 46 16
Venture Capital Funds................... 193 8
Other Private Funds..................... 1,066 146
-------------------------------
Total Private Fund Advisers......... 4,756 296
------------------------------------------------------------------------
Table 4--The Number and Gross Assets of Private Funds Advised by SEC-Registered Investment Advisers \938\
----------------------------------------------------------------------------------------------------------------
Number of private funds Gross assets, $bln
---------------------------------------------------------------
Fund type Bank- Bank-
All RIA affiliated RIA All RIA affiliated RIA
----------------------------------------------------------------------------------------------------------------
Hedge Funds..................................... 10,431 929 7,160 668
Private Equity Funds............................ 14,775 1,420 3,446 395
Real Estate Funds............................... 3,472 320 646 100
Securitized Asset Funds......................... 1,814 358 661 129
Liquidity Funds................................. 83 30 297 195
Venture Capital Funds........................... 1,201 43 136 3
Other Private Funds............................. 4,460 1,217 1,396 474
---------------------------------------------------------------
Total Private Funds......................... 36,230 4,316 13,741 1,964
----------------------------------------------------------------------------------------------------------------
In addition, for an additional period of 2 years until July 21,
2021, the banking agencies will not treat qualifying foreign excluded
funds that meet the conditions included in the policy statement
discussed above as banking entities or attribute their activities and
investments to the banking entity that sponsors the fund or otherwise
may control the fund under the circumstances set forth in the policy
statement.\939\
---------------------------------------------------------------------------
\937\ This table includes only the advisers that list private
funds on Section 7.B.(1) of Form ADV. The number of advisers in the
``Any Private Fund'' row is not the sum of the rows that follow,
since an adviser may advise multiple types of private funds. Each
listed private fund type (e.g., real estate fund, liquidity fund) is
defined in Form ADV, and those definitions are the same for purposes
of the SEC's Form PF.
\938\ Gross assets include uncalled capital commitments on Form
ADV.
\939\ See ``Statement regarding Treatment of Certain Foreign
Funds under the Rules Implementing Section 13 of the Bank Holding
Company Act,'' July 19, 2019, available at https://www.occ.gov/news-issuances/news-releases/2019/nr-ia-2019-79a.pdf, last accessed July
19, 2019.
---------------------------------------------------------------------------
iv. Registered Investment Companies
The potential that a registered investment company (RIC) or a
business development company (BDC) would be treated as a banking entity
where the fund's sponsor is a banking entity and holds 25% or more of
the RIC or BDC's voting securities after a seeding period also forms
part of the baseline. On the basis of Commission filings and public
data, the SEC estimates that, as of year-end 2018, there were
approximately
[[Page 62057]]
15,700 RICs \940\ and 104 BDCs. Although RICs and BDCs are generally
not banking entities themselves subject to the 2013 rule, they may be
indirectly affected by the 2013 rule and the final rule, for example,
if their sponsors or advisers are banking entities. For instance, bank-
affiliated RIAs or their affiliates may reduce their level of
investment in the funds they advise, or potentially close those funds,
to avoid those funds becoming banking entities themselves.
---------------------------------------------------------------------------
\940\ This estimate includes open-end companies, exchange-traded
funds, closed-end funds, and non-insurance unit investment trusts
and does not include fund of funds. The inclusion of fund of funds
increases this estimate to approximately 17,200.
---------------------------------------------------------------------------
v. Entities Reporting Metrics to the SEC \941\
---------------------------------------------------------------------------
\941\ The estimates in this section are based on Appendix A
information provided by reporters to the SEC under the 2013 rule at
the holding company level for April 2018 through March 2019, based
on the most complete filing for each reporting period. Appendix A
records for a particular trading desk are reported to the SEC if a
trading desk books activity into the SEC registrant.
---------------------------------------------------------------------------
The regulatory reporting requirements of the 2013 rule with respect
to bank-affiliated broker-dealers, SBSDs, and RIAs are described in
section V.F.2.a above. As discussed below, the final rule increases the
threshold for entities subject to metrics reporting from the $10
billion under the 2013 rule to $20 billion in trading assets and
liabilities. Moreover, the final amendments that link the trading desk
definition to the market risk capital rule have an effect on the volume
of reporting to the SEC and corresponding burdens.
The agencies have received a number of comments opposing the
proposed amendments to metrics reporting and challenging the agencies'
assessment of the proposed amendments.\942\ For example, one commenter
indicated that the SEC's assessment of the overall streamlining effects
of the amendments to metrics reporting and recordkeeping will not be
supported by a full-fledged cost-benefit analysis.\943\ Another
commenter stated that the proposal presented no analysis showing that
the benefits of eliminating some metrics outweigh the costs of imposing
new metrics.\944\ A number of commenters indicated that the agencies
should not adopt any of the proposed amendments to metrics reporting as
they would result in a significant net increase in metrics data.\945\
One commenter estimated that the proposed requirements would require
its member institutions to report hundreds of thousands of additional
data points each month.\946\ One commenter indicated that the extended
reporting timeframe for metrics submission is insufficient and frequent
resubmissions are likely to persist.\947\ In response to these comments
and to enable a quantification of the economic effects of the metrics
amendments on the volume and timeliness of metrics reporting, the SEC
is updating the economic baseline with summary information about the
current volume and resubmission statistics by different groups of
Appendix A filers.
---------------------------------------------------------------------------
\942\ See, e.g., ABA; Credit Suisse; CCMR; FSF, Public Citizen
and SIFMA.
\943\ See SIFMA Annex C.
\944\ See CCMR.
\945\ See, e.g., CCMC and FSF.
\946\ See FSF.
\947\ See SIFMA Annex C.
\948\ For the purposes of this analysis, each record is one line
of the matrix reported to the SEC, with the value filled out by the
reporting entity, on a monthly basis, for all its related trading
desks. The total number of records also includes the header, body,
and footer. Each submission is the full data matrix reported by the
reporting entity to the SEC for any specific reporting month.
Table 5--Volume of Metrics Records Submitted to the SEC, by Trading
Assets and Liabilities \948\
------------------------------------------------------------------------
Number of Records
Trading assets & liabilities reporters submitted
------------------------------------------------------------------------
>50bln.................................. 8 40,771,825
20bln-50bln............................. 4 7,357,794
<20bln.................................. 6 10,440,677
-------------------------------
Total............................... 18 58,570,296
------------------------------------------------------------------------
Table 6--Trading Desks Reporting Metrics to the SEC, by Trading Assets and Liabilities
----------------------------------------------------------------------------------------------------------------
Average Average
Average number of number of
Trading assets & liabilities number of records per records per
desks submission desk
----------------------------------------------------------------------------------------------------------------
>50bln.......................................................... 56 450,921 7,588
20bln-50bln..................................................... 43 195,010 5,172
<20bln.......................................................... 38 216,433 7,093
----------------------------------------------------------------------------------------------------------------
Table 7--Time Delays and Resubmissions of Metrics Records Submitted to the SEC
----------------------------------------------------------------------------------------------------------------
Percent of Percent of
Total number Percent of records records
Trading assets & liabilities of submitted records not resubmitted resubmitted
records resubmitted once twice
----------------------------------------------------------------------------------------------------------------
Panel A. Resubmissions of Initial Records
----------------------------------------------------------------------------------------------------------------
>50bln.......................................... 40,785,033 34 56 10
20bln-50bln..................................... 6,908,332 61 39 0
<20bln.......................................... 10,441,265 96 4 0
----------------------------------------------------------------------------------------------------------------
[[Page 62058]]
Average delay
Total records Average delay in initial
submitted late Percent of in initial submissions
Trading assets & liabilities (initial late initial submissions (days,
submission) submissions (days, simple weighted by
average) record count)
----------------------------------------------------------------------------------------------------------------
Panel B. Delayed Submission of Initial Records
----------------------------------------------------------------------------------------------------------------
>50bln.......................................... 4,771,713 12 2 2
20bln-50bln..................................... 4,020,778 58 32 32
<20bln.......................................... 10,437,647 99.97 46 42
----------------------------------------------------------------------------------------------------------------
The SEC notes two important caveats relevant for the interpretation
of these statistics. First, direct attribution of specific trading
activity by a trading desk to an SEC registrant or group of registrants
is not feasible, since the trading desk may book transactions into
multiple legal entities, including both those registered with the SEC
as well as those that are not registered. As a result, the scope of
activity reported in this section is likely to overestimate the records
and reporting by legal entities registered with the SEC. Second, the
SEC does not receive reporting from trading desks that do not transact
on behalf of SEC-registered entities. Therefore, these estimates may
significantly underestimate the overall volume of metrics reporting by
all banking entities (including those that are not registered with the
SEC) related to the 2013 rule.
3. Economic Effects
a. Treatment of Entities Based on the Size of Trading Assets and
Liabilities
As proposed, the agencies are adopting a categorization of banking
entities into three groups on the basis of the size of their trading
activity. Under the final rule, banking entities with significant
trading assets and liabilities (Group A entities) are required to
comply with a streamlined but comprehensive version of the 2013 rule's
compliance program requirements, as discussed below. Banking entities
with moderate trading assets and liabilities (Group B entities) are
subject to reduced requirements and an even more tailored approach in
light of their smaller trading activities. The burdens are further
reduced for banking entities with limited trading assets and
liabilities (Group C entities), for which the amendments establish a
presumption of compliance, which can be rebutted by the agencies. The
sections that follow discuss the economic effects of each of the
amendments on these groups of entities.
i. Costs and Benefits
First, banking entities with significant trading assets and
liabilities are defined as those that have, together with affiliates
and subsidiaries, trading assets and liabilities (excluding trading
assets and liabilities attributable to trading activities permitted
pursuant to Sec. __.6(a)(1) and (2) of subpart B) the average gross
sum of which, over the previous consecutive four quarters, as measured
as of the last day of each of the four previous calendar quarters,
equals or exceeds $20 billion.\949\ This $20 billion threshold is
higher than the threshold that the agencies proposed in the proposal.
Accordingly, more banking entities may qualify as Group B entities
rather than Group A entities (as compared to those that would have
qualified under the proposal's lower threshold), which will reduce
compliance burdens for more banking entities relative to the
proposal.\950\ The agencies received comments that a higher than the
proposed $10 billion trading assets and liabilities threshold would
provide Group B banking entities that are near or approaching $10
billion threshold with flexibility to have moderate growth over time
and to manage their business without triggering the more stringent
compliance requirements imposed on Group A banking entities.\951\ In
addition, some commenters stated that potential fluctuations resulting
from customer-driven trades, quarter-end activity, and market and
foreign exchange volatility may cause banking entities that are near or
approaching the $10 billion threshold to exceed this threshold.\952\
The SEC recognizes that fluctuations in customer demand or market
events may cause these banking entities to exceed the $10 billion
threshold temporarily or permanently, which could trigger a more
enhanced compliance regime and expose these banking entities to higher
compliance costs.\953\ Thus, a $20 billion threshold accounts for such
fluctuations and provides banking entities that are near or approaching
$10 billion in trading assets and liabilities with more certainty
regarding their compliance burdens.
---------------------------------------------------------------------------
\949\ With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, this
threshold for having significant trading assets and liabilities
applies according to the trading assets and liabilities of the
combined U.S. operations of the top-tier foreign banking
organization (including all subsidiaries, affiliates, branches, and
agencies of the foreign banking organization operating, located, or
organized in the United States).
\950\ The final rule defines banking entities with moderate
trading assets and liabilities as those that are neither banking
entities with significant trading assets and liabilities nor banking
entities with limited trading assets and liabilities.
\951\ See, e.g., Capital One et al.; ABA; BPI; and Custody
Banks.
\952\ See, e.g., Custody Banks and BPI.
\953\ See supra note 123.
---------------------------------------------------------------------------
Some commenters stated that changing the threshold from $10 to $20
billion would have minimal effect on the number of banking entities
that would remain categorized as having significant trading assets and
liabilities.\954\ The SEC estimates that there are 66 broker-dealers
with approximately 16% of all broker-dealer holdings (or 6% based on
the alternative measure) that would qualify as Group B entities with
the adopted $20 billion threshold--compared to 57 broker-dealers with
between 9% and 4% of all broker-dealer holdings that would have
qualified under the proposed threshold value. Thus, relative to the
proposal, 15 additional broker-dealers will experience the cost
reduction because of reduced compliance burdens.
---------------------------------------------------------------------------
\954\ See, e.g., ABA; Custody Banks; New England Council;
Capital One et al.; SIFMA; State Street and BPI.
---------------------------------------------------------------------------
Second, as in the proposal, the agencies are defining a banking
entity with limited trading assets and liabilities as a banking entity
that has, together with its affiliates and subsidiaries on a
consolidated basis, trading assets and liabilities (excluding trading
assets and liabilities attributable to trading activities permitted
pursuant to Sec. __.6(a)(1) and (2) of subpart B) the average gross
sum of which, over the previous consecutive four quarters, as measured
as of the last day of each of the four previous calendar quarters, is
[[Page 62059]]
less than $1 billion. However, in the proposal, the agencies proposed
this threshold to be calculated on the worldwide consolidated basis for
both foreign and domestic registrants. Unlike in the proposal, with
respect to a banking entity that is a foreign banking organization or a
subsidiary of a foreign banking organization, this threshold will be
applied on the basis of the combined U.S. operations of the top-tier
foreign banking organization (including all subsidiaries, affiliates,
branches, and agencies of the foreign banking organization operating,
located, or organized in the United States).
The SEC continues to recognize that the 2013 rule may have resulted
in significant compliance burdens for banking entities that do not have
significant U.S. operations, even though such entities may not pose
substantial risks to the U.S. financial system because of their limited
presence in the U.S. The SEC estimates that the adopted definition of
limited trading assets and liabilities will allow 97 broker-dealers to
reduce compliance costs related to the 2013 rule as a result of the
final rule's presumption of compliance. In contrast, if the final rule
adopted the proposed calculation of limited trading assets and
liabilities, some foreign broker-dealers would not qualify as those
affiliated with entities with limited trading assets and liabilities,
even though the entities these broker-dealers are affiliated with may
have very limited activity in the U.S.
Third, in the final rule the calculation of thresholds for limited
and significant trading assets and liabilities will exclude--in
addition to the proposed exclusion of trading assets and liabilities
involving obligations of, or guaranteed by, the United States, or any
agency of the United States--trading assets and liabilities involving
obligations, participations, or other instruments of, or issued or
guaranteed by, government-sponsored enterprises listed in Sec.
__.6(a)(2). Some commenters stated that the calculation of trading
assets and liabilities should exclude financial instruments that are
not regulated under the 2013 rule.\955\ The SEC recognizes that
inclusion of trading assets and liabilities involving obligations of,
participations by, or other instruments of, or issued or guaranteed by,
government-sponsored enterprises in the calculation of trading assets
and liabilities may inadvertently scope in entities whose trading
assets and liabilities primarily consist of financial instruments that
are excluded from the prohibition on proprietary trading under the 2013
rule.\956\ Accordingly, the final rule will better align the
application of the tiered compliance regime with trading activities
that are subject to the proprietary trading prohibitions. The SEC
estimates that the exclusion of the aforementioned trading assets and
liabilities from the calculation of the $1 billion and $20 billion
thresholds will not change the assignment of banking entities into the
tiered compliance groups.
---------------------------------------------------------------------------
\955\ See, e.g., KeyCorp; BMO and Capital One et al.
\956\ See Sec. __.6(a)(2).
---------------------------------------------------------------------------
The SEC continues to believe that the primary effect of these
amendments for SEC registrants is the reduced compliance burdens, as
discussed in more detail in later sections. To the extent that the
compliance costs are currently passed along to customers and
counterparties, some of the cost reductions for these entities
associated with the final rule may flow through to counterparties and
clients in the form of reduced transaction costs or a greater
willingness to engage in activity, including intermediation that
facilitates risk-sharing.
The SEC notes that, from above, Group B and Group C broker-dealers
currently account for approximately 7% to 18% of total bank broker-
dealer holdings and that, to the extent that holdings reflect risk
exposure resulting from trading activity, current trading activity by
Group B and Group C entities may represent lower risks than the risks
posed by Group A entities' trading activities addressed in the 2013
rule. In addition, the SEC continues to recognize that some Group B and
Group C entities that currently exhibit low levels of trading activity
because of the costs of compliance may respond to the final rule by
increasing their trading assets and liabilities while still remaining
under the $20 billion or $1 billion threshold, as applicable. Increases
in aggregate risk exposure by Group B and Group C entities may be
magnified if trading activity becomes more highly correlated among such
entities, or dampened if trading activity becomes less correlated among
such entities. Since it is difficult to estimate the number of Group B
and Group C entities that may increase the riskiness of their
activities and the degree to which their trading activity would be
correlated, the implications of this effect for aggregate risk and
capital market activity are unclear.
The shifts in risk exposure may have two competing effects. On the
one hand, if Group B and Group C entities are able to bear risk at a
lower cost than their customers, increased risk exposures could promote
secondary market trading activity and capital formation in primary
markets and increase access to capital for issuers, benefitting issuers
and investors. On the other hand, Group B and Group C firms may be
incentivized to increase their risk exposures, resulting in more
aggregate risk in the banking sector, greater market fragility, and
exacerbated conflicts of interest between banking entities and their
customers. This may ultimately adversely affect issuers and investors.
However, the SEC continues to recognize that the amendments are focused
on tailoring the compliance regime based on the amount of trading
activity engaged in by each banking entity, and all banking entities
would still be subject to the statutory prohibitions related to such
activities. Thus, the potential risk of increased market fragility and
the severity of conflicts of interest effects is mitigated.
In response to the final rule, it is possible that trading activity
that was once consolidated within a small number of unaffiliated
banking entities may become fragmented among a larger number of
unaffiliated banking entities that each manage down their trading books
under the $20 billion and $1 billion trading assets and liabilities
thresholds to enjoy reduced hedging compliance and documentation
requirements and a less costly compliance and reporting regime
described in sections V.F.3.c, V.F.3.d, V.F.3.g, and V.F.3.h. The
extent to which banking entities may seek to manage down their trading
books will depend on a number of factors, such as the size and
complexity of each banking entity's trading activities and
organizational structure, along with those of its affiliated entities,
as well as forms of potential restructuring and the magnitude of
expected compliance savings from such restructuring relative to the
cost of restructuring. The SEC anticipates that the incentives to
manage the trading book under the $20 billion or $1 billion threshold,
as applicable, may be strongest for those holding companies that are
near or just above the thresholds. Such management of the trading book
may reduce the size of trading activity of some banking entities and
reduce the number of banking entities subject to more stringent
hedging, compliance, and reporting requirements. At the same time, if
the amendments incentivize banking entities to have smaller trading
books, they may mitigate moral hazard and reduce market impacts from
the failure of a given banking entity.
[[Page 62060]]
ii. Efficiency, Competition, and Capital Formation
The 2013 rule imposes compliance burdens that may be particularly
significant for smaller market participants. Moreover, such compliance
burdens may be passed along to counterparties and customers in the form
of higher costs, reduced capital formation, or a reduced willingness to
transact. For example, in the proposal, the SEC cited one commenter's
estimate that the funding cost for an average non-financial firm may
have increased by as much as $30 million after the 2013 rule's
implementation.\957\ At the same time, and as discussed in section
V.F.2, the SEC continues to recognize that the 2013 rule may have
yielded important qualitative benefits, such as reducing certain types
of risks in the financial system and mitigating potential incentive
conflicts that could be posed by certain types of proprietary trading
by dealers, as well as enhancing oversight and supervision.
---------------------------------------------------------------------------
\957\ See 83 FR at 33526.
---------------------------------------------------------------------------
On one hand, as a result of the amendments, Group B and Group C
entities might enjoy a competitive advantage relative to similarly
situated Group A and Group B entities respectively. As noted, firms
that are near to the $20 billion threshold may actively manage their
trading book to avoid triggering stricter requirements, and some firms
above the threshold may seek to manage down the trading activity to
qualify for streamlined treatment under the amendments. As a result,
the amendments may result in greater competition between Group B and
Group A entities around the $20 billion threshold, and similarly,
between Group B and Group C entities around the $1 billion threshold,
to the extent that Group C and Group B entities will increase their
trading activity without reaching the $1 and $20 billion thresholds
respectively. On the other hand, to the extent that the risk exposure
of Group B and Group C entities increases as they compete with Group A
and Group B entities, respectively, investors may demand additional
compensation for bearing financial risk. A higher required rate of
return and higher cost of capital could therefore offset potential
competitive advantages for Group B and Group C entities.
In addition, the adopted methods for the calculation of limited and
significant trading assets and liabilities may result in lower
compliance costs for foreign banking entities relative to the domestic
banking entities, increasing the competitive advantage of foreign Group
B and C entities.
As in the proposal, the SEC recognizes that cost savings to Group B
and Group C entities related to the compliance requirements and
requirements described in sections V.F.3.g and V.F.3.h may be partially
or fully passed along to clients and counterparties. To the extent that
hedging documentation and compliance requirements for Group B and Group
C entities are currently resulting in a reduced willingness to make
markets or underwrite securities, the amendments may facilitate trading
activity and risk-sharing, as well as capital formation and reduced
costs of access to capital. Again, the SEC notes that the amendments do
not eliminate statutory prohibitions under section 13 of the BHC but
create a simplified compliance regime for banking entities that do not
have significant trading assets and liabilities. Thus, the statutory
prohibitions on proprietary trading and covered funds activities will
continue to apply to all affected entities, including Group B and Group
C entities.
iii. Alternatives
Alternative approaches were considered. For example, the rule could
have used other values for thresholds for total consolidated trading
assets and liabilities in the definition of entities with significant
trading assets and liabilities. As noted in the discussion of the
economic baseline, using different thresholds would affect the scope of
application of compliance requirements and requirements described in
sections V.F.3.g and V.F.3.h by changing the number and size of
affected broker-dealers. For instance, using the proposed $10 billion
threshold or a lower threshold, such as $5 billion, in the definition
of significant trading assets and liabilities would scope a larger
number of entities into Group A, as compared to the final rule's $20
billion threshold, thereby subjecting a larger share of the dealer and
investment adviser industries to six-pillar compliance obligations.
However, the SEC continues to recognize that trading activity is
heavily concentrated in the right tail of the distribution and that
using a lower threshold would not significantly increase the volume of
trading assets and liabilities scoped into the Group A regime.\958\ For
example, Table 2 shows that 57 bank-affiliated broker-dealers that have
between $1 and $10 billion in consolidated trading assets and
liabilities and are subject to section 13 of the BHC Act account for
only approximately 10% of bank-affiliated broker-dealer assets and
between approximately 4% and 9% of holdings. In addition, 33 broker-
dealer affiliates of firms that have between $1 and $5 billion in
consolidated trading assets and liabilities and are subject to section
13 of the BHC Act account for only approximately 2% of bank-affiliated
broker-dealer assets and between approximately 1% and 2% of
holdings.\959\ At the same time, with a lower threshold, more banking
entities would face higher compliance burdens and related costs.
Therefore, as discussed in section IV.A.1.b, the agencies decided
against this alternative.
---------------------------------------------------------------------------
\958\ Some commenters supported this view. See, e.g., Capital
One et al.
\959\ In addition, one commenter stated that firms with $20
billion or more in trading assets and liabilities represented
approximately 94.80% of total reported U.S. trading assets and
liabilities and firms with $5 billion or less in trading assets and
liabilities represented approximately 1.32% of total reported U.S.
trading assets and liabilities. See BPI.
---------------------------------------------------------------------------
A different threshold for the definition of banking entities with
limited trading assets and liabilities was also considered. As pointed
out by some commenters, a higher threshold, such as $5 billion, would
allow small and mid-size banking entities to have moderate growth over
time without triggering more costly compliance requirements.\960\ As
shown in Table 2, 33 more broker-dealers would qualify for presumed
compliance under this alternative. However, as discussed in section
IV.A.1.b, the agencies continue to believe that banking entities with
$1 billion or less in trading assets and liabilities differ from
banking entities with between $1 and $5 billion in trading assets and
liabilities in their business models and risk exposures, and that a $1
billion threshold appropriately accounts for the risks posed by Group B
and Group C entities; therefore, the agencies are not adopting this
alternative.
---------------------------------------------------------------------------
\960\ See, e.g., ABA.
---------------------------------------------------------------------------
An alternative of splitting banking entities into only two groups
according to their trading assets and liabilities--those with
significant trading assets and liabilities and those without, i.e.
joining the limited and moderate trading assets and liabilities groups
was also considered.\961\ This alternative could have reduced
compliance burdens for Group B entities if the threshold was set at $20
billion. But, if the threshold for this alternative would have been set
at $1 billion, the compliance burdens for Group B entities would have
been
[[Page 62061]]
higher than their compliance costs under the final rule. As shown in
Table 2, Group B broker-dealers represent approximately 16% of total
assets of bank-affiliated broker-dealers and approximately 16% of their
holdings, while Group C broker-dealers account for only 4% of total
assets of bank-affiliated broker-dealers and 2% of their holdings. The
SEC continues to believe that Groups B and C differ in their business
models (e.g., level of trading activity) and the risks posed to the
U.S. financial system. For these reasons, the agencies decided not to
adopt this alternative.
---------------------------------------------------------------------------
\961\ This alternative approach was also suggested by some
commenters. See, e.g., Capital One et al.
---------------------------------------------------------------------------
A percentage-based threshold for determining whether a banking
entity has significant trading assets and liabilities was also
considered. For example, the amendment could have relied exclusively on
a threshold where banking entities are considered to be entities with
significant trading assets and liabilities if the firm's total
consolidated trading assets and liabilities are above a certain
percentage (for example, 10% or 25%) of the firm's total consolidated
assets. Under this alternative, a greater number of entities could have
benefited from lower compliance costs and a streamlined regime for
Group B entities. In addition, as pointed out by a commenter, this
alternative could address risk for individual banking entities since it
would base the threshold on the materiality of trading activity to the
entity's business.\962\ However, under this approach, even firms in the
extreme right tail of the trading asset distribution could be
considered without significant trading assets and liabilities if they
are also in the extreme right tail of the total assets distribution.
Thus, without placing an additional limit on total assets within such
regime, entities with the largest trading books could have been scoped
into the Group B regime if they also had a sufficiently large amount of
total consolidated assets, while entities with significantly smaller
trading books could be categorized as Group A entities if they had
fewer assets overall. Thus, the SEC believes that this alternative
would not have appropriately accounted for the size of banking
entities' trading activity.
---------------------------------------------------------------------------
\962\ See, e.g., KeyCorp.
---------------------------------------------------------------------------
In addition, a threshold based on total assets could have been
adopted. It is possible that losses on small trading portfolios can be
amplified through their effect on non-trading assets held by a banking
entity. To that extent, a threshold based on total assets may be useful
in potentially capturing both direct and indirect losses that originate
from trading activity of a holding company.\963\ However, such
threshold may not be as meaningful as a threshold based on trading
assets and liabilities when applied in the context of section 13 of the
BHC Act. A threshold based on total assets would scope in entities
merely on the basis of their balance sheet size, even though they may
have little or no trading activity of the type that section 13 of the
BHC Act is intended to address. Therefore, the agencies decided against
this alternative.
---------------------------------------------------------------------------
\963\ Some commenters supported this view. See, e.g., Data
Boiler.
---------------------------------------------------------------------------
Thresholds based on the level of total revenues from permitted
trading activities could have been adopted. To the extent that revenues
could be a proxy for the structure of a banking entity's business and
the focus of its operations, this alternative may apply more stringent
compliance requirements to those entities that focus their business the
most on covered activities. However, revenues from trading activity
fluctuate over time, rising during economic booms and deteriorating
during crises and liquidity freezes. As a result, under the
alternative, a banking entity that is scoped into the regulatory regime
during normal times may be scoped out during a time of market stress
because of a decrease in the revenues from permitted activities. That
is, under such alternative, the weakest compliance regime may be
applied to banking entities with the largest trading books in times of
acute market stress, when the performance of trading desks is
deteriorating and the underlying requirements of the 2013 rule may be
the most valuable.
Finally, the agencies could have excluded from the definition of
entities with significant trading assets and liabilities those entities
that may be affiliated with a firm with over $20 billion in
consolidated trading assets and liabilities but that are operated
separately and independently and are not consolidated with the parent
company that have total trading assets and liabilities (excluding
trading assets and liabilities involving obligations of or guaranteed
by the United States or any agency of the United States) under $20
billion. As shown in Table 8 below, the SEC estimates that there are 17
broker-dealers that have holdings of less than $20 billion and are
affiliated with bank holding companies that have trading assets and
liabilities in excess of $20 billion. The SEC does not have data on how
many of these 17 broker-dealers are operated separately and
independently and are not consolidated with affiliated entities with
significant trading assets and liabilities. However, the SEC notes
that, at a maximum, this alternative could decrease the scope of
application of the Group A regime for 17 broker-dealers.
Table 8--Broker-Dealer Assets and Holdings, by Gross Trading Assets and Liabilities Threshold of Affiliated
Banking Entities
----------------------------------------------------------------------------------------------------------------
Holdings
Type of broker-dealer Number Total assets, Holdings, $mln (altern.),
$mln $mln
----------------------------------------------------------------------------------------------------------------
Holdings >=$20bln and affiliated with firms with 19 2,225,989 594,513 514,360
gross trading assets and liabilities >=$20bln..
Holdings <$20bln and affiliated with firms with 17 275,951 31,328 13,576
gross trading assets and liabilities >=$20bln..
Affiliated with firms with gross trading assets 163 640,840 135,691 39,451
and liabilities <$20bln \964\..................
---------------------------------------------------------------
Total....................................... 199 3,142,780 761,532 567,387
----------------------------------------------------------------------------------------------------------------
Some commenters indicated that this alternative may be beneficial
for banking entities.\965\ The SEC recognizes that this alternative
would increase the number of entities able to avail themselves of the
reduced compliance, documentation, and metrics reporting requirements,
potentially resulting in cost reductions flowing through to
[[Page 62062]]
customers and counterparties. At the same time, this alternative would
permit more trading activities by entities affiliated with firms that
have gross trading assets and liabilities in excess of $20 billion. In
addition, it could encourage such firms to fragment their trading
activity, for instance, across multiple dealers, and operate them
separately and independently, thereby relieving such firms of the
requirement to comply with the hedging, compliance, and reporting
regime of the 2013 rule. This alternative may, therefore, reduce the
regulatory oversight and compliance benefits of the full hedging,
documentation, reporting, and compliance requirements for Group A
banking entities. The feasibility and costs of such fragmentation would
depend, in part, on the organizational complexity of a firm's trading
activity, the architecture of trading systems, the location and
skillsets of personnel across various dealers affiliated with such
entities, and current inter-affiliate hedging and risk mitigation
practices.
---------------------------------------------------------------------------
\965\ See, e.g., JBA.
---------------------------------------------------------------------------
Some commenters suggested that periodic adjustment to thresholds to
account for inflation should be adopted.\966\ This alternative would
account for changing market conditions in the absence of any changes in
a banking entity's business and level of trading activities. In an
environment with a moderate level of inflation, Group B and Group C
banking entities that are situated just below the thresholds may reduce
their level of activity to avoid triggering a more costly compliance
regime. However, the agencies do not believe that the additional
complexity associated with inflation-indexing the thresholds in the
final rule is necessary in light of the other changes to the thresholds
and calculation methodologies described above. Therefore, the agencies
decided against this alternative.
---------------------------------------------------------------------------
\964\ This category excludes SEC-registered broker-dealers
affiliated with banks that have consolidated total assets less than
or equal to $10 billion and trading assets and liabilities less than
or equal to 5% of total assets, as well as firms for which bank
trading assets and liabilities data was not available.
\966\ See, e.g., BPI and Capital One et al.
---------------------------------------------------------------------------
b. Proprietary Trading
Under section 13 of the BHC act and the 2013 rule, proprietary
trading is defined as engaging as principal for the ``trading account''
of a banking entity.\967\ Thus, the definition of the trading account
determines the trading activity that falls within the scope of the
statutory prohibitions and the compliance regime in the 2013 rule
associated with such activity. The definition of trading account in the
2013 rule has three prongs, including the dealer prong. The final
amendments introduce certain changes to the definition of trading
account; however, these amendments do not remove or modify the dealer
prong. In addition, the amendments introduce new exclusions from the
trading account and a new definition of the trading desk.
---------------------------------------------------------------------------
\967\ See 2013 rule Sec. __.3(b).
---------------------------------------------------------------------------
i. Trading Account
(1) Costs and Benefits
Under the final rule, the definition of ``trading account''
continues to include purchases and sales of financial instruments by
banking entities engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
these instruments are purchased or sold in connection with the
activities of such business.\968\ Thus, the SEC expects that most (if
not substantially all) trading activity by SEC-regulated dealers that
are banking entities will continue to be captured by the dealer prong
of a banking entity, notwithstanding any of the changes made to the
definition of the trading account.
---------------------------------------------------------------------------
\968\ See 2013 rule Sec. __.3(b)(1)(iii).
---------------------------------------------------------------------------
Some commenters pointed out that not all of dealers' trading
activity is conducted in a dealer capacity.\969\ The SEC recognizes the
possibility that some dealers engage in transaction activity that, by
itself, would not trigger a dealer registration requirement.\970\ Under
the baseline, such activity may be scoped into the ``trading account''
definition by the short-term prong or the market risk capital prong.
Thus, as discussed below, the SEC believes that only a small subset of
trading activity by dealers may be affected by the changes to the
definition of the trading account.
---------------------------------------------------------------------------
\969\ See, e.g., SIFMA and BPI.
\970\ See 79 FR at 5549 (``The Agencies believe the scope of the
dealer prong is appropriate because, as noted in the proposal,
positions held by a registered dealer in connection with its dealing
activity are generally held for sale to customers upon request or
otherwise support the firm's trading activities (e.g., by hedging
its dealing positions), which is indicative of short term
intent.'').
---------------------------------------------------------------------------
The agencies are adopting three changes to the definition of the
trading account. First, the applicability of the short-term prong and
the market risk capital prong is changed under the final rule. In
particular, for dealers that are subject to the market risk capital
prong, trading activity outside of the dealer prong will be scoped into
the trading account only if it is a covered position for the purposes
of the market risk capital rule. That is, if the activity is not
captured by the dealer prong or the market risk capital prong, it would
be scoped out from the definition of the trading account under the
final rule. This is in contrast to the 2013 rule, under which, for
banking entities that are subject to the market risk capital prong,
trading activity that is not captured by the dealer prong or the market
risk capital prong could still be captured by the short-term
prong.\971\ Thus, under the 2013 rule, bank dealers that are subject to
the market risk capital prong have to apply three prongs: The dealer
prong, the market risk capital prong, and the short-term prong. Under
the final rule, these same entities will apply only two prongs: The
dealer prong and the market-risk capital prong. To the extent that
dealers subject to the market risk capital prong have trading
activities that are not captured by the dealer prong currently
experience organizational inefficiencies or duplicative costs as a
result of being subject to both short-term and market risk capital
prongs, this amendment may benefit such dealers by decreasing their
compliance costs, as discussed in section V.F.3.g, and decreasing the
regulatory complexity, consequently increasing operational efficiency.
The SEC expects that these benefits are likely to be greater for
banking entities that are not subject to the dealer prong, although, as
noted above, the SEC does not analyze those potential benefits here.
---------------------------------------------------------------------------
\971\ As noted in section IV.B.1.a.iii, the scope of activities
captured by the short-term intent prong substantially overlaps with
the scope of activities captured by the market risk capital prong.
---------------------------------------------------------------------------
In addition, to the extent that the definition of trading account
in the 2013 rule involves position-by-position analysis of financial
instruments which may be costly, and to the extent that the costs of
such analysis discourage dealers that are subject to the market risk
capital prong from conducting activities that could be scoped in by the
short-term intent prong, this amendment may promote trading activities
that would not be captured by the dealer prong or the market risk
capital prong. On the one hand, such trading activities may allow
dealers that are subject to the market risk capital rule to manage
their business more efficiently. On the other hand, to the extent that,
under the final rule, trading activity that is not captured by either
the dealer prong or the market risk capital prong would have been
captured by the short-term intent prong, and to the extent that this
activity exposes dealers to additional risks, this amendment may
increase risk exposure of dealers that are subject to the market risk
capital rule. The SEC does not have information about the amount of
trading activity of SEC-registered broker-dealers
[[Page 62063]]
that is not captured by the dealer prong or the market risk capital
prong and about the prevalence of the current application of the market
risk capital prong and the short-term prong under the 2013 rule. As
shown in Table 9 below, the SEC estimates that there are 100 broker-
dealers that in aggregate hold between 98% and 99% of holdings by
broker-dealers affected by the final rule that are subject to the
market risk capital rule and may be affected by this amendment. The SEC
continues to believe that the largest share of dealers' trading
activity will continue to be captured by the dealer prong. Thus, the
SEC expects that the effects of this amendment on SEC-regulated dealers
will be modest.
Table 9--Market Risk Capital Rule Application
----------------------------------------------------------------------------------------------------------------
Number of Total assets, Holdings
Market risk capital rule application broker-dealers $mln Holdings (altern.)
----------------------------------------------------------------------------------------------------------------
Subject to the market risk capital rule......... 100 3,002,834 749,867 562,515
Not subject to the market risk capital rule..... 99 139,946 11,665 4,872
---------------------------------------------------------------
Total....................................... 199 3,142,780 761,532 567,387
----------------------------------------------------------------------------------------------------------------
The second change to the definition of trading account affects
banking entities that are not subject to the market risk capital rule
and cannot apply the market risk capital prong under the 2013 rule.
Under the final rule, these entities will be able to elect to apply the
market risk capital prong instead of the short-term prong to determine
the scope of the banking entity's trading account. This amendment will
affect those dealers that have trading activity that is not captured by
the dealer prong and instead captured by the short-term prong. To the
extent that the market risk capital prong is less costly to comply
with, relative to the short-term prong, this amendment may benefit
dealers that are not subject to the market risk capital rule and have
trading activity that is not captured by the dealer prong by providing
them with flexibility to apply the prong that is more cost-effective.
This amendment may particularly benefit foreign banking entities that
are not subject to the market risk capital rule but are applying a
different market risk framework, to the extent that this framework is
similar to the market risk capital rule. To the extent that foreign
dealers with frameworks similar to the framework of the market risk
capital rule are currently experiencing inefficiencies because they
cannot apply the market risk capital prong of the trading account
definition, this amendment may reduce the compliance costs of these
dealers. The SEC estimates that, at most, 99 broker-dealers that are
not subject to the market risk capital rule may be affected by this
amendment, to the extent that they have trading activity that is
captured by the short-term prong under the 2013 rule. However, the SEC
continues to believe that the largest share of dealers' trading
activity will continue to be captured by the dealer prong. Thus, the
SEC expects that the effects of this amendment for dealers will be
modest.
The third amendment to the trading account definition will
eliminate the 60-day rebuttable presumption in the short-term prong and
instead establish a new rebuttable presumption that financial
instruments held for 60 days or more are not within the short-term
prong. Many commenters supported the proposed rule's elimination of the
60-day rebuttable presumption,\972\ and some commenters suggested that
the agencies should presume, for banking entities not subject to the
market risk capital rule, that financial instruments held for longer
than 60 days, or that have an original maturity or remaining maturity
upon acquisition, of fewer than 60 days to their stated maturities, are
not for the banking entity's trading account.\973\ As recognized in
section IV.B.1.a.iv, the agencies have found that the rebuttable
presumption has captured many activities that should not be included in
the definition of proprietary trading. In addition, as stated by some
commenters, the presumption may be difficult to rebut.\974\ Therefore,
the SEC believes that the reversal of the presumption in the 2013 rule
would reduce the compliance burdens for dealers that conduct trading
activity that is not otherwise captured by the dealer prong or the
market risk capital prong. To the extent that the compliance burdens
related to the rebuttable presumption of the 2013 rule limit dealers'
ability to conduct customer-accommodating transactions or liquidity
management activities, the cost reductions of the amendment may flow
through to customers and counterparties and increase operational
efficiency of dealers. The SEC estimates that this amendment may affect
99 broker-dealers--the broker-dealers that are not subject to the
market risk capital rule--which on aggregate have 1.5% of broker-dealer
holdings. However, the SEC expects that the largest share of dealing
activity subject to SEC oversight will continue to be captured by the
dealer prong. Thus, the SEC expects that the effects of this amendment
for dealers will be modest.
---------------------------------------------------------------------------
\972\ See, e.g., State Street; Chatham; BPI; FSF; CCMR and CFA.
\973\ See, e.g., ABA; Arvest; BPI; SIFMA and IIB.
\974\ See, e.g., State Street; Chatham; BPI; FSF; CCMR and CFA.
---------------------------------------------------------------------------
(2) Efficiency, Competition, and Capital Formation
To the extent that the compliance related to the rebuttable
presumption of the 2013 rule limits dealers' ability to conduct
customer-accommodating transactions, or liquidity management or risk
management activities that are covered by the short-term prong, the
amendments to the definition of trading account may facilitate such
activities, which could, in turn, promote capital formation. In
addition, to the degree that the amendments to the trading account may
provide banking entities with more flexibility to underwrite, market
make, and hedge, and to the extent these activities facilitate capital
formation, these amendments may improve allocative efficiency. To the
extent that the amendments to the short-term prong reduce compliance
costs and to the extent that the short-term prong primarily applies to
smaller dealers (i.e., those not covered by the market risk capital
prong), the amendments to the trading account definition may improve
the competitive position of smaller dealers. However, the SEC notes
that the largest share of dealing activity subject to SEC oversight is
already captured by the dealer prong; and, therefore, the above
economic effects of the amendments to the definition of the trading
account on SEC-regulated entities, including the effects on efficiency,
competition, and capital formation, may be de minimis.
[[Page 62064]]
(3) Alternatives
As an alternative to the short-term prong, the agencies proposed
replacing the short-term prong in the 2013 rule with an accounting
prong that would have included within the definition of ``trading
account'' any account used by a banking entity to purchase or sell one
or more financial instruments that are recorded at fair value on a
recurring basis under applicable accounting standards.\975\ As the
agencies noted when they proposed this alternative, the accounting
prong was designed to provide more certainty and clarity about which
financial instruments should be included in the trading account due to
the fact that banking entities should know which positions are recorded
at fair value on their balance sheets.\976\ In addition, as pointed out
by some commenters,\977\ this alternative could deter noncompliance and
facilitate the agencies' supervision. However, a large number of
commenters stated that the proposed accounting prong would
inadvertently scope in activities that are not principally for the
purpose of selling in the near term or otherwise with the intent to
resell in order to profit from short-term price movements. For example,
some commenters pointed out that longer term positions, such as
available-for-sale debt securities,\978\ certain long-term
investments,\979\ static hedging of long term investments,\980\
traditional asset-liability management activities,\981\ derivative
transactions entered into for any purpose and duration,\982\ long-term
holdings of commercial mortgage-backed securities; \983\ would be
scoped in under this alternative. Although some of these instruments
are held for less than 60 days and may fall under the short-term prong
of the trading account under the 2013 rule, these instruments, in
general, are not held for trading purposes, i.e., they are not held
principally for the purpose of selling in the near term; rather, the
majority of the aforementioned instruments are held for
investment.\984\ Since this alternative would include all instruments
reported at fair value, regardless of the purpose with which these
instruments are bought or sold and regardless of the period during
which these instruments are held (short-term or long-term), the scope
of the trading account would be significantly greater under this
alternative than the scope of the trading account in the 2013 rule.
Given that many of the instruments that would be captured by the
accounting prong are not held principally for the purpose of selling in
the near term, the agencies are not adopting this alternative. The SEC
also notes that if this alternative had been adopted, the effect on
SEC-regulated dealers would have been limited because the majority of
dealer trading activity falls under the dealer prong.
---------------------------------------------------------------------------
\975\ See proposed rule Sec. __.3(b)(3); 83 FR at 33447-48.
\976\ See id.
\977\ See, e.g., Better Markets.
\978\ See, e.g., BPI and SIFMA.
\979\ See, e.g., Capital One et al.; BPI; SIFMA; and CCMR.
\980\ See, e.g., BPI and ISDA.
\981\ See, e.g., KeyCorp; BPI; Capital One et al.; FSF and
Goldman Sachs.
\982\ See e.g., ISDA and BPI.
\983\ See MBA.
\984\ See, e.g., FASB defines available-for-sale securities as
investments that are not classified as trading securities nor as
held-to-maturity securities and states that cash flows from these
investments should be classified as cash flows from investing
activities. See ``Statement of Financial Accounting Standards No.
115'', FASB.
---------------------------------------------------------------------------
The agencies also proposed, but are not adopting, including a
reservation of authority allowing for a determination, on a case-by-
case basis, with appropriate notice and response procedures, that any
purchase or sale of one or more financial instruments by a banking
entity for which it is the primary financial regulatory agency either
is or is not for the trading account. While the SEC continues to
recognize that the use of objective factors to define proprietary
trading is intended to provide bright lines that simplify compliance,
the SEC also recognizes that this approach may, in some circumstances,
produce results that are either underinclusive or overinclusive with
respect to the definition of proprietary trading. The SEC continues to
believe that the reservation of authority may add uncertainty for
banking entities about whether a particular transaction could be deemed
as a proprietary trade by the regulatory agency, which may affect the
banking entity's decision to engage in transactions that are not
included in the definition of the trading account under the 2013 rule.
As discussed in the proposal, notice and response procedures related to
the reservation of authority provision would cost as much as $19,877
for SEC-registered broker-dealers, and $5,006 for entities that may
choose to register with the SEC as SBSDs.\985\
---------------------------------------------------------------------------
\985\ See 83 FR 33432.
---------------------------------------------------------------------------
The agencies proposed but are not adopting the revision of the
market risk capital prong to apply to the activities of FBOs to take
into account the different market risk frameworks FBOs may have in
their home countries.\986\ This alternative may better align foreign
banking entities' compliance with the 2013 rule and compliance with
market risk regulations of their home counties, increasing
organizational efficiency and potentially decreasing compliance costs
for such banking entities. However, as suggested by some commenters,
under this alternative, positions that are not held for short-term
trading would be captured in some foreign market risk capital
frameworks.\987\ Therefore, the agencies decided against this
alternative and instead are adopting a more flexible approach, under
which foreign banking entities would be able to apply the market risk
capital prong if they choose to do so.\988\
---------------------------------------------------------------------------
\986\ See proposed rule Sec. __. 3(b)(1)(ii); 83 FR at 33447.
\987\ See, e.g., IIB.
\988\ See section IV.B.1.a.v.
---------------------------------------------------------------------------
As an alternative, the agencies could have modified the dealer
prong of the trading account definition to include only near-term
trading, e.g., positions held for less than 60, 90, or 120 days. This
alternative would likely narrow the scope of application of the
substantive proprietary trading prohibitions to a smaller portion of a
banking entity's activities. Under this alternative, bank-affiliated
dealers would be able to amass large trading positions at the near-term
definition boundary (e.g., for 61, 91, or 121 days) to take advantage
of a directional market view, to profit from mispricing in an
instrument, or to collect a liquidity premium in a particular
instrument. This may significantly increase the risk exposure of bank-
affiliated dealers. However, as this alternative could stimulate an
increase in potentially impermissible proprietary trading by these
dealers, the volume of trading activity in certain instruments and
liquidity in certain markets may increase. The SEC also notes that the
temporal thresholds necessary to implement such a short-term trading
alternative would be difficult to quantify and may have to vary by
product, asset class, and aggregate market conditions, among other
factors. For instance, the markets for large cap equities and
investment grade corporate bonds have different structures, types of
participants, latency of trading, and liquidity levels. Therefore, an
appropriate horizon for short-term positions will likely vary across
these markets. Similarly, the ability to transact quickly differs under
strong macroeconomic conditions and in times of stress. A meaningful
implementation of this alternative would likely require calibrating and
[[Page 62065]]
recalibrating complex thresholds to exempt non-near-term proprietary
trading and so could introduce additional uncertainty and increase the
compliance burdens on SEC-regulated banking entities.
As another alternative, the agencies could have categorically
excluded financial instruments of dealers purchased in a non-dealing
capacity, such as financial instruments purchased for long-term
investment purposes. Some commenters pointed out that it is not always
clear whether such instruments are scoped in the dealer prong and that
banking entities may engage in costly and time-consuming position-by-
position analysis to confirm that a long-term investment is captured in
the trading account.\989\ As discussed in section IV.B.1.a.vi, the
agencies continue to believe that only the activities that are done in
connection with activities that would require the banking entity to be
licensed or registered are covered by the dealer prong. For example, if
a banking entity purchases or sells a financial instrument in
connection with activities that do not require registration as a
dealer, this activity would not be covered by the dealer prong.
However, this activity could still be included in the trading account
under the short-term prong or the market risk capital prong, as
applicable.\990\
---------------------------------------------------------------------------
\989\ See, e.g., SIFMA and BPI.
\990\ See 79 FR 5549.
---------------------------------------------------------------------------
ii. Exclusions From Proprietary Trading
The agencies are adopting the proposed expansion of the liquidity
management exclusion, as well as an exclusion for trading errors and
subsequent correcting transactions, certain matched derivative
transactions, certain trades related to hedging mortgage servicing
rights or mortgage servicing assets, and transactions in instruments
not included in the definition of trading asset or trading liability
under the applicable reporting form for a banking entity.
(1) Costs and Benefits
Exclusion for Liquidity Management Activities
The agencies are adopting the proposed expansion of the liquidity
management exclusion substantially as proposed, but with a modification
to permit the use of non-deliverable cross-currency swaps. Thus,
liquidity management exclusion would apply not only to securities, but
also to foreign exchange forwards and foreign exchange swaps (each as
defined in the Commodity Exchange Act), and to cross-currency swaps
(both physically- and cash-settled) that are traded for the purpose of
liquidity management in accordance with a documented liquidity
management plan. On the one hand, under this amendment, SEC-regulated
banking entities would face lower burdens and enjoy greater flexibility
in currency-risk management as part of their overall liquidity
management plans. In the proposal, the SEC recognized that the
liquidity management exclusion in the 2013 rule may be narrow and that
the trading account definition may scope in routine asset-liability
management and commercial-banking related activities. In their response
to the proposal, some commenters supported that view and stated that
the 2013 rule may be restricting liquidity-risk management by banking
entities.\991\ Therefore, the SEC continues to believe that, to the
degree that these effects constrain activities of dealers, this
amendment could facilitate more efficient risk management, greater
secondary market activity, and more capital formation in primary
markets.
---------------------------------------------------------------------------
\991\ See, e.g., ISDA; Goldman Sachs and SIFMA.
---------------------------------------------------------------------------
Some commenters indicated that this amendment may make it easier to
trade in currency markets for speculative purposes under the guise of
legitimate liquidity management.\992\ The SEC continues to recognize
that this liquidity-management amendment may lead to currency
derivatives exposures, including potentially very large exposures,
being scoped out of the trading account definition and the ensuing
substantive prohibitions of the 2013 rule, which may increase the risk
exposures of banking entities and reduce the effectiveness of
regulatory oversight. However, the SEC continues to believe that the
conditions maintained in the exemption, including the requirement to
conduct liquidity management in accordance with a documented liquidity
management plan, will limit these adverse effects.
---------------------------------------------------------------------------
\992\ See Volcker Alliance and Data Boiler.
---------------------------------------------------------------------------
Exclusion for Error Trades
The agencies are also adopting an exclusion for trading errors and
subsequent correcting transactions from the definition of proprietary
trading. The 2013 rule excludes from the proprietary trading
prohibition certain excluded clearing activities by banking entities
that are members of clearing agencies, derivatives clearing
organizations, or designated financial market utilities. Specifically,
such excluded clearing activities are defined to include, among others,
any purchase or sale necessary to correct error trades made by, or on
behalf of, customers with respect to customer transactions that are
cleared, provided the purchase or sale is conducted in accordance with
certain regulations, rules, or procedures.\993\ Accordingly, the
exclusion for error trades under the 2013 rule is applicable only to
clearing members with respect to cleared customer transactions.\994\
---------------------------------------------------------------------------
\993\ See 2013 rule Sec. __.3(e)(7).
\994\ Id.
---------------------------------------------------------------------------
[[Page 62066]]
This amendment primarily benefits dealers that are not clearing
members with respect to all customer trades and dealers that are
clearing members with respect to customer trades that are not cleared,
since under the 2013 rule error trades of these dealers are not
considered excluded clearing activity. Table 10 reports information
about broker-dealer count, assets, and holdings, by affiliation and
clearing type.
Table 10--Broker-Dealer Assets and Holdings, By Clearing Status \995\
----------------------------------------------------------------------------------------------------------------
Holdings
Broker-dealers subject to section 13 of the BHC Number Total assets, Holdings, $mln (altern.),
Act $mln $mln
----------------------------------------------------------------------------------------------------------------
Clear or carry (or both)........................ 76 3,101,936 755,975 562,649
Other........................................... 123 40,844 5,557 4,738
---------------------------------------------------------------
Total....................................... 199 3,142,780 761,532 567,387
----------------------------------------------------------------------------------------------------------------
Since correcting error trades is not conducted for the purpose of
profiting from short-term price movements, as also pointed out by some
commenters,\996\ this amendment is likely to facilitate valuable
customer-facing activities and promote effective risk management by
dealers. As discussed in section IV.B.1.b.ii, the agencies continue to
believe that banking entities generally should monitor and manage their
error trade account because doing so would help prevent personnel from
using these accounts for proprietary trading. Some commenters stated
that banking entities could still make profits while relying on the
error trade exclusion.\997\ To the degree that this may happen, banking
entities could become incentivized to use error trade exclusion to
conduct proprietary trading. However, some commenters noted that bona
fide trade error activity is separately managed and classified as an
operational loss when there is a loss event or a near miss when error
activity results in a gain.\998\ The SEC agrees with the commenters'
view and believes that existing requirements and operational risk
management practices would be sufficient to deter participants from
using the error trade exclusion to obfuscate impermissible proprietary
trades.
---------------------------------------------------------------------------
\995\ Broker-dealers clearing or carrying customer accounts (or
both) are identified using FOCUS filings. Broadly, broker-dealers
that are clearing or carrying firms directly carry customer
accounts, maintain custody of the assets, and clear trades. Other
broker-dealers may accept customer orders but do not maintain
custody of assets. This analysis excludes SEC-registered broker-
dealers affiliated with banks that have consolidated total assets
less than or equal to $10 billion and trading assets and liabilities
less than or equal to 5% of total assets, as well as firms for which
bank trading assets and liabilities data was not available.
\996\ See, e.g., BPI; FSF and BB&T.
\997\ See, e.g., Data Boiler; CAP and Public Citizen.
\998\ See, e.g., ABA; BB&T; BPI and Capital One et al.
---------------------------------------------------------------------------
Exclusion for Customer-Driven Swaps and Customer-Driven Security-Based
Swaps
In addition, the agencies are adopting an exclusion for
transactions in which banking entities contemporaneously enter into a
customer-driven swap or security-based swap and a matched swap or
security-based swap if (i) the banking entity retains no more than
minimal price risk; and (ii) the banking entity is not a registered
dealer, swap dealer, or security-based swap dealer. The SEC continues
to recognize that loan-related swaps and customer accommodation back-
to-back derivatives facilitate lending transactions as a customer
service and are not designed to profit from speculative price
movements.\999\ Some commenters indicated that such customer
accommodation loan-related swaps transactions may reduce the risk of
banking entities and borrowers, and encourage the extension of credit,
commonly for smaller and medium-size banking entities that engage in
trading in connection with loans and other extensions of customer
credit. Some commenters stated that this amendment increases the scope
of permissible trading activity. The SEC notes that under the final
rule this exclusion is not available to banking entities that are
subject to the market risk or the dealer prong, reducing such risks.
Therefore, the SEC believes that the effects of this amendment
discussed above on SEC-regulated entities would be de minimis.
---------------------------------------------------------------------------
\999\ Commenters agreed with this view. See, e.g., Covington;
Credit Suisse; SIFMA; Chatham and ABA.
---------------------------------------------------------------------------
Exclusion for Hedges of Mortgage Servicing Rights or Mortgage Servicing
Assets
The agencies are adopting an exclusion for transactions involving
any purchase or sale of one or more financial instrument that the
banking entity uses to hedge mortgage servicing rights or mortgage
servicing assets in accordance with a documented hedging strategy. This
amendment will provide more clarity to banking entities that are
subject to the short-term prong that intangibles, including servicing
assets, are not included in the definition of proprietary trading.
Because under the market risk capital prong, intangibles, including
servicing assets, are explicitly excluded from the definition of
``covered position,'' the exclusion will provide additional certainty
to dealers that do not apply the market risk capital prong. To the
extent that dealers that do not apply the market risk capital prong
currently experience uncertainty as to whether the aforementioned
financial instruments are included in the trading account and to the
extent that this uncertainty impedes transactions involving these types
of financial instruments, the amendment may facilitate permitted
trading activity in these financial instruments. In addition, to the
extent that these exclusions facilitate more efficient risk management,
dealers that are not subject to the market risk capital rule may
benefit from this amendment.\1000\
---------------------------------------------------------------------------
\1000\ The SEC estimates that there are 99 SEC-registered
broker-dealers that are not subject to the market risk capital rule,
which on aggregate hold approximately 1.5% of broker-dealer
holdings.
---------------------------------------------------------------------------
Exclusion for Financial Instruments That Are Not Trading Assets or
Trading Liabilities
In addition to the above exclusions, the agencies are adopting an
exclusion for purchases or sales of financial instruments that do not
meet the definition of trading assets or trading liabilities under the
applicable reporting form for a banking entity as of January 1, 2020.
Similar to the exclusion for hedges of mortgage servicing rights or
assets, this exclusion is intended to clarify the scope of the
prohibition on proprietary trading and to provide parity between
banking entities that apply the market risk capital prong and banking
entities that apply the short-
[[Page 62067]]
term intent prong by scoping out of the rule positions that would not
be captured by the market risk capital prong. In addition, this
amendment will exclude financial instruments purchased by a dealer in
its dealing capacity that are not trading assets or liabilities.
Therefore, the SEC believes that this amendment will benefit dealers,
to the extent that the 2013 rule's dealer prong is overinclusive
because it scopes in financial instruments acquired in dealer capacity,
regardless of their purpose (i.e. both for trading and non-trading
purposes). To the extent that this aspect of the 2013 rule leads to
inefficiencies or increases costs at the dealer level, the SEC expects
that the final rule will promote dealers' organizational efficiency by
narrowing the scope of the dealer prong to financial instruments that
are considered trading assets and liabilities.
To the extent that some financial instruments that are not trading
assets or liabilities are currently scoped-into the rule by the short-
term prong due to the fact that they are held for less than 60 days,
this amendment may decrease the scope of the trading account. For
example, some fair value financial instruments that are not trading
assets or liabilities, such as available-for-sale securities or
derivatives not reported as trading, may be held for less than 60 days
and therefore be presumed to be for the trading account under the 2013
rule. However, under the 2013 rule, banking entities could rebut this
presumption by demonstrating that such instruments are not purchased or
sold principally for the purpose of selling in the near term.\1001\ In
addition, the SEC notes that dealers, in general, hold primarily
trading assets and trading liabilities due to the nature of their
business. The SEC does not have data or information about what fraction
of dealers' financial instruments that are not defined as trading
assets or liabilities under the applicable banking agency reporting
forms is currently being scoped-into the trading account by the short-
term prong in the 2013 rule. This is because only non-trading fair
value instruments held for fewer than 60 days are likely to be scoped
into the trading account via the short-term prong under the 2013 rule,
rather than all such financial instruments, and the data disaggregated
by maturity of non-trading fair value instruments is not available.
However, the SEC reiterates that only a small subset of trading
activity by dealers may be affected by this exclusion, as majority of
financial instruments purchased or sold by dealers are trading assets
and liabilities. For this reason and the reasons discussed above, the
SEC expects that this amendment will not substantially affect the scope
of the trading account for banking entities that are dealers.
---------------------------------------------------------------------------
\1001\ As discussed above, the final rule eliminates the 60-day
rebuttable presumption in the short-term prong and instead
establishes a new rebuttable presumption that financial instruments
held for 60 days or more are not within the short-term prong.
---------------------------------------------------------------------------
(2) Efficiency, Competition, and Capital Formation
To the degree that the 2013 rule may be restricting liquidity-risk
management by banking entities, and to the extent that this affects
their trading activity, the liquidity management amendment could
facilitate more efficient risk management, greater secondary market
activity, and more capital formation in primary markets. Similarly, to
the extent that corrections for bona-fide errors and exclusions for
customer-driven swaps and customer-driven security-based swaps and
transactions related to mortgage servicing rights facilitate customer-
driven transactions and increase banking entities' willingness to
conduct such transactions, these exclusions could facilitate more
efficient risk management and promote capital formation and secondary
market activity. In addition, to the degree that the exclusions from
proprietary trading may provide banking entities with more flexibility
to manage risks, and to the extent these activities facilitate capital
formation, these amendments may improve allocative efficiency.
To the extent that these amendments may increase the ability of
dealers that are banking entities to hedge risks related to customer
transactions, the competitive position of dealers that are banking
entities may improve relative to nonbanking dealers. In addition, to
the extent that these amendments reduce compliance costs of dealers
that are banking entities and to the extent that these compliance costs
are currently passed onto customers and counterparties, the reduction
in costs related to the exclusions from proprietary trading may result
in more competitive prices set by dealers that are banking entities,
improving their competitive position further.
(3) Alternatives
The agencies could have taken the approach of expanding the
liquidity management exclusion to exclude additional trading
activities. For example, the agencies could exclude transactions in
other derivatives, such as derivatives related to government
securities, derivatives on foreign sovereign debt,\1002\ instruments
that qualify for certain treatment under the liquidity coverage ratio
or section 165 of the Dodd-Frank Act, or transactions executed by SEC-
registered dealers on behalf of their asset management customers.\1003\
---------------------------------------------------------------------------
\1002\ Some commenters indicated that all derivatives should be
excluded in the liquidity management exclusion. See, e.g., FSF;
Capital One et al.; IIB and JBA.
\1003\ See, e.g., Capital One et al. and ABA.
---------------------------------------------------------------------------
The 2013 rule exempts all trading in domestic government
obligations and trading in foreign government obligations under certain
conditions; however, derivatives referencing such obligations that are
intended to manage risks--including derivatives portfolios that can
replicate the payoffs and risks of such government obligations--are not
excluded from the trading account. Therefore, existing requirements
reduce the flexibility of banking entities to engage in asset-liability
management and result in a different treatment of two groups of
financial instruments that have similar risks and payoffs. Excluding
derivatives transactions on government obligations from the trading
account definition could reduce costs to market participants and
provide greater flexibility in their asset-liability management. This
alternative could also result in increased volume of trading in markets
for derivatives on government obligations, such as Treasury futures.
The SEC recognizes, nonetheless, that derivatives portfolios that
reference an obligation, including Treasuries, can be structured to
magnify the economic exposure to fluctuations in the price of the
reference obligation. Moreover, derivatives transactions involve
counterparty credit risk not present in transactions in reference
obligations themselves. Since the alternative would exclude all
derivatives transactions on government obligations, and not just those
that are intended to mitigate risk, this alternative could permit
banking entities to increase their exposure to counterparty, interest
rate, and liquidity risk. For the reasons discussed in section
IV.B.1.i, the agencies decided not to expand the liquidity management
exclusion further.
The agencies also considered mandating the use of a separately-
managed trade error account for the purposes of this amendment. This
alternative could deter banking entities from using the error trade
exclusion to obfuscate impermissible proprietary trades. However, as
indicated by the commenters, this approach may result in duplicative
systems and additional
[[Page 62068]]
compliance costs.\1004\ The agencies agree with these commenters and,
therefore, are not adopting this alternative.
---------------------------------------------------------------------------
\1004\ See, e.g., ABA; Credit Suisse; JBA and SIFMA.
---------------------------------------------------------------------------
iii. Trading Desk Definition
The final rule adopts a multi-factor definition of the trading desk
that is substantially similar to the definition included in the request
for comment in the proposal, except that the reference to incentive
compensation has been removed from the first prong. The definition of
trading desk includes a new second prong that aligns the definition
with the market risk capital rule. Specifically, for a banking entity
that is subject to the market risk capital rule, the trading desk
established for purposes of the market risk capital rule must be the
same unit of organization that is established as a trading desk for
purposes of the regulations implementing section 13 of the BHC Act.
(1) Costs and Benefits
The SEC continues to recognize that the definition of trading desk
is an important component of the implementation of the 2013 rule in
that certain requirements, such as those applicable to the underwriting
and market making exemptions, and the metrics-reporting requirements,
apply at the trading desk level of organization. Under the 2013 rule, a
trading desk is defined as the smallest discrete unit of organization
of a banking entity that purchases or sells financial instruments for
the trading account of the banking entity or an affiliate thereof. Some
commenters asserted that the smallest discrete unit language of the
2013 rule was subjective, ambiguous, or could be interpreted in
different ways.\1005\ Thus, the SEC continues to believe that SEC-
regulated banking entities may currently experience substantial
compliance costs related to the trading desk designation for the
purposes of compliance with section 13 of the BHC Act. Accordingly, the
SEC believes that the adopted definition of the trading desk may
provide more certainty to SEC-regulated banking entities regarding
trading desk designations and will reduce their compliance burdens, as
the multi-factor definition better aligns with other operational,
management, and compliance purposes,\1006\ which typically depend on
the type of trading activity, asset class, product line offered, and
individual banking entity's structure. Among the metrics submissions
from 18 entities received by the SEC, the SEC estimates that the
average number of desks reported per entity is approximately 51.\1007\
To the extent that the trading desk designations under the final rule
will be less granular than those under the 2013 rule, and to the extent
that establishing a large number of desks is more costly, this
amendment will reduce compliance costs for dealers that are banking
entities.
---------------------------------------------------------------------------
\1005\ See, e.g., ABA and CCMC.
\1006\ This was also supported by commenters. See, e.g., ABA;
JBA; FSF; Goldman; ISDA; SIFMA and CCMC.
\1007\ See section V.0.
---------------------------------------------------------------------------
As seen in Table 9, the SEC estimates that 100 broker-dealers with
between 98% and 99% of holdings are currently subject to the market
risk capital rule and would be able to align their trading desks for
the purposes of the Volcker Rule and the market risk capital rule. The
SEC continues to believe that such alignment will reduce organizational
complexity, consequently reducing compliance burdens for these banking
entities.\1008\ The SEC also estimates that 99 broker-dealers are not
currently subject to the market risk capital rule--these broker-dealers
will be able to establish trading desks on the basis of the multi-
factor definition. To the extent that the current operational,
management, or compliance structure of these entities may not perfectly
align with the adopted multi-factor definition of the trading desk,
these entities may experience one-time setup costs related to the
reorganization of trading activity in order to satisfy the multi-factor
definition. The SEC does not have information or data about the costs
of this reorganization. However, the SEC believes that these
reorganization costs will be offset by a reduction in ongoing
compliance costs, which will be reduced as a result of the amended
definition of the trading desk for dealers that are not subject to the
market risk capital rule, to the extent that the trading desk
designations under the final rule will be less granular than those
under the 2013 rule and will better align with criteria used to
establish trading desks for operational and management purposes.
---------------------------------------------------------------------------
\1008\ See id.
---------------------------------------------------------------------------
(2) Efficiency, Competition, and Capital Formation
To the extent that the reduction in compliance costs stemming from
this amendment facilitates permitted trading activity by banking
entities, capital formation may increase. To the extent that the
reduced compliance costs stemming from this amendment flow through to
customers and counterparties, bank-affiliated dealers may become more
competitive with nonbanking dealers. The amendment to the definition of
the trading desk does not change the information available to market
participants, and the SEC does not believe that these amendments are
likely to have an effect on informational efficiency. To the degree
that this amendment facilitates capital formation, allocative
efficiency may improve.
(3) Alternatives
The agencies could have adopted an amendment that would allow
trading desks to be set completely at the discretion of banking
entities.\1009\ This would provide banking entities greater flexibility
in determining their own optimal organizational structure and allow
banking entities organized with various degrees of complexity to
reflect their organizational structure in the trading desk definition.
This alternative could reduce operational costs from fragmentation of
trading activity and compliance program requirements, as well as enable
more streamlined metrics reporting. However, under this alternative, a
banking entity may be able to aggregate impermissible proprietary
trading with permissible activity (e.g., underwriting, market making,
or hedging) into the same trading desk and consequently take
speculative positions under the guise of permitted activities. To the
extent that this alternative would allow banking entities to use a
highly aggregated definition of a trading desk, it may increase risk
exposures of banking entities and the conflicts of interest that the
prohibitions of section 13 of the BHC Act aimed to address.\1010\ The
SEC does not have data on operating and compliance costs that arise
because of the fragmentation of trading activity by SEC-regulated
banking entities, or data on their organizational complexity, and the
extent of variation therein. For the reasons discussed in section
IV.B.1.c, the agencies are not adopting this definition.
---------------------------------------------------------------------------
\1009\ This alternative was also suggested by a commenter. See
JBA.
\1010\ See, e.g., Volcker Alliance.
---------------------------------------------------------------------------
c. Permitted Underwriting and Market Making
Underwriting and market making are customer-oriented financial
services that are essential to capital formation and market liquidity,
and the risks and profit sources related to these activities are
distinct from those related to impermissible proprietary trading.
Moreover, as discussed above, market liquidity can be important to
investors
[[Page 62069]]
as it may enable investors to exit (in a timely manner and at an
acceptable price) from their positions in instruments, products, and
portfolios. At the same time, excessive risk exposure by banking
entities can, of course, adversely affect markets and, therefore,
investors.
Under the final rule, banking entities with covered activities are
presumed compliant with the RENTD requirements of the exemption for
underwriting and market making-related activities if the banking entity
establishes and implements, maintains, and enforces certain internal
limits that are designed not to exceed RENTD, taking into account the
liquidity, maturity, and depth of the market for the relevant type of
security or financial instrument. These internal limits are subject to
supervisory review and oversight on an ongoing basis.
For Group A entities, these limits are required to be established
either within the entity's internal compliance program or under the
presumption of compliance within the exemptions for permitted
underwriting and market making related activities. Under the final
rule, Group B entities are not required to establish a separate
compliance program for underwriting and market making requirements,
including the internal limits for RENTD. However, in order to be
presumed compliant with the RENTD requirements under the exemptions for
underwriting and market making-related activities, banking entities are
required to establish and enforce limits designed not to exceed RENTD,
as well as authorization procedures for limit breaches and increases
for each trading desk as described below.
With respect to limit increases and breaches, banking entities are
required to maintain and make available upon request records regarding
any limit that is exceeded and any temporary or permanent increase to
any limit. Unlike the proposal, the final rule does not include the
requirement of prompt reporting of breaches or limit increases but
requires that banking entities keep and provide such records to the
agencies upon request. However, consistent with the requirements under
the 2013 rule, the final rule includes certain requirements for the
continued availability of the presumption of compliance in the event of
limit increases or breaches. Specifically, the presumption of
compliance will continue to remain available in the event of a breach
or limit increase only if (i) the banking entity takes prompt action to
bring the trading desk into compliance; and (ii) establishes and
complies with a set of written authorization procedures, including
escalation procedures that require review and approval of any trade
that exceeds a trading desk's limits, demonstrable analysis of the
basis for any temporary or permanent increase to a trading desk's
limits, and independent review of such demonstrable analysis and
approval.
i. Costs and Benefits
This section discusses the expected benefits of the final rule and
how regulatory oversight of internal limits may reduce such benefits;
potential costs related to deterioration of risk management practices
and increased risk exposures of banking entities, including with
respect to the removal of the demonstrability requirement; aspects of
the final rule and baseline that mitigate these costs; and factors
likely to affect the overall balance of these economic effects.
The primary expected benefits of the final rule are threefold.
First, the agencies have received comments that the 2013 rule has
created significant costs and uncertainty about some banking entities'
ability to rely on the exemption for underwriting and market making-
related activities,\1011\ and the economic baseline discusses existing
research on the baseline effects of the 2013 rule on market quality,
trading, and client facilitation activities. The SEC believes that the
final rule may provide SEC-regulated banking entities with beneficial
flexibility and certainty in conducting permissible underwriting and
market making-related activities. Second, consistent with commenter
views,\1012\ the SEC recognizes that banking entities may already
routinely establish and monitor internally set risk and position limits
for purposes of meeting capital requirements and internal risk
management. Thus, to the degree that some banking entities already
establish limits that meet the requirements under the final rule, the
presumption allows the reliance on internal limits in accordance with a
banking entity's risk management function that may already be used to
meet other regulatory requirements. Therefore, the amendment may
prevent unnecessary duplication of risk-management compliance
procedures for the purposes of complying with multiple regulations and
may reduce compliance costs for SEC-regulated banking entities. Third,
to the extent that the uncertainty and compliance burdens related to
the RENTD requirements are currently impeding otherwise profitable
permissible underwriting and market making by dealers,\1013\ the
amendments may increase banking entities' profits and the volume of
dealer underwriting and market making activity. The SEC notes that the
returns and risks arising from banking entity activity may flow through
to investors and that investors in securities markets may benefit from
market liquidity as it enables exit from investment positions.
---------------------------------------------------------------------------
\1011\ See, e.g., ABA; Credit Suisse; State Street and BB&T.
\1012\ See JBA.
\1013\ See section V.F.2.
---------------------------------------------------------------------------
Since the 2013 rule requires oversight of internal limits and
authorization policies and procedures related to internal limit
increases or breaches, this aspect of the final rule is unlikely to
result in new compliance burdens for SEC registrants. In addition, the
SEC has received comment that some banking entities may already have
escalation and recordkeeping procedures when limits are breached or
changed.\1014\ The SEC continues to believe that agency oversight of
internal limits for the purposes of compliance with the final rule may
help support the benefits and costs of the substantive prohibitions of
section 13 of the BHC Act. The agencies have also received comment that
the amendments may allow the agencies to challenge the limit approval
and exception process but not the nexus between RENTD and limits.\1015\
As discussed above, sections __.4(c)(1)(i)-(ii) of the final rule
require that such limits must be designed not to exceed RENTD.
---------------------------------------------------------------------------
\1014\ See JBA.
\1015\ See, e.g., Better Markets.
---------------------------------------------------------------------------
In the proposal, the SEC noted that some entities may be able to
maintain positions that are larger than RENTD and increase risk
exposures arising out of trading activities, thus reducing the economic
effects of section 13 of the BHC Act and the 2013 rule. The agencies
have received comment that limits may be designed to exceed RENTD and
banking entities may frequently exceed limits and that introducing the
presumption may lead to a deterioration of risk management practices
and increase risk taking by banking entity dealers.\1016\ However, as
discussed above, under the final rule internal limits need to be tied
to RENTD, such that if the banking entity complies with the limits it
will not maintain positions that are larger than RENTD. The SEC also
notes that breaches and changes to internal limits may reflect banking
entities' close
[[Page 62070]]
monitoring of market conditions and tailoring such limits, valuable for
both internal risk management and supervision and oversight over
banking entities. The agencies have received comment that some banking
entities may change the way they set internal limits in response to the
final rule, for instance, by selecting higher initial limits to avoid
breaches or increases for the purposes of section 13 of the BHC
Act.\1017\ The SEC recognizes these possible effects from entities
changing their internal limit setting practices and notes that this
effect may reduce the value of closely tailored and dynamically
adjusted internal limits for internal oversight and agency supervision.
Moreover, the SEC notes that this effect may lead some banking entities
to take on greater trading risks. Nevertheless, to satisfy the
presumption of compliance, such trading activity must conducted within
risk and position limits designed not to exceed RENTD, and thus be
consistent with section 13(d)(1)(B) of the BHC Act. The SEC also notes
that the final rule contains recordkeeping obligations concerning any
exceeded limits or temporary or permanent increases to limits, which
may facilitate agency oversight but impose new burdens on banking
entities. As discussed in section V.B, this aspect of the final rule
may increase initial burdens \1018\ by $8,870 \1019\ for SEC-registered
banking entities and ongoing burdens for SEC-registered broker-dealers
by approximately $227,278 per year and for SBSDs by approximately
$38,831 per year.\1020\
---------------------------------------------------------------------------
\1016\ See, e.g., Volcker Alliance; Better Markets; NAFCU and
Public Citizen.
\1017\ See, e.g., Capital One et al.; Better Markets; and State
Street.
\1018\ For the purposes of the burden estimates in this release,
the SEC is assuming the cost of $423 per hour for an attorney, from
SIFMA's ``Management & Professional Earnings in the Securities
Industry 2013,'' modified to account for an 1,800-hour work year,
multiplied by 5.35 to account for bonuses, firm size, employee
benefits, and overhead, and adjusted for inflation as of June 2019.
\1019\ Initial reporting and recordkeeping burdens: 0.5 hours x
0.18 dealer weight x [199 broker-dealers + 34 SBSDs not already
registered as broker-dealers] x Attorney at $423 per hour = $8,870.
\1020\ Ongoing burdens for broker-dealers: [10 hours
recordkeeping + 5 hours reporting] x 0.18 dealer weight x 199 x
Attorney at $423 per hour = $227,278.
Ongoing burdens for SBSDs: [10 hours recordkeeping + 5 hours
reporting] x 0.18 dealer weight x 34 SBSDs not already registered as
broker-dealers x Attorney at $423 per hour = $38,831.
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The final rule also eliminates the requirements of the market
making exemption related to the demonstrable analysis of historical
customer demand, current inventory of financial instruments, and market
and other factors concerning financial instruments in which the trading
desk makes a market, including though block trades. Some commenters
indicated that this aspect of the amendments gives banking entities
greater discretion to establish higher risk and inventory limits in
excess of RENTD \1021\ and that banking entities should be required to
demonstrate the analysis behind their RENTD forecasts and compare ex-
ante forecasts with ex-post realizations.\1022\ However, the agencies
also received comment that RENTD can significantly deviate from
historically observed levels, particularly in times of severe market
stress, and internal limits designed to not to exceed RENTD may be
based on current or forward looking customer inquiries, anticipated
volatility shocks, and other forward looking information about market
conditions and the evolving risks of a particular desk.\1023\ The SEC
also notes that, under the final rule, the presumption of compliance
requires risk and position limits to be designed not to exceed RENTD
and that the agencies may rebut the presumption as discussed above.
---------------------------------------------------------------------------
\1021\ See Volcker Alliance.
\1022\ See Data Boiler.
\1023\ See, e.g., FSF.
---------------------------------------------------------------------------
Four key aspects of the final rule are aimed at mitigating these
risks and costs. First, the internal limits, including any changes to
limits, used to establish the presumption of compliance are subject to
rebuttal procedures discussed above, and the final rule requires that
the internal limits are designed not to exceed RENTD and take into
account the liquidity, maturity, and depth of the market for the
relevant type of security or financial instrument. Second, the
presumption of compliance is conditional on the banking entity's prompt
action to bring the trading desk into compliance if a limit is
exceeded. Third, banking entities are required to establish and comply
with a robust set of internal policies and procedures, requiring review
of limits, demonstrable analysis of a basis for any limit increase, and
independent review of such analysis and approval. Fourth, the economic
effects of the presumption of compliance interact with the effects of
the amended trading desk definition, which the SEC believes will allow
the agencies to better oversee trading activity across a given banking
entity's trading desks and across groups of banking entities to
determine whether the internal limits are appropriately designed not to
exceed RENTD.
The SEC also notes that the final rule tailors compliance
obligations of banking entities for purposes of the exemptions for
underwriting and market making-related activities. The economic effects
of the final amendments related to compliance are discussed in section
V.F.3.g.
The SEC continues to believe that the overall economic effect of
these amendments will depend on how banking entities choose to comply
with the substantive prohibitions in section 13 of the BHC Act and the
2013 rule as amended. Specifically, banking entities are likely to
weigh the unmet demand for and profitability of client facilitation
activity against the potential costs of establishing and maintaining
appropriate internal limits.\1024\ The SEC does not have data on the
volume of trading activity that does not occur because of the costs
associated with complying with the RENTD requirement or data on the
profitability of such trading activity for SEC-regulated banking
entities. The SEC is not aware of any such data, and commenters did not
provide data enabling such quantification.\1025\
---------------------------------------------------------------------------
\1024\ See, e.g., 83 FR at 33532.
\1025\ The SEC observes that, as shown in Table 1, broker-
dealers affected by the final rule have total assets of
approximately $3.14 trillion and holdings of approximately $761.53
billion. If the final amendments increase affected broker-dealer
holdings by even 0.01%, the economic impact of the final rule may
exceed $100 million.
---------------------------------------------------------------------------
ii. Efficiency, Competition, and Capital Formation
The SEC believes that the final rule may reduce the costs of
relying on the exemptions for underwriting and market making-related
activities, which may facilitate the activities related to these
exemptions. The evolution in market structure in some asset classes
(e.g., equities) has transformed the role of traditional dealers vis-
[agrave]-vis other participants, particularly as it relates to high-
frequency trading and electronic platforms. However, dealers continue
to play a central role in less liquid markets, such as corporate bond
and over-the-counter (OTC) derivatives markets. While it is difficult
to establish causality, corporate bond dealers, particularly bank-
affiliated dealers, have, on aggregate, significantly reduced their
capital commitment post-crisis.\1026\ Corporate bond dealers are
increasingly shifting from trading in a principal capacity to agency
trading. To the extent that this change cannot be explained by enhanced
ability of dealers to manage corporate bond inventory, electronic
trading, post-crisis changes in dealer risk tolerance and macro factors
(effects
[[Page 62071]]
which themselves need not be fully independent of the effect of section
13 of the BHC Act and the 2013 rule), such effects may point to a
reduced supply of liquidity by dealers. Moreover, corporate bond
dealers decrease liquidity provision in times of stress after the 2013
rule.\1027\ In dealer-centric single-name CDS markets, interdealer
trade activity, trade sizes, quoting activity, and quoted spreads for
illiquid underliers have deteriorated since 2010, but dealer-customer
activity and various trading activity metrics have remained
stable.\1028\
---------------------------------------------------------------------------
\1026\ See, e.g., FRB's ``Staff Q2 2017 Report on Corporate Bond
Market Liquidity.'' See also section V.F.2 above.
\1027\ See section V.F.2. above.
\1028\ For a literature review and data, see SEC Report 2017,
supra note 774.
---------------------------------------------------------------------------
Because of the methodological challenges described earlier in this
analysis, the SEC cannot quantify potential effects of the 2013 rule in
general--and the RENTD, underwriting, and market making provisions of
the 2013 rule in particular--on capital formation and market liquidity.
The SEC also recognizes, as discussed above, that these provisions may
not be currently affecting all securities markets, asset classes, and
products uniformly. If, because of uncertainty and the costs of relying
on exemptions for market making-related activity and risk-mitigating
hedging, dealers currently limit their market making and hedging
activity in certain products, the final rule may facilitate market
making. Because secondary market liquidity can affect the willingness
to invest in primary markets, and access to liquidity in these markets
can enable market participants to mitigate undesirable risk exposures,
the amendments may increase trading activity and capital formation in
some segments of the market.
While section 13 of the BHC Act and the 2013 rule, as amended,
prohibit banking entities from engaging in proprietary trading, some
trading desks may attempt to use certain elements of the final RENTD
amendments to circumvent those restrictions, which may reduce the
economic effects of the 2013 rule outlined in the economic baseline.
However, under the final rule, internal limits and policies and
procedures regarding breaches and limit increases and other aspects of
banking entities' compliance with section 13 of the BHC Act remain
subject to the full scope of agency oversight and supervision, and the
presumption of compliance is rebuttable.
The SEC continues to recognize that proprietary trading by banking
entities may increase the risk exposures of banking entities, may give
rise to economic inefficiency because of implicitly subsidized risk
exposures of banking entities, and may increase market fragility and
conflicts of interest between banking entities and their
customers.\1029\ However, the SEC also recognizes the comments and
research discussed above concerning the unintended effects of the 2013
rule on valuable underwriting and market making activities, and the
nuanced effects of section 13 of the BHC Act and the 2013 rule on the
overall volume and structure of banking entity risk exposures.
---------------------------------------------------------------------------
\1029\ See 83 FR at 33533.
---------------------------------------------------------------------------
The SEC continues to believe that, where the final rule increases
the scope of permissible activities or decreases the risk of detection
of proprietary trading, its effect on informational efficiency stems
from a balance of two effects.\1030\ On the one hand, where proprietary
trading strategies are based on superior analysis and prediction
models, their enhanced ability to trade on such information may make
securities markets more informationally efficient. While such
proprietary trading strategies can be executed by dealers that are not
affiliated with banking entities and therefore unaffected by the
prohibitions on proprietary trading, their ability to do so may be
constrained by their limited access to capital and a lack of scale
needed to profit from such strategies. On the other hand, if superior
information is obtained by an entity from its customer-facing
activities and as a result of conflicts of interest, and if such
conflicts are recognized by other market participants, proprietary
trading may make other market participants less willing to transact
with banks or participate in securities markets, potentially reducing
informational efficiency.
---------------------------------------------------------------------------
\1030\ See 83 FR at 33534.
---------------------------------------------------------------------------
iii. Alternatives: Prompt Notice, Thresholds
The agencies could have adopted a prompt notice requirement for
limit breaches and limit changes, such as internal limit increases, for
all or a subgroup of banking entities. Prompt notification of breaches
and changes to internal limits under the alternative may provide more
immediate information to agencies about limit breaches and changes
supporting oversight.\1031\ The agencies have received comment that
such prompt notice may be especially beneficial for the oversight of
smaller and mid-size banking entities with less sophisticated internal
controls that may be more susceptible to risks from rogue
trading.\1032\
---------------------------------------------------------------------------
\1031\ See, e.g., Data Boiler.
\1032\ See, e.g., CFA.
---------------------------------------------------------------------------
However, consistent with the views of a number of commenters,\1033\
the SEC believes that the prompt notice requirement would have imposed
considerable costs on registrants. Such information may duplicate
metrics reporting for Group A entities and other information provided
to the agencies in the ordinary course of prudential supervision.\1034\
Further, such costs would likely be most significant for Group B and
Group C entities that do not engage in significant trading activity and
which may face more difficulties absorbing reporting costs,\1035\ as
well as for non-U.S. banking entities with large non-U.S.
operations.\1036\ In addition, internal limit increases or breaches may
reflect changes in market conditions and not changes in a banking
entity strategy or risk tolerance, and smaller and mid-size banks may
currently be setting internal limits considerably below RENTD.\1037\
Finally, to the degree that market participants may interpret the
prompt reporting requirement as an enhanced regulatory focus on the
number of times an entity has breached RENTD, traders may become less
willing to request limit increases to accommodate customer demand;
\1038\ alternatively, entities may set higher internal limits to avoid
breaches or increases.\1039\
---------------------------------------------------------------------------
\1033\ See, e.g., ABA; Committee on Capital Markets; Credit
Suisse; GFMA; FSF; JBA and BB&T.
\1034\ See, e.g., FSF; SIFMA; ABA; CREFC; GFMA; Goldman Sachs;
Real Estate Associations and ISDA.
\1035\ See, e.g., Capital One et al.
\1036\ See, e.g., JBA and IIB.
\1037\ See BOK.
\1038\ See, e.g., CCMC.
\1039\ See, e.g., Capital One et al.; Better Markets; MBA and
State Street.
---------------------------------------------------------------------------
The final rule balances these considerations by imposing
recordkeeping requirements that enable the agencies to access books and
records concerning internal limit increases and breaches in the course
of other supervision, inspections, and examinations; require prompt
action to bring the trading desk back in compliance in the event of a
breach; and impose requirements concerning policies and procedures for
escalation, for demonstrable analysis of the basis for internal limit
increases, and for independent review for such analysis and approval.
The agencies could have also adopted the internal limit approach,
but with more or less flexibility provided to banking entities in
setting internal limits. For example, the agencies could have specified
that a desk's internal
[[Page 62072]]
limits can reflect risk appetite, risk capacity, and business strategy,
so long as that desk holds itself out as a market maker; the agencies
could have also permitted limits based on absolute value of profit and
loss (in the case of an underwriting desk).\1040\ The agencies could
have also adopted an approach under which the internal limits necessary
for the presumption of compliance are developed in collaboration with
onsite supervisors or prudential examiners.\1041\ The agencies could
have also adopted an approach under which all or Group B and Group C
banking entities would be able to rely on the presumption of compliance
if their internal limits were appropriate to the activities of the desk
subject to other existing bank regulations, supervisory review, and
oversight by the appropriate agency.\1042\ Finally, the agencies could
have adopted an approach under which the presumption of compliance is
available for activity-based internal limits, such as those based on
notional size and inventory turnover.\1043\ Alternatives that would
provide banking entities with greater flexibility in setting internal
limits would bolster the ability of market makers and underwriters to
proactively adjust their risk exposures to changing market conditions
and potentially accommodate a greater volume of customer demand. At the
same time, such alternatives may also allow banking entities to engage
in a greater degree of trading activity while relying on the
presumption of compliance.
---------------------------------------------------------------------------
\1040\ See JBA.
\1041\ See, e.g., FSF and SIFMA.
\1042\ See Capital One et al.
\1043\ See BB&T.
---------------------------------------------------------------------------
Similarly, one commenter suggested an approach that more
prescriptively specifies how banking entities should set and adjust
internal limits and what factors they should consider.\1044\ Another
commenter stated that such a one-size-fits all approach ignores
differences in the business models of banking entities and desks.\1045\
The SEC believes that, while this alternative may decrease the trading
activity of banking entities, it would not appropriately tailor the
2013 rule to the differences in organization, operation, and risks of
various banking entities and their trading desks; may hamper client
facilitation activity when market conditions are in flux; and may have
the unintended effect of banking entities delegating certain risk
management functions to the agencies. As discussed above, the final
rule specifies that internal limits must be designed not to exceed
RENTD and that internal limits of banking entities are subject to
ongoing regulatory oversight by the agencies.
---------------------------------------------------------------------------
\1044\ See Better Markets.
\1045\ See Committee on Capital Markets.
---------------------------------------------------------------------------
The agencies could have adopted an approach under which
underwriting and market making requirements are tailored to banking
entities on the basis of different thresholds. For example, the
agencies could have instead relied on the trading assets and
liabilities threshold for market making compliance (as in the final
rule), but applied a different threshold for underwriting compliance,
such as on the basis of the volume or profitability of past
underwriting activity. This alternative would have tailored the
compliance requirements for SEC-regulated banking entities with respect
to underwriting activities. However, the volume and profitability of
underwriting activity is highly cyclical and is likely to decline in
weak macroeconomic conditions. As a result, under the alternative, SEC-
regulated banking entities would face lower limits with respect to
underwriting activity during times of economic stress when covered
trading activity related to underwriting may pose the highest risk of
loss. The alternative may also limit banking entities in their ability
to engage in underwriting during economic weakness when economic
activity and capital formation are in decline.
One commenter suggested that the agencies interpret the
underwriting exemption broadly to accommodate any activity that assists
persons or entities in accessing the capital markets or raising
capital, as well as any activities done in connection with a capital
raise.\1046\ Under such an approach, an underwriter's hedging of
unsold, contingent, or forward underwriting allotments would be
permissible under the underwriting exemption. To the degree that
banking entities are unable to engage in such activities in reliance on
the hedging or other exemptions under the 2013 rule, this alternative
may increase the ability of some banking entities to hedge some of the
risks related to underwriting and their willingness to engage in
underwriting activity. Moreover, a broad underwriting exemption would
eliminate the need to categorize the underwritten instruments, which
may be difficult to do in some foreign markets with respect to loans,
repos, securities loans, financial instruments, or derivatives. At the
same time, the SEC believes that banking entities may currently be able
to engage in hedging related to underwriting activity under the rule,
such as in reliance on the hedging exemption.
---------------------------------------------------------------------------
\1046\ See, e.g., ISDA.
---------------------------------------------------------------------------
d. Permitted Risk-Mitigating Hedging
i. Costs and Benefits
As discussed in the proposal,\1047\ hedging is an essential tool
for risk mitigation and can enhance a banking entity's provision of
client-facing services, such as market making and underwriting, as well
as facilitate financial stability. In recognition of the important role
that this activity can play as part of a banking entity's overall
operations, the agencies are adopting a number of changes that
streamline and clarify the 2013 rule's exemption for risk-mitigating
hedging activities to reduce unnecessary compliance burdens and
uncertainty some banking entities face concerning their ability to rely
on the hedging exemption.
---------------------------------------------------------------------------
\1047\ See, e.g., 83 FR at 33535.
---------------------------------------------------------------------------
First, the final rule simplifies the requirements of the risk-
mitigating hedging exemption for banking entities that do not have
significant trading assets and liabilities. The amendment removes the
requirement to have a specific risk-mitigating hedging compliance
program, as well as the documentation requirements and certain hedging
activity requirements for such entities. As a result, these banking
entities are subject to the following requirements: (1) The hedging
activity, at the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof; and (2) the hedging
activity is subject, as appropriate, to ongoing recalibration by the
banking entity to ensure that the hedging activity satisfies these
requirements and is not prohibited proprietary trading.
As discussed in the proposal,\1048\ banking entities without
significant trading assets and liabilities may be less likely to engage
in large or complicated trading activities and hedging strategies. The
agencies have received comment supporting such reduced compliance
[[Page 62073]]
requirements for banking entities that do not have significant trading
assets and liabilities.\1049\ One commenter stated that reduced
compliance requirements for risk-mitigating hedging by Group B and
Group C banking entities would not affect the safety and soundness of
banking entities or financial stability and pointed to the importance
of robust monitoring and banking entity risk management in the context
of risk-mitigating hedging.\1050\ Another commenter opposed this aspect
of the amendments and stated that, absent proprietary trading intent,
ensuring that hedging does not increase banking entities' risks at
inception of the hedge and that trading personnel are not compensated
for doing so is not complex.\1051\
---------------------------------------------------------------------------
\1048\ See, e.g., 83 FR at 33536.
\1049\ See, e.g., Credit Suisse and BB&T.
\1050\ See BB&T.
\1051\ See Better Markets.
---------------------------------------------------------------------------
The SEC continues to believe that compliance with the 2013 rule,
including compliance with the requirements of Sec. __.5(b)(2), imposes
disproportionate costs on banking entities without significant trading
assets and liabilities.\1052\ The SEC continues to note that, as
quantified in the economic baseline, Group B and Group C broker-dealers
represent a very small fraction of total assets and holdings in the
broker-dealer industry. In addition, fixed compliance costs represent
disproportionately greater burdens for smaller entities as they may
face greater difficulty absorbing such costs into revenue. Importantly,
the final rule does not waive the substantive proprietary trading
prohibitions in section 13 of the BHC Act for any banking entity,
including for any Group B or Group C banking entity. Instead, the SEC
continues to believe that the amendment reduces the costs of relying on
the hedging exemption and, thus, the costs of engaging in hedging
activities for Group B and Group C entities. To the extent that the
removal of these requirements may reduce the costs of risk-mitigating
hedging activity, Group B and Group C entities may increase their
intermediation activity while also growing their trading assets and
liabilities.
---------------------------------------------------------------------------
\1052\ See, e.g., 83 FR at 33536.
---------------------------------------------------------------------------
Second, the final rule reduces documentation requirements for Group
A entities. In particular, the final rule removes the documentation
requirements for some risk-mitigating hedging activity. More
specifically, the activity is not subject to the documentation
requirement if (1) the financial instrument used for hedging is
identified on a written list of pre-approved financial instruments
commonly used by the trading desk for the specific type of hedging
activity; and (2) at the time the financial instrument is purchased or
sold the hedging activity (including the purchase or sale of the
financial instrument) complies with written, pre-approved hedging
limits for the trading desk purchasing or selling the financial
instrument for hedging activities undertaken for one or more other
trading desks.
The agencies received comment that this and other final amendments
to the risk-mitigating hedging exemption may lead banking entities to
engage in less planning, documentation, and testing in their hedging
activities, may reduce the effectiveness of agency oversight, and may
weaken the proprietary trading prohibitions of the 2013 rule.\1053\
Other commenters supported the revisions, but stated that enhanced
documentation requirements for the hedging exemption, as a whole, are
unnecessary given the robust compliance framework under the 2013 rule
and amendments, and supported the complete elimination of the
documentation requirements for all banking entities.\1054\
---------------------------------------------------------------------------
\1053\ See, e.g., Better Markets; Data Boiler and Bean.
\1054\ See, e.g., ABA; FSF; CREFC; BPI and SIFMA.
---------------------------------------------------------------------------
Consistent with the views of some commenters,\1055\ the economic
effects with respect to internal limits for the purposes of hedging
with pre-approved instruments may be similar to the effects of internal
limits for the purposes the underwriting and market making exemptions
discussed above. The SEC recognizes that the economic effects of this
aspect of the final rule depend on the prevalence of hedging activities
in each registrant, their organizational structure, business model, and
complexity of risk exposures. However, the SEC continues to believe
that the flexibility to choose between providing documentation
regarding risk-mitigating hedging transactions and establishing hedging
limits for pre-approved instruments may be beneficial for Group A
entities, as it will allow these entities to tailor their compliance
programs to their specific organizational structure and existing
policies and procedures.\1056\ At the same time, the SEC believes that
the remaining documentation requirements for Group A entities being
adopted will facilitate effective internal risk management and agency
oversight.
---------------------------------------------------------------------------
\1055\ See, e.g., Credit Suisse.
\1056\ See, e.g., 83 FR at 33536.
---------------------------------------------------------------------------
Third, the final rule eliminates the requirement that the risk-
mitigating hedging activity must demonstrably reduce or otherwise
significantly mitigate one or more specific identifiable risks at the
inception of the hedge. Additionally, the demonstrability requirement
is also removed from the requirement to continually review, monitor,
and manage the banking entity's existing hedging activity. Banking
entities will continue to be subject to the requirement that the risk-
mitigating hedging activity be designed to reduce or otherwise
significantly mitigate one or more specific, identifiable risks, as
well as to the requirement that the hedging activity be subject to
continuing review, monitoring and management by the banking entity to
confirm that such activity is designed to reduce or otherwise
significantly mitigate the specific, identifiable risks that develop
over time from the risk-mitigating hedging.
Consistent with the views of a number of commenters,\1057\ the SEC
believes that the removal of the demonstrability requirement may
benefit banking entity dealers, as it decreases uncertainty about the
ability to rely on the risk-mitigating hedging exemption and may reduce
the compliance costs of engaging in permitted hedging activities. The
SEC continues to recognize that some SEC-regulated banking entities may
respond to this aspect of the final rule by accumulating positions that
increase the banking entity's risk exposure through adjustments (or
lack thereof) to otherwise permissible hedging portfolios.\1058\ The
SEC also recognizes concerns raised by commenters that some banking
entities may forecast changes in correlations and construct hedging
portfolios such that they leave the entity exposed to directional
market movements.\1059\ The SEC continues to recognize that this may
result in increased risks from the trading activity of some banking
entities.\1060\ However, the final rule's requirement concerning
ongoing recalibration may mitigate these adverse effects. In addition,
as discussed in greater detail in the economic baseline, the SEC
recognizes that trading activity is only one form of activity conducted
by banking entities that can increase risk exposure, and that market,
credit, and liquidity risks of the banking book as well as the degree
to which banking book risks are hedged by tradeable assets all
contribute to the overall risk of a banking entity or group of banking
entities. As a result, the SEC
[[Page 62074]]
recognizes that, to the degree that some banking entities may respond
to the final rule by increasing risk exposures arising out of trading
activity, these effects may be partly offset by changes in the risks
these banking entities take in the normal course of their banking
activity or more complete hedging of their banking and trading risks
through trading portfolios. Moreover, the SEC believes that this aspect
of the final rules may not only benefit banking entities by alleviating
compliance burdens related to risk management, but may also benefit
clients and counterparties by enabling greater trading activity and
liquidity provision by dealers that are banking entities. Furthermore,
the SEC reiterates that the returns and risks arising from the activity
of banking entities may flow through to banking entity's investors and
that investors in securities markets may benefit from greater liquidity
as it enables exit from investment positions.
---------------------------------------------------------------------------
\1057\ See, e.g., ABA; Credit Suisse and SIFMA.
\1058\ See 83 FR at 33535. See also, e.g., Better Markets; Bean;
Data Boiler and CFA.
\1059\ See, e.g., Public Citizen.
\1060\ See, e.g., 83 FR at 33536.
---------------------------------------------------------------------------
Finally, the final rule removes the requirement to perform the
correlation analysis. The SEC continues to recognize that a correlation
analysis based on returns may be prohibitively complex for some asset
classes and that a correlation coefficient may not always serve as a
meaningful or predictive risk metric.\1061\ The agencies received
comment that permitting additional time to provide correlation analysis
would better address time-related challenges; \1062\ that requiring
statistical tests of randomness to the observed returns on the hedged
positions may serve to duly constrain hedging; \1063\ and that there
should be no regulation-related delays when hedging if banking entities
rely on documented and stable risk relationships.\1064\ The SEC notes
that time costs are only one of the issues in the correlation
requirement and that banking entities may not be able to rely on
documented and stable risk relationships in quickly evolving market
conditions. Although in some instances correlation analysis of past
returns may be helpful in evaluating whether a hedging transaction was
effective in offsetting the risks intended to be mitigated, the SEC
continues to recognize that correlation analysis may not be an
effective tool for such evaluation in other instances. For example,
correlations across assets and asset classes evolve over time and may
exhibit jumps at times of idiosyncratic or systematic stress. In such
circumstances, historical correlations among the returns on assets or
asset classes may not be representative of the way in which they will
affect portfolio risk going forward. Moreover, the SEC notes that asset
return correlations may not be informative when financial instruments
are traded infrequently, if the prices used to construct asset returns
are non-binding indicative quotes (and not actual execution prices).
Additionally, the hedging activity, even if properly designed to reduce
risk, may not be practicable if costly delays or compliance
complexities result from a requirement to undertake a correlation
analysis.\1065\ These costs and delays may be most acute in times of
market stress and during spikes in volatility, during which customers
and other dealers may demand greater liquidity. The SEC continues to
believe that the removal of the correlation analysis requirement may
provide dealers with greater flexibility in selecting and executing
risk-mitigating hedging activities.\1066\
---------------------------------------------------------------------------
\1061\ See 83 FR at 33535. See also, e.g., ABA; Credit Suisse;
JBA; SIFMA and CREFC.
\1062\ See, e.g., Better Markets.
\1063\ Id.
\1064\ Id.
\1065\ See, e.g., SIFMA.
\1066\ See, e.g., 83 FR at 33535.
---------------------------------------------------------------------------
The SEC received comments that the elimination of the correlation
analysis may impede supervisory review, enable some banking entities to
disguise proprietary trades as hedges, or result in permissible over-
or under-hedging due to changes in asset correlations over time.\1067\
Other commenters indicated that correlation analysis is highly
automated and forces banking entities to be more purposeful in hedging
activities.\1068\ The SEC recognizes these concerns and continues to
recognize that the removal of the correlation analysis requirement
involves the tensions of the effects discussed above.\1069\ The SEC
continues to recognize that, to the extent that some banking entities
may respond to this aspect of the final rule by engaging in more
trading activities that leave them exposed to directional market
movements while relying on the risk-mitigating hedging exemption, this
aspect of the final rule may increase risk taking and conflicts of
interest between banking entities and their customers. However, the SEC
believes that the final rule's requirement concerning ongoing
recalibration by the banking entity to ensure that the hedging activity
satisfies the requirements above and is not prohibited proprietary
trading may mitigate these concerns. In addition, similar to the
discussion above, the SEC continues to recognize that changes in the
overall risk of banking entities reflect both changes in the risk of
trading activities and their banking activities. Importantly, the SEC
continues to believe that the requirement to engage in correlation
analysis may have slowed the timing of hedging activities by some
banking entities and may not be beneficial for prudent risk management
or practical under some circumstances. Moreover, the SEC continues to
believe that potential increases in permitted risk-mitigating hedging
may benefit clients, customers, and counterparties by increasing
trading activity and capital formation by banking entities,
particularly in times of market stress and during spikes in volatility.
Finally, under the final rule, banking entities remain subject to the
full scope of agency oversight over trading activities in reliance on
the hedging exemption.
---------------------------------------------------------------------------
\1067\ See, e.g., AFR; Bean; NAFCU; Public Citizen; Volcker
Alliance; Better Markets and Systemic Risk Council.
\1068\ See, e.g., AFR and Data Boiler.
\1069\ See 83 FR at 33536.
---------------------------------------------------------------------------
As discussed above, the SEC estimates burden reductions, per firm,
as a result of the final rule. The final amendments to Sec. __.5(c)
may result in ongoing cost savings for SEC-registered broker-dealers
\1070\ estimated at $1,295,903.\1071\ Additionally, the final rule will
result in lower ongoing costs for potential SBSD registrants relative
to the costs that they would incur under the 2013 rule's regime if they
were to choose to register with the SEC--this cost reduction is
estimated to reach up to $51,775.\1072\ However, the SEC recognizes
that compliance with SBSD registration
[[Page 62075]]
requirements is not yet required and that there are currently no
registered SBSDs.
---------------------------------------------------------------------------
\1070\ The SEC continues to believe that the burden reduction
for SEC-regulated entities will be a fraction of the burden
reduction for the holding company as a whole. In the proposal, the
SEC attributed 18% of the reductions in holding company (parent)
burdens to the dealer affiliates, on the basis of the average weight
of broker-dealer assets in holding company assets. The SEC received
no comment on this estimate and continues to rely on this figure in
estimates of compliance burden reductions for SEC registrants.
However, the SEC recognizes that compliance burdens may be borne
disproportionately by dealer affiliates because of their role in
trading for the holding company. As a result, some dealers may
currently be bearing a larger fraction of holding company compliance
burdens related to section 13 of the BHC Act. To this extent, the
estimates of compliance burden savings may underestimate the
magnitude of the benefits enjoyed by SEC registrants under the final
amendments.
\1071\ Ongoing recordkeeping burden reduction for broker-
dealers: (100 hours per firm x 0.18 weight x (Attorney at $423 per
hour) x 199 firms)-(80 hours per firm x 0.18 weight x (Attorney at
$423 per hour) x 36 firms affiliated with Group A entities) =
$1,515,186-$219,283 = $1,295,903.
\1072\ Recordkeeping burden reduction for entities that may
register as SBSDs: (100-80) hours per firm x 0.18 weight x (Attorney
at $423 per hour) x 34 SBSDs not already registered as broker-
dealers = $51,775. This estimate assumes all SBSDs are Group A
entities and will still be subject to these ongoing recordkeeping
obligations.
---------------------------------------------------------------------------
ii. Efficiency, Competition, and Capital Formation
The primary efficiency, competition, and capital formation effects
of the risk-mitigating hedging amendments stem from competition and
capital formation. The final hedging amendments provide greater relief
with respect to the requirements of the exemption for hedging activity
to Group B and Group C entities relative to Group A entities. Since the
fixed costs of relying on such exemptions may be more significant for
entities with smaller trading books, the final hedging amendments may
permit Group B entities just below the $20 billion threshold to more
effectively compete with Group A entities just above the threshold.
The final hedging amendments may also influence the volume of
hedging activity and capital formation. To the extent that some
registrants currently experience significant compliance costs related
to the hedging exemption, these costs may constrain the amount of risk-
mitigating hedging they currently engage in. The ability to hedge
underlying risks at a low cost can facilitate the willingness of SEC-
regulated entities to commit capital and take on underlying risk
exposures. Because the final rule may reduce costs of relying on the
hedging exemption, these entities may become more incentivized to
engage in risk-mitigating hedging activity, which may in turn
contribute to greater capital formation.
These amendments to risk-mitigating hedging do not change the
amount or type of information available to market participants, and the
SEC does not believe that the final rule is likely to have an effect on
informational efficiency. To the degree that these amendments may
enable some banking entities to more easily rely on the hedging
exemption, and to the extent that hedging supports extension of credit
and other capital formation, these amendments may somewhat improve
allocative efficiency.
iii. Alternatives
The agencies could have adopted an approach that would exclude from
the proprietary trading prohibition or allow all or a subset of banking
entities (such as Group B and Group C entities) to rely on the
presumption of compliance with respect to hedging activity accounted
for under hedge accounting principles.\1073\ The agencies could have
also adopted an approach excluding trading activity of non-U.S. banking
entities accounted for under hedge accounting rules in their home
jurisdictions.\1074\ The SEC believes that such alternatives would
effectively replace the compliance and documentation obligations for
permitted risk-mitigating hedging in the 2013 rule as amended in this
final rule with the compliance obligations necessary for an entity to
qualify for hedge accounting treatment. For example, banking entities
must generally document the hedge relationship, including hedge
objectives, risks being hedged, hedged item and the financial
instrument used in the hedge, demonstrate that the hedge is highly
effective, and recognize any ineffectiveness in profits and
losses.\1075\ As a result, some commenters \1076\ indicated that such
approaches may reduce compliance duplication and further reduce
uncertainty regarding the ability of some banking entities to rely on
the risk-mitigating hedging exemption with respect to certain hedging
transactions.
---------------------------------------------------------------------------
\1073\ See, e.g., Capital One et al., JBA, ABA and KeyCorp.
\1074\ See JBA.
\1075\ See FASB, Derivatives and Hedging (Topic 815) (Aug.
2017). See also International Financial Reporting Standard
(``IFRS'') 9 (Financial Instruments). See also Capital One et al.
\1076\ See Capital One et al. and JBA.
---------------------------------------------------------------------------
However, the SEC also recognizes commenter concerns that the
compliance and effectiveness testing for the purposes of hedge
accounting are designed for the purposes of transparent and informative
financial statements and are not designed to distinguish between
prohibited proprietary trading and permissible risk-mitigating hedging
for the purposes of section 13 of the BHC Act.\1077\ Moreover,
international accounting standards may not involve the same level of
compliance, documentation, and effectiveness testing as either the U.S.
hedge accounting standards or the compliance program for the hedging
exemption of the 2013 rule. As a result, the SEC continues to believe
that the final rule implements the purposes of section 13 of the BHC
Act while reducing compliance burdens on most affected registrants.
---------------------------------------------------------------------------
\1077\ See, e.g., Data Boiler.
---------------------------------------------------------------------------
As another alternative, the agencies could have adopted an
approach, under which compliance with the risk-mitigating hedging
exemption is applied on the basis of analysis of the trading desk's
activities as a whole and not on a trade-by-trade basis.\1078\ In a
related vein, the agencies could have adopted an approach that allows
portfolio hedging that is not contemporaneous with the inception of the
position being hedged and that does not occur at the desk to which the
risk is booked, so long as the hedging exposure remains within
permitted internal limits applicable to each desk and to the banking
entity as a whole.\1079\ The SEC believes that such alternatives would
have the effect of enabling firm-wide macro hedges of a banking
entity's risk exposures by centralized risk management desks, which may
involve fewer transaction costs and reduce the burden of demonstrating
compliance with the hedging exemption for each trade. However, such an
approach may make it more difficult for the agencies and banking
entities to oversee compliance with the hedging exemption and
distinguish between transactions reasonably designed at their inception
to hedge specific risks and impermissible proprietary trades intended
to profit from asset mispricing or directional changes in the value of
assets or asset classes.
---------------------------------------------------------------------------
\1078\ See, e.g., Credit Suisse and CCMC.
\1079\ Id.
---------------------------------------------------------------------------
As discussed above, the agencies could have also eliminated all
enhanced documentation requirements for Group A banking entities and
all other conditions of the hedging exemption not expressly required by
the statute.\1080\ The SEC believes that, relative to the final rule,
such an alternative would further reduce compliance burdens on Group A
banking entities and uncertainty regarding their ability to rely on the
hedging exemption and may increase the volume of risk-mitigating
hedging by Group A banking entities. However, the elimination of
enhanced documentation requirements as a whole and other conditions of
the exemption may also reduce the effectiveness of internal risk
management and agency oversight of Group A entities and may result in
increased trading activity by Group A entities in reliance on the
hedging exemption. This risk may be particularly acute given the size
and complexity of trading activity of Group A entities and their role
in the dealer industry and in the U.S. financial system as a whole.
---------------------------------------------------------------------------
\1080\ See, e.g., ABA; FSF; CREFC; BPI and SIFMA.
---------------------------------------------------------------------------
The agencies could have adopted an explicit exclusion from the
proprietary trading prohibition for hedges of corporate debt issuances.
Specifically, the agencies have received comment that financial
institutions may routinely hedge debt securities issued for corporate
purposes with interest rate swaps, which fall into the trading account
under the 60-day rebuttable
[[Page 62076]]
presumption of the 2013 rule.\1081\ As discussed above, the final rule
modifies the short-term prong of the trading account definition,
reducing the likelihood that such activity would fall in to the trading
account and require the reliance on the hedging exemption. As a result,
the SEC believes that the final rule may enable valuable and routine
hedging of corporate debt issued by banking entities subject to the
short-term prong without the costs of complying with the risk-
mitigating hedging exemption.
---------------------------------------------------------------------------
\1081\ See KeyCorp.
---------------------------------------------------------------------------
e. Exemption for Foreign Trading
i. Costs and Benefits
Foreign banking entities seeking to rely on the exemption for
trading outside of the United States under the 2013 rule face a complex
set of compliance requirements that may result in significant burdens
and implementation inefficiencies, which may have reduced cross-border
trading activity and liquidity between U.S. and non-U.S.
entities.\1082\ In particular, agencies have received comment from some
market participants that compliance with the financing prong may be
difficult for some non-U.S. banking entities because of the fungibility
of some forms of financing.\1083\ In addition, the SEC continues to
recognize that satisfying the U.S counterparty prong is burdensome for
foreign banking entities and may have led some foreign banking entities
to reduce the range of counterparties with which they engage in trading
activity.\1084\ The final rule removes the financing and counterparty
prongs.
---------------------------------------------------------------------------
\1082\ See, e.g., JBA; HSBC; ABA; ISDA; Credit Suisse; Committee
on Capital Markets and IIB.
\1083\ See, e.g., EBF (citing 83 FR at 33468-69).
\1084\ See, e.g., 83 FR at 33537.
---------------------------------------------------------------------------
Under the final rule, financing for a transaction relying on the
foreign trading exemption can be provided by U.S. branches or
affiliates of foreign banking entities, including U.S. branches or
affiliates that are SEC-registered dealers. Foreign banking entities
may benefit from the final rule because of the greater flexibility
afforded to how they are permitted to finance their transaction
activity in reliance on the foreign trading exemption. The agencies
have also received comment supporting the focus of the exemption on the
location of the principal risk and the location in which decision
making behind the trading occurs.\1085\ At the same time, the agencies
have received comment that the proposed amendments to the exemption may
increase the vulnerability of the U.S. financial system to proprietary
trading losses of foreign banking entities.\1086\ However, for the
reasons noted below, the SEC does not believe that the amendments will,
on balance, increase vulnerability in the manner described by
commenters. Specifically, the SEC continues to recognize that some of
the economic exposure and risks of proprietary trading by foreign
banking entities may flow not just to the foreign banking entities, but
to U.S.-located entities financing the transactions, e.g., through
margin loans.\1087\ However, potential adverse effects on vulnerability
may be mitigated by two primary factors. First, the SEC notes that the
final rule retains the condition that any purchases or sales by a
foreign banking entity, including any hedging trades, are not accounted
for as principal directly or on a consolidated basis by any U.S. branch
or affiliate of the foreign banking entity. Thus, under the final rule,
the principal risk of proprietary trading by non-U.S. banking entities
will remain outside of the United States. Moreover, U.S. banking
entities providing financing to their foreign banking entity affiliates
are likely to be separately subject to a full range of capital, margin,
and other obligations unrelated to section 13 of the BHC Act, which may
reduce risks to the U.S. branches and affiliates of foreign banking
entities. The SEC believes that the focus on where the principal risk
and decision making behind the trading resides tailors the application
of the 2013 rule with respect to foreign banks' non-U.S. operations by
reducing compliance burdens and uncertainties of foreign banking
entities in their trading activity.\1088\
---------------------------------------------------------------------------
\1085\ See, e.g., ABA; ISDA; Credit Suisse; Committee on Capital
Markets and IIB.
\1086\ See, e.g., Bean; NAFCU; Better Markets; Merkley and Data
Boiler.
\1087\ Id.
\1088\ In addition, the agencies confirmed in this Supplementary
Information that the foreign trading exemption does not preclude a
foreign banking entity from engaging a non-affiliated U.S.
investment adviser as long as the actions and decisions of the
banking entity as principal occur outside of the United States. To
the extent that foreign banking entities were restricting engagement
of non-affiliated U.S. investment advisers due to uncertainty about
the 2013 rule, non-affiliated U.S. investment advisers may become
better able to compete for the foreign banking entity's investment
mandates.
---------------------------------------------------------------------------
In addition, the final rule removes the counterparty prong and its
corresponding clearing and anonymous exchange and personnel
requirements. As a result, the final rule makes it easier for foreign
banking entities to transact with or through U.S. counterparties. To
the extent that foreign banking entities are currently bearing \1089\
and passing along compliance burdens to their U.S. counterparties, or
are unwilling to intermediate or engage in certain transactions with or
through U.S. counterparties, the final rule may reduce transaction
costs for U.S. counterparties and may increase the volume of trading
activity between U.S. counterparties and foreign banking
entities.\1090\
---------------------------------------------------------------------------
\1089\ See, e.g., HSBC.
\1090\ See, e.g., JBA.
---------------------------------------------------------------------------
The SEC recognizes that this aspect of the final rule may adversely
affect the current competitive standing of U.S. banking entities
insofar as foreign banking entities will have greater ability to engage
in proprietary trading activities with U.S. counterparties.\1091\
However, the removal of the counterparty prong in the final rule
maintains a comparable treatment of the U.S. operations of U.S. and
non-U.S. banking entities with respect to the transactions that are
booked in the U.S., as neither U.S. nor non-U.S. banking entities are
able to rely on the foreign trading exemption for such activity.\1092\
The agencies have also received comment that the elimination of
clearing and exchange requirements may enable U.S. intermediaries to
compete for business in OTC financial products with foreign banking
entity counterparties, and that the amendments may foster trading
activity between foreign affiliates and branches of U.S. banking
entities and foreign banking entities without the constraints under the
counterparty prong on the involvement of their U.S. personnel.\1093\
---------------------------------------------------------------------------
\1091\ See, e.g., FSF.
\1092\ See, e.g., IIB.
\1093\ Id.
---------------------------------------------------------------------------
When a foreign banking entity engages in proprietary trading
through a U.S. dealer, such trades expose the counterparty to risks
related to the transaction, though such risks born by U.S.
counterparties likely depend on both the identity of the counterparty
and the nature of the instrument and terms of trading position.
Moreover, the SEC continues to emphasize that concerns about moral
hazard and the volume of risk-taking by foreign banking entities may be
less relevant for U.S. markets for two reasons.\1094\ First, foreign
banking entities are less likely to be beneficiaries of U.S. deposit
insurance and implicit bailout guarantees. Second, foreign banking
entities are likely subject to foreign
[[Page 62077]]
securities and prudential regulations that address these concerns.
---------------------------------------------------------------------------
\1094\ See, e.g., 83 FR at 33537. See also JBA.
---------------------------------------------------------------------------
In addition, as proposed, the final rule replaces references to
personnel arranging, negotiating, and executing trades with references
to relevant personnel. This change is consistent with the views of some
commenters, who stated that the current arrange, negotiate, or execute
test is burdensome and may restrain trading activity outside of the
U.S.\1095\ Specifically, the availability of the foreign trading
exemption is amended to be conditioned on the banking entity engaging
as a principal (including relevant personnel) not being located in the
U.S. or organized under U.S. laws. As discussed elsewhere in this
Supplementary Information, the agencies are modifying the rule such
that relevant personnel for the purposes of the foreign trading
exemption are limited to personnel engaged in the banking entity's
decision in the purchase or sale as principal. The SEC believes that
the location of the personnel engaged in the banking entity's decision
in the purchase or sale is a meaningful trigger for the application of
section 13 of the BHC Act and implementing rules. Specifically, the SEC
has considered how narrowing the personnel requirement may increase
risk exposure of banking entities from trading activity and conflicts
of interest between banking entities and their clients on the one hand
and may enhance market quality and availability of trading
counterparties on the other hand. In addition, as part of the baseline
for analysis, the conditions for the foreign trading exemption in the
2013 rule include both requirements concerning relevant personnel that
makes the decision to purchase or sell as principal and requirements
concerning personnel involved in arranging, negotiating, and executing
trades. As a result, under the 2013 rule foreign banking entities have
to determine whether a particular employee meets both the requirements
related to relevant personnel and related to personnel arranging,
negotiating, and executing purchases and sales. This aspect of the
final rule eliminates the need for a foreign banking entity to
separately establish that a given employee meets both sets of
requirements, reducing inefficiencies associated with foreign banking
entities relying on the foreign trading exemption from the proprietary
trading prohibition.
---------------------------------------------------------------------------
\1095\ See, e.g., EBF; HSBC and IIB.
---------------------------------------------------------------------------
ii. Efficiency, Competition, and Capital Formation
The final rule likely expands the scope of trading activity by
foreign banking entities that may qualify for the foreign trading
exemption. As a result, the amendments may reduce the costs, benefits,
and effects on efficiency and capital formation of the 2013 rule
discussed in the economic baseline, and may increase competition
between U.S. and foreign banking entities. The final rule reflects
consideration of the potentially inefficient restructuring of
activities undertaken by foreign banking entities after the 2013 rule
came into effect and the loss of access of U.S. market participants to
foreign banking entity counterparties, on the one hand,\1096\ and,
advancement of the objectives of section 13 of the BHC Act, on the
other hand.
---------------------------------------------------------------------------
\1096\ In the Proposing Release, the SEC noted that, according
to one market participant, at least seven international banks have
terminated or transferred existing transactions with U.S.
counterparties in order to comply with the foreign trading exemption
and to avoid compliance costs of relying on alternative exemptions
or exclusions. See 83 FR at 33537.
---------------------------------------------------------------------------
Allowing foreign banking entities to be financed by U.S.-dealer
affiliates and to transact with U.S. counterparties on an OTC basis
(i.e., off-exchange) and without clearing the trades, may reduce costs
of non-U.S. banking entities' trading activity under the foreign
trading exemption, including with U.S. counterparties. These costs may
currently represent barriers to entry for foreign banking entities that
contemplate engaging in trading and other transaction activity using a
U.S. affiliate's financing and OTC trading with U.S. counterparties. To
that extent, the final rule may provide (1) incentives for foreign
banking entities that currently receive financing from non-U.S.
affiliates or other sources to move financing to U.S. dealer
affiliates, and (2) incentives for foreign banking entities that
currently do not transact with or through U.S. counterparties (or
transact with or through U.S. counterparties only in transactions that
are promptly cleared) to transact with or through U.S. counterparties
(or transact with or through U.S. counterparties outside of promptly
cleared transactions). As a result, the number of banking entities
engaging in trading activities in U.S. markets may increase, which may
enhance the incorporation of new information into prices. However, the
amendments may result in a shift in securities trading activity away
from U.S. banking entities to foreign banking entities that are not
comparably regulated.
The final rule may increase market entry, as it will decrease the
need for foreign banking entities to rely on a narrower set of
unaffiliated market intermediaries in order to conduct trading activity
under the foreign trading exemption in compliance with the 2013 rule.
Additionally, the final rule may increase operational efficiency of
trading activity by foreign banking entities in the United States,
which may decrease costs to market participants and may increase the
level of market participation by U.S-dealer affiliates of foreign
banking entities.
Consistent with the views of commenters,\1097\ the SEC continues to
recognize that the final rule may also affect competition among banking
entities.\1098\ The statute may introduce competitive disparities
between U.S. and foreign banking entities. Under the final rule,
foreign banking entities may enjoy a greater degree of flexibility in
financing proprietary trading and transacting with or through U.S.
counterparties relative to the baseline. At the same time, U.S. banking
entities are not able to engage in proprietary trading and are subject
to the substantive prohibitions of section 13 of the BHC Act. One
commenter indicated that non-U.S. banking entities will continue to
bear operational burdens because of the legal entity
requirements.\1099\ To the degree that the final requirements regarding
the location of the principal risk and relevant personnel are still
burdensome and constraining foreign banking entities in their reliance
on the foreign trading exemption, this may partly dampen the above
competitive effect. To the extent that banking entities at the holding
company level may be able to reorganize and move their business to a
foreign jurisdiction, some U.S. banking entity holding companies may
exit from the U.S. regulatory regime. However, under sections 4(c)(9)
and 4(c)(13) of the Banking Act, U.S. entities would have to conduct
the majority of their business outside of the United States to become
eligible for the exemption, reducing potential effects of their
activities on U.S. markets. In addition, certain changes in control of
banks and bank holding companies require supervisory approval. Hence,
the feasibility and magnitude of such regulatory arbitrage remain
unclear. The SEC also notes that, as referenced above, the final rule
preserves equal competitive treatment of the U.S. operations of both
U.S. and
[[Page 62078]]
non-U.S. banking entities that will remain unable to rely on the
foreign trading exemption and will remain subject to section 13 of the
BHC Act.\1100\
---------------------------------------------------------------------------
\1097\ See, e.g., Bean; Data Boiler; FSF and Better Markets.
\1098\ See 83 FR at 33538.
\1099\ See, e.g., JBA.
\1100\ See, e.g., IIB.
---------------------------------------------------------------------------
To the extent that foreign banking entities currently engage in
cleared transactions with or through U.S. counterparties because of the
existing counterparty prong but would have chosen not to do so
otherwise, the final rule may reduce the amount of cleared
transactions. This may reduce opportunities for risk-sharing among
market participants and increase idiosyncratic counterparty risk born
by U.S. and foreign counterparties.
At the same time, the final rule may increase the availability of
liquidity and reduce transaction costs for market participants seeking
to trade in U.S. securities markets. To the extent that non-U.S.
banking entities will face lower costs of transacting with U.S.
counterparties, it may become easier for U.S. banking entities or
customers to find a transaction counterparty willing to engage in, for
instance, hedging transactions. To that extent, U.S. market
participants accessing securities markets to hedge financial and
commercial risks may increase their hedging activity and assume a more
efficient amount of risk. The potential consequences of relocation of
non-U.S. banking entity activity to the United States for liquidity and
risk-sharing may be most concentrated in those asset classes and market
segments where activity is most constrained by the requirements in the
2013 rule.
iii. Alternatives
The agencies could have amended the foreign trading exemption to
remove all conditions for the exemption, including the engaging as
principal and decision-making requirements, except for the booking
requirement.\1101\ Relative to the final rule, the SEC believes that
such an alternative approach would further lower the compliance burdens
of non-U.S. banking entities relying on the foreign trading exemption
and may foster more trading activity by U.S. affiliates of non-U.S.
banking entities. For example, the agencies have received comment that
the engaging as principal and decision-making requirements have led
Japanese firms to downsize their U.S. affiliates and that the decision-
making requirement is operationally difficult for Japanese banks
executing trades in U.S. markets because of time zone differences.
\1102\ To the degree that this alternative encourages more activity of
non-U.S. banking entities in the United States, U.S. counterparties may
benefit from greater availability and choice of banking entity
counterparties. However, the alternative would place U.S. banking
entities at a greater competitive disadvantage relative to the final
rule, because it would result in more flexibility for the U.S.
operations of non-U.S. banking entities to engage in trading activities
relative to the U.S. operations of U.S. banking entities.
---------------------------------------------------------------------------
\1101\ See, e.g., JBA.
\1102\ Id.
---------------------------------------------------------------------------
In addition, the agencies have received comment suggesting an
exclusion of non-U.S. banking entities with limited U.S. assets and
operations from the scope of section 13 of the BHC Act.\1103\ The SEC
notes that nothing in the final rule changes or waives ongoing
statutory obligations of banking entities. However, to the degree that
reliance on the foreign trading exemption is burdensome and prevents
non-U.S. entities from trading in the United States, the final rule may
reduce compliance burdens related to the 2013 rule by introducing the
presumption of compliance for Group C banking entities. As discussed
above, the Group C threshold of $1 billion applies to the trading
assets and liabilities of the combined U.S. operations of the top-tier
foreign banking organization (including all subsidiaries, affiliates,
branches, and agencies of the foreign banking organization operating,
located, or organized in the United States). As a result, under the
final rule, non-U.S. banking entities that have limited trading assets
and liabilities in the United States will be able to avail themselves
of the rebuttable presumption of compliance and will no longer be
required to bear the fixed costs and burdens of demonstrating
compliance with section 13 of the BHC Act and the 2013 rule.
---------------------------------------------------------------------------
\1103\ See IIB.
---------------------------------------------------------------------------
f. Covered Funds
The agencies are adopting amendments to Sec. __.11 and Sec.
__.13, as proposed.
i. Costs and Benefits
First, the final rule removes the requirement in Sec. __.11(c)(3)
of the 2013 rule that a banking entity include, for purposes of the
aggregate fund limit and capital deduction, the value of any ownership
interests of a third-party covered fund (i.e., a covered fund that the
banking entity does not advise or organize and offer pursuant to Sec.
__.11 of the 2013 rule) acquired or retained in accordance with the
underwriting or market making exemptions in Sec. __.4. In addition,
the final rule removes the guarantee language in Sec. __.11(c)(2) of
the 2013 rule which requires a banking entity to include, for purposes
of the aggregate fund limit and capital deduction, the value of any
ownership interests of a covered fund, the obligations or performance
of which is directly or indirectly guaranteed, assumed, or insured by
the banking entity.
The final amendments aim to more closely align the requirements for
engaging in underwriting or market making-related activities with
respect to ownership interests in covered funds with the requirements
for engaging in these activities with respect to other financial
instruments. The SEC agrees with a number of commenters \1104\ and
continues to believe that the 2013 rule imposed requirements on
dealers' transactions in ownership interests in covered funds that may
limit the ability of dealers to underwrite and make markets in
ownership interests in covered funds, even if dealers are able to
underwrite and make markets in the underlying securities owned by
covered funds or in securities that are otherwise similar to ownership
interests in covered funds. The SEC continues to believe that, as also
articulated by a number of commenters,\1105\ the final amendments
provide banking entities with greater flexibility in underwriting and
market making ownership interests in covered funds.
---------------------------------------------------------------------------
\1104\ See, e.g., SIFMA.
\1105\ See, e.g., SIFMA and ISDA.
---------------------------------------------------------------------------
In addition, the SEC continues to recognize that the 2013 rule's
restrictions on underwriting and market making-related activities
involving ownership interests in covered funds impose costs on banking
entities, as also discussed by a number of commenters.\1106\ Under the
final rule, banking entities are able to engage in potentially
profitable market making and underwriting in ownership interests in
covered funds that they do not advise or organize or offer without the
value of any ownership interests of the covered fund acquired or
retained in connection with underwriting or market making-related
activities becoming subject to aggregate limits and capital deduction.
Some commenters noted that this amendment would facilitate capital-
raising activities of covered funds,\1107\ increase liquidity, and
generally benefit the marketplace.\1108\ The SEC agrees with these
commenters and continues to believe that SEC-regulated banking
[[Page 62079]]
entities will benefit from this amendment to the extent that they
engage in underwriting and market making activities involving ownership
interests in covered funds, or to the extent that they restricted or
eliminated such activities as a result of the requirements in the 2013
rule. These benefits may also, at least partially, flow to funds and
investors in those covered funds. In addition, as some commenters
pointed out,\1109\ banking entities may become more willing and able to
underwrite and make markets in ownership interests in covered funds.
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\1106\ See, e.g., BPI; IIB; SIFMA; ABA and Goldman Sachs.
\1107\ See SIFMA.
\1108\ See ISDA.
\1109\ See, e.g., BPI.
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Some commenters indicated that these amendments would greatly
increase banking entities' exposure to interests in covered funds,
which would entail additional risks.\1110\ For example, the removal of
the guarantee language in Sec. __.11(c)(2) would allow dealers to have
arrangements such as a put option on the ownership interest in the
covered fund, which could expose the banking entity to additional risk.
The SEC continues to recognize that ownership interests in covered
funds expose banking entities to the risks related to covered funds.
The SEC agrees with the commenters that it is possible that covered
fund ownership interests acquired or retained by a banking entity
acting as an underwriter or engaged in market making-related activities
may lead to losses for banking entities.\1111\ However, the SEC also
continues to recognize that the risks of market making or underwriting
of ownership interests in covered funds are substantively similar to
the risks of market making or underwriting of otherwise comparable
financial instruments, the activity which is expressly permitted by
section 13 of the BHC Act. Therefore, the same general tensions
discussed in section V.F.3.c of this Supplementary Information between
potential benefits for capital formation and liquidity and potential
costs related to banking entity risk exposures and market fragility
apply to banking entities' underwriting and market making activities
involving ownership interests in covered funds and other types of
securities.
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\1110\ See, e.g., Volcker Alliance; AFR and Bean.
\1111\ See, e.g., AFR and Data Boiler.
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Second, the final rule amends section Sec. __.13(a) of the 2013
rule to expand the scope of permissible risk-mitigating hedging
activities involving ownership interests in covered funds, and to
remove the demonstrability requirement of the risk-mitigating hedging
exemption for covered funds activities, in each case as proposed.\1112\
Under the final rule, in addition to being able to acquire or retain an
ownership interest in a covered fund as a risk-mitigating hedge with
respect to certain employee compensation agreements as permitted under
the 2013 rule, the banking entity will be able to acquire or retain an
ownership interest in a covered fund when acting as intermediary on
behalf of a customer that is not itself a banking entity to facilitate
the exposure by the customer to the profits and losses of the covered
fund. Some commenters stated that acquiring or retaining ownership
interests in covered funds as a hedge when acting as intermediary on
behalf of a customer accommodates client facilitation and related risk
management activities.\1113\ The SEC agrees with those commenters and
continues to recognize that the 2013 rule's restrictions on risk-
mitigating hedging activities with respect to ownership interests in
covered funds limit banking entities' ability to hedge the risks of
fund-linked derivatives through ownership interests in the covered
funds referenced by those derivatives. In addition, in the proposal the
SEC recognized that, as a result of the approach in the 2013 rule,
banking entities may not be able to participate in offering certain
customer facilitating products related to covered funds.\1114\ The
final rule is likely to benefit banking entities and their customers,
as well as bank-affiliated advisers of covered funds, as the final rule
increases the ability of banking entities to facilitate customer-facing
transactions while hedging banking entities' own risk exposure.\1115\
As a result, this amendment may increase banking entity intermediation
and provide customers with more efficient access to the risks and
returns of covered funds. To the degree that banking entities'
acquisition or retention of ownership interests in covered funds to
hedge customer-facing transactions may facilitate banking entities'
engagement in customer-facing transactions, customers of banking
entities may benefit from greater availability of financial instruments
providing exposure to covered funds and related intermediation. Banking
entities' ability to hedge customer-facing transactions through the
acquisition or retention of ownership interests in covered funds may be
particularly valuable as private capital plays an increasingly
important role in U.S. capital markets and firm financing.
---------------------------------------------------------------------------
\1112\ The effects of removal of demonstrability requirement are
discussed in section V.F.3.c.
\1113\ See, e.g., BPI and FSF.
\1114\ See 83 FR at 33547-33549.
\1115\ This was also supported by commenters. See, e.g., BPI;
Forum; ISDA and SIFMA.
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The SEC recognizes that, under certain circumstances, an increased
ability of banking entities to acquire or retain ownership interests in
covered funds in connection with risk-mitigating hedging activities may
result in banking entities' exposure to greater risk.\1116\ Some
commenters supported this view.\1117\ The SEC continues to recognize
that banking entities' transactions in fund-linked products that
reference covered funds with customers can expose a banking entity to
risk in cases where a customer fails to perform, transforming the
banking entity's covered fund hedge of the customer trade into an
unhedged, and potentially illiquid, position in the covered fund
(unless and until the banking entity takes action to hedge this
exposure and bears the corresponding costs of hedging). However, the
SEC also continues to recognize that such counterparty default risk is
present in any principal transaction in illiquid financial instruments,
including when facilitating customer trades in the securities in which
covered funds invest, as well as in market making and underwriting
activities. Commenters also recognized this.\1118\ The SEC continues to
note that, under the final rule, risk-mitigating hedging transactions
involving covered funds must be conducted consistent with the other
requirements of the 2013 rule, including the requirements with respect
to risk-mitigating hedging transactions. For example, such transactions
must be made in accordance with the banking entity's written policies,
procedures, and internal controls; not give rise, at the inception of
the hedge, to any significant new or additional risk that is not itself
hedged contemporaneously with the risk-mitigating hedging requirements;
and be subject to continuing review, monitoring, and management by the
banking entity. Therefore, the SEC continues to believe that hedging
and customer facilitation in ownership interests in covered funds does
not necessarily pose a greater risk to banking entities than hedging or
customer facilitation in similar financial instruments that is
permissible under the 2013 rule.
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\1116\ 79 FR at 5737.
\1117\ See, e.g., AFR and Volcker Alliance.
\1118\ See, e.g., SIFMA; Forum and ISDA.
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Third, the final rule amends section Sec. __.13(b)(4) of the 2013
rule to remove the financing prong of the foreign fund exemption and
formally incorporates existing staff guidance regarding the marketing
of ownership
[[Page 62080]]
interests in foreign funds to U.S. residents into section Sec.
__.13(b)(3).\1119\ Under the final rule, a foreign banking entity is
able to acquire or retain ownership interests in and sponsor covered
funds with financing for the banking entity's ownership or sponsorship
provided, directly or indirectly, by branches or affiliates of the
banking entity, including SEC-regulated dealers, that are located in
the United States or organized under the laws of the United States or
any state. The costs, benefits, and effects on efficiency, competition,
and capital formation of this amendment generally parallel those of the
removal of the financing prong with respect to trading activity outside
of the United States in section V.F.3.e of this Supplementary
Information.\1120\
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\1119\ The SEC understands that, as a practical matter, market
participants have adjusted their activity in light of the FAQs
regarding the marketing restriction. See supra note 59, FAQ 13.
Hence, the SEC continues to believe that the economic effects of the
amendment to incorporate existing staff guidance are likely to be de
minimis, and the SEC focuses this discussion on the removal of the
financing prong.
\1120\ In addition, the agencies confirmed in this Supplementary
Information that the foreign fund exemption (1) permits the U.S.
personnel and operations of a foreign banking entity to act as an
investment adviser to a covered fund in certain circumstances and
(2) does not preclude a foreign banking entity from engaging a non-
affiliated U.S. investment adviser as long as the actions and
decisions of the banking entity as principal occur outside of the
United States. To the extent that foreign banking entities were
restricting (1) hiring of U.S. personnel to provide investment
advice and recommend investment selections to the manager or general
partner of a covered fund relying on the foreign fund exemption, or
(2) engagement of non-affiliated U.S. investment advisers due to
uncertainty about the 2013 rule, foreign banking entities may be
more likely to hire U.S. personnel to provide such services, and
non-affiliated U.S. investment advisers may become better able to
compete for the foreign banking entity's investment mandates.
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In light of commenters' responses,\1121\ the SEC continues to
believe that foreign banking entities may benefit from the final rule
and enjoy greater flexibility in financing their covered fund activity.
In addition, allowing foreign banking entities to obtain financing of
covered fund transactions from U.S.-dealer affiliates may reduce costs
to foreign banking entities as the amendment may decrease their need to
rely on foreign dealer affiliates solely for the purposes of avoiding
the compliance costs and prohibitions of the 2013 rule. This may
increase the operational efficiency of covered fund activity by foreign
banking entities outside the United States.
---------------------------------------------------------------------------
\1121\ Several commenters supported removing the financing prong
from the foreign fund exemption. See, e.g., BPI; EBF; IIB; JBA and
New England Council.
---------------------------------------------------------------------------
Other commenters indicated that elimination of the financing prong
could result in a U.S. branch or affiliate that extends financing to
bear some risks.\1122\ The SEC agrees with the commenters and continues
to recognize that the economic exposure and risks of foreign banking
entities' covered funds activities may be incurred not just by the
foreign banking entities, but by U.S. entities financing the covered
fund ownership interests, e.g., through margin loans covering
particular transactions. However, the SEC also continues to note that
the final rule retains the 2013 rule's requirement that the investment
or sponsorship, including any related hedging, is not accounted for as
principal by any U.S. branch or affiliate.\1123\ The SEC continues to
believe that concerns about the size of U.S. banking entity risk
exposures are less relevant when the covered fund activity is conducted
by, and the risk consolidates to, foreign banking entities. Moreover,
as noted above, U.S. banking entities providing financing to their
foreign banking entity affiliates are likely to be separately subject
to a full range of capital, margin, and other obligations unrelated to
section 13 of the BHC Act, which may further mitigate risks to the U.S.
branches and affiliates of foreign banking entities.
---------------------------------------------------------------------------
\1122\ See, e.g., Better Markets and CAP.
\1123\ Some commenters supported this view. See, e.g., EBF and
BPI.
---------------------------------------------------------------------------
ii. Efficiency, Competition, and Capital Formation
As discussed above, the SEC believes that the final rule's
amendments to the covered fund provisions in subpart C provide banking
entities with greater flexibility in underwriting, market making, and
hedging ownership interests in covered funds. To the extent that the
2013 rule's restrictions on underwriting and market making with
interests in covered funds limit fund formation, the final rule may
reduce long-term compliance costs and, as a result, increase capital
formation. In addition, to the extent that banking entities experience
a reduction in compliance costs and an increased ability to accommodate
clients and perform risk management activities, the willingness of SEC-
regulated entities to commit capital and take on underlying risk
exposures may increase, which may enhance capital formation.
The final rule may affect competition between foreign and domestic
entities, as foreign banking entities may benefit from the final rule
and enjoy greater flexibility in financing their covered fund activity.
To the extent that costs of compliance with the ``financing prong'' of
the 2013 rule's foreign fund exemption may represent barriers to entry
for foreign banking entities' covered fund activities, the final rule
may increase foreign banking entities' operational efficiency and
promote their sponsorship and financing of covered funds.
The final rule's amendments to Sec. __.11 and Sec. __.13 do not
change the information available to market participants, and the SEC
does not believe that these amendments are likely to have an effect on
informational efficiency. To the degree that these amendments may
provide banking entities with more flexibility to underwrite, make
markets in, and hedge ownership interests in covered funds, and to the
extent these activities facilitate capital formation, these amendments
may improve allocative efficiency.
iii. Alternatives
The agencies considered alternatives that would scope out from
calculation of the per-fund limit, aggregate fund limit, and capital
deduction for banking entities all ownership interests acquired or
retained by banking entities in connection with other underwriting and
market making. For example, the agencies considered excluding the value
of ownership interests acquired or retained in connection with
underwriting or market making-related activities with respect to
covered funds offered or organized by the banking entity from the
calculation of the per-fund and aggregate limits and capital
deductions.\1124\ If the agencies had adopted this alternative, this
would have provided dealers a level of flexibility in underwriting and
making markets in ownership interests in covered funds that is more
similar to the level of flexibility for dealers in conducting these
activities with respect to all other types of financial instruments,
including the underlying financial instruments owned by the same
covered funds.
---------------------------------------------------------------------------
\1124\ Some commenters supported this alternative. See, e.g.,
ISDA.
---------------------------------------------------------------------------
Compliance with the 2013 rule for covered funds imposes costs on
banking entities. To the extent that, under the baseline, such costs
prevent banking entities that are dealers from making markets in or
underwriting certain financial instruments, this alternative would
enable them to engage in potentially profitable market making in and
underwriting ownership interests in covered funds. The benefits of this
alternative may also flow through to funds, investors, and customers as
[[Page 62081]]
banking entities may become more willing and able to underwrite and
make markets in products linked to covered funds and to provide
customers with an economic interest in the profits and losses of
covered funds. This may increase investor access to the returns and
risks of private funds, which may be particularly valuable when issuers
are increasingly relying on private capital and delaying public
offerings. Finally, the increased ability of banking entities to engage
in market making and underwriting activities with respect to covered
funds under this alternative may have increased market quality for
covered funds that are traded.
The SEC also continues to recognize that transactions in covered
funds--including transactions with customers, and holdings of ownership
interests in covered funds related to underwriting and market making--
necessarily involve the risk of losses. However, the risks of market
making or underwriting by banking entities of financial instruments
held by the covered fund, or financial instruments or securities that
are otherwise similar to covered funds, are substantively similar.
Therefore, the same tensions among the economic effects discussed in
section V.F.3.c of this Supplementary Information between potential
benefits to capital formation and liquidity and potential costs related
to bank risk exposures and market fragility apply to both banking
entity interests from underwriting and market making in financial
instruments and underwriting and market making in covered funds. It is
not clear that the existence of a legal and management structure of a
covered fund per se changes the economic risk exposure of banking
entities, and, thus, the capital formation and other tensions of the
economic effects discussed above. Therefore, the SEC continues to
believe that this alternative would simply involve a more consistent
treatment of financial instruments and interests in covered funds as it
pertains to underwriting and market making. However, as discussed above
in section V.F.1 of this Supplementary Information, some of the effects
of the 2013 rule's provisions are difficult to evaluate outside of
economic downturns, and the SEC is unable to measure the amount of
capital formation or liquidity in covered funds or investments of the
covered funds that does not occur because of the existing treatment of
underwriting and market making activities by banking entities involving
covered funds.
g. Compliance Program
The SEC continues to recognize that the scope and breadth of the
compliance obligations under the 2013 rule impose significant costs on
banking entities, which may be particularly burdensome for smaller
entities. For example, in the proposal, the SEC cited a market
participants' estimate that some banking entities have added as many as
2,500 pages, per institution, of policies, procedures, mandates, and
controls (which need to be monitored and updated on an ongoing basis)
\1125\ for purposes of compliance with the 2013 rule, and that some
banking entities may spend, on average, more than 10,000 hours on
training each year.\1126\ The SEC also cited a market participants'
estimate that some banking entities may have 15 regularly meeting
committees and forums, with as many as 50 participants per institution
dedicated to compliance with the 2013 rule.\1127\
---------------------------------------------------------------------------
\1125\ See 83 FR 33432.
\1126\ Id.
\1127\ Id.
---------------------------------------------------------------------------
The compliance regime of the 2013 rule and related burdens may
reduce the profitability of covered activities by dealers and
investment advisers that are banking entities and may be passed along
to customers or clients in the form of reduced provision of services or
higher service costs. Moreover, the SEC recognizes that the extensive
compliance program under the 2013 rule may detract resources of banking
entities and their compliance departments and supervisors from other
compliance matters, risk management, and supervision. Finally,
prescriptive compliance requirements may not optimally reflect the
organizational structures, governance mechanisms, or risk management
practices of complex, innovative, and global banking entities. However,
the SEC agrees with commenters \1128\ that compliance programs are
important to support the safety and soundness of the U.S. financial
markets.
---------------------------------------------------------------------------
\1128\ See, e.g., AFR and Bean.
---------------------------------------------------------------------------
i. Costs and Benefits
The final rule is expected to lower compliance burdens in two ways.
First, the SEC continues to believe that the amendments would increase
flexibility in complying with the final rule for banking entities
without significant trading assets and liabilities, reducing compliance
costs for these entities. Second, the adopted amendments would
streamline the compliance program for banking entities with significant
trading assets and liabilities. The SEC continues to believe that, to
the extent that the requirements in the 2013 rule are duplicative and
that maintaining compliance systems to comply with both the general and
an enhanced compliance program requirements is inefficient, banking
entities with significant trading assets and liabilities may benefit
from the amendments. The specific final amendments are discussed below.
For Group C entities, the agencies are adopting presumed compliance
with proprietary trading and covered fund prohibitions. Some commenters
noted that the presumed compliance standard proposed for Group C
entities may benefit entities with very low levels of trading
activity.\1129\ In light of the commenters' responses, the SEC
continues to believe that the presumption of compliance will provide
Group C entities with additional compliance flexibility. The SEC
estimates that approximately 97 broker-dealers that hold 3.6% of assets
held by broker-dealers subject to the final rule would be able to avail
themselves of the rebuttable presumption of compliance and would not
have to apply the final rule's compliance program requirements. Out of
these 97 broker-dealers, 28 are subject to the enhanced requirements
under the 2013 rule, 51 are subject to the standard compliance
requirements under the 2013 rule, and 18 qualify for the simplified
compliance regime under the 2013 rule. As discussed in section V.B, the
agencies estimate recordkeeping or reporting burden reductions related
to presumed compliance with the final rule are as high as
$1,648,812.\1130\
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\1129\ See, e.g., B&F Capital Markets Inc.
\1130\ See section V.B. Ongoing cost reduction for broker-
dealers: (40 hours per firm x 18 broker-dealers + 265 hours per firm
x 79 broker-dealers) x 0.18 dealer weight x (Attorney at $423 per
hour) = $1,648,812.
---------------------------------------------------------------------------
Some commenters expressed concern that Group C entities may
experience uncertainty because of the absence of specific guidance
about what events would trigger an agency to rebut the presumption of
compliance,\1131\ and, as a result, incur compliance costs related to
establishing internal systems and controls in anticipation of potential
rebuttal of the presumption.\1132\ To the extent that some Group C
entities experience this uncertainty and costs, they may not fully
enjoy the benefits of presumed compliance. One commenter estimated that
smaller banking entities would likely incur an additional one-time cost
of $50,000-$100,000 in
[[Page 62082]]
consulting or legal advice fees.\1133\ Using this estimate, the total
initial cost related to consulting or legal advice fees for Group C
broker-dealers may range between $873,000 and $1,746,000.\1134\
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\1131\ See, e.g., Chatham; ABA and SIFMA.
\1132\ See, e.g., Covington; Chatham; EBF; JBA and Data Boiler.
\1133\ See Data Boiler.
\1134\ Initial set-up burden increase for broker-dealers: 97
broker-dealers x 0.18 dealer weight x $100,000 = $1,746,000. Using
the lower bound: 97 broker-dealers x 0.18 dealer weight x $50,000 =
$873,000.
---------------------------------------------------------------------------
Some commenters opposed the presumption of compliance.\1135\ The
SEC continues to recognize that the presumption of compliance for Group
C entities may increase the risks of non-compliance with the statute.
However, the SEC also continues to note that the amendments do not
waive the proprietary trading and covered fund prohibitions of section
13 of the BHC Act for such entities.
---------------------------------------------------------------------------
\1135\ See, e.g., Occupy the SEC and Data Boiler.
---------------------------------------------------------------------------
For Group B entities, the agencies are adopting the simplified
compliance program as proposed. Some commenters expressed support for
this approach for Group B entities.\1136\ In the proposal, the SEC
recognized that existing compliance program requirements may burden
entities that engage in little covered trading activity but have larger
total assets.\1137\ The SEC continues to recognize that this amendment
may reduce costs for banking entities that have more than $10 billion
in total assets but do not have significant trading assets and
liabilities, as these banking entities do not qualify for the
simplified compliance program under the 2013 rule. As shown in Table 2,
the SEC estimates that 66 broker-dealers would qualify for the
simplified compliance regime under the final rule. As discussed in
section V.B, the agencies estimate recordkeeping or reporting burden
reductions related to the simplified compliance program for Group B
broker-dealers to be $1,130,679 for registered broker-dealers and up to
$582,471 for entities that may choose to register as SBSDs.\1138\
---------------------------------------------------------------------------
\1136\ See, e.g., CFA and JBA.
\1137\ See 83 FR 33432.
\1138\ Cost reduction for broker-dealers: 225 hours per firm x
0.18 dealer weight x 66 broker-dealers x (Attorney at $423 per hour)
= $1,130,679.
Cost reductions for entities that may register as SBSDs may be
as high as 225 hours per firm x 0.18 dealer weight x 34 SBSDs x
(Attorney at $423 per hour) = $582,471. The estimate for SBSDs
assumes that 34 SBSDs not already registered as broker-dealers would
be Group B entities and so may overestimate the cost savings.
---------------------------------------------------------------------------
The agencies are amending covered fund recordkeeping requirements
to apply to Group A entities only, rather than to banking entities with
over $10 billion in total assets. The SEC believes that the covered
funds activities of banking entities without significant trading assets
and liabilities may generally be smaller in scale and less complex than
those of banking entities with significant trading assets and
liabilities. Thus, the value of additional documentation requirements
for banking entities without significant trading assets and liabilities
may be lower. The final amendment reflects these considerations and may
reduce the costs associated with these covered funds recordkeeping
requirements by reducing the number of banking entities subject to
these requirements.\1139\ The SEC continues to note that entities with
moderate trading assets and liabilities would still be required to
comply with all the covered fund provisions and that the proposal
simply eliminates recordkeeping for the purposes of demonstrating
compliance. However, in general, the SEC believes that SEC oversight of
dealers and investment advisers of covered funds should not be
adversely affected, as the remaining compliance requirements will be
sufficient to monitor compliance with the statute. As discussed in
section V.B, the agencies estimate recordkeeping or reporting burden
reductions related to the covered fund recordkeeping requirements to be
$2,208,060 for registered broker-dealers and up to $517,752 for
entities that may choose to register as SBSDs.\1140\
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\1139\ As discussed in section V.F.2.c, RIAs do not typically
engage in proprietary trading, and the SEC continues to believe that
they will not be affected by the final rule as it relates to
proprietary trading. In addition, the SEC does not have the
information necessary to quantify the compliance program costs at
the RIA level of a BHC. Thus, the SEC does not allocate cost savings
from monetized PRA burdens to bank-affiliated RIAs from the proposed
Appendix B amendments. To the degree that some bank-affiliated RIAs
may be extending compliance resources and systems independent of the
affiliated holding company and other affiliates and subsidiaries,
this approach may be underestimating the cost savings from the final
rule.
\1140\ Cost reduction for broker-dealers: 200 hours per firm x
0.18 dealer weight x 145 broker-dealers x (Attorney at $423 per
hour) = $2,208,060.
Cost reductions for entities that may register as SBSDs may be
as high as 200 hours per firm x 0.18 dealer weight x 34 SBSDs x
(Attorney at $423 per hour) = $517,752. The estimate for SBSDs
assumes that all 34 SBSDs not already registered as broker-dealers
would be Group B entities and so may overestimate the cost savings.
---------------------------------------------------------------------------
The agencies are also adopting the removal of the requirements in
Appendix B of the 2013 rule as proposed, with an exception for the CEO
attestation. The removal of Appendix B requirements will affect all
banking entities that have trading assets and liabilities above $10
billion, as well as banking entities that have total consolidated
assets of $50 billion or more. Some commenters expressed general
support for this amendment.\1141\ In addition, some commenters
indicated that compliance with Appendix B required entities to develop
and administer an enhanced compliance program that may not be tailored
to the business model or risks of specific institutions.\1142\ Further,
in the proposal the SEC cited a market participants' estimate that some
banking entities have established as many as 500 controls related to
Appendix B obligations, some of which may be duplicating other policies
and procedures designed as part of prudential safety and
soundness.\1143\ In light of these comments, the SEC continues to
believe that compliance with Appendix B may impose significant costs on
SEC-regulated banking entities and that removal of the Appendix B
requirements may significantly reduce the number and complexity of the
compliance requirements to which such entities are subject. The SEC
estimates that there are 122 broker-dealers that may experience reduced
compliance costs as a result of this amendment, among which 28 are
Group C entities, 58 are Group B entities and 36 are Group A entities.
As discussed in section V.B, the removal of Appendix B requirements
will result in ongoing annual cost savings estimated as $10,217,988 for
registered broker-dealers and up to $2,847,636 for entities that may
choose to register as SBSDs.\1144\
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\1141\ See, e.g., Insurance Coalition; Real Estate Associations;
CREFC; Credit Suisse; JBA; FSF and ABA.
\1142\ See, e.g., Credit Suisse; CREFC; SIFMA and Capital One et
al.
\1143\ See 83 FR at 33551.
\1144\ Cost reduction for broker-dealers: 1,100 hours per firm x
0.18 dealer weight x 122 broker-dealers x (Attorney at $423 per
hour) = $10,217,988.
Cost reductions for entities that may register as SBSDs may be
as high as 1,100 hours per firm x 0.18 dealer weight x 34 SBSDs x
(Attorney at $423 per hour) = $ 2,847,636. The estimate for SBSDs
assumes that all 34 SBSDs not already registered as broker-dealers
would be subject to Appendix B requirements and so may overestimate
the cost savings.
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Some commenters opposed the removal of Appendix B, arguing that,
given the size of affected holding companies, the 2013 rule's stringent
compliance regime may help reduce compliance risks related to the
substantive prohibitions of section 13 of the BHC Act and the 2013
rule.\1145\ However, the SEC notes that, under the final rule, both
Group A and Group B entities will be required to establish and maintain
a compliance program under Sec. __.20.
---------------------------------------------------------------------------
\1145\ See, e.g., AFR and Bean.
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Finally, the agencies are adopting the amendment to require CEO
attestation
[[Page 62083]]
for Group A entities only.\1146\ In the proposal, the SEC recognized
that the CEO attestation process is costly and cited market
participants' estimates that some banking entities may spend more than
1,700 hours on the CEO attestation process and that the elimination of
this requirement may reduce time dedicated towards the compliance
program by as much as 10%.\1147\ In addition, as indicated by some
commenters, the CEO attestation requirement requires banking entities
to undertake costly internal compliance efforts that are not consistent
with the activities or risks of such firms.\1148\ Therefore, the SEC
believes that the amendments to the application of the CEO attestation
requirement will benefit SEC-regulated banking entities and their
holding companies that do not have significant trading assets and
liabilities but are subject to the CEO requirement under the 2013 rule.
---------------------------------------------------------------------------
\1146\ As a baseline matter, under the 2013 rule, the CEO is
required to annually attest that the banking entity has in place
processes to establish, maintain, enforce, review, test, and modify
the compliance program established pursuant to Appendix B in a
manner reasonably designed to achieve compliance with section 13 of
the BHC Act and the 2013 rule.
\1147\ See 83 FR at 33551.
\1148\ See, e.g., Capital One, et al.
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The SEC continues to note that, under the 2013 rule, SEC-regulated
banking entities have flexibility to comply with the attestation
requirement either at the SEC-registrant or at the holding-company
level. In 2019, the SEC received a total of 55 attestations that cover
compliance for 2018, including 14 attestations directly from SEC
registrants, none of which are Group A entities. Therefore, the SEC
expects that, under the final rule, these registrants would no longer
be providing CEO attestations. The SEC estimates that there are 122
broker-dealers that are subsidiaries or affiliates of bank holding
companies that are required to comply with the CEO attestation
requirement under the 2013 rule. The SEC estimates that under the final
rule this number will decrease to 36 Group A broker-dealers. Therefore,
the amendment may result in annual cost savings from $654,804 to
$774,000 for broker-dealers and up to between $258,876 and $306,000 for
entities that may choose to register as SBSDs.\1149\
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\1149\ Cost reduction for broker-dealers: 100 hours per firm x
0.18 dealer weight x 86 broker-dealers x (Attorney at $423 per hour)
= $654,804. Alternatively, using the CEO hourly rate, cost reduction
for broker-dealers is: 100 hours per firm x 78 broker-dealers x 0.18
dealer weight x (CEO at $500 per hour) = $774,000.
Cost reduction for entities that may register as SBSDs may be as
high as: 100 hours per firm x 0.18 dealer weight x 34 SBSDs x
(Attorney at $423 per hour) = $258,876. Alternatively, using the CEO
hourly rate, cost reduction for broker-dealers is: 100 hours per
firm x 34 SBSDs x 0.18 dealer weight x (CEO at $500 per hour) =
$306,000. The SEC assumes that all entities that may register as
SBSDs would be subject to the CEO attestation requirement, and so
may overestimate the cost savings.
---------------------------------------------------------------------------
The agencies are also adopting notice and response procedures
related to sections __.3(b)(4), __.4(c)(4), __.20(g)(2), and __.20(h)
of the final rule. As a result, all broker-dealers and entities that
may potentially register as SBSDs may experience increases in initial
reporting set-up costs. As discussed in section V.B, the agencies
estimate the initial set-up reporting burden increase related to the
notice and response procedures to be $303,037 for registered broker-
dealers and up to $51,775 for entities that may choose to register as
SBSDs.\1150\ In addition, as discussed in section V.B, the agencies may
exercise a reservation of authority and seek to rebut the presumption
in section __.3(b)(4) in accordance with the notice and response
procedures in section __.20(i) of the final rule, involving a burden of
up to 20 hours per entity per response. In such cases, an SEC-regulated
banking entity may incur a cost of up to $1,523 (=20 hours per response
x 0.18 dealer weight x Attorney at $423 per hour) per response. The SEC
is unable to estimate how many entities may bear such costs since this
figure will depend on how SEC-regulated banking entities may choose to
comply with the final rule.
---------------------------------------------------------------------------
\1150\ Initial set-up reporting burden increase for broker-
dealers: 20 hours per firm x 0.18 dealer weight x 199 broker-dealers
x (Attorney at $423 per hour) = $303,037.
Initial set-up reporting burden increase for entities that may
register as SBSDs may be as high as: 20 hours per firm x 0.18 dealer
weight x 34 SBSDs x (Attorney at $423 per hour) = $51,775.
---------------------------------------------------------------------------
ii. Efficiency, Competition, and Capital Formation
Under the final amendments, both Group A and Group B entities will
benefit from reduced compliance program requirements and Group C
entities will be presumed compliant with prohibitions of subparts B and
C of the final rule. To the extent that compliance program requirements
for Group B entities are less costly, Group A entities close to the $20
billion threshold may choose to manage down their trading book such
that they would qualify for the simplified compliance program,
resulting in more competition among entities that are close to the
threshold. Similarly, the final rule may incentivize Group B entities
close to the $1 billion threshold to rebalance their trading book in
order to qualify for the presumed compliance treatment of Group C
entities. Such management of the trading book may reduce the risk of
each individual banking entity and may decrease the risks to the
financial system. The SEC notes that entities are likely to weigh
potential cost savings related to lighter compliance requirements for
Group B and Group C entities against the costs of reducing trading
activity below the $20 billion and $1 billion thresholds. Therefore,
this competition effect may be particularly significant for Group A
entities that are close to the $20 billion threshold and for Group B
entities that are close to the $1 billion threshold.
Since the compliance requirements do not affect the scope of
information available to investors, the SEC does not anticipate effects
on informational efficiency to be significant. To the extent that some
dealers are experiencing large compliance costs and partially or fully
passing them along to customers in the form of reduced access to
capital or higher cost of capital, the amendment may reduce costs of
and increase access to capital.
iii. Alternatives
As an alternative, the agencies could have applied the CEO
attestation requirement to both Group A and Group B entities. Under
this alternative, some banking entities would have become subject to
the CEO attestation requirement for the first time, as noted by some
commenters.\1151\ As discussed above and noted by commenters,\1152\ the
SEC continues to recognize that Group B entities pose lower risks to
the financial system that may not necessarily justify a costly and
stringent compliance regime that requires CEO attestation.
---------------------------------------------------------------------------
\1151\ See, e.g., IIB.
\1152\ See, e.g., Capital One et al.; BB&T; ABA; Arvest; State
Street and IIB.
---------------------------------------------------------------------------
As other alternatives, the agencies could have required CEO
attestations for Group A entities only if they have over $50 billion in
total assets; removed the CEO attestation requirement; or allowed other
senior officers, such as the chief compliance officer (CCO), to provide
the requisite attestation for some or all affected banking entities. As
discussed above, the SEC recognized in the proposal that the CEO
attestation process is costly and that some market participants
estimated that some banking entities may spend more than 1,700 hours on
the CEO attestation process and that eliminating this requirement may
reduce time dedicated toward the compliance program by as
[[Page 62084]]
much as 10%.\1153\ Under the aforementioned alternatives, more SEC-
regulated banking entities would generally experience larger cost
reductions. However, as discussed in section IV.D.1, the agencies
continue to believe that incorporating the CEO attestation requirement
into Sec. __.20(c) for Group A banking entities will help to ensure
that the compliance program established pursuant to that section is
reasonably designed to achieve compliance with section 13 of the BHC
Act and the final rule.
---------------------------------------------------------------------------
\1153\ See 83 FR at 33551.
---------------------------------------------------------------------------
As an alternative, the agencies could have included a knowledge
qualifier for CEO attestation. Since CEOs of banking entities do not
necessarily know every single policy, procedure, process, and control,
as pointed out by some commenters,\1154\ they may rely on multiple
layers of sub-attestations within a banking entity. If CEOs of banking
entities are risk averse, they may require additional liability
insurance, higher compensation, or lower incentive pay as a fraction of
overall compensation. Under this alternative, such effects stemming
from risk aversion would be mitigated. However, the attestation may
also serve as a disciplining mechanism and incentivize compliance. In
addition, as one commenter stated, CEOs of publically traded banking
entities regularly attest that their company's annual and quarterly
reports are accurate and complete and that internal controls have been
established and maintained.\1155\ The SEC also notes that the covered
activities of larger and more complex banking entities with higher
volumes of trading activity may involve risk exposures with a larger
potential for systemic risk and conflicts of interest.
---------------------------------------------------------------------------
\1154\ See, e.g., FSF; BPI and SIFMA.
\1155\ See, e.g., BOK.
---------------------------------------------------------------------------
The agencies also recognize that CEO attestation may be costly for
banking entities affiliated with foreign banking organizations. For
example, the SEC noted in the proposal that one foreign firm reported
that it organized and managed a global controls sub-certification
process that takes 6 months to complete and involves over 400 staff
(including over 260 outside of the United States) in order for the CEO
to sign and deliver the annual attestation.\1156\ As an alternative,
the agencies could have proposed exempting banking entities affiliated
with a foreign banking organization from the CEO attestation
requirement. Under the 2013 rule, the requirement covers only the U.S.
operations of a foreign banking entity and not its foreign operations.
Similar to the analysis of the final amendment to trading outside of
the United States, this alternative may decrease compliance costs and
increase trading activity by foreign banking entities in the United
States but result in losses in market share and profitability for U.S.
banking entities that would remain subject to the attestation
requirement and would be placed at a competitive disadvantage as a
result.
---------------------------------------------------------------------------
\1156\ See 83 FR at 33552.
---------------------------------------------------------------------------
h. Metrics
i. Costs and Benefits
In the proposal, the SEC discussed the compliance burdens related
to the metrics reporting and recordkeeping requirements under the 2013
rule. For example, the SEC reported that a market participant estimated
that the average cost of collecting and filing metrics subject to the
reporting requirements may be as high as $2 million per year per
participant, and that market participants may submit an average of over
5 million data points in each filing.\1157\ The SEC also reported an
estimate from a market participant incurring approximately $3 million
in costs associated with the buildout of new IT infrastructure and
system enhancements and estimated that this IT infrastructure will
require at least $250,000 in maintenance and operating costs year-to-
year.\1158\ In addition, the SEC noted that the same firm estimated
costs related to compliance consultants assisting with the construction
of the 2013 rule compliance regime at $3 million.\1159\
---------------------------------------------------------------------------
\1157\ See 83 FR at 33539.
\1158\ Id.
\1159\ To the extent that costs related to compliance consulting
include both costs of metrics reporting and related systems, as well
as costs related to other compliance requirements under the 2013
rule, the SEC cannot estimate the firm's all-in metrics reporting
costs.
---------------------------------------------------------------------------
The SEC continues to believe that the metrics reporting and
recordkeeping requirements of the 2013 rule may involve large
compliance costs.\1160\ The agencies have received comment that the
proposed amendments do not streamline metrics reporting and
recordkeeping requirements but impose costly new requirements.\1161\
Moreover, the agencies received comment that the new qualitative
information requirements, such as the trading desk information, are
unlikely to enhance review by regulators.\1162\ In addition, the
agencies received comment that even where underlying data is already
collected by reporters in the regular course of business and for
regulatory compliance, reporters will still incur costs of determining
how best to compile and standardize the information.\1163\
---------------------------------------------------------------------------
\1160\ See, e.g., 83 FR at 33538.
\1161\ See, e.g., CCMC; JBA; Committee on Capital Markets; SIFMA
Annex C and IIB.
\1162\ See SIFMA.
\1163\ Id.
---------------------------------------------------------------------------
As discussed below, the SEC continues to recognize that some
aspects of the final rule may impose new requirements on reporters.
Moreover, the SEC continues to emphasize that quantitative metrics do
not clearly identify impermissible proprietary trading, but, rather,
inform general agency oversight and supervision. As discussed further
below, in response to the comments received, the SEC has revised its
estimates of the compliance costs of various amendments and burden
savings from metrics amendments as a whole. Importantly, the final
metrics amendments include changes from the proposed approach--changes
that both reduce the scope of new requirements and eliminate other
existing quantitative metrics, such as risk factor sensitivities. For
example, as discussed in section IV.E, the agencies estimate that the
final rule may significantly reduce both the number of reported data
items (by approximately 67%) and the overall volume of submissions (by
approximately 94%) relative to baseline.
Overall, the SEC believes that the final rule reduces the costs of
metrics requirements for reporters, eliminating certain metrics on the
basis of regulatory experience with the data and provides some entities
with additional reporting time. Broadly, metrics reporting provides
information for regulatory oversight and supervision but presents
compliance burdens for registrants. The balance of these effects turns
on the value of different metrics in evaluating covered trading
activity for compliance with the rule, as well as their usefulness for
risk assessment and general supervision. These effects are discussed
with respect to each final amendment in the sections that follow.
The SEC considered how to assess the costs of the final rule for
SEC-regulated banking entities. The metrics costs are generally
estimated at the holding company level for each reporter.\1164\ The SEC
allocates these costs to the affiliated
[[Page 62085]]
SEC-regulated banking entity.\1165\ The SEC believes that estimating
the cost savings of the final rule at the individual registrant level
would be inconsistent with the SEC's understanding of how these
entities are complying with the metrics reporting requirements of the
2013 rule. The SEC continues to believe that SEC-regulated banking
entities within the same corporate group will collaborate with one
another to comply with the final rule, to take advantage of
efficiencies of scale. Further, the SEC continues to note that
individual SEC-regulated banking entities may vary in the scope and
type of activity they conduct and that not all entities within an
organization subject to Appendix A engage in the types of covered
trading activity for which metrics must be reported. Thus, to the
extent that metrics compliance occurs at the holding company level,
estimating costs at the registrant level may overstate the magnitude of
the costs and cost savings for SEC-regulated entities as a result of
the final rule.
---------------------------------------------------------------------------
\1164\ The SEC currently receives metrics from 18 entities,
including 2 reporters that are below $10 billion in trading assets
and liabilities. Since voluntary reporters are not constrained by
the requirements of the amendment, they are not reflected in the
SEC's cost estimates. In addition, the SEC believes that the
additional systems costs estimated here will be incurred at the
holding company level and scope in the trading activity of all SEC-
registered banking entity affiliates.
\1165\ See supra note 1070.
---------------------------------------------------------------------------
The discussion that follows addresses the effects of the final rule
on the reporting and recordkeeping burdens and other compliance costs
for banking entities, the effects of the elimination and streamlining
of certain metrics, the effects of extended time to report, and
amendments related to the XML format.
(1) Reporting and Recordkeeping Burden for SEC-Regulated Banking
Entities
The changes in reporting and recordkeeping burdens as a result of
the final rule stem from four key groups of changes to the metrics
reporting regime. First, the final rule requires metrics reporting for
Group A entities only. Under the 2013 rule, banking entities with
consolidated trading assets and liabilities above $10 billion are
required to record and report certain quantitative measurements for
each trading desk engaged in covered trading.\1166\ Under the amended
rules, entities with $20 billion or more in trading assets and
liabilities would be required to furnish metrics. The SEC estimates
that three metrics reporters that have affiliated broker-dealers
required to submit metrics to the SEC under the 2013 rule will no
longer be required to report metrics under the final rule.
---------------------------------------------------------------------------
\1166\ See 2013 rule Sec. __.20(d) and Appendix A.
---------------------------------------------------------------------------
Second, as discussed above, the agencies are narrowing the scope of
many of the 2013 rule's metrics requirements or eliminating them as a
whole. For example, the agencies are eliminating the Inventory Aging
metric, the Stress Value-at-Risk (VaR) metric, and the Risk Factor
Sensitivities metric. As discussed above, the agencies estimate that
the final rule eliminates approximately 67% of data items by number and
94% of data by volume. The reduction in the volume of data required to
be compiled, reviewed, and transmitted to the agencies is expected to
decrease the volume of data that needs to be produced, manipulated, and
submitted to the agencies for purposes of compliance with the 2013
rule.
Third, the amendment to the trading account definition may change
the scope of desks required to report metrics. Specifically, some
trading desks, such as some asset and liability management desks, under
the 2013 rule, may be required to report metrics solely due to activity
that falls within the 60-day rebuttable presumption. Because of the
nature of their activity, such trading desks may face greater burdens
of producing metrics that are routine for other trading desks. The
elimination of the 60-day rebuttable presumption may eliminate the need
for such desks to report metrics, removing related burdens.
Fourth, the agencies are adopting an amendment to require metrics
reporting by all reporters on a quarterly basis within 30 days of the
end of each calendar quarter. Under the 2013 rule, banking entities
that report metrics and have less than $50 billion in consolidated
trading assets and liabilities are required to report metrics for each
quarter within 30 days of the end of that quarter. In contrast, under
the 2013 rule, banking entities with total trading assets and
liabilities equal to or above $50 billion are required to report
metrics more frequently--each month within 10 days of the end of that
month.\1167\ As discussed further below, because processes enabling
reporting under tight deadlines may generally be costlier, the SEC
anticipates that the amended reporting requirements may reduce
compliance costs for entities that are subject to the 2013 rule's
metrics requirements and have more than $50 billion in trading assets
and liabilities and may result in fewer resubmissions by such filers.
---------------------------------------------------------------------------
\1167\ See 2013 rule Sec. __.20(d)(3).
---------------------------------------------------------------------------
In the proposal, the SEC stated that reporters may incur systems-
related costs of approximately $120,000 to $130,000, estimated at the
level of the reporter. The agencies have received comment that the
SEC's estimates of the costs of the metrics amendments are a
significant underestimate, since reporters will need to revise all of
their metrics reporting systems and embark on a new round of systems
integration with multiple agencies independently.\1168\ The commenter
indicated that the exercise is not dissimilar from the initial
implementation of the 2013 rule's metrics.\1169\ Another commenter
supported retaining requirements of the 2013 rule, since any metrics
amendments would require modifications to measurement tools, involving
burdens, testing time, and outsourcing costs of development
staff.\1170\
---------------------------------------------------------------------------
\1168\ See SIFMA.
\1169\ Id.
\1170\ See, e.g., JBA.
---------------------------------------------------------------------------
The SEC agrees that compliance with the final rule will involve
one-time costs to transition systems and compliance architecture to the
metrics amendments for Group A entities, including the new requirements
related to granular Transaction Volumes and Positions metrics,
Comprehensive Profit and Loss Attribution, Trading Desk and
Quantitative Measurements Identifying Information, and the elimination
of reporting of other metrics (such as Inventory Turnover, Customer-
Facing Trade Ratio, Risk Factor Sensitivities, and Stress VaR). The SEC
notes that its analysis is specific to SEC registrants, and the
estimates represent only a fraction of the compliance costs of holding
companies allocated to affiliated SEC-regulated banking entities.
Moreover, the SEC anticipates considerable variation in one-time system
transition costs among reporters, depending on the size and complexity
of their existing trading activity, the number of trading desks per
reporter for the purposes of metrics reporting, the way in which
reporters may organize reporting and compliance obligations for the
purposes of, for instance, the market risk capital rule, and the
complexity of their current systems. However, if transitioning
reporting systems to meet the requirements of the final rule impose
one-time costs and IT burdens comparable with those of the metrics
requirements of the 2013 rule,\1171\ the compliance costs related to
the 2013 rule can be used to estimate potential one-time switching
costs for some banking entities. In the proposal, the SEC reported an
estimate from a market participant incurring approximately $3 million
in costs associated with the buildout of new IT infrastructure and
system enhancements.\1172\ Using this estimate, the one-time costs
related to transitioning metrics reporting to
[[Page 62086]]
comply with the requirements of the final rule may be as high as
$540,000 \1173\ for SEC-regulated dealers affiliated with a single
Group A metrics reporter and as high as $6,480,000 \1174\ for all SEC-
regulated entities affiliated with all reporters.
---------------------------------------------------------------------------
\1171\ See SIFMA.
\1172\ Id.
\1173\ $3 million x 0.18 x 1 reporter = $540,000.
\1174\ $540,000 x 12 reporters = $6,480,000.
---------------------------------------------------------------------------
However, as discussed earlier in this section, the SEC believes
that the final metrics amendments may reduce reporting and
recordkeeping burdens.\1175\ The SEC estimates that the amendments may
decrease ongoing annual reporting and recordkeeping cost by
$463,921.\1176\ These figures reflect the estimated burden reductions
net of any new systems costs imposed by the final rule.
---------------------------------------------------------------------------
\1175\ In the proposal, the SEC estimated the effect on SEC-
registered broker-dealers and entities that may register as SBS
dealers by scaling per-reporter estimates by 0.18 and multiplying by
the number of broker-dealers or SBSDs affiliated with reporters in
an affected category. This approach assumes that reporters with
multiple dealers may allocate metrics compliance costs savings to
each dealer. The SEC now more conservatively allocates compliance
cost savings to multiple dealers affiliated with a reporter as one
dealer entity. This approach also avoids assuming that entities that
may register as SBSDs that are not broker-dealers are affiliated
with reporters with over $50 billion in trading assets and
liabilities (TAL) and is consistent with how the SEC allocates
systems costs related to metrics amendments.
\1176\ Ongoing reporting cost reduction for SEC entities: [(55
hours per report x 12 reports per year x 9 reporters with over $50
billion) + (55 hours per report x 4 reports per year x 9 reporters
with under $50 billion)-(41 hours per report x 4 reports per year x
12 reporters with TAL above $20 billion)] x 0.18 dealer weight x
(Attorney at $423 per hour) = $453,185.
Ongoing recordkeeping cost reduction for SEC entities: [(16
hours per firm x 9 reporters with over $50 billion + 13 hours per
firm x 9 reporters with <$50 billion)-(10 hours per firm x 12
reporters with >$20 billion TAL)] x 0.18 x (Attorney at $423 per
hour) = $10,736.
Total ongoing cost reduction: $453,185 reporting + $10,736
recordkeeping = $463,921.
---------------------------------------------------------------------------
(2) Elimination, Replacement, and Streamlining of Certain Metrics
As discussed above, the final rule includes a number of amendments
eliminating, replacing, and streamlining metrics reporting. For
example, the final rule eliminates the Inventory Aging, Stress VaR, and
Risk Factor Sensitivities metrics, as well as replaces the Inventory
Turnover with the Positions metric and the Customer Facing Trade Ratio
with the Transaction Volumes metric. As discussed above, both the
Transaction Volumes metric and the Positions metric will be required
only by desks involved in underwriting or market making-related
activity. The SEC continues to believe that the key balancing of
economic effects from metrics reporting is between compliance burdens
(which may be particularly significant for smaller entities) and the
amount and usefulness of information provided for regulatory oversight
of the 2013 rule, as well as for general supervision and oversight. As
estimated above, the limitation of certain metrics to desks engaged in
covered trading activities, elimination of the above metrics, and
removal of the Stress VaR limit requirements is expected to reduce
burdens related to reporting and recordkeeping for Group A entities.
Although metrics do not allow the SEC to clearly identify proprietary
trading from permitted market making, risk-mitigating hedging, or
underwriting activity, certain metrics may provide additional
information that is useful for regulatory oversight.
Replacement of Inventory Turnover With Positions and Customer-Facing
Trade Ratio With Transaction Volumes
The final rule replaces the Inventory Turnover metric with the
Market Value of Positions quantitative measurement and replaces the
Customer-Facing Trade Ratio metric with the Transaction Volumes
quantitative measurement. The Inventory Turnover and Customer-Facing
Trade Ratio metrics are ratios that measure the turnover of a trading
desk's inventory and compare the transactions involving customers and
non-customers of the trading desk, respectively.
The Positions and Transaction Volumes metrics are expected to
provide information about risk exposure and trading activity at a more
granular level. Specifically, the final rule requires that banking
entities provide the relevant agency with the underlying data used to
calculate the ratios for each trading day, rather than providing more
aggregated data over 30-, 60-, and 90-day calculation periods. By
providing more granular data, the Positions metric, in conjunction with
the Transaction Volumes metric, is expected to provide the SEC with the
flexibility to calculate inventory turnover ratios and customer-facing
trade ratios over any period of time, including a single trading day,
allowing the use of the calculation method the SEC finds most effective
for purposes of regulatory oversight.
Moreover, the new Positions and Transaction Volumes metrics will
distinguish between securities and derivatives positions, unlike the
Inventory Turnover and Customer-Facing Trade Ratio metrics. These
metrics would require a banking entity to separately report the value
of securities positions and the value of derivatives positions. While
the Inventory Turnover and Customer-Facing Trade Ratio metrics require
banking entities to use different methodologies for valuing securities
positions and derivatives positions because of differences between
these asset classes, these metrics currently require banking entities
to aggregate such values for reporting purposes. By combining separate
and distinct valuation types (e.g., market value and notional value),
the Inventory Turnover and Customer-Facing Trade Ratio metrics are
providing less meaningful information than was intended by the 2013
rule. Therefore, requiring banking entities to disaggregate the value
of securities positions and the value of derivatives positions for
reporting purposes may enhance the usability of this information.
In addition to requiring separate reporting of the value of
securities positions and the value of derivatives positions, the final
rule would also streamline valuation method requirements for different
product types. The removal of the notional value of derivative
positions in the Positions metric avoids complexities related to mixing
various calculation methods for notional value for different
derivatives. For example, using delta-adjusted notional for options,
bond equivalents for interest rate derivatives, commodity price
adjusted values for commodity derivatives, and gross notional for other
derivatives increases complexity and reduces comparability. Moreover,
certain valuation methodologies required by the 2013 rule's Inventory
Turnover and the Customer-Facing Trade Ratio metrics may not be
otherwise used by banking entities (e.g., for internal monitoring or
external reporting purposes). Furthermore, the 2013 rule's requirements
result in information being aggregated and furnished to the SEC in non-
comparable units. At the same time, the final rule retains gross
notional value of derivatives as part of the Transactions Volumes
Metric. The SEC believes that changing market values of positions as
well as the volume of derivative contracts in terms of notional are
important measures of risk useful for ongoing agency oversight.
Therefore, this aspect of the final rule may further enhance the
usability of the information provided in the Positions metric.
Moreover, the valuation methods required under the final rule are
intended to be more consistent with the agencies' understanding of how
banking entities value securities and derivatives positions in other
contexts, such as internal monitoring or external reporting purposes,
which may allow them to leverage existing systems and
[[Page 62087]]
reduce ongoing costs relative to the costs of reporting requirements
under the 2013 rule. While a banking entity may incur one-time costs in
modifying how it values certain positions for purposes of metrics
reporting, the SEC does not expect such systems costs to be
significant, particularly if the banking entity is able to use the
systems it currently has in place for purposes of metrics reporting to
value positions consistent with the final rule. However, the SEC
recognizes that some metrics reporters may incur such costs, and they
are reflected in the estimate of the one-time metrics switching costs
of up to $540,000 for SEC-registered dealers affiliated with a single
Group A metrics reporter in section V.F.3.h.i above.
The agencies have received a number of comments on the proposed
replacement of the Inventory Turnover metric with the Positions metric
and of the Customer-Facing Trade Ratio metric with the Transaction
Volumes metrics. With respect to the replacement of Inventory Turnover
with Positions, commenters indicated that the Positions metric will
involve costly modifications to existing infrastructure and re-scoping
of products.\1177\ In addition, commenters indicated that Positions
metric will provide few valuable insights regarding each desk's overall
risk profile and that the granularity will result in false
positives.\1178\ Commenters also opposed the replacement of the
Customer-Facing Trade Ratio with the Transactions Volume metric,
arguing that it would create a new metric, require firms to classify
inter-affiliate transactions, increase transition and system update
costs, and fail to provide the agencies with valuable information
enhancing oversight for the purposes of section 13 of the BHC
Act.\1179\
---------------------------------------------------------------------------
\1177\ See, e.g., SIFMA and GFMA.
\1178\ Id.
\1179\ See IIB; SIFMA and JBA.
---------------------------------------------------------------------------
The SEC continues to believe that requiring banking entities to
provide more granular data in the Positions and Transaction Volumes
metrics will not significantly alter the costs associated with the 2013
rule's Inventory Turnover and Customer-Facing Trade Ratio
metrics.\1180\ The Positions and Transaction Volumes metrics are based
on the same underlying data regarding the trading activity of a trading
desk as the Inventory Turnover and Customer-Facing Trade Ratio metrics.
The SEC expects that banking entities already keep records of these
data and have systems in place that collect these data. Moreover, in
response to commenter concerns regarding the extra recordkeeping costs
related to distinguishing trades across affiliated banking entities
from trades within a single banking entity, the final rule adds a
category of counterparty for internal transactions that consolidates
the two proposed categories (transactions across affiliated banking
entities from trades within a single banking entity) into one category
(transactions with trading desks and other organizational units). This
additional category of information may facilitate better classification
of internal transactions, which may assist the SEC in evaluating
whether the trading desk's activities are consistent with the
requirements of the exemptions for underwriting or market making-
related activity.
---------------------------------------------------------------------------
\1180\ See, e.g., 83 FR at 33541.
---------------------------------------------------------------------------
The SEC remains cognizant of the costs of the amendments on
reporters. In the proposal the SEC anticipated that reporting more
granular information in the Positions and Transaction Volumes metrics
may result in costs of $24,480.\1181\ The SEC revises the estimate to
$17,280 to reflect updated information about the number of reporters
with affiliated SEC-registered dealers affected by the metrics
amendments.\1182\ In addition, in the proposal, the SEC estimated that
modifying the 2013 rule's requirements of the Customer-Facing Trade
Ratio to require SEC-regulated banking entities to further categorize
trading desk transactions may impose additional systems costs related
to tagging internal transactions and maintaining associated records
valued at $21,420 for all reporters.\1183\ The SEC now revises this
estimate to $15,120 to reflect updated information about the number of
reporters with affiliated SEC-registered dealers affected by the
metrics amendments.\1184\
---------------------------------------------------------------------------
\1181\ In the Proposing Release, the SEC anticipated that costs
associated with the more granular reporting in the Positions and
Transaction Volumes metrics will be $8,000 per affiliated group of
SEC-regulated banking entities. ($8,000 x 17 reporters x 0.18 SEC-
registered banking entity weight) = $24,480.
\1182\ $8,000 x 12 reporters x 0.18 SEC-registered banking
entity weight = $17,280.
\1183\ In that Release, the SEC estimated that the additional
costs associated with categorizing transactions under the
Transaction Volumes metric will be $7,000 per reporter. ($7,000 x 17
reporters x 0.18 SEC-registered banking entity weight) = $21,420.
\1184\ $7,000 x 12 reporters x 0.18 SEC-registered banking
entity weight = $15,120.
---------------------------------------------------------------------------
Importantly, the Positions and Transaction Volumes metrics
requirements as amended may reduce costs compared to the reporting
requirements under the 2013 rule by limiting the scope of trading desks
that must provide the position- and trade-based data that is currently
required by the Inventory Turnover and Customer-Facing Trade Ratio
metrics. Under the 2013 rule, banking entities are required to
calculate and report the Inventory Turnover and the Customer-Facing
Trade Ratio metrics for all trading desks engaged in covered trading
activity. The final rule would limit the scope of trading desks for
which a banking entity would be required to calculate and report the
Positions and Transaction Volumes metrics to only those trading desks
engaged in market making-related activity or underwriting activity.
These burden reductions are captured in the estimates of reporting and
recordkeeping burden reductions in section V.F.3.h.i.
Risk Factor Sensitivities, Inventory Aging, and Stress VaR
The final rule eliminates the Risk Factor Sensitivities, Inventory
Aging, and Stress VaR metrics of the 2013 rule. As estimated in section
V.F.3.h.i, the SEC expects that the metrics amendments, including the
elimination of these quantitative metrics requirements, will reduce
burdens related to reporting and recordkeeping for Group A entities
without adversely affecting the SEC's ability to oversee banking
entities for purposes of section 13 of the BHC Act.
The final rule removes the requirement to report Risk Factor
Sensitivities metrics, which is expected to reduce burdens related to
data manipulation. The SEC understands that reporters may routinely
calculate Risk Factor Sensitivities as part of their risk systems.
However, the SEC understands that reporters have to routinely summarize
large volumes of highly disaggregated Risk Factor Sensitivities from
the risk systems for purposes of compliance with the 2013 rule. As
discussed in section IV.E.5, the agencies estimate that the removal of
Risk Factor Sensitivities may reduce the total volume of data submitted
by reporters by more than half.
In addition, the SEC recognizes that one size may not fit all with
respect to risk factors. Specifically, different risk factors at
various levels of granularity may be relevant for different banking
entities, and the Risk Factor Sensitivities may not adequately capture
structural differences among the types of risk managed by trading desks
in some banking entities.\1185\ The SEC also notes that banking
entities may already provide information about risk factor
sensitivities as part of market risk
[[Page 62088]]
reporting.\1186\ As discussed in section IV.E.9.a.i above, the final
rule may reduce redundancy in metrics reporting since banking entities
would be required to submit one consolidated Internal Limits
Information Schedule for the covered trading activity of the entire
entity.
---------------------------------------------------------------------------
\1185\ See SIFMA.
\1186\ Id.
---------------------------------------------------------------------------
The elimination of the Inventory Aging metric in the final rule
recognizes the limitations of this metric for SEC's oversight for
purposes of section 13 of the BHC Act, the information in the newly
required Positions metric, as well as the fact that the notions of
inventory and inventory aging are not meaningful indicators of the
scale and risk of derivative positions.\1187\ The SEC continues to
believe that this amendment does not reduce the benefits of metrics
reporting, as inventory aging does not enable a clear identification of
prohibited proprietary trading or exempt market making, risk-mitigating
hedging, or underwriting activities.
---------------------------------------------------------------------------
\1187\ For example, the value of derivatives fluctuates with the
price of an underlying asset and the notional amount of the
contract, and derivative contracts are routinely amended and
terminated prior to expiry. See also, e.g., GFMA, State Street, Data
Boiler.
---------------------------------------------------------------------------
The elimination of the Stress VaR metric is expected to reduce
burdens related to reporting and recordkeeping for Group A entities,
contributing to the estimates of burden reductions in section
V.F.3.h.i. The SEC recognizes one commenter's concerns that banking
entities may currently face computational challenges, including those
related to the determination of the stressed period and dynamic
recalibration and that multinational holding companies may use
different stress periods for subsidiaries in different
jurisdictions.\1188\ As discussed above, under the final rule, banking
entities would still be required to submit one consolidated Internal
Limits Information Schedule for the covered trading activity of the
entire entity. The SEC understands that many banking entities do not
routinely set Stress VaR limits at the trading desk level but compute
Stress VaR at the entity level. Thus, as discussed above, the final
rule may alleviate the need for redundant computations and submissions
of Stress VaR at the desk level and may reduce the size of electronic
submissions. Importantly, the SEC continues to note that eliminating
the Stress VaR metric is unlikely to reduce the benefits of metrics
reporting, as Stress VaR does not enable the SEC to distinguish between
prohibited proprietary trading and permissible market making, risk-
mitigating hedging, or underwriting activities of a trading desk.\1189\
---------------------------------------------------------------------------
\1188\ See, e.g., Data Boiler.
\1189\ See, e.g., Goldman Sachs; FSF and Data Boiler.
---------------------------------------------------------------------------
Comprehensive Profit and Loss Attribution
The final rule makes two main changes to the Source-of-Revenue
Measurements. First, the final rule eliminates the requirement that
banking entities calculate and report the volatility of comprehensive
profit and loss. Since the volatility of profit and loss can be
calculated from other items being reported by the banking entities, the
SEC does not believe that this aspect of the final rule would adversely
affect the information available for the oversight of entities for the
purposes of section 13 of the BHC Act.
Second, the final rule requires banking entities to provide a
complete attribution of their profit and loss and, for one or more
factors that explain the preponderance of the profit or loss changes
due to risk factor changes, banking entities are required to report a
unique identification label for the factor and the profit or loss due
to the factor change. The SEC recognizes that the Risk Factor
Attribution Information Schedule and the new unique identification
label reporting requirement may impose additional burdens on reporters.
As discussed in section IV.E, the agencies generally expect that the
final rule may enable banking entities to leverage compliance with
market risk capital programs to meet the final metrics requirements,
which may reduce complexity and cost for banking entities and improve
the effectiveness of the final rule. The SEC also notes that the final
rule also includes an amendment to the trading desk definition,
allowing reporters to use the same trading desk and risk factor
attribution and risk factor sensitivity hierarchies. At the same time,
profit and loss attribution and the identification label may enhance
the ability of regulators to connect risk factors that explain a
preponderance of the profit or loss changes due to risk factors with a
separate Risk Factor Attribution Information Schedule. Thus, these
amendments may help enhance the agencies' understanding of the
structure of reporters' activity and the nature of their revenue
sources.
(3) Trading Desk Information, Quantitative Measurements Identifying
Information, and Narrative Statement
As recognized in Appendix A of the 2013 rule, the effectiveness of
particular quantitative measurements may differ depending on the
profile of a particular trading desk, including the types of
instruments traded and trading activities and strategies.\1190\ Thus,
the additional qualitative information the agencies would collect in
the Trading Desk Information and Quantitative Measurements Identifying
Information provision may facilitate SEC review and analysis of covered
trading activities and reported metrics. For instance, the trading desk
description may help the SEC assess the risks associated with a given
activity and establish the appropriate frequency and scope of
examination of such activity. Having access to such information may
allow the agencies to consider the specifics of each trading desk's
activities during the reporting period, which may facilitate regulatory
oversight.
---------------------------------------------------------------------------
\1190\ See 79 FR 5798.
---------------------------------------------------------------------------
In addition, under the final rule, banking entities may choose to
provide a Narrative Statement that describes any changes in calculation
methods used, a description of and reasons for changes in the trading
desk structure or trading desk strategies, and when any such change
occurred. The Narrative Statement may include any information the
banking entity views as relevant for assessing the information
reported, such as further description of calculation methods used. The
Narrative Statement may provide banking entities with an opportunity to
describe and explain unusual aspects of the data or modifications that
may have occurred since the last submission, which may facilitate
better evaluation of the reported data.
The SEC has received comments opposing the inclusion of additional
descriptive information about metrics, including the Trading Desk
Information, Narrative Statement, and Quantitative Measurements
Identifying Information, as part of amended metrics reporting
requirements.\1191\ Specifically, a number of commenters indicated that
there are few benefits of such qualitative information for the
agencies' ability to oversee registrants for purposes of section 13 of
the BHC Act.\1192\ In addition, some commenters stated that the
requirements are costly and burdensome as they vastly expand the scope
of information requested.\1193\ With respect to the Narrative
Statement, one commenter recognized that banking entities currently
provide such additional information voluntarily but indicated that the
requirement would impose costs on banking entities that are
[[Page 62089]]
unnecessary given that the agencies may be able to obtain this
information through other supervision.\1194\ Another commenter
indicated that the proposed amendments significantly expanded the scope
of the Narrative Statement requirement relative to current voluntary
submissions, and that the Narrative Statement may provide little value
to the agencies when assessing data submissions for purposes of
compliance with the 2013 rule.\1195\
---------------------------------------------------------------------------
\1191\ See, e.g., Credit Suisse; JBA and SIFMA.
\1192\ See ABA; CCMR; SIFMA and Credit Suisse.
\1193\ See, e.g., Credit Suisse and CCMR.
\1194\ See SIFMA.
\1195\ See Credit Suisse.
---------------------------------------------------------------------------
As discussed above, the SEC continues to believe that the Trading
Desk Information and Quantitative Measurements Identifying Information
may enhance the efficiency of data review by regulators. Three aspects
of the final rule address the cost concerns of commenters regarding the
proposed Trading Desk, Narrative Statement, and Quantitative
Measurements Identifying Information amendments discussed above. First,
the final rule would not require reporters to identify the legal entity
used as a booking entity by the trading desk, but instead would require
the reporting of a list of agencies receiving the submission of the
trading desk and the exemptions or exclusions under which the desk
conducts trading activity. Second, the final rule would not require
reporters to identify products traded by the desk. Third, under the
final rule, the submission of the Narrative Statement would be optional
for reporters. The SEC believes that these aspects of the qualitative
information amendments would mitigate any new burdens related to these
requirements while facilitating oversight by the agencies.
However, the SEC recognizes that several proposed schedules in
quantitative measurements identifying information may create reporting
burdens. As discussed in section IV.E, the final rule does not require
reporting of the risk factor sensitivities information schedule, the
limit/sensitivity cross-reference schedule, and the risk-factor
sensitivity/attribution cross-reference schedule. However, the final
rules would require reporting of Risk Factor Attribution Information
Schedules and Internal Limits Information Schedules that includes
identification of the corresponding risk factor attribution for certain
limits, imposing two new schedule requirements relative to the
regulatory baseline under the 2013 rule. However, as discussed above,
some reporters may currently use the same limits and risk factors for
multiple desks, resulting in duplicative reporting of daily limits by
multiple desks for a given reporter. To the extent that these reporters
may choose to use the two new schedules to submit a comprehensive list
of risk and position limits and risk-factor sensitivities, these
schedules may reduce duplicative reporting burdens. The agencies have
also received comment that the agencies have alternative tools for
monitoring banking entity risk (such as the CCAR process) and that the
risk factor attribution schedule does not adequately capture
differences between risks managed by different trading desks of a
banking entity.\1196\ The SEC believes that the descriptions of the
Internal Limits Information Schedule and Risk Factor Attribution
Information Schedule for certain limits may inform oversight of SEC-
regulated banking entities affiliated with reporters with respect to
their compliance with the requirements of the final rule.
---------------------------------------------------------------------------
\1196\ See, e.g., SIFMA.
---------------------------------------------------------------------------
Moreover, the SEC continues to note that all the SEC-regulated
entities that currently report metrics are also currently providing
certain elements of the Trading Desk Information to the SEC. The SEC
continues to believe that the costs associated with preparing the
Narrative Statement will depend on the extent to which a banking entity
modifies its calculation methods, makes changes to a trading desk's
structure or trading strategies, or otherwise has additional
information that it views as relevant for assessing the information
reported. Preparation of a Narrative Statement is expected to be more
of a manual process involving a written description of pertinent
issues. However, all but one SEC reporter already provides a narrative
with every submission.
In the proposal, the SEC estimated that the proposed Narrative
Statement requirement is expected to result in ongoing personnel and
monitoring costs of only $1,980.\1197\ The agencies have received
comment that this estimate of ongoing costs is a significant
underestimate, since reporters will need to revise all of their metrics
reporting systems and embark on a new round of systems integration with
multiple agencies independently.\1198\ The commenter indicated that the
exercise is not dissimilar from the initial implementation of the 2013
rule's metrics.\1199\ Another commenter supported retaining
requirements of the 2013 rule since any metrics amendments would
require modifications to measurement tools, involving burdens, testing
time, and outsourcing costs of development staff.\1200\
---------------------------------------------------------------------------
\1197\ The SEC estimates that costs associated with the proposed
Narrative Statement will be $11,000 per affiliated group of SEC-
regulated banking entities. ($11,000 x 1 reporter x 0.18) = $1,980.
\1198\ See SIFMA.
\1199\ Id.
\1200\ See, e.g., JBA.
---------------------------------------------------------------------------
The SEC agrees that the final rule will involve one-time costs to
transition their systems and transition their compliance architecture
to the amended metrics requirements for Group A entities, which are
incorporated in the agencies' estimates in section V.B and in the SEC's
analysis in section V.F.3.h.i. The SEC notes that its analysis is
specific to SEC regulated banking entities and the estimates only
represent a fraction of the compliance costs of holding companies
allocated to affiliated SEC-regulated banking entities. The SEC also
notes that the $1,980 estimate in the proposal was specific to the
Narrative Statement requirement for one reporter, rather than the
totality of the burdens imposed on registrants from new metrics
requirements; and, under the final rule, the submission of the
Narrative Statement is optional. Moreover, the SEC anticipates
considerable variation in one-time system transition costs among
reporters, depending on the size and complexity of their existing
trading activity, the number of trading desks per reporter for the
purposes of metrics reporting, the way in which reporters may organize
reporting and compliance obligations for the purposes of, for instance,
the market risk capital rule, and the complexity of their current
systems.
However, recognizing the above comments concerning systems changes
that all reporters may have to make for the purposes of reporting of
qualitative information, the SEC now estimates that the combined one-
time systems costs related to the submission of new qualitative
information (including Trading Desk Information, Quantitative
Measurements Identifying Information, and the optional Narrative
Statement) may be as high as $22,500 for SEC-registered entities
affiliated with a single Group A metrics reporter \1201\ and
[[Page 62090]]
$270,000 for all SEC-registered entities affiliated with all
reporters.\1202\ If transitioning reporting systems to meet the
requirements of the final rule impose one-time costs and IT burdens
comparable with those of the metrics requirements of the 2013
rule,\1203\ the compliance costs related to the 2013 rule can be used
to estimate potential one-time switching costs for some banking
entities. In the proposal, the SEC reported an estimate from a market
participant incurring approximately $3 million in costs associated with
the buildout of new IT infrastructure and system enhancements.\1204\
Using this estimate, the one-time costs related to transitioning
metrics reporting to comply with the requirements of the final rule may
be as high as $540,000 \1205\ for SEC-registered dealers affiliated
with a single Group A metrics reporter and as high as $6,480,000 \1206\
for all SEC-registered entities affiliated with all reporters.
---------------------------------------------------------------------------
\1201\ In Regulation Crowdfunding, the SEC estimated that
intermediaries (whether broker-dealers or funding portals) that
already have in place platforms and related systems that will need
to tailor their existing platform and systems to comply with the
requirements of Regulation Crowdfunding may incur an initial average
cost of $250,000. See 80 FR 71509. Since the qualitative information
requirements in the final rule are considerably more limited than
the requirements in Regulation Crowdfunding, the SEC estimates that
tailoring existing platforms and systems with respect to the
qualitative information requirements for metrics reporters may be
half as costly as the cost estimate in Regulation Crowdfunding.
$250,000 x 0.5 x 0.18 = $22,500.
\1202\ $22,500 x 12 reporters = $270,000.
\1203\ See SIFMA.
\1204\ Id.
\1205\ $3 million x 0.18 x 1 reporter = $540,000.
\1206\ $540,000 x 12 reporters = $6,480,000.
---------------------------------------------------------------------------
(4) Time to Report
The agencies are amending the time frame for metrics reporting by
requiring quarterly reporting for all reporters and extending the
timeline for metrics submissions to 30 days following the end of each
calendar quarter. The SEC has received comments supporting a move to
quarterly reporting \1207\ and an extended reporting timeframe for
reporters with more than $50 billion in trading assets and liabilities
\1208\ and stating that such timeframes account for the scale and
complexity of profit and loss reconciliations as well as the internal
compliance and governance processes of such banking entities. The SEC
also notes that, to the extent that the shorter timeframe for
submission may result in later resubmissions to correct errors, the
increase in time for some reporters may decrease compliance burdens and
make the information collection process more efficient.
---------------------------------------------------------------------------
\1207\ See, e.g., SIFMA.
\1208\ See, e.g., Goldman Sachs; Credit Suisse and FSF.
---------------------------------------------------------------------------
As estimated in Table 5 of the economic baseline, this amendment
would not affect the reporting schedule of four reporters with between
$20 billion and $50 billion in trading assets and liabilities and would
provide additional flexibility and time to eight reporters with over
$50 billion in trading assets and liabilities. In addition to
reductions in compliance burdens, the final rule may also involve
greater improvements in the number of banking entities reporting on
time and in the quality of submissions. As estimated in Panel A of
Table 7, approximately 66% of all records submitted by reporters with
over $50 billion in trading assets and liabilities are resubmitted to
the SEC at least once. In addition, from Panel B of Table 7, the
average delay in initial submissions is approximately 2 days. The SEC
notes that in addition to resulting in potentially higher quality
submissions with fewer resubmissions, under the final rule the agencies
may not receive the information as promptly. However, the SEC will
continue to have access to quantitative metrics and related information
through the standard examination and review process and existing
recordkeeping requirements.
(5) XML Format
The agencies are requiring banking entities to submit the Trading
Desk Information, the Quantitative Measurements Identifying
Information, and each applicable quantitative measurement in accordance
with the XML Schema specified and published on the relevant agency's
website.\1209\ Under the 2013 rule, the metrics are not required to be
reported in a structured format, and banking entities are currently
reporting quantitative measurement data electronically. In the
proposal, the SEC noted that, on the basis of discussions with metrics
reporters, most of these entities indicated a familiarity with XML, and
further, several indicated that they use XML internally for other
reporting purposes. In addition, banks currently submit quarterly
Reports of Condition and Income (``Call Reports'') to the Federal
Financial Institutions Examination Council (``FFIEC'') Central Data
Repository in eXtensible Business Reporting Language (``XBRL'') format,
an XML-based reporting language, so they are generally familiar with
the processes and technology for submitting regulatory reports in a
structured data format. The SEC believes that familiarity with these
practices at the bank level will facilitate the implementation of these
practices for SEC registrants. Furthermore, FINRA requires its member
broker-dealers to file their FOCUS Reports in a structured format
through its eFOCUS system.\1210\ The eFOCUS system permits broker-
dealers to import the FOCUS Report data into a filing using an Excel,
XML, or text file. Therefore, the SEC continues to believe that SEC-
regulated dealers covered by the metrics reporting and recordkeeping
requirements may have experience applying the XML format to their data.
---------------------------------------------------------------------------
\1209\ XML is an open standard, meaning that it is a
technological standard that is widely available to the public at no
cost. XML is also widely used across the industry.
\1210\ For example, FINRA members commonly use FINRA's Web EFT
system, which requires that all data be submitted in XML. See https://www.finra.org/industry/web-crd/web-eft-schema-documentation-and-schema-files. Also see 81 FR 49499. Information about FINRA's eFOCUS
system is available at https://www.finra.org/industry/focus.
---------------------------------------------------------------------------
Reporting metrics and other information in XML allows data to be
tagged, which in turn identifies the content of the underlying
information. The data then becomes instantly machine readable through
the use of standard software. Requiring banking entities to submit the
metrics in accordance with the XML Schema would enhance the agencies'
ability to process and analyze the data. Once the data is in a
structured format, it can be easily organized for viewing,
manipulation, and analysis through the use of commonly used software
tools and applications. Structured data can allow the agencies to
discern patterns from large quantities of information much more easily
than unstructured data. The SEC continues to believe that structured
data also facilitates the ability to dynamically search, aggregate, and
compare information across submissions, whether within a banking
entity, across multiple banking entities, or across multiple date
ranges. The data supplied in a structured format could help the SEC
identify outliers or trends that could warrant further investigation.
Specifying the format in which banking entities must report
information may help ensure that the agencies receive consistently
comparable information in an efficient manner across banking entities.
The costs associated with providing XML data lie in the specialized
software or services required to make the submission and the time
required to map the required data elements to the requisite taxonomy.
In addition to enhanced viewing, manipulation, and analysis, the
benefits associated with providing XML data lie in the enhanced
validation tools that minimize the likelihood that data are reported
with errors. Therefore, subsequent reporting periods may require fewer
resources, relative to both initial reporting periods under the final
rule and the current reporting process.
In the proposal, the SEC recognized that, as a result of the
proposed amendments, banking entities will be
[[Page 62091]]
required to establish and implement systems in accordance with the XML
Schema that will result in one-time costs and estimated such costs at
an average of $75,000 \1211\ per reporter, for an expected aggregate
one-time cost of approximately $229,500 for all SEC registrants.\1212\
---------------------------------------------------------------------------
\1211\ These cost estimates were based in part on the SEC's
recent estimates of the one-time systems costs associated with the
proposed requirement that security-based swap data repositories
(SDRs) make transaction-level security-based swap data available to
the SEC in Financial products Markup Language (FpML) and Financial
Information eXchange Markup Language (FIXML). See Establishing the
Form and Manner with which Security-Based Swap Data Repositories
Must Make Security-Based Swap Data Available to the Commission,
Exchange Act Release No. 76624 (Dec. 11, 2015), 80 FR 79757 (Dec.
23, 2015) (SBS Taxonomy rule proposing release). The SBS Taxonomy
rule proposing release estimates a one-time cost per SDR of
$127,000. Although the substance of reporting associated with the
metrics is different from the information collected and made
available by SDRs, in the Proposing Release, the SEC stated that
similar costs may apply to the implementation of XML for the
reporting metrics. In particular, on the basis of its experience
with similar structured data reporting requirements in other
contexts (e.g., the SBS Taxonomy rule), the SEC expected that
systems engineering fixed costs will represent the bulk of the costs
related to the XML requirement. Among other things, the proposed SBS
Taxonomy rule would require SDRs to make available to the SEC in a
specific format (in this case, FpML or FIXML) transaction-level data
that they are already required to provide. Similarly, in the
Proposing Release, the SEC noted that the proposed metrics
amendments would require banking entities to produce in XML metrics
reports that they are already required (or will be required) to
provide. However, the SEC's estimate was reduced to account for the
fact that registered broker-dealers already provide eFOCUS reports
to FINRA in XML and, therefore, must have the requisite systems in
place. The SEC's cost estimates at proposal included
responsibilities for modifications of information technology systems
to an attorney, a compliance Manager, a programmer analyst, and a
senior business analyst and responsibilities for policies and
procedures to an attorney, a compliance Manager, a senior systems
analyst, and an operations specialist.
\1212\ In the Proposing Release, the SEC computed total costs as
follows: $75,000 x 17 reporters x 0.18 entity weight = $229,500.
---------------------------------------------------------------------------
The agencies received several comments regarding the costs of
transitioning to metrics reporting in an XML format. Some commenters
indicated that they did not support the amendment as it would increase
costs related to switching formats of reporting software and systems
and supported the retention of existing (.DAT) format used for
submissions but did not provide any quantification for the costs of
switching to the .XML format.\1213\ Other commenters generally
supported metrics reporting in a standardized data format and the
proposed transition to XML reporting.\1214\ One commenter indicated
that the transition to XML reporting of metrics will require
significant switching costs and that there will also be ongoing costs
because of potential changes to the XML schema or the underlying
information to which the XML schema relates over time.\1215\ Another
commenter supported the XML reporting format and estimated that
reporters would incur a one-time switching cost related to equipment,
systems, training, and staffing or maintenance of $40,000 per banking
entity.\1216\
---------------------------------------------------------------------------
\1213\ See, e.g., JBA and Credit Suisse.
\1214\ See, e.g., Goldman Sachs and Data Boiler.
\1215\ See SIFMA.
\1216\ See Data Boiler.
---------------------------------------------------------------------------
The SEC continues to estimate that each reporter may incur a one-
time switching cost of up to $75,000 but is adjusting the total
aggregate reporting costs to reflect an updated count of metrics
reporters with affiliated SEC-registered banking entities. As discussed
in the economic baseline, using data from March 2018 through March
2019, the SEC estimates that 12 reporters with trading assets and
liabilities in excess of $20 billion may be subject to the final
metrics reporting amendments, resulting in an aggregate estimate of a
one-time switching cost of $162,000 for all SEC registrants.\1217\
Moreover, since the final rule involves a single one-time change to the
reporting format, the SEC continues to believe that SEC-regulated
banking entities will not incur significant ongoing costs from this
aspect of the final rule. Moreover, the SEC continues to believe that
XML reporting will result in a more efficient submission process,
including validation of submissions, and anticipates that some of the
implementation costs may be offset over time by these greater
efficiencies.
---------------------------------------------------------------------------
\1217\ $75,000 x 12 reporters x 0.18 entity weight = $162,000.
---------------------------------------------------------------------------
ii. Competition, Efficiency, and Capital Formation
Under the amendments, entities that have between $10 and $20
billion in trading assets and liabilities would incur lower costs of
compliance as they would no longer be subject to metrics requirements.
To the extent that these compliance burdens may be significant for some
entities, and since Group B entities are not subject to any metrics
requirements, Group A entities close to the threshold may become more
competitive with Group B entities. To the extent that some entities are
currently experiencing significant metrics-reporting costs and
partially or fully passing them along to customers in the form of
reduced willingness to transact or higher costs, the final rule may
reduce costs of and increase access to capital. However, estimated
reporting and recordkeeping burden savings resulting from the final
rule are relatively modest, and the SEC does not anticipate a
substantial increase in access to capital as a result of the final rule
to metrics reporting requirements.
iii. Alternatives
The agencies could have taken several alternative approaches.
First, the agencies could have kept the metrics being reported
unchanged, but increased or decreased the trading activity thresholds
used to determine metrics recordkeeping and reporting by filers and the
frequency of such reporting. For instance, the agencies could have used
the $10 billion trading activity threshold as proposed. As shown in
Table 2, the SEC estimates that this alternative would affect nine
bank-affiliated SEC-registered broker-dealers. The alternative would
increase the amount and frequency of quantitative data available for
regulatory oversight of banking entities. However, under the
alternative, these dealers would be required to keep or report metrics,
experiencing higher compliance burdens. Similarly, increasing the
recordkeeping and reporting thresholds would reduce the scope of
application of the metrics reporting requirement, lowering accompanying
recordkeeping and reporting obligations as well as potential oversight
and supervision benefits. The SEC continues to recognize that while
metrics may be used to flag risks and enhance general supervision, as
well as demonstrate prudent risk management, metrics being reported
under the 2013 rule do not clearly distinguish proprietary trading from
market making or hedging activities.
In addition, the agencies could have eliminated the VaR requirement
\1218\ or replaced VaR with Expected Shortfall \1219\ as a potentially
better measure of tail risk of a trading desk or banking entity.\1220\
The SEC recognizes that VaR and Expected Shortfall are normally based
on firm-wide activity, and some entities may not be routinely using
such measures to manage and control risk at the trading desk level. As
a result, VaR, or Expected Shortfall limits may not be meaningful at
the trading desk level. These alternatives
[[Page 62092]]
may reduce the burden of reporting and compliance costs relative to the
approach being adopted without necessarily reducing the effectiveness
of regulatory oversight by the SEC. In addition, VaR and Expected
Shortfall may not be informative about banking entity compliance with
section 13 of the BHC Act but may help agencies understand the tail
risk of supervised entities as a part of ongoing oversight and
supervision.
---------------------------------------------------------------------------
\1218\ See, e.g., Goldman Sachs.
\1219\ Expected Shortfall is an estimate of the expected value
of losses beyond a given confidence level and is generally
calculated as the area under the probability distribution of asset
or portfolio returns in the left tail. For an expected shortfall at
the 99 percent confidence level, the measure would capture the area
under the probability distribution from the 99th percentile to the
100th percentile. See Saunders and Cornett (2014), pp. 458-461.
\1220\ See, e.g., Data Boiler.
---------------------------------------------------------------------------
The agencies could have required all Group A banking entities to
report metrics on a monthly basis within 20 days of the end of the
calendar month. The SEC believes that this alternative would have two
partly offsetting effects relative to the baseline. First, the
reporters with more than $50 billion in trading assets and liabilities,
which are required to report metrics monthly and within 10 days of the
end of each calendar month under the 2013 rule, would, under the
alternative, have 20 days after the end of each calendar month to
report metrics. As estimated in Table 5 of the economic baseline, this
aspect of the alternative would affect eight reporters with SEC-
registered affiliated banking entities. Second, reporters with more
than $20 billion but less than $50 billion in trading assets and
liabilities are required to report metrics on a quarterly basis and
have 30 days after the end of reach calendar month to do so under the
2013 rule. Under the alternative, these reporters would be required to
report on a monthly basis and would have 10 fewer days to do so,
relative to the baseline. As estimated in Table 5, this aspect of the
alternative would affect four reporters with SEC-registered affiliated
banking entities. Thus, the effects of the alternative on the
compliance costs and resubmissions of data, as well on changes to the
timeliness of data available to the SEC, would likely to be partly
offsetting for these two groups of reporters.
The SEC recognizes that the alternative would increase how promptly
the SEC receives data from some SEC-registered banking entities
relative to the baseline and the final rule. However, more frequent
reporting may also decrease the quality of submissions and the need for
resubmissions by some SEC-registered banking entities. In addition,
because processes enabling more frequent reporting under tight
deadlines may generally be costlier, the alternative would result in
even smaller reductions in compliance costs for reporters.
The agencies could have eliminated all quantitative metrics
recordkeeping and reporting requirements under Appendix A of the 2013
rule.\1221\ Alternatively, the agencies could have eliminated all
quantitative metrics except for Risk Management and Source of Revenue
Metrics.\1222\ The SEC recognizes that these alternatives would reduce
the amount of data produced and transmitted to the agencies. Metrics
reporting enables regulators to have a more complete picture of risk
exposures from trading and profit and loss attribution for supervised
entities. However, the metrics reporting regime is costly, and banking
entities subject to the 2013 rule and SEC oversight are also subject to
other compliance and reporting requirements unrelated to the 2013 rule,
as well as the standard examination and review process. It is not clear
that metrics are superior to internal quantitative risk measurements or
other data (such as metrics in the FOCUS reports) reported by SEC-
registered broker-dealers in illustrating risk exposures and
profitability of various activities by SEC registrants. As previously
noted, metrics--such as VaR, dealer inventory, transaction volume, and
profit and loss attribution--do not delineate a prohibited proprietary
trade and a permitted market making, underwriting or hedging trade. In
addition, reporting at the trading desk level may obscure potential
prohibited proprietary trades since a banking entity could attempt to
accumulate large proprietary trading exposures by allocating them to a
large number of trading desks and comingling these proprietary
positions with customer facilitation positions for reporting purposes.
For example, as can be seen from Table 6 of the economic baseline,
reporters across various trading assets and liabilities thresholds
currently report metrics for an average or 38 to 56 trading desks.
Moreover, reporters' flexibility in defining the metrics may reduce
their comparability. The SEC continues to recognize that metrics do not
delineate a prohibited proprietary trade and a permitted market making,
underwriting or hedging trade, but they may be used to enhance
regulatory oversight. The SEC notes that reporters are already
currently subject to a large number of reporting obligations unrelated
to section 13 of the BHC Act, such as those under the Market Risk
Capital rule and Form FOCUS reporting requirements, providing large
volumes of distinct data that can be used to flag risks and enhance
general supervision. However, as discussed above, the SEC recognizes
that metrics may have value for ongoing oversight, and the final rule
tailors and streamlines metrics reporting requirements rather than
eliminating all metrics as a whole.
---------------------------------------------------------------------------
\1221\ See New England Council.
\1222\ See, e.g., New England Council and State Street.
---------------------------------------------------------------------------
As discussed elsewhere in this supplementary information, the final
rule has a compliance date of January 1, 2021, while enabling early
voluntary compliance with the final rule (subject to the agencies'
completion of necessary technological changes). This approach
recognizes the heterogeneity in the existing compliance burdens related
to the 2013 rule and in the one-time burdens and time costs that
different banking entities may incur as a result of transitioning their
compliance programs, while preserving continuity of metrics reporting
and agency oversight. The SEC has considered alternative approaches
adopting more (or less) delayed compliance dates and disallowing
voluntary early compliance with some aspects of the final rule. Such
alternatives would provide more (or less) time to transition their
compliance programs and adapt reporting systems to the requirements of
the final rule. Moreover, as discussed elsewhere in this economic
analysis, the SEC continues to believe that the final rule may result
in significant burden reductions for some banking entities.
Alternatives disallowing early voluntary compliance would delay the
benefits of such burden reductions for the most affected banking
entities.
G. Congressional Review Act
For the SEC, the Office of Information and Regulatory Affairs,
pursuant to the Congressional Review Act (CRA), has designated this
rule as a ``major rule'' as defined by 5 U.S.C. 804(2). For the FDIC
and OCC, the Office of Information and Regulatory Affairs, pursuant to
the CRA, has designated this rule as not a ``major rule.''
List of Subjects
12 CFR Part 44
Banks, Banking, Compensation, Credit, Derivatives, Government
securities, Insurance, Investments, National banks, Penalties,
Reporting and recordkeeping requirements, Risk, Risk retention,
Securities, Trusts and trustees.
12 CFR Part 248
Administrative practice and procedure, Banks, Banking, Conflict of
interests, Credit, Foreign banking, Government securities, Holding
companies, Insurance, Insurance companies, Investments, Penalties,
Reporting and recordkeeping requirements, Securities, State
[[Page 62093]]
nonmember banks, State savings associations, Trusts and trustees.
12 CFR Part 351
Banks, Banking, Conflicts of interest, Credit, Government
securities, Insurance, Insurance companies, Investments, Penalties,
Reporting and recordkeeping requirements, Securities, Trusts and
trustees.
17 CFR Part 75
Banks, Banking, Compensation, Credit, Derivatives, Federal branches
and agencies, Federal savings associations, Government securities,
Hedge funds, Insurance, Investments, National banks, Penalties,
Proprietary trading, Reporting and recordkeeping requirements, Risk,
Risk retention, Securities, Swap dealers, Trusts and trustees, Volcker
rule.
17 CFR Part 255
Banks, Brokers, Dealers, Investment advisers, Recordkeeping,
Reporting, Securities.
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Chapter I
Authority and Issuance
For the reasons stated in the Common Preamble, the Office of the
Comptroller of the Currency amends chapter I of Title 12, Code of
Federal Regulations as follows:
PART 44--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS
0
1. The authority citation for part 44 continues to read as follows:
Authority: 7 U.S.C. 27 et seq., 12 U.S.C. 1, 24, 92a, 93a, 161,
1461, 1462a, 1463, 1464, 1467a, 1813(q), 1818, 1851, 3101 3102,
3108, 5412.
Subpart A--Authority and Definitions
0
2. Section 44.2 is revised to read as follows:
Sec. 44.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(c) Banking entity. (1) Except as provided in paragraph (c)(2) of
this section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an insured depository institution;
(iii) Any company that is treated as a bank holding company for
purposes of section 8 of the International Banking Act of 1978 (12
U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any entity described in
paragraph (c)(1)(i), (ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a banking entity under
paragraph (c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraph (c)(1)(i), (ii), or (iii) of
this section; or
(iii) The FDIC acting in its corporate capacity or as conservator
or receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(d) Board means the Board of Governors of the Federal Reserve
System.
(e) CFTC means the Commodity Futures Trading Commission.
(f) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(g) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(h) Derivative. (1) Except as provided in paragraph (h)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the immediate family of the
employee.
(j) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(k) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(l) FDIC means the Federal Deposit Insurance Corporation.
(m) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(n) Foreign banking organization has the same meaning as in Sec.
211.21(o) of the Board's Regulation K (12 CFR 211.21(o)), but does not
include a foreign bank, as defined in section 1(b)(7) of the
International Banking Act of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the Commonwealth of Puerto Rico, Guam,
American Samoa, the United States Virgin Islands, or the Commonwealth
of the Northern Mariana Islands.
(o) Foreign insurance regulator means the insurance commissioner,
or a similar official or agency, of any country other than the United
States that is engaged in the supervision of insurance companies under
foreign insurance law.
(p) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(q) Insurance company means a company that is organized as an
insurance company, primarily and predominantly engaged in writing
insurance or reinsuring risks
[[Page 62094]]
underwritten by insurance companies, subject to supervision as such by
a state insurance regulator or a foreign insurance regulator, and not
operated for the purpose of evading the provisions of section 13 of the
BHC Act (12 U.S.C. 1851).
(r) Insured depository institution has the same meaning as in
section 3(c) of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)),
but does not include:
(1) An insured depository institution that is described in section
2(c)(2)(D) of the BHC Act (12 U.S.C. 1841(c)(2)(D)); or
(2) An insured depository institution if it has, and if every
company that controls it has, total consolidated assets of $10 billion
or less and total trading assets and trading liabilities, on a
consolidated basis, that are 5 percent or less of total consolidated
assets.
(s) Limited trading assets and liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities (excluding trading assets
and liabilities attributable to trading activities permitted pursuant
to Sec. 44.6(a)(1) and (2) of subpart B) the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, is less
than $1 billion; and
(ii) The OCC has not determined pursuant to Sec. 44.20(g) or (h)
of this part that the banking entity should not be treated as having
limited trading assets and liabilities.
(2) With respect to a banking entity other than a banking entity
described in paragraph (s)(3) of this section, trading assets and
liabilities for purposes of this paragraph (s) means trading assets and
liabilities (excluding trading assets and liabilities attributable to
trading activities permitted pursuant to Sec. 44.6(a)(1) and (2) of
subpart B) on a worldwide consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (s) means the
trading assets and liabilities (excluding trading assets and
liabilities attributable to trading activities permitted pursuant to
Sec. 44.6(a)(1) and (2) of subpart B) of the combined U.S. operations
of the top-tier foreign banking organization (including all
subsidiaries, affiliates, branches, and agencies of the foreign banking
organization operating, located, or organized in the United States).
(ii) For purposes of paragraph (s)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary. For purposes of paragraph (s)(3)(i) of
this section, all foreign operations of a U.S. agency, branch, or
subsidiary of a foreign banking organization are considered to be
located in the United States, including branches outside the United
States that are managed or controlled by a U.S. branch or agency of the
foreign banking organization, for purposes of calculating the banking
entity's U.S. trading assets and liabilities.
(t) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(u) Moderate trading assets and liabilities means, with respect to
a banking entity, that the banking entity does not have significant
trading assets and liabilities or limited trading assets and
liabilities.
(v) Primary financial regulatory agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 5301(12)).
(w) Purchase includes any contract to buy, purchase, or otherwise
acquire. For security futures products, purchase includes any contract,
agreement, or transaction for future delivery. With respect to a
commodity future, purchase includes any contract, agreement, or
transaction for future delivery. With respect to a derivative, purchase
includes the execution, termination (prior to its scheduled maturity
date), assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a derivative, as the
context may require.
(x) Qualifying foreign banking organization means a foreign banking
organization that qualifies as such under Sec. 211.23(a), (c), or (e)
of the Board's Regulation K (12 CFR 211.23(a), (c), or (e)).
(y) SEC means the Securities and Exchange Commission.
(z) Sale and sell each include any contract to sell or otherwise
dispose of. For security futures products, such terms include any
contract, agreement, or transaction for future delivery. With respect
to a commodity future, such terms include any contract, agreement, or
transaction for future delivery. With respect to a derivative, such
terms include the execution, termination (prior to its scheduled
maturity date), assignment, exchange, or similar transfer or conveyance
of, or extinguishing of rights or obligations under, a derivative, as
the context may require.
(aa) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(bb) Security-based swap dealer has the same meaning as in section
3(a)(71) of the Exchange Act (15 U.S.C. 78c(a)(71)).
(cc) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(dd) Separate account means an account established and maintained
by an insurance company in connection with one or more insurance
contracts to hold assets that are legally segregated from the insurance
company's other assets, under which income, gains, and losses, whether
or not realized, from assets allocated to such account, are, in
accordance with the applicable contract, credited to or charged against
such account without regard to other income, gains, or losses of the
insurance company.
(ee) Significant trading assets and liabilities means with respect
to a banking entity that:
(1)(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, equals or
exceeds $20 billion; or
(ii) The OCC has determined pursuant to Sec. 44.20(h) of this part
that the banking entity should be treated as having significant trading
assets and liabilities.
(2) With respect to a banking entity, other than a banking entity
described in paragraph (ee)(3) of this section, trading assets and
liabilities for purposes of this paragraph (ee) means trading assets
and liabilities (excluding trading assets and liabilities attributable
to trading activities permitted pursuant to Sec. 44.6(a)(1) and (2) of
subpart B) on a worldwide consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (ee) means the
trading assets and liabilities (excluding trading assets and
liabilities attributable to trading activities permitted pursuant to
Sec. 44.6(a)(1) and (2) of subpart B) of the combined U.S. operations
of the top-tier foreign banking organization (including all
subsidiaries, affiliates, branches, and agencies of the foreign banking
organization operating, located, or
[[Page 62095]]
organized in the United States as well as branches outside the United
States that are managed or controlled by a branch or agency of the
foreign banking entity operating, located or organized in the United
States).
(ii) For purposes of paragraph (ee)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary. For purposes of paragraph (ee)(3)(i) of
this section, all foreign operations of a U.S. agency, branch, or
subsidiary of a foreign banking organization are considered to be
located in the United States for purposes of calculating the banking
entity's U.S. trading assets and liabilities.
(ff) State means any State, the District of Columbia, the
Commonwealth of Puerto Rico, Guam, American Samoa, the United States
Virgin Islands, and the Commonwealth of the Northern Mariana Islands.
(gg) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(hh) State insurance regulator means the insurance commissioner, or
a similar official or agency, of a State that is engaged in the
supervision of insurance companies under State insurance law.
(ii) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
Subpart B--Proprietary Trading
0
3. Section 44.3 is amended by:
0
a. Revising paragraphs (b), (d)(3), and (d)(8) and (9);
0
b. Adding paragraphs (d)(10) through (13);
0
c. Redesignating paragraphs (e)(5) through (13) as paragraphs (e)(6)
through (14);
0
d. Adding new paragraph (e)(5); and
0
e. Revising newly redesignated paragraphs (e)(11), (12), and (14).
The revisions and additions read as follows:
Sec. 44.3 Prohibition on proprietary trading.
* * * * *
(b) Definition of trading account. (1) Trading account. Trading
account means:
(i) Any account that is used by a banking entity to purchase or
sell one or more financial instruments principally for the purpose of
short-term resale, benefitting from actual or expected short-term price
movements, realizing short-term arbitrage profits, or hedging one or
more of the positions resulting from the purchases or sales of
financial instruments described in this paragraph;
(ii) Any account that is used by a banking entity to purchase or
sell one or more financial instruments that are both market risk
capital rule covered positions and trading positions (or hedges of
other market risk capital rule covered positions), if the banking
entity, or any affiliate with which the banking entity is consolidated
for regulatory reporting purposes, calculates risk-based capital ratios
under the market risk capital rule; or
(iii) Any account that is used by a banking entity to purchase or
sell one or more financial instruments, if the banking entity:
(A) Is licensed or registered, or is required to be licensed or
registered, to engage in the business of a dealer, swap dealer, or
security-based swap dealer, to the extent the instrument is purchased
or sold in connection with the activities that require the banking
entity to be licensed or registered as such; or
(B) Is engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
the instrument is purchased or sold in connection with the activities
of such business.
(2) Trading account application for certain banking entities. (i) A
banking entity that is subject to paragraph (b)(1)(ii) of this section
in determining the scope of its trading account is not subject to
paragraph (b)(1)(i) of this section.
(ii) A banking entity that does not calculate risk-based capital
ratios under the market risk capital rule and is not a consolidated
affiliate for regulatory reporting purposes of a banking entity that
calculates risk based capital ratios under the market risk capital rule
may elect to apply paragraph (b)(1)(ii) of this section in determining
the scope of its trading account as if it were subject to that
paragraph. A banking entity that elects under this section to apply
paragraph (b)(1)(ii) of this section in determining the scope of its
trading account as if it were subject to that paragraph is not required
to apply paragraph (b)(1)(i) of this section.
(3) Consistency of account election for certain banking entities.
(i) Any election or change to an election under paragraph (b)(2)(ii) of
this section must apply to the electing banking entity and all of its
wholly owned subsidiaries. The primary financial regulatory agency of a
banking entity that is affiliated with but is not a wholly owned
subsidiary of such electing banking entity may require that the banking
entity be subject to this uniform application requirement if the
primary financial regulatory agency determines that it is necessary to
prevent evasion of the requirements of this part after notice and
opportunity for response as provided in subpart D of this part.
(ii) A banking entity that does not elect under paragraph
(b)(2)(ii) of this section to be subject to the trading account
definition in (b)(1)(ii) of this section may continue to apply the
trading account definition in paragraph (b)(1)(i) of this section for
one year from the date on which it becomes, or becomes a consolidated
affiliate for regulatory reporting purposes with, a banking entity that
calculates risk-based capital ratios under the market risk capital
rule.
(4) Rebuttable presumption for certain purchases and sales. The
purchase (or sale) of a financial instrument by a banking entity shall
be presumed not to be for the trading account of the banking entity
under paragraph (b)(1)(i) of this section if the banking entity holds
the financial instrument for sixty days or longer and does not transfer
substantially all of the risk of the financial instrument within sixty
days of the purchase (or sale).
* * * * *
(d) * * *
(3) Any purchase or sale of a security, foreign exchange forward
(as that term is defined in section 1a(24) of the Commodity Exchange
Act (7 U.S.C. 1a(24)), foreign exchange swap (as that term is defined
in section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)), or
cross-currency swap by a banking entity for the purpose of liquidity
management in accordance with a documented liquidity management plan of
the banking entity that:
(i) Specifically contemplates and authorizes the particular
financial instruments to be used for liquidity management purposes, the
amount, types, and risks of these financial instruments that are
consistent with liquidity management, and the liquidity circumstances
in which the particular financial instruments may or must be used;
(ii) Requires that any purchase or sale of financial instruments
contemplated and authorized by the plan be principally for the purpose
of managing the liquidity of the banking entity, and not for the
purpose of short-term resale, benefitting from actual or expected
short-term price movements, realizing short-term arbitrage profits, or
hedging a
[[Page 62096]]
position taken for such short-term purposes;
(iii) Requires that any financial instruments purchased or sold for
liquidity management purposes be highly liquid and limited to financial
instruments the market, credit, and other risks of which the banking
entity does not reasonably expect to give rise to appreciable profits
or losses as a result of short-term price movements;
(iv) Limits any financial instruments purchased or sold for
liquidity management purposes, together with any other financial
instruments purchased or sold for such purposes, to an amount that is
consistent with the banking entity's near-term funding needs, including
deviations from normal operations of the banking entity or any
affiliate thereof, as estimated and documented pursuant to methods
specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of financial instruments that are not permitted under Sec. 44.6(a) or
(b) of this subpart are for the purpose of liquidity management and in
accordance with the liquidity management plan described in this
paragraph (d)(3); and
(vi) Is consistent with the OCC's regulatory requirements regarding
liquidity management;
* * * * *
(8) Any purchase or sale of one or more financial instruments by a
banking entity through a deferred compensation, stock-bonus, profit-
sharing, or pension plan of the banking entity that is established and
administered in accordance with the law of the United States or a
foreign sovereign, if the purchase or sale is made directly or
indirectly by the banking entity as trustee for the benefit of persons
who are or were employees of the banking entity;
(9) Any purchase or sale of one or more financial instruments by a
banking entity in the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
financial instrument as soon as practicable, and in no event may the
banking entity retain such instrument for longer than such period
permitted by the OCC;
(10) Any purchase or sale of one or more financial instruments that
was made in error by a banking entity in the course of conducting a
permitted or excluded activity or is a subsequent transaction to
correct such an error;
(11) Contemporaneously entering into a customer-driven swap or
customer-driven security-based swap and a matched swap or security-
based swap if:
(i) The banking entity retains no more than minimal price risk; and
(ii) The banking entity is not a registered dealer, swap dealer, or
security-based swap dealer;
(12) Any purchase or sale of one or more financial instruments that
the banking entity uses to hedge mortgage servicing rights or mortgage
servicing assets in accordance with a documented hedging strategy; or
(13) Any purchase or sale of a financial instrument that does not
meet the definition of trading asset or trading liability under the
applicable reporting form for a banking entity as of January 1, 2020.
(e) * * *
(5) Cross-currency swap means a swap in which one party exchanges
with another party principal and interest rate payments in one currency
for principal and interest rate payments in another currency, and the
exchange of principal occurs on the date the swap is entered into, with
a reversal of the exchange of principal at a later date that is agreed
upon when the swap is entered into.
* * * * *
(11) Market risk capital rule covered position and trading position
means a financial instrument that meets the criteria to be a covered
position and a trading position, as those terms are respectively
defined, without regard to whether the financial instrument is reported
as a covered position or trading position on any applicable regulatory
reporting forms:
(i) In the case of a banking entity that is a bank holding company,
savings and loan holding company, or insured depository institution,
under the market risk capital rule that is applicable to the banking
entity; and
(ii) In the case of a banking entity that is affiliated with a bank
holding company or savings and loan holding company, other than a
banking entity to which a market risk capital rule is applicable, under
the market risk capital rule that is applicable to the affiliated bank
holding company or savings and loan holding company.
(12) Market risk capital rule means the market risk capital rule
that is contained in 12 CFR part 3, subpart F, with respect to a
banking entity for which the OCC is the primary financial regulatory
agency, 12 CFR part 217 with respect to a banking entity for which the
Board is the primary financial regulatory agency, or 12 CFR part 324
with respect to a banking entity for which the FDIC is the primary
financial regulatory agency.
* * * * *
(14) Trading desk means a unit of organization of a banking entity
that purchases or sells financial instruments for the trading account
of the banking entity or an affiliate thereof that is:
(i)(A) Structured by the banking entity to implement a well-defined
business strategy;
(B) Organized to ensure appropriate setting, monitoring, and
management review of the desk's trading and hedging limits, current and
potential future loss exposures, and strategies; and
(C) Characterized by a clearly defined unit that:
(1) Engages in coordinated trading activity with a unified approach
to its key elements;
(2) Operates subject to a common and calibrated set of risk
metrics, risk levels, and joint trading limits;
(3) Submits compliance reports and other information as a unit for
monitoring by management; and
(4) Books its trades together; or
(ii) For a banking entity that calculates risk-based capital ratios
under the market risk capital rule, or a consolidated affiliate for
regulatory reporting purposes of a banking entity that calculates risk-
based capital ratios under the market risk capital rule, established by
the banking entity or its affiliate for purposes of market risk capital
calculations under the market risk capital rule.
0
4. Section 44.4 is revised to read as follows:
Sec. 44.4 Permitted underwriting and market making-related
activities.
(a) Underwriting activities--(1) Permitted underwriting activities.
The prohibition contained in Sec. 44.3(a) does not apply to a banking
entity's underwriting activities conducted in accordance with this
paragraph (a).
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii)(A) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
taking into account the liquidity, maturity, and depth of the market
for the relevant types of securities; and
(B) Reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity,
[[Page 62097]]
maturity, and depth of the market for the relevant types of securities;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (a) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, in accordance with paragraph
(a)(2)(ii)(A) of this section;
(C) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
(D) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
(iv) A banking entity with significant trading assets and
liabilities may satisfy the requirements in paragraphs (a)(2)(iii)(B)
and (C) of this section by complying with the requirements set forth in
paragraph (c) of this section;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
(3) Definition of distribution. For purposes of this paragraph (a),
a distribution of securities means:
(i) An offering of securities, whether or not subject to
registration under the Securities Act of 1933, that is distinguished
from ordinary trading transactions by the presence of special selling
efforts and selling methods; or
(ii) An offering of securities made pursuant to an effective
registration statement under the Securities Act of 1933.
(4) Definition of underwriter. For purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an issuer or selling security
holder to:
(A) Purchase securities from the issuer or selling security holder
for distribution;
(B) Engage in a distribution of securities for or on behalf of the
issuer or selling security holder; or
(C) Manage a distribution of securities for or on behalf of the
issuer or selling security holder; or
(ii) A person who has agreed to participate or is participating in
a distribution of such securities for or on behalf of the issuer or
selling security holder.
(5) Definition of selling security holder. For purposes of this
paragraph (a), selling security holder means any person, other than an
issuer, on whose behalf a distribution is made.
(6) Definition of underwriting position. For purposes of this
section, underwriting position means the long or short positions in one
or more securities held by a banking entity or its affiliate, and
managed by a particular trading desk, in connection with a particular
distribution of securities for which such banking entity or affiliate
is acting as an underwriter.
(7) Definition of client, customer, and counterparty. For purposes
of this paragraph (a), the terms client, customer, and counterparty, on
a collective or individual basis, refer to market participants that may
transact with the banking entity in connection with a particular
distribution for which the banking entity is acting as underwriter.
(b) Market making-related activities--(1) Permitted market making-
related activities. The prohibition contained in Sec. 44.3(a) does not
apply to a banking entity's market making-related activities conducted
in accordance with this paragraph (b).
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure, routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure, and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The trading desk's market-making related activities are
designed not to exceed, on an ongoing basis, the reasonably expected
near term demands of clients, customers, or counterparties, taking into
account the liquidity, maturity, and depth of the market for the
relevant types of financial instruments;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of this
paragraph (b), including reasonably designed written policies and
procedures, internal controls, analysis and independent testing
identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and positions; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, in accordance with paragraph
(b)(2)(ii) of this section;
(D) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
(E) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
(iv) A banking entity with significant trading assets and
liabilities may satisfy the requirements in paragraphs (b)(2)(iii)(C)
and (D) by complying with the requirements set forth in paragraph (c)
of this section;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (b) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in
activity
[[Page 62098]]
described in this paragraph (b) in accordance with applicable law.
(3) Definition of client, customer, and counterparty. For purposes
of this paragraph (b), the terms client, customer, and counterparty, on
a collective or individual basis refer to market participants that make
use of the banking entity's market making-related services by obtaining
such services, responding to quotations, or entering into a continuing
relationship with respect to such services, provided that:
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with the methodology described in
Sec. 44.2(ee) of this part, unless:
(A) The trading desk documents how and why a particular trading
desk or other organizational unit of the entity should be treated as a
client, customer, or counterparty of the trading desk for purposes of
paragraph (b)(2) of this section; or
(B) The purchase or sale by the trading desk is conducted
anonymously on an exchange or similar trading facility that permits
trading on behalf of a broad range of market participants.
(ii) [Reserved]
(4) Definition of financial exposure. For purposes of this section,
financial exposure means the aggregate risks of one or more financial
instruments and any associated loans, commodities, or foreign exchange
or currency, held by a banking entity or its affiliate and managed by a
particular trading desk as part of the trading desk's market making-
related activities.
(5) Definition of market-maker positions. For the purposes of this
section, market-maker positions means all of the positions in the
financial instruments for which the trading desk stands ready to make a
market in accordance with paragraph (b)(2)(i) of this section, that are
managed by the trading desk, including the trading desk's open
positions or exposures arising from open transactions.
(c) Rebuttable presumption of compliance--(1) Internal limits. (i)
A banking entity shall be presumed to meet the requirement in paragraph
(a)(2)(ii)(A) or (b)(2)(ii) of this section with respect to the
purchase or sale of a financial instrument if the banking entity has
established and implements, maintains, and enforces the internal limits
for the relevant trading desk as described in paragraph (c)(1)(ii) of
this section.
(ii)(A) With respect to underwriting activities conducted pursuant
to paragraph (a) of this section, the presumption described in
paragraph (c)(1)(i) of this section shall be available to each trading
desk that establishes, implements, maintains, and enforces internal
limits that should take into account the liquidity, maturity, and depth
of the market for the relevant types of securities and are designed not
to exceed the reasonably expected near term demands of clients,
customers, or counterparties, based on the nature and amount of the
trading desk's underwriting activities, on the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.
(B) With respect to market making-related activities conducted
pursuant to paragraph (b) of this section, the presumption described in
paragraph (c)(1)(i) of this section shall be available to each trading
desk that establishes, implements, maintains, and enforces internal
limits that should take into account the liquidity, maturity, and depth
of the market for the relevant types of financial instruments and are
designed not to exceed the reasonably expected near term demands of
clients, customers, or counterparties, based on the nature and amount
of the trading desk's market-making related activities, that address
the:
(1) Amount, types, and risks of its market-maker positions;
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
(4) Period of time a financial instrument may be held.
(2) Supervisory review and oversight. The limits described in
paragraph (c)(1) of this section shall be subject to supervisory review
and oversight by the OCC on an ongoing basis.
(3) Limit breaches and increases. (i) With respect to any limit set
pursuant to paragraph (c)(1)(ii)(A) or (B) of this section, a banking
entity shall maintain and make available to the OCC upon request
records regarding:
(A) Any limit that is exceeded; and
(B) Any temporary or permanent increase to any limit(s), in each
case in the form and manner as directed by the OCC.
(ii) In the event of a breach or increase of any limit set pursuant
to paragraph (c)(1)(ii)(A) or (B) of this section, the presumption
described in paragraph (c)(1)(i) of this section shall continue to be
available only if the banking entity:
(A) Takes action as promptly as possible after a breach to bring
the trading desk into compliance; and
(B) Follows established written authorization procedures, including
escalation procedures that require review and approval of any trade
that exceeds a trading desk's limit(s), demonstrable analysis of the
basis for any temporary or permanent increase to a trading desk's
limit(s), and independent review of such demonstrable analysis and
approval.
(4) Rebutting the presumption. The presumption in paragraph
(c)(1)(i) of this section may be rebutted by the OCC if the OCC
determines, taking into account the liquidity, maturity, and depth of
the market for the relevant types of financial instruments and based on
all relevant facts and circumstances, that a trading desk is engaging
in activity that is not based on the reasonably expected near term
demands of clients, customers, or counterparties. The OCC's rebuttal of
the presumption in paragraph (c)(1)(i) must be made in accordance with
the notice and response procedures in subpart D of this part.
0
5. Section 44.5 is amended by revising paragraphs (b) and (c)(1)
introductory text and adding paragraph (c)(4) to read as follows:
Sec. 44.5 Permitted risk-mitigating hedging activities.
* * * * *
(b) Requirements. (1) The risk-mitigating hedging activities of a
banking entity that has significant trading assets and liabilities are
permitted under paragraph (a) of this section only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(B) Internal controls and ongoing monitoring, management, and
[[Page 62099]]
authorization procedures, including relevant escalation procedures; and
(C) The conduct of analysis and independent testing designed to
ensure that the positions, techniques and strategies that may be used
for hedging may reasonably be expected to reduce or otherwise
significantly mitigate the specific, identifiable risk(s) being hedged;
(ii) The risk-mitigating hedging activity:
(A) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(B) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(D) Is subject to continuing review, monitoring and management by
the banking entity that:
(1) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1)(i) of this section;
(2) Is designed to reduce or otherwise significantly mitigate the
specific, identifiable risks that develop over time from the risk-
mitigating hedging activities undertaken under this section and the
underlying positions, contracts, and other holdings of the banking
entity, based upon the facts and circumstances of the underlying and
hedging positions, contracts and other holdings of the banking entity
and the risks and liquidity thereof; and
(3) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(1)(ii) of this section and is not
prohibited proprietary trading; and
(iii) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(2) The risk-mitigating hedging activities of a banking entity that
does not have significant trading assets and liabilities are permitted
under paragraph (a) of this section only if the risk-mitigating hedging
activity:
(i) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to ongoing recalibration by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading.
(c) * * *
(1) A banking entity that has significant trading assets and
liabilities must comply with the requirements of paragraphs (c)(2) and
(3) of this section, unless the requirements of paragraph (c)(4) of
this section are met, with respect to any purchase or sale of financial
instruments made in reliance on this section for risk-mitigating
hedging purposes that is:
* * * * *
(4) The requirements of paragraphs (c)(2) and (3) of this section
do not apply to the purchase or sale of a financial instrument
described in paragraph (c)(1) of this section if:
(i) The financial instrument purchased or sold is identified on a
written list of pre-approved financial instruments that are commonly
used by the trading desk for the specific type of hedging activity for
which the financial instrument is being purchased or sold; and
(ii) At the time the financial instrument is purchased or sold, the
hedging activity (including the purchase or sale of the financial
instrument) complies with written, pre-approved limits for the trading
desk purchasing or selling the financial instrument for hedging
activities undertaken for one or more other trading desks. The limits
shall be appropriate for the:
(A) Size, types, and risks of the hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased and sold for hedging activities
by the trading desk; and
(C) Levels and duration of the risk exposures being hedged.
0
6. Section 44.6 is amended by revising paragraph (e)(3), removing
paragraphs (e)(4) and (6), and redesignating paragraph (e)(5) as
paragraph (e)(4).
The revision reads as follows:
Sec. 44.6 Other permitted proprietary trading activities.
* * * * *
(e) * * *
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
* * * * *
Subpart C--Covered Funds Activities and Investments
0
7. Section 44.10 is amended by revising paragraphs (c)(7)(ii) and
(c)(8)(i)(A) to read as follows:
Sec. 44.10 Prohibition on Acquiring or Retaining an Ownership
Interest in and Having Certain Relationships with a Covered Fund.
* * * * *
(c) * * *
(7) * * *
(ii) Participates in the profits and losses of the separate account
other than in compliance with applicable requirements regarding bank
owned life insurance.
(8) * * *
(i) * * *
(A) Loans as defined in Sec. 44.2(t) of subpart A;
* * * * *
0
8. Section 44.11 is amended by revising paragraph (c) to read as
follows:
[[Page 62100]]
Sec. 44.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
* * * * *
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 44.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 44.4(a) or (b) of subpart B, respectively; and
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; or acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in such covered fund in
compliance with section 15G of that Act (15 U.S.C. 78o-11) and the
implementing regulations issued thereunder each as permitted by
paragraph (b) of this section, then in each such case any ownership
interests acquired or retained by the banking entity and its affiliates
in connection with underwriting and market making related activities
for that particular covered fund are included in the calculation of
ownership interests permitted to be held by the banking entity and its
affiliates under the limitations of Sec. 44.12(a)(2)(ii) and (iii) and
(d).
Sec. 44.12 [Amended]
0
9. Section 44.12 is amended by redesignating the second instance of
paragraph (e)(2)(vi) as paragraph (e)(2)(vii).
0
10. Section 44.13 is amended by revising paragraphs (a), (b)(3) and
(4), and (c) to read as follows:
Sec. 44.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 44.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to reduce or otherwise
significantly mitigate the specific, identifiable risks to the banking
entity in connection with:
(i) A compensation arrangement with an employee of the banking
entity or an affiliate thereof that directly provides investment
advisory, commodity trading advisory or other services to the covered
fund; or
(ii) A position taken by the banking entity when acting as
intermediary on behalf of a customer that is not itself a banking
entity to facilitate the exposure by the customer to the profits and
losses of the covered fund.
(2) The risk-mitigating hedging activities of a banking entity are
permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program in accordance with subpart
D of this part that is reasonably designed to ensure the banking
entity's compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures,
and internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks arising:
(1) Out of a transaction conducted solely to accommodate a specific
customer request with respect to the covered fund; or
(2) In connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) With respect to risk-mitigating hedging activity conducted
pursuant to paragraph (a)(1)(i) of this section, the compensation
arrangement relates solely to the covered fund in which the banking
entity or any affiliate has acquired an ownership interest pursuant to
paragraph (a)(1)(i) and such compensation arrangement provides that any
losses incurred by the banking entity on such ownership interest will
be offset by corresponding decreases in amounts payable under such
compensation arrangement.
(b) * * *
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is not sold and has not been
sold pursuant to an offering that targets residents of the United
States in which the banking entity or any affiliate of the banking
entity participates. If the banking entity or an affiliate sponsors or
serves, directly or indirectly, as the investment manager, investment
adviser, commodity pool operator or commodity trading advisor to a
covered fund, then the banking entity or affiliate will be deemed for
purposes of this paragraph (b)(3) to participate in any offer or sale
by the covered fund of ownership interests in the covered fund.
(4) An activity or investment occurs solely outside of the United
States for purposes of paragraph (b)(1)(iv) of this section only if:
(i) The banking entity acting as sponsor, or engaging as principal
in the acquisition or retention of an ownership interest in the covered
fund, is not itself, and is not controlled directly or indirectly by, a
banking entity that is located in the United States or organized under
the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to acquire or retain the ownership interest or act as
sponsor to the covered fund is not located in the United States or
organized under the laws of the United States or of any State; and
(iii) The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State.
* * * * *
(c) Permitted covered fund interests and activities by a regulated
insurance company. The prohibition contained in Sec. 44.10(a) of this
subpart does not apply to the acquisition or retention by an insurance
company, or an affiliate thereof, of any ownership interest in, or the
sponsorship of, a covered fund only if:
(1) The insurance company or its affiliate acquires and retains the
ownership interest solely for the general account of the insurance
company or for one or more separate accounts established by the
insurance company;
[[Page 62101]]
(2) The acquisition and retention of the ownership interest is
conducted in compliance with, and subject to, the insurance company
investment laws and regulations of the State or jurisdiction in which
such insurance company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law or regulation described in paragraph (c)(2) of
this section is insufficient to protect the safety and soundness of the
banking entity, or the financial stability of the United States.
0
11. Section 44.14 is amended by revising paragraph (a)(2)(ii)(B) to
read as follows:
Sec. 44.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually no later than March 31 to
the OCC (with a duty to update the certification if the information in
the certification materially changes) that the banking entity does not,
directly or indirectly, guarantee, assume, or otherwise insure the
obligations or performance of the covered fund or of any covered fund
in which such covered fund invests; and
* * * * *
Subpart D--Compliance Program Requirement; Violations
0
12. Section 44.20 is amended by revising paragraphs (a), (b)
introductory text, (c), (d), (e) introductory text, and (f)(2) and
adding paragraphs (g), (h), and (i) to read as follows:
Sec. 44.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities) shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
(b) Banking entities with significant trading assets and
liabilities. With respect to a banking entity with significant trading
assets and liabilities, the compliance program required by paragraph
(a) of this section, at a minimum, shall include:
* * * * *
(c) CEO attestation. The CEO of a banking entity that has
significant trading assets and liabilities must, based on a review by
the CEO of the banking entity, attest in writing to the OCC, each year
no later than March 31, that the banking entity has in place processes
to establish, maintain, enforce, review, test and modify the compliance
program required by paragraph (b) of this section in a manner
reasonably designed to achieve compliance with section 13 of the BHC
Act and this part. In the case of a U.S. branch or agency of a foreign
banking entity, the attestation may be provided for the entire U.S.
operations of the foreign banking entity by the senior management
officer of the U.S. operations of the foreign banking entity who is
located in the United States.
(d) Reporting requirements under appendix A to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B of this part shall comply with the reporting requirements
described in appendix A to this part, if:
(i) The banking entity has significant trading assets and
liabilities; or
(ii) The OCC notifies the banking entity in writing that it must
satisfy the reporting requirements contained in appendix A to this
part.
(2) Frequency of reporting: Unless the OCC notifies the banking
entity in writing that it must report on a different basis, a banking
entity subject to the Appendix shall report the information required by
appendix A to this part for each quarter within 30 days of the end of
the quarter.
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities shall maintain records
that include:
* * * * *
(f) * * *
(2) Banking entities with moderate trading assets and liabilities.
A banking entity with moderate trading assets and liabilities may
satisfy the requirements of this section by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act and this part and adjustments
as appropriate given the activities, size, scope, and complexity of the
banking entity.
(g) Rebuttable presumption of compliance for banking entities with
limited trading assets and liabilities--(1) Rebuttable presumption.
Except as otherwise provided in this paragraph, a banking entity with
limited trading assets and liabilities shall be presumed to be
compliant with subpart B and subpart C of this part and shall have no
obligation to demonstrate compliance with this part on an ongoing
basis.
(2) Rebuttal of presumption. If upon examination or audit, the OCC
determines that the banking entity has engaged in proprietary trading
or covered fund activities that are otherwise prohibited under subpart
B or subpart C of this part, the OCC may require the banking entity to
be treated under this part as if it did not have limited trading assets
and liabilities. The OCC's rebuttal of the presumption in this
paragraph must be made in accordance with the notice and response
procedures in paragraph (i) of this section.
(h) Reservation of authority. Notwithstanding any other provision
of this part, the OCC retains its authority to require a banking entity
without significant trading assets and liabilities to apply any
requirements of this part that would otherwise apply if the banking
entity had significant or moderate trading assets and liabilities if
the OCC determines that the size or complexity of the banking entity's
trading or investment activities, or the risk of evasion of subpart B
or subpart C of this part, does not warrant a presumption of compliance
under paragraph (g) of this section or treatment as a banking entity
with moderate trading assets and liabilities, as applicable. The OCC's
exercise of this reservation of authority must be made in accordance
with the notice and response procedures in paragraph (i) of this
section.
(i) Notice and response procedures--(1) Notice. The OCC will notify
the banking entity in writing of any determination requiring notice
under this part and will provide an explanation of the determination.
(2) Response. The banking entity may respond to any or all items in
the notice described in paragraph (i)(1) of this section. The response
should include any matters that the banking entity would have the OCC
consider in deciding whether to make the determination. The response
must be in writing and delivered to the designated OCC official within
30 days after the date on which the banking entity received the notice.
The OCC may shorten the time period when, in the opinion of the OCC,
the activities or condition of the banking entity so requires, provided
that the banking
[[Page 62102]]
entity is informed of the time period at the time of notice, or with
the consent of the banking entity. In its discretion, the OCC may
extend the time period for good cause.
(3) Waiver. Failure to respond within 30 days or such other time
period as may be specified by the OCC shall constitute a waiver of any
objections to the OCC's determination.
(4) Decision. The OCC will notify the banking entity of the
decision in writing. The notice will include an explanation of the
decision.
0
13. Revise appendix A to part 44 to read as follows:
Appendix A to Part 44--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
44.20(d), this appendix applies to a banking entity that, together
with its affiliates and subsidiaries, has significant trading assets
and liabilities. These entities are required to (i) furnish periodic
reports to the OCC regarding a variety of quantitative measurements
of their covered trading activities, which vary depending on the
scope and size of covered trading activities, and (ii) create and
maintain records documenting the preparation and content of these
reports. The requirements of this appendix must be incorporated into
the banking entity's internal compliance program under Sec. 44.20.
b. The purpose of this appendix is to assist banking entities
and the OCC in:
(1) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(2) Monitoring the banking entity's covered trading activities;
(3) Identifying covered trading activities that warrant further
review or examination by the banking entity to verify compliance
with the proprietary trading restrictions;
(4) Evaluating whether the covered trading activities of trading
desks engaged in market making-related activities subject to Sec.
44.4(b) are consistent with the requirements governing permitted
market making-related activities;
(5) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. 44.4, Sec. 44.5, or Sec. 44.6(a) and (b) (i.e., underwriting
and market making-related activity, risk-mitigating hedging, or
trading in certain government obligations) are consistent with the
requirement that such activity not result, directly or indirectly,
in a material exposure to high-risk assets or high-risk trading
strategies;
(6) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by the OCC of such activities; and
(7) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. Information that must be furnished pursuant to this appendix
is not intended to serve as a dispositive tool for the
identification of permissible or impermissible activities.
d. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 44.20. The effectiveness of particular
quantitative measurements may differ based on the profile of the
banking entity's businesses in general and, more specifically, of
the particular trading desk, including types of instruments traded,
trading activities and strategies, and history and experience (e.g.,
whether the trading desk is an established, successful market maker
or a new entrant to a competitive market). In all cases, banking
entities must ensure that they have robust measures in place to
identify and monitor the risks taken in their trading activities, to
ensure that the activities are within risk tolerances established by
the banking entity, and to monitor and examine for compliance with
the proprietary trading restrictions in this part.
e. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 44.4 through 44.6(a) and (b), or that
result in a material exposure to high-risk assets or high-risk
trading strategies, must be escalated within the banking entity for
review, further analysis, explanation to the OCC, and remediation,
where appropriate. The quantitative measurements discussed in this
appendix should be helpful to banking entities in identifying and
managing the risks related to their covered trading activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 44.2 and 44.3. In addition, for purposes of this
appendix, the following definitions apply:
Applicability identifies the trading desks for which a banking
entity is required to calculate and report a particular quantitative
measurement based on the type of covered trading activity conducted
by the trading desk.
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of a trading desk's holdings, dividend income, and
interest income and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. 44.4, Sec. 44.5, Sec. 44.6(a), or Sec. 44.6(b).
A banking entity may include in its covered trading activity trading
conducted under Sec. 44.3(d), Sec. 44.6(c), Sec. 44.6(d), or
Sec. 44.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading day means a calendar day on which a trading desk is open
for trading.
III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each banking entity made subject
to this appendix by Sec. 44.20 must furnish the following
quantitative measurements, as applicable, for each trading desk of
the banking entity engaged in covered trading activities and
calculate these quantitative measurements in accordance with this
appendix:
i. Internal Limits and Usage;
ii. Value-at-Risk;
iii. Comprehensive Profit and Loss Attribution;
iv. Positions; and
v. Transaction Volumes.
2. Trading desk information. Each banking entity made subject to
this appendix by Sec. 44.20 must provide certain descriptive
information, as further described in this appendix, regarding each
trading desk engaged in covered trading activities.
3. Quantitative measurements identifying information. Each
banking entity made subject to this appendix by Sec. 44.20 must
provide certain identifying and descriptive information, as further
described in this appendix, regarding its quantitative measurements.
4. Narrative statement. Each banking entity made subject to this
appendix by Sec. 44.20 may provide an optional narrative statement,
as further described in this appendix.
5. File identifying information. Each banking entity made
subject to this appendix by Sec. 44.20 must provide file
identifying information in each submission to the OCC pursuant to
this appendix, including the name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the Board, and
identification of the reporting period and creation date and time.
b. Trading Desk Information
1. Each banking entity must provide descriptive information
regarding each trading desk engaged in covered trading activities,
including:
i. Name of the trading desk used internally by the banking
entity and a unique identification label for the trading desk;
ii. Identification of each type of covered trading activity in
which the trading desk is engaged;
iii. Brief description of the general strategy of the trading
desk;
v. A list identifying each Agency receiving the submission of
the trading desk;
2. Indication of whether each calendar date is a trading day or
not a trading day for the trading desk; and
[[Page 62103]]
3. Currency reported and daily currency conversion rate.
c. Quantitative Measurements Identifying Information
Each banking entity must provide the following information
regarding the quantitative measurements:
1. An Internal Limits Information Schedule that provides
identifying and descriptive information for each limit reported
pursuant to the Internal Limits and Usage quantitative measurement,
including the name of the limit, a unique identification label for
the limit, a description of the limit, the unit of measurement for
the limit, the type of limit, and identification of the
corresponding risk factor attribution in the particular case that
the limit type is a limit on a risk factor sensitivity and profit
and loss attribution to the same risk factor is reported; and
2. A Risk Factor Attribution Information Schedule that provides
identifying and descriptive information for each risk factor
attribution reported pursuant to the Comprehensive Profit and Loss
Attribution quantitative measurement, including the name of the risk
factor or other factor, a unique identification label for the risk
factor or other factor, a description of the risk factor or other
factor, and the risk factor or other factor's change unit.
d. Narrative Statement
Each banking entity made subject to this appendix by Sec. 44.20
may submit in a separate electronic document a Narrative Statement
to the OCC with any information the banking entity views as relevant
for assessing the information reported. The Narrative Statement may
include further description of or changes to calculation methods,
identification of material events, description of and reasons for
changes in the banking entity's trading desk structure or trading
desk strategies, and when any such changes occurred.
e. Frequency and Method of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report the
Trading Desk Information, the Quantitative Measurements Identifying
Information, and each applicable quantitative measurement
electronically to the OCC on the reporting schedule established in
Sec. 44.20 unless otherwise requested by the OCC. A banking entity
must report the Trading Desk Information, the Quantitative
Measurements Identifying Information, and each applicable
quantitative measurement to the OCC in accordance with the XML
Schema specified and published on the OCC's website.
f. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the OCC pursuant to this appendix and Sec. 44.20(d),
create and maintain records documenting the preparation and content
of these reports, as well as such information as is necessary to
permit the OCC to verify the accuracy of such reports, for a period
of five years from the end of the calendar year for which the
measurement was taken. A banking entity must retain the Narrative
Statement, the Trading Desk Information, and the Quantitative
Measurements Identifying Information for a period of five years from
the end of the calendar year for which the information was reported
to the OCC.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Internal Limits and Usage
i. Description: For purposes of this appendix, Internal Limits
are the constraints that define the amount of risk and the positions
that a trading desk is permitted to take at a point in time, as
defined by the banking entity for a specific trading desk. Usage
represents the value of the trading desk's risk or positions that
are accounted for by the current activity of the desk. Internal
limits and their usage are key compliance and risk management tools
used to control and monitor risk taking and include, but are not
limited to, the limits set out in Sec. Sec. 44.4 and 44.5. A
trading desk's risk limits, commonly including a limit on ``Value-
at-Risk,'' are useful in the broader context of the trading desk's
overall activities, particularly for the market making activities
under Sec. 44.4(b) and hedging activity under Sec. 44.5.
Accordingly, the limits required under Sec. Sec. 44.4(b)(2)(iii)(C)
and 44.5(b)(1)(i)(A) must meet the applicable requirements under
Sec. Sec. 44.4(b)(2)(iii)(C) and 44.5(b)(1)(i)(A) and also must
include appropriate metrics for the trading desk limits including,
at a minimum, ``Value-at-Risk'' except to the extent the ``Value-at-
Risk'' metric is demonstrably ineffective for measuring and
monitoring the risks of a trading desk based on the types of
positions traded by, and risk exposures of, that desk.
A. A banking entity must provide the following information for
each limit reported pursuant to this quantitative measurement: The
unique identification label for the limit reported in the Internal
Limits Information Schedule, the limit size (distinguishing between
an upper and a lower limit), and the value of usage of the limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
2. Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the measurement of the risk of future financial loss in
the value of a trading desk's aggregated positions at the ninety-
nine percent confidence level over a one-day period, based on
current market conditions.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into two categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); and (ii) profit and loss attributable to
new positions resulting from the current day's trading activity
(``new positions'').
A. The comprehensive profit and loss associated with existing
positions must reflect changes in the value of these positions on
the applicable day. The comprehensive profit and loss from existing
positions must be further attributed, as applicable, to (i) changes
in the specific risk factors and other factors that are monitored
and managed as part of the trading desk's overall risk management
policies and procedures; and (ii) any other applicable elements,
such as cash flows, carry, changes in reserves, and the correction,
cancellation, or exercise of a trade.
B. For the attribution of comprehensive profit and loss from
existing positions to specific risk factors and other factors, a
banking entity must provide the following information for the
factors that explain the preponderance of the profit or loss changes
due to risk factor changes: The unique identification label for the
risk factor or other factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss due to the risk factor
or other factor change.
C. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and loss from existing
positions that is not attributed to changes in specific risk factors
and other factors must be allocated to a residual category.
Significant unexplained profit and loss must be escalated for
further investigation and analysis.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
c. Positions and Transaction Volumes Measurements
1. Positions
i. Description: For purposes of this appendix, Positions is the
value of securities and derivatives positions managed by the trading
desk. For purposes of the Positions quantitative measurement, do not
include in the Positions calculation for ``securities'' those
securities that are also ``derivatives,'' as those terms are defined
under subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \1223\ A banking
[[Page 62104]]
entity must separately report the trading desk's market value of
long securities positions, short securities positions, derivatives
receivables, and derivatives payables.
---------------------------------------------------------------------------
\1223\ See Sec. 44.2(h), (aa). For example, under this part, a
security-based swap is both a ``security'' and a ``derivative.'' For
purposes of the Positions quantitative measurement, security-based
swaps are reported as derivatives rather than securities.
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 44.4(a)
or (b) to conduct underwriting activity or market-making-related
activity, respectively.
2. Transaction Volumes
i. Description: For purposes of this appendix, Transaction
Volumes measures three exclusive categories of covered trading
activity conducted by a trading desk. A banking entity is required
to report the value and number of security and derivative
transactions conducted by the trading desk with: (i) Customers,
excluding internal transactions; (ii) non-customers, excluding
internal transactions; and (iii) trading desks and other
organizational units where the transaction is booked into either the
same banking entity or an affiliated banking entity. For securities,
value means gross market value. For derivatives, value means gross
notional value. For purposes of calculating the Transaction Volumes
quantitative measurement, do not include in the Transaction Volumes
calculation for ``securities'' those securities that are also
``derivatives,'' as those terms are defined under subpart A;
instead, report those securities that are also derivatives as
``derivatives.'' \1224\ Further, for purposes of the Transaction
Volumes quantitative measurement, a customer of a trading desk that
relies on Sec. 44.4(a) to conduct underwriting activity is a market
participant identified in Sec. 44.4(a)(7), and a customer of a
trading desk that relies on Sec. 44.4(b) to conduct market making-
related activity is a market participant identified in Sec.
44.4(b)(3).
---------------------------------------------------------------------------
\1224\ See Sec. 44.2(h), (aa).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 44.4(a)
or (b) to conduct underwriting activity or market-making-related
activity, respectively.
Appendix B to Part 44--[Removed]
0
14. Appendix B to part 44 is removed.
0
15. Effective January 1. 2020 until December 31, 2020, appendix Z to
part 44 is added to read as follows:
Appendix Z to Part 44--Proprietary Trading and Certain Interests in and
Relationships With Covered Funds (Alternative Compliance)
Note: The content of this appendix reproduces the regulation
implementing Section 13 of the Bank Holding Company Act as of
November 13, 2019.
Subpart A--Authority and Definitions
Sec. 44.1 Authority, purpose, scope, and relationship to other
authorities.
(a) Authority. This part is issued by the OCC under section 13 of
the Bank Holding Company Act of 1956, as amended (12 U.S.C. 1851).
(b) Purpose. Section 13 of the Bank Holding Company Act establishes
prohibitions and restrictions on proprietary trading and on investments
in or relationships with covered funds by certain banking entities,
including national banks, Federal branches and agencies of foreign
banks, Federal savings associations, and certain subsidiaries thereof.
This part implements section 13 of the Bank Holding Company Act by
defining terms used in the statute and related terms, establishing
prohibitions and restrictions on proprietary trading and on investments
in or relationships with covered funds, and explaining the statute's
requirements.
(c) Scope. This part implements section 13 of the Bank Holding
Company Act with respect to banking entities for which the OCC is
authorized to issue regulations under section 13(b)(2) of the Bank
Holding Company Act (12 U.S.C. 1851(b)(2)) and take actions under
section 13(e) of that Act (12 U.S.C. 1851(e)). These include national
banks, Federal branches and Federal agencies of foreign banks, Federal
savings associations, Federal savings banks, and any of their
respective subsidiaries (except a subsidiary for which there is a
different primary financial regulatory agency, as that term is defined
in this part), but do not include such entities to the extent they are
not within the definition of banking entity in Sec. 44.2(c).
(d) Relationship to other authorities. Except as otherwise provided
under section 13 of the Bank Holding Company Act or this part, and
notwithstanding any other provision of law, the prohibitions and
restrictions under section 13 of the Bank Holding Company Act and this
part shall apply to the activities and investments of a banking entity
identified in paragraph (c) of this section, even if such activities
and investments are authorized for the banking entity under other
applicable provisions of law.
(e) Preservation of authority. Nothing in this part limits in any
way the authority of the OCC to impose on a banking entity identified
in paragraph (c) of this section additional requirements or
restrictions with respect to any activity, investment, or relationship
covered under section 13 of the Bank Holding Company Act or this part,
or additional penalties for violation of this part provided under any
other applicable provision of law
Sec. 44.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(c) Banking entity. (1) Except as provided in paragraph (c)(2) of
this section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an insured depository institution;
(iii) Any company that is treated as a bank holding company for
purposes of section 8 of the International Banking Act of 1978 (12
U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any entity described in
paragraphs (c)(1)(i), (ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a banking entity under
paragraphs (c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraphs (c)(1)(i), (ii), or (iii) of
this section; or
(iii) The FDIC acting in its corporate capacity or as conservator
or receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(d) Board means the Board of Governors of the Federal Reserve
System.
(e) CFTC means the Commodity Futures Trading Commission.
(f) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(g) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(h) Derivative. (1) Except as provided in paragraph (h)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
[[Page 62105]]
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, guidance, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the immediate family of the
employee.
(j) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(k) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(l) FDIC means the Federal Deposit Insurance Corporation.
(m) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(n) Foreign banking organization has the same meaning as in section
211.21(o) of the Board's Regulation K (12 CFR 211.21(o)), but does not
include a foreign bank, as defined in section 1(b)(7) of the
International Banking Act of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the Commonwealth of Puerto Rico, Guam,
American Samoa, the United States Virgin Islands, or the Commonwealth
of the Northern Mariana Islands.
(o) Foreign insurance regulator means the insurance commissioner,
or a similar official or agency, of any country other than the United
States that is engaged in the supervision of insurance companies under
foreign insurance law.
(p) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(q) Insurance company means a company that is organized as an
insurance company, primarily and predominantly engaged in writing
insurance or reinsuring risks underwritten by insurance companies,
subject to supervision as such by a state insurance regulator or a
foreign insurance regulator, and not operated for the purpose of
evading the provisions of section 13 of the BHC Act (12 U.S.C. 1851).
(r) Insured depository institution, unless otherwise indicated, has
the same meaning as in section 3(c) of the Federal Deposit Insurance
Act (12 U.S.C. 1813(c)), but does not include:
(1) An insured depository institution that is described in section
2(c)(2)(D) of the BHC Act (12 U.S.C. 1841(c)(2)(D)); or
(2) An insured depository institution if it has, and if every
company that controls it has, total consolidated assets of $10 billion
or less and total trading assets and trading liabilities, on a
consolidated basis, that are 5 percent or less of total consolidated
assets.
(s) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(t) Primary financial regulatory agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 5301(12)).
(u) Purchase includes any contract to buy, purchase, or otherwise
acquire. For security futures products, purchase includes any contract,
agreement, or transaction for future delivery. With respect to a
commodity future, purchase includes any contract, agreement, or
transaction for future delivery. With respect to a derivative, purchase
includes the execution, termination (prior to its scheduled maturity
date), assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a derivative, as the
context may require.
(v) Qualifying foreign banking organization means a foreign banking
organization that qualifies as such under section 211.23(a), (c) or (e)
of the Board's Regulation K (12 CFR 211.23(a), (c), or (e)).
(w) SEC means the Securities and Exchange Commission.
(x) Sale and sell each include any contract to sell or otherwise
dispose of. For security futures products, such terms include any
contract, agreement, or transaction for future delivery. With respect
to a commodity future, such terms include any contract, agreement, or
transaction for future delivery. With respect to a derivative, such
terms include the execution, termination (prior to its scheduled
maturity date), assignment, exchange, or similar transfer or conveyance
of, or extinguishing of rights or obligations under, a derivative, as
the context may require.
(y) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(z) Security-based swap dealer has the same meaning as in section
3(a)(71) of the Exchange Act (15 U.S.C. 78c(a)(71)).
(aa) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(bb) Separate account means an account established and maintained
by an insurance company in connection with one or more insurance
contracts to hold assets that are legally segregated from the insurance
company's other assets, under which income, gains, and losses, whether
or not realized, from assets allocated to such account, are, in
accordance with the applicable contract, credited to or charged against
such account without regard to other income, gains, or losses of the
insurance company.
(cc) State means any State, the District of Columbia, the
Commonwealth of Puerto Rico, Guam, American Samoa, the United States
Virgin Islands, and the Commonwealth of the Northern Mariana Islands.
(dd) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(ee) State insurance regulator means the insurance commissioner, or
a similar official or agency, of a State that is engaged in the
supervision of insurance companies under State insurance law.
(ff) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
Subpart B--Proprietary Trading
Sec. 44.3 Prohibition on proprietary trading.
(a) Prohibition. Except as otherwise provided in this subpart, a
banking entity may not engage in proprietary trading. Proprietary
trading means engaging as principal for the trading account of the
banking entity in any
[[Page 62106]]
purchase or sale of one or more financial instruments.
(b) Definition of trading account. (1) Trading account means any
account that is used by a banking entity to:
(i) Purchase or sell one or more financial instruments principally
for the purpose of:
(A) Short-term resale;
(B) Benefitting from actual or expected short-term price movements;
(C) Realizing short-term arbitrage profits; or
(D) Hedging one or more positions resulting from the purchases or
sales of financial instruments described in paragraphs (b)(1)(i)(A),
(B), or (C) of this section;
(ii) Purchase or sell one or more financial instruments that are
both market risk capital rule covered positions and trading positions
(or hedges of other market risk capital rule covered positions), if the
banking entity, or any affiliate of the banking entity, is an insured
depository institution, bank holding company, or savings and loan
holding company, and calculates risk-based capital ratios under the
market risk capital rule; or
(iii) Purchase or sell one or more financial instruments for any
purpose, if the banking entity:
(A) Is licensed or registered, or is required to be licensed or
registered, to engage in the business of a dealer, swap dealer, or
security-based swap dealer, to the extent the instrument is purchased
or sold in connection with the activities that require the banking
entity to be licensed or registered as such; or
(B) Is engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
the instrument is purchased or sold in connection with the activities
of such business.
(2) Rebuttable presumption for certain purchases and sales. The
purchase (or sale) of a financial instrument by a banking entity shall
be presumed to be for the trading account of the banking entity under
paragraph (b)(1)(i) of this section if the banking entity holds the
financial instrument for fewer than sixty days or substantially
transfers the risk of the financial instrument within sixty days of the
purchase (or sale), unless the banking entity can demonstrate, based on
all relevant facts and circumstances, that the banking entity did not
purchase (or sell) the financial instrument principally for any of the
purposes described in paragraph (b)(1)(i) of this section.
(c) Financial instrument. (1) Financial instrument means:
(i) A security, including an option on a security;
(ii) A derivative, including an option on a derivative; or
(iii) A contract of sale of a commodity for future delivery, or
option on a contract of sale of a commodity for future delivery.
(2) A financial instrument does not include:
(i) A loan;
(ii) A commodity that is not:
(A) An excluded commodity (other than foreign exchange or
currency);
(B) A derivative;
(C) A contract of sale of a commodity for future delivery; or
(D) An option on a contract of sale of a commodity for future
delivery; or
(iii) Foreign exchange or currency.
(d) Proprietary trading. Proprietary trading does not include:
(1) Any purchase or sale of one or more financial instruments by a
banking entity that arises under a repurchase or reverse repurchase
agreement pursuant to which the banking entity has simultaneously
agreed, in writing, to both purchase and sell a stated asset, at stated
prices, and on stated dates or on demand with the same counterparty;
(2) Any purchase or sale of one or more financial instruments by a
banking entity that arises under a transaction in which the banking
entity lends or borrows a security temporarily to or from another party
pursuant to a written securities lending agreement under which the
lender retains the economic interests of an owner of such security, and
has the right to terminate the transaction and to recall the loaned
security on terms agreed by the parties;
(3) Any purchase or sale of a security by a banking entity for the
purpose of liquidity management in accordance with a documented
liquidity management plan of the banking entity that:
(i) Specifically contemplates and authorizes the particular
securities to be used for liquidity management purposes, the amount,
types, and risks of these securities that are consistent with liquidity
management, and the liquidity circumstances in which the particular
securities may or must be used;
(ii) Requires that any purchase or sale of securities contemplated
and authorized by the plan be principally for the purpose of managing
the liquidity of the banking entity, and not for the purpose of short-
term resale, benefitting from actual or expected short-term price
movements, realizing short-term arbitrage profits, or hedging a
position taken for such short-term purposes;
(iii) Requires that any securities purchased or sold for liquidity
management purposes be highly liquid and limited to securities the
market, credit, and other risks of which the banking entity does not
reasonably expect to give rise to appreciable profits or losses as a
result of short-term price movements;
(iv) Limits any securities purchased or sold for liquidity
management purposes, together with any other instruments purchased or
sold for such purposes, to an amount that is consistent with the
banking entity's near-term funding needs, including deviations from
normal operations of the banking entity or any affiliate thereof, as
estimated and documented pursuant to methods specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of securities that are not permitted under Sec. Sec. 44.6(a) or (b) of
this subpart are for the purpose of liquidity management and in
accordance with the liquidity management plan described in paragraph
(d)(3) of this section; and
(vi) Is consistent with the OCC's supervisory requirements,
guidance, and expectations regarding liquidity management;
(4) Any purchase or sale of one or more financial instruments by a
banking entity that is a derivatives clearing organization or a
clearing agency in connection with clearing financial instruments;
(5) Any excluded clearing activities by a banking entity that is a
member of a clearing agency, a member of a derivatives clearing
organization, or a member of a designated financial market utility;
(6) Any purchase or sale of one or more financial instruments by a
banking entity, so long as:
(i) The purchase (or sale) satisfies an existing delivery
obligation of the banking entity or its customers, including to prevent
or close out a failure to deliver, in connection with delivery,
clearing, or settlement activity; or
(ii) The purchase (or sale) satisfies an obligation of the banking
entity in connection with a judicial, administrative, self-regulatory
organization, or arbitration proceeding;
(7) Any purchase or sale of one or more financial instruments by a
banking entity that is acting solely as agent, broker, or custodian;
(8) Any purchase or sale of one or more financial instruments by a
banking entity through a deferred compensation, stock-bonus, profit-
sharing, or pension plan of the banking entity that is established and
administered in accordance with the law of the United
[[Page 62107]]
States or a foreign sovereign, if the purchase or sale is made directly
or indirectly by the banking entity as trustee for the benefit of
persons who are or were employees of the banking entity; or
(9) Any purchase or sale of one or more financial instruments by a
banking entity in the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
financial instrument as soon as practicable, and in no event may the
banking entity retain such instrument for longer than such period
permitted by the OCC.
(e) Definition of other terms related to proprietary trading. For
purposes of this subpart:
(1) Anonymous means that each party to a purchase or sale is
unaware of the identity of the other party(ies) to the purchase or
sale.
(2) Clearing agency has the same meaning as in section 3(a)(23) of
the Exchange Act (15 U.S.C. 78c(a)(23)).
(3) Commodity has the same meaning as in section 1a(9) of the
Commodity Exchange Act (7 U.S.C. 1a(9)), except that a commodity does
not include any security;
(4) Contract of sale of a commodity for future delivery means a
contract of sale (as that term is defined in section 1a(13) of the
Commodity Exchange Act (7 U.S.C. 1a(13)) for future delivery (as that
term is defined in section 1a(27) of the Commodity Exchange Act (7
U.S.C. 1a(27))).
(5) Derivatives clearing organization means:
(i) A derivatives clearing organization registered under section 5b
of the Commodity Exchange Act (7 U.S.C. 7a-1);
(ii) A derivatives clearing organization that, pursuant to CFTC
regulation, is exempt from the registration requirements under section
5b of the Commodity Exchange Act (7 U.S.C. 7a-1); or
(iii) A foreign derivatives clearing organization that, pursuant to
CFTC regulation, is permitted to clear for a foreign board of trade
that is registered with the CFTC.
(6) Exchange, unless the context otherwise requires, means any
designated contract market, swap execution facility, or foreign board
of trade registered with the CFTC, or, for purposes of securities or
security-based swaps, an exchange, as defined under section 3(a)(1) of
the Exchange Act (15 U.S.C. 78c(a)(1)), or security-based swap
execution facility, as defined under section 3(a)(77) of the Exchange
Act (15 U.S.C. 78c(a)(77)).
(7) Excluded clearing activities means:
(i) With respect to customer transactions cleared on a derivatives
clearing organization, a clearing agency, or a designated financial
market utility, any purchase or sale necessary to correct trading
errors made by or on behalf of a customer provided that such purchase
or sale is conducted in accordance with, for transactions cleared on a
derivatives clearing organization, the Commodity Exchange Act, CFTC
regulations, and the rules or procedures of the derivatives clearing
organization, or, for transactions cleared on a clearing agency, the
rules or procedures of the clearing agency, or, for transactions
cleared on a designated financial market utility that is neither a
derivatives clearing organization nor a clearing agency, the rules or
procedures of the designated financial market utility;
(ii) Any purchase or sale in connection with and related to the
management of a default or threatened imminent default of a customer
provided that such purchase or sale is conducted in accordance with,
for transactions cleared on a derivatives clearing organization, the
Commodity Exchange Act, CFTC regulations, and the rules or procedures
of the derivatives clearing organization, or, for transactions cleared
on a clearing agency, the rules or procedures of the clearing agency,
or, for transactions cleared on a designated financial market utility
that is neither a derivatives clearing organization nor a clearing
agency, the rules or procedures of the designated financial market
utility;
(iii) Any purchase or sale in connection with and related to the
management of a default or threatened imminent default of a member of a
clearing agency, a member of a derivatives clearing organization, or a
member of a designated financial market utility;
(iv) Any purchase or sale in connection with and related to the
management of the default or threatened default of a clearing agency, a
derivatives clearing organization, or a designated financial market
utility; and
(v) Any purchase or sale that is required by the rules or
procedures of a clearing agency, a derivatives clearing organization,
or a designated financial market utility to mitigate the risk to the
clearing agency, derivatives clearing organization, or designated
financial market utility that would result from the clearing by a
member of security-based swaps that reference the member or an
affiliate of the member.
(8) Designated financial market utility has the same meaning as in
section 803(4) of the Dodd-Frank Act (12 U.S.C. 5462(4)).
(9) Issuer has the same meaning as in section 2(a)(4) of the
Securities Act of 1933 (15 U.S.C. 77b(a)(4)).
(10) Market risk capital rule covered position and trading position
means a financial instrument that is both a covered position and a
trading position, as those terms are respectively defined:
(i) In the case of a banking entity that is a bank holding company,
savings and loan holding company, or insured depository institution,
under the market risk capital rule that is applicable to the banking
entity; and
(ii) In the case of a banking entity that is affiliated with a bank
holding company or savings and loan holding company, other than a
banking entity to which a market risk capital rule is applicable, under
the market risk capital rule that is applicable to the affiliated bank
holding company or savings and loan holding company.
(11) Market risk capital rule means the market risk capital rule
that is contained in subpart F of 12 CFR part 3, 12 CFR parts 208 and
225, or 12 CFR part 324, as applicable.
(12) Municipal security means a security that is a direct
obligation of or issued by, or an obligation guaranteed as to principal
or interest by, a State or any political subdivision thereof, or any
agency or instrumentality of a State or any political subdivision
thereof, or any municipal corporate instrumentality of one or more
States or political subdivisions thereof.
(13) Trading desk means the smallest discrete unit of organization
of a banking entity that purchases or sells financial instruments for
the trading account of the banking entity or an affiliate thereof.
Sec. 44.4 Permitted underwriting and market making-related
activities.
(a) Underwriting activities--(1) Permitted underwriting activities.
The prohibition contained in Sec. 44.3(a) does not apply to a banking
entity's underwriting activities conducted in accordance with this
paragraph (a).
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or
[[Page 62108]]
counterparties, and reasonable efforts are made to sell or otherwise
reduce the underwriting position within a reasonable period, taking
into account the liquidity, maturity, and depth of the market for the
relevant type of security;
(iii) The banking entity has established and implements, maintains,
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of paragraph (a) of this section,
including reasonably designed written policies and procedures, internal
controls, analysis and independent testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, based on the nature and amount of
the trading desk's underwriting activities, including the reasonably
expected near term demands of clients, customers, or counterparties, on
the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held;
(C) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(D) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis of the basis for any temporary
or permanent increase to a trading desk's limit(s), and independent
review of such demonstrable analysis and approval;
(iv) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(v) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
(3) Definition of distribution. For purposes of this paragraph (a),
a distribution of securities means:
(i) An offering of securities, whether or not subject to
registration under the Securities Act of 1933, that is distinguished
from ordinary trading transactions by the presence of special selling
efforts and selling methods; or
(ii) An offering of securities made pursuant to an effective
registration statement under the Securities Act of 1933.
(4) Definition of underwriter. For purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an issuer or selling security
holder to:
(A) Purchase securities from the issuer or selling security holder
for distribution;
(B) Engage in a distribution of securities for or on behalf of the
issuer or selling security holder; or
(C) Manage a distribution of securities for or on behalf of the
issuer or selling security holder; or
(ii) A person who has agreed to participate or is participating in
a distribution of such securities for or on behalf of the issuer or
selling security holder.
(5) Definition of selling security holder. For purposes of this
paragraph (a), selling security holder means any person, other than an
issuer, on whose behalf a distribution is made.
(6) Definition of underwriting position. For purposes of this
paragraph (a), underwriting position means the long or short positions
in one or more securities held by a banking entity or its affiliate,
and managed by a particular trading desk, in connection with a
particular distribution of securities for which such banking entity or
affiliate is acting as an underwriter.
(7) Definition of client, customer, and counterparty. For purposes
of this paragraph (a), the terms client, customer, and counterparty, on
a collective or individual basis, refer to market participants that may
transact with the banking entity in connection with a particular
distribution for which the banking entity is acting as underwriter.
(b) Market making-related activities--(1) Permitted market making-
related activities. The prohibition contained in Sec. 44.3(a) does not
apply to a banking entity's market making-related activities conducted
in accordance with this paragraph (b).
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The amount, types, and risks of the financial instruments in
the trading desk's market-maker inventory are designed not to exceed,
on an ongoing basis, the reasonably expected near term demands of
clients, customers, or counterparties, based on:
(A) The liquidity, maturity, and depth of the market for the
relevant types of financial instrument(s); and
(B) Demonstrable analysis of historical customer demand, current
inventory of financial instruments, and market and other factors
regarding the amount, types, and risks, of or associated with financial
instruments in which the trading desk makes a market, including through
block trades;
(iii) The banking entity has established and implements, maintains,
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of paragraph (b) of this section,
including reasonably designed written policies and procedures, internal
controls, analysis and independent testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and inventory; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, based on the nature and amount of
the trading desk's market making-related activities, that address the
factors prescribed by paragraph (b)(2)(ii) of this section, on:
(1) The amount, types, and risks of its market-maker inventory;
(2) The amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) The level of exposures to relevant risk factors arising from
its financial exposure; and
(4) The period of time a financial instrument may be held;
[[Page 62109]]
(D) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(E) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis that the basis for any temporary
or permanent increase to a trading desk's limit(s) is consistent with
the requirements of this paragraph (b), and independent review of such
demonstrable analysis and approval;
(iv) To the extent that any limit identified pursuant to paragraph
(b)(2)(iii)(C) of this section is exceeded, the trading desk takes
action to bring the trading desk into compliance with the limits as
promptly as possible after the limit is exceeded;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (b) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in
activity described in this paragraph (b) in accordance with applicable
law.
(3) Definition of client, customer, and counterparty. For purposes
of paragraph (b) of this section, the terms client, customer, and
counterparty, on a collective or individual basis refer to market
participants that make use of the banking entity's market making-
related services by obtaining such services, responding to quotations,
or entering into a continuing relationship with respect to such
services, provided that:
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with Sec. 44.20(d)(1) of subpart D,
unless:
(A) The trading desk documents how and why a particular trading
desk or other organizational unit of the entity should be treated as a
client, customer, or counterparty of the trading desk for purposes of
paragraph (b)(2) of this section; or
(B) The purchase or sale by the trading desk is conducted
anonymously on an exchange or similar trading facility that permits
trading on behalf of a broad range of market participants.
(4) Definition of financial exposure. For purposes of this
paragraph (b), financial exposure means the aggregate risks of one or
more financial instruments and any associated loans, commodities, or
foreign exchange or currency, held by a banking entity or its affiliate
and managed by a particular trading desk as part of the trading desk's
market making-related activities.
(5) Definition of market-maker inventory. For the purposes of this
paragraph (b), market-maker inventory means all of the positions in the
financial instruments for which the trading desk stands ready to make a
market in accordance with paragraph (b)(2)(i) of this section, that are
managed by the trading desk, including the trading desk's open
positions or exposures arising from open transactions.
Sec. 44.5 Permitted risk-mitigating hedging activities.
(a) Permitted risk-mitigating hedging activities. The prohibition
contained in Sec. 44.3(a) does not apply to the risk-mitigating
hedging activities of a banking entity in connection with and related
to individual or aggregated positions, contracts, or other holdings of
the banking entity and designed to reduce the specific risks to the
banking entity in connection with and related to such positions,
contracts, or other holdings.
(b) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under paragraph (a) of this section only
if:
(1) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(i) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(ii) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(iii) The conduct of analysis, including correlation analysis, and
independent testing designed to ensure that the positions, techniques
and strategies that may be used for hedging may reasonably be expected
to demonstrably reduce or otherwise significantly mitigate the
specific, identifiable risk(s) being hedged, and such correlation
analysis demonstrates that the hedging activity demonstrably reduces or
otherwise significantly mitigates the specific, identifiable risk(s)
being hedged;
(2) The risk-mitigating hedging activity:
(i) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(ii) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate and demonstrably reduces or
otherwise significantly mitigates one or more specific, identifiable
risks, including market risk, counterparty or other credit risk,
currency or foreign exchange risk, interest rate risk, commodity price
risk, basis risk, or similar risks, arising in connection with and
related to identified positions, contracts, or other holdings of the
banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(iii) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(iv) Is subject to continuing review, monitoring and management by
the banking entity that:
(A) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1) of this section;
(B) Is designed to reduce or otherwise significantly mitigate and
demonstrably reduces or otherwise significantly mitigates the specific,
identifiable risks that develop over time from the risk-mitigating
hedging activities undertaken under this section and the underlying
positions, contracts, and other holdings of the banking entity, based
upon the facts and circumstances of the underlying and hedging
positions, contracts and other holdings of the banking entity and the
risks and liquidity thereof; and
(C) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading; and
(3) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(c) Documentation requirement--(1) A banking entity must comply
with the requirements of paragraphs (c)(2) and (3) of this section with
respect to any purchase or sale of financial instruments made in
reliance on this
[[Page 62110]]
section for risk-mitigating hedging purposes that is:
(i) Not established by the specific trading desk establishing or
responsible for the underlying positions, contracts, or other holdings
the risks of which the hedging activity is designed to reduce;
(ii) Established by the specific trading desk establishing or
responsible for the underlying positions, contracts, or other holdings
the risks of which the purchases or sales are designed to reduce, but
that is effected through a financial instrument, exposure, technique,
or strategy that is not specifically identified in the trading desk's
written policies and procedures established under paragraph (b)(1) of
this section or under Sec. 44.4(b)(2)(iii)(B) of this subpart as a
product, instrument, exposure, technique, or strategy such trading desk
may use for hedging; or
(iii) Established to hedge aggregated positions across two or more
trading desks.
(2) In connection with any purchase or sale identified in paragraph
(c)(1) of this section, a banking entity must, at a minimum, and
contemporaneously with the purchase or sale, document:
(i) The specific, identifiable risk(s) of the identified positions,
contracts, or other holdings of the banking entity that the purchase or
sale is designed to reduce;
(ii) The specific risk-mitigating strategy that the purchase or
sale is designed to fulfill; and
(iii) The trading desk or other business unit that is establishing
and responsible for the hedge.
(3) A banking entity must create and retain records sufficient to
demonstrate compliance with the requirements of this paragraph (c) for
a period that is no less than five years in a form that allows the
banking entity to promptly produce such records to the OCC on request,
or such longer period as required under other law or this part.
Sec. 44.6 Other permitted proprietary trading activities.
(a) Permitted trading in domestic government obligations. The
prohibition contained in Sec. 44.3(a) does not apply to the purchase
or sale by a banking entity of a financial instrument that is:
(1) An obligation of, or issued or guaranteed by, the United
States;
(2) An obligation, participation, or other instrument of, or issued
or guaranteed by, an agency of the United States, the Government
National Mortgage Association, the Federal National Mortgage
Association, the Federal Home Loan Mortgage Corporation, a Federal Home
Loan Bank, the Federal Agricultural Mortgage Corporation or a Farm
Credit System institution chartered under and subject to the provisions
of the Farm Credit Act of 1971 (12 U.S.C. 2001 et seq.);
(3) An obligation of any State or any political subdivision
thereof, including any municipal security; or
(4) An obligation of the FDIC, or any entity formed by or on behalf
of the FDIC for purpose of facilitating the disposal of assets acquired
or held by the FDIC in its corporate capacity or as conservator or
receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(b) Permitted trading in foreign government obligations--(1)
Affiliates of foreign banking entities in the United States. The
prohibition contained in Sec. 44.3(a) does not apply to the purchase
or sale of a financial instrument that is an obligation of, or issued
or guaranteed by, a foreign sovereign (including any multinational
central bank of which the foreign sovereign is a member), or any agency
or political subdivision of such foreign sovereign, by a banking
entity, so long as:
(i) The banking entity is organized under or is directly or
indirectly controlled by a banking entity that is organized under the
laws of a foreign sovereign and is not directly or indirectly
controlled by a top-tier banking entity that is organized under the
laws of the United States;
(ii) The financial instrument is an obligation of, or issued or
guaranteed by, the foreign sovereign under the laws of which the
foreign banking entity referred to in paragraph (b)(1)(i) of this
section is organized (including any multinational central bank of which
the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign; and
(iii) The purchase or sale as principal is not made by an insured
depository institution.
(2) Foreign affiliates of a U.S. banking entity. The prohibition
contained in Sec. 44.3(a) does not apply to the purchase or sale of a
financial instrument that is an obligation of, or issued or guaranteed
by, a foreign sovereign (including any multinational central bank of
which the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign, by a foreign entity that is
owned or controlled by a banking entity organized or established under
the laws of the United States or any State, so long as:
(i) The foreign entity is a foreign bank, as defined in section
211.2(j) of the Board's Regulation K (12 CFR 211.2(j)), or is regulated
by the foreign sovereign as a securities dealer;
(ii) The financial instrument is an obligation of, or issued or
guaranteed by, the foreign sovereign under the laws of which the
foreign entity is organized (including any multinational central bank
of which the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign; and
(iii) The financial instrument is owned by the foreign entity and
is not financed by an affiliate that is located in the United States or
organized under the laws of the United States or of any State.
(c) Permitted trading on behalf of customers--(1) Fiduciary
transactions. The prohibition contained in Sec. 44.3(a) does not apply
to the purchase or sale of financial instruments by a banking entity
acting as trustee or in a similar fiduciary capacity, so long as:
(i) The transaction is conducted for the account of, or on behalf
of, a customer; and
(ii) The banking entity does not have or retain beneficial
ownership of the financial instruments.
(2) Riskless principal transactions. The prohibition contained in
Sec. 44.3(a) does not apply to the purchase or sale of financial
instruments by a banking entity acting as riskless principal in a
transaction in which the banking entity, after receiving an order to
purchase (or sell) a financial instrument from a customer, purchases
(or sells) the financial instrument for its own account to offset a
contemporaneous sale to (or purchase from) the customer.
(d) Permitted trading by a regulated insurance company. The
prohibition contained in Sec. 44.3(a) does not apply to the purchase
or sale of financial instruments by a banking entity that is an
insurance company or an affiliate of an insurance company if:
(1) The insurance company or its affiliate purchases or sells the
financial instruments solely for:
(i) The general account of the insurance company; or
(ii) A separate account established by the insurance company;
(2) The purchase or sale is conducted in compliance with, and
subject to, the insurance company investment laws, regulations, and
written guidance of the State or jurisdiction in which such insurance
company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law, regulation, or written guidance described in
paragraph (d)(2) of this
[[Page 62111]]
section is insufficient to protect the safety and soundness of the
covered banking entity, or the financial stability of the United
States.
(e) Permitted trading activities of foreign banking entities. (1)
The prohibition contained in Sec. 44.3(a) does not apply to the
purchase or sale of financial instruments by a banking entity if:
(i) The banking entity is not organized or directly or indirectly
controlled by a banking entity that is organized under the laws of the
United States or of any State;
(ii) The purchase or sale by the banking entity is made pursuant to
paragraph (9) or (13) of section 4(c) of the BHC Act; and
(iii) The purchase or sale meets the requirements of paragraph
(e)(3) of this section.
(2) A purchase or sale of financial instruments by a banking entity
is made pursuant to paragraph (9) or (13) of section 4(c) of the BHC
Act for purposes of paragraph (e)(1)(ii) of this section only if:
(i) The purchase or sale is conducted in accordance with the
requirements of paragraph (e) of this section; and
(ii)(A) With respect to a banking entity that is a foreign banking
organization, the banking entity meets the qualifying foreign banking
organization requirements of section 211.23(a), (c) or (e) of the
Board's Regulation K (12 CFR 211.23(a), (c) or (e)), as applicable; or
(B) With respect to a banking entity that is not a foreign banking
organization, the banking entity is not organized under the laws of the
United States or of any State and the banking entity, on a fully-
consolidated basis, meets at least two of the following requirements:
(1) Total assets of the banking entity held outside of the United
States exceed total assets of the banking entity held in the United
States;
(2) Total revenues derived from the business of the banking entity
outside of the United States exceed total revenues derived from the
business of the banking entity in the United States; or
(3) Total net income derived from the business of the banking
entity outside of the United States exceeds total net income derived
from the business of the banking entity in the United States.
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including any personnel of the banking entity or its affiliate
that arrange, negotiate or execute such purchase or sale) is not
located in the United States or organized under the laws of the United
States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State;
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State;
(iv) No financing for the banking entity's purchases or sales is
provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State; and
(v) The purchase or sale is not conducted with or through any U.S.
entity, other than:
(A) A purchase or sale with the foreign operations of a U.S. entity
if no personnel of such U.S. entity that are located in the United
States are involved in the arrangement, negotiation, or execution of
such purchase or sale;
(B) A purchase or sale with an unaffiliated market intermediary
acting as principal, provided the purchase or sale is promptly cleared
and settled through a clearing agency or derivatives clearing
organization acting as a central counterparty; or
(C) A purchase or sale through an unaffiliated market intermediary
acting as agent, provided the purchase or sale is conducted anonymously
on an exchange or similar trading facility and is promptly cleared and
settled through a clearing agency or derivatives clearing organization
acting as a central counterparty.
(4) For purposes of this paragraph (e), a U.S. entity is any entity
that is, or is controlled by, or is acting on behalf of, or at the
direction of, any other entity that is, located in the United States or
organized under the laws of the United States or of any State.
(5) For purposes of this paragraph (e), a U.S. branch, agency, or
subsidiary of a foreign banking entity is considered to be located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(6) For purposes of this paragraph (e), unaffiliated market
intermediary means an unaffiliated entity, acting as an intermediary,
that is:
(i) A broker or dealer registered with the SEC under section 15 of
the Exchange Act or exempt from registration or excluded from
regulation as such;
(ii) A swap dealer registered with the CFTC under section 4s of the
Commodity Exchange Act or exempt from registration or excluded from
regulation as such;
(iii) A security-based swap dealer registered with the SEC under
section 15F of the Exchange Act or exempt from registration or excluded
from regulation as such; or
(iv) A futures commission merchant registered with the CFTC under
section 4f of the Commodity Exchange Act or exempt from registration or
excluded from regulation as such.
Sec. 44.7 Limitations on permitted proprietary trading activities.
(a) No transaction, class of transactions, or activity may be
deemed permissible under Sec. Sec. 44.4 through 44.6 if the
transaction, class of transactions, or activity would:
(1) Involve or result in a material conflict of interest between
the banking entity and its clients, customers, or counterparties;
(2) Result, directly or indirectly, in a material exposure by the
banking entity to a high-risk asset or a high-risk trading strategy; or
(3) Pose a threat to the safety and soundness of the banking entity
or to the financial stability of the United States.
(b) Definition of material conflict of interest. (1) For purposes
of this section, a material conflict of interest between a banking
entity and its clients, customers, or counterparties exists if the
banking entity engages in any transaction, class of transactions, or
activity that would involve or result in the banking entity's interests
being materially adverse to the interests of its client, customer, or
counterparty with respect to such transaction, class of transactions,
or activity, and the banking entity has not taken at least one of the
actions in paragraph (b)(2) of this section.
(2) Prior to effecting the specific transaction or class or type of
transactions, or engaging in the specific activity, the banking entity:
(i) Timely and effective disclosure. (A) Has made clear, timely,
and effective disclosure of the conflict of interest, together with
other necessary information, in reasonable detail and in a manner
sufficient to permit a reasonable client, customer, or
[[Page 62112]]
counterparty to meaningfully understand the conflict of interest; and
(B) Such disclosure is made in a manner that provides the client,
customer, or counterparty the opportunity to negate, or substantially
mitigate, any materially adverse effect on the client, customer, or
counterparty created by the conflict of interest; or
(ii) Information barriers. Has established, maintained, and
enforced information barriers that are memorialized in written policies
and procedures, such as physical separation of personnel, or functions,
or limitations on types of activity, that are reasonably designed,
taking into consideration the nature of the banking entity's business,
to prevent the conflict of interest from involving or resulting in a
materially adverse effect on a client, customer, or counterparty. A
banking entity may not rely on such information barriers if, in the
case of any specific transaction, class or type of transactions or
activity, the banking entity knows or should reasonably know that,
notwithstanding the banking entity's establishment of information
barriers, the conflict of interest may involve or result in a
materially adverse effect on a client, customer, or counterparty.
(c) Definition of high-risk asset and high-risk trading strategy.
For purposes of this section:
(1) High-risk asset means an asset or group of related assets that
would, if held by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
(2) High-risk trading strategy means a trading strategy that would,
if engaged in by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
Sec. Sec. 44.8-44.9 [Reserved]
Subpart C--Covered Funds Activities and Investments
Sec. 44.10 Prohibition on acquiring or retaining an ownership
interest in and having certain relationships with a covered fund.
(a) Prohibition. (1) Except as otherwise provided in this subpart,
a banking entity may not, as principal, directly or indirectly, acquire
or retain any ownership interest in or sponsor a covered fund.
(2) Paragraph (a)(1) of this section does not include acquiring or
retaining an ownership interest in a covered fund by a banking entity:
(i) Acting solely as agent, broker, or custodian, so long as;
(A) The activity is conducted for the account of, or on behalf of,
a customer; and
(B) The banking entity and its affiliates do not have or retain
beneficial ownership of such ownership interest;
(ii) Through a deferred compensation, stock-bonus, profit-sharing,
or pension plan of the banking entity (or an affiliate thereof) that is
established and administered in accordance with the law of the United
States or a foreign sovereign, if the ownership interest is held or
controlled directly or indirectly by the banking entity as trustee for
the benefit of persons who are or were employees of the banking entity
(or an affiliate thereof);
(iii) In the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
ownership interest as soon as practicable, and in no event may the
banking entity retain such ownership interest for longer than such
period permitted by the OCC; or
(iv) On behalf of customers as trustee or in a similar fiduciary
capacity for a customer that is not a covered fund, so long as:
(A) The activity is conducted for the account of, or on behalf of,
the customer; and
(B) The banking entity and its affiliates do not have or retain
beneficial ownership of such ownership interest.
(b) Definition of covered fund. (1) Except as provided in paragraph
(c) of this section, covered fund means:
(i) An issuer that would be an investment company, as defined in
the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.), but for
section 3(c)(1) or 3(c)(7) of that Act (15 U.S.C. 80a-3(c)(1) or (7));
(ii) Any commodity pool under section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10)) for which:
(A) The commodity pool operator has claimed an exemption under 17
CFR 4.7; or
(B)(1) A commodity pool operator is registered with the CFTC as a
commodity pool operator in connection with the operation of the
commodity pool;
(2) Substantially all participation units of the commodity pool are
owned by qualified eligible persons under 17 CFR 4.7(a)(2) and (3); and
(3) Participation units of the commodity pool have not been
publicly offered to persons who are not qualified eligible persons
under 17 CFR 4.7(a)(2) and (3); or
(iii) For any banking entity that is, or is controlled directly or
indirectly by a banking entity that is, located in or organized under
the laws of the United States or of any State, an entity that:
(A) Is organized or established outside the United States and the
ownership interests of which are offered and sold solely outside the
United States;
(B) Is, or holds itself out as being, an entity or arrangement that
raises money from investors primarily for the purpose of investing in
securities for resale or other disposition or otherwise trading in
securities; and
(C)(1) Has as its sponsor that banking entity (or an affiliate
thereof); or
(2) Has issued an ownership interest that is owned directly or
indirectly by that banking entity (or an affiliate thereof).
(2) An issuer shall not be deemed to be a covered fund under
paragraph (b)(1)(iii) of this section if, were the issuer subject to
U.S. securities laws, the issuer could rely on an exclusion or
exemption from the definition of ``investment company'' under the
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) other than the
exclusions contained in section 3(c)(1) and 3(c)(7) of that Act.
(3) For purposes of paragraph (b)(1)(iii) of this section, a U.S.
branch, agency, or subsidiary of a foreign banking entity is located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(c) Notwithstanding paragraph (b) of this section, unless the
appropriate Federal banking agencies, the SEC, and the CFTC jointly
determine otherwise, a covered fund does not include:
(1) Foreign public funds. (i) Subject to paragraphs (ii) and (iii)
below, an issuer that:
(A) Is organized or established outside of the United States;
(B) Is authorized to offer and sell ownership interests to retail
investors in the issuer's home jurisdiction; and
(C) Sells ownership interests predominantly through one or more
public offerings outside of the United States.
(ii) With respect to a banking entity that is, or is controlled
directly or indirectly by a banking entity that is, located in or
organized under the laws of the United States or of any State and any
issuer for which such banking entity acts as sponsor, the sponsoring
banking entity may not rely on the
[[Page 62113]]
exemption in paragraph (c)(1)(i) of this section for such issuer unless
ownership interests in the issuer are sold predominantly to persons
other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring banking entity or such issuer;
and
(D) Directors and employees of such entities.
(iii) For purposes of paragraph (c)(1)(i)(C) of this section, the
term ``public offering'' means a distribution (as defined in Sec.
44.4(a)(3) of subpart B) of securities in any jurisdiction outside the
United States to investors, including retail investors, provided that:
(A) The distribution complies with all applicable requirements in
the jurisdiction in which such distribution is being made;
(B) The distribution does not restrict availability to investors
having a minimum level of net worth or net investment assets; and
(C) The issuer has filed or submitted, with the appropriate
regulatory authority in such jurisdiction, offering disclosure
documents that are publicly available.
(2) Wholly-owned subsidiaries. An entity, all of the outstanding
ownership interests of which are owned directly or indirectly by the
banking entity (or an affiliate thereof), except that:
(i) Up to five percent of the entity's outstanding ownership
interests, less any amounts outstanding under paragraph (c)(2)(ii) of
this section, may be held by employees or directors of the banking
entity or such affiliate (including former employees or directors if
their ownership interest was acquired while employed by or in the
service of the banking entity); and
(ii) Up to 0.5 percent of the entity's outstanding ownership
interests may be held by a third party if the ownership interest is
acquired or retained by the third party for the purpose of establishing
corporate separateness or addressing bankruptcy, insolvency, or similar
concerns.
(3) Joint ventures. A joint venture between a banking entity or any
of its affiliates and one or more unaffiliated persons, provided that
the joint venture:
(i) Is comprised of no more than 10 unaffiliated co-venturers;
(ii) Is in the business of engaging in activities that are
permissible for the banking entity or affiliate, other than investing
in securities for resale or other disposition; and
(iii) Is not, and does not hold itself out as being, an entity or
arrangement that raises money from investors primarily for the purpose
of investing in securities for resale or other disposition or otherwise
trading in securities.
(4) Acquisition vehicles. An issuer:
(i) Formed solely for the purpose of engaging in a bona fide merger
or acquisition transaction; and
(ii) That exists only for such period as necessary to effectuate
the transaction.
(5) Foreign pension or retirement funds. A plan, fund, or program
providing pension, retirement, or similar benefits that is:
(i) Organized and administered outside the United States;
(ii) A broad-based plan for employees or citizens that is subject
to regulation as a pension, retirement, or similar plan under the laws
of the jurisdiction in which the plan, fund, or program is organized
and administered; and
(iii) Established for the benefit of citizens or residents of one
or more foreign sovereigns or any political subdivision thereof.
(6) Insurance company separate accounts. A separate account,
provided that no banking entity other than the insurance company
participates in the account's profits and losses.
(7) Bank owned life insurance. A separate account that is used
solely for the purpose of allowing one or more banking entities to
purchase a life insurance policy for which the banking entity or
entities is beneficiary, provided that no banking entity that purchases
the policy:
(i) Controls the investment decisions regarding the underlying
assets or holdings of the separate account; or
(ii) Participates in the profits and losses of the separate account
other than in compliance with applicable supervisory guidance regarding
bank owned life insurance.
(8) Loan securitizations--(i) Scope. An issuing entity for asset-
backed securities that satisfies all the conditions of this paragraph
(c)(8) and the assets or holdings of which are comprised solely of:
(A) Loans as defined in Sec. 44.2(s) of subpart A;
(B) Rights or other assets designed to assure the servicing or
timely distribution of proceeds to holders of such securities and
rights or other assets that are related or incidental to purchasing or
otherwise acquiring and holding the loans, provided that each asset
meets the requirements of paragraph (c)(8)(iii) of this section;
(C) Interest rate or foreign exchange derivatives that meet the
requirements of paragraph (c)(8)(iv) of this section; and
(D) Special units of beneficial interest and collateral
certificates that meet the requirements of paragraph (c)(8)(v) of this
section.
(ii) Impermissible assets. For purposes of this paragraph (c)(8),
the assets or holdings of the issuing entity shall not include any of
the following:
(A) A security, including an asset-backed security, or an interest
in an equity or debt security other than as permitted in paragraph
(c)(8)(iii) of this section;
(B) A derivative, other than a derivative that meets the
requirements of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities. Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may hold securities if those
securities are:
(A) Cash equivalents for purposes of the rights and assets in
paragraph (c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts previously contracted with
respect to the loans supporting the asset-backed securities.
(iv) Derivatives. The holdings of derivatives by the issuing entity
shall be limited to interest rate or foreign exchange derivatives that
satisfy all of the following conditions:
(A) The written terms of the derivative directly relate to the
loans, the asset-backed securities, or the contractual rights of other
assets described in paragraph (c)(8)(i)(B) of this section; and
(B) The derivatives reduce the interest rate and/or foreign
exchange risks related to the loans, the asset-backed securities, or
the contractual rights or other assets described in paragraph
(c)(8)(i)(B) of this section.
(v) Special units of beneficial interest and collateral
certificates. The assets or holdings of the issuing entity may include
collateral certificates and special units of beneficial interest issued
by a special purpose vehicle, provided that:
(A) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate meets the requirements in
this paragraph (c)(8);
(B) The special unit of beneficial interest or collateral
certificate is used for the sole purpose of transferring to the issuing
entity for the loan securitization the economic risks and benefits of
the assets that are permissible for loan securitizations under this
paragraph (c)(8) and does not directly or indirectly transfer any
interest in any other economic or financial exposure;
(C) The special unit of beneficial interest or collateral
certificate is created solely to satisfy legal requirements or
otherwise facilitate the
[[Page 62114]]
structuring of the loan securitization; and
(D) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate and the issuing entity
are established under the direction of the same entity that initiated
the loan securitization.
(9) Qualifying asset-backed commercial paper conduits. (i) An
issuing entity for asset-backed commercial paper that satisfies all of
the following requirements:
(A) The asset-backed commercial paper conduit holds only:
(1) Loans and other assets permissible for a loan securitization
under paragraph (c)(8)(i) of this section; and
(2) Asset-backed securities supported solely by assets that are
permissible for loan securitizations under paragraph (c)(8)(i) of this
section and acquired by the asset-backed commercial paper conduit as
part of an initial issuance either directly from the issuing entity of
the asset-backed securities or directly from an underwriter in the
distribution of the asset-backed securities;
(B) The asset-backed commercial paper conduit issues only asset-
backed securities, comprised of a residual interest and securities with
a legal maturity of 397 days or less; and
(C) A regulated liquidity provider has entered into a legally
binding commitment to provide full and unconditional liquidity coverage
with respect to all of the outstanding asset-backed securities issued
by the asset-backed commercial paper conduit (other than any residual
interest) in the event that funds are required to redeem maturing
asset-backed securities.
(ii) For purposes of this paragraph (c)(9), a regulated liquidity
provider means:
(A) A depository institution, as defined in section 3(c) of the
Federal Deposit Insurance Act (12 U.S.C. 1813(c));
(B) A bank holding company, as defined in section 2(a) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(a)), or a subsidiary
thereof;
(C) A savings and loan holding company, as defined in section 10a
of the Home Owners' Loan Act (12 U.S.C. 1467a), provided all or
substantially all of the holding company's activities are permissible
for a financial holding company under section 4(k) of the Bank Holding
Company Act of 1956 (12 U.S.C. 1843(k)), or a subsidiary thereof;
(D) A foreign bank whose home country supervisor, as defined in
Sec. 211.21(q) of the Board's Regulation K (12 CFR 211.21(q)), has
adopted capital standards consistent with the Capital Accord for the
Basel Committee on banking Supervision, as amended, and that is subject
to such standards, or a subsidiary thereof; or
(E) The United States or a foreign sovereign.
(10) Qualifying covered bonds--(i) Scope. An entity owning or
holding a dynamic or fixed pool of loans or other assets as provided in
paragraph (c)(8) of this section for the benefit of the holders of
covered bonds, provided that the assets in the pool are comprised
solely of assets that meet the conditions in paragraph (c)(8)(i) of
this section.
(ii) Covered bond. For purposes of this paragraph (c)(10), a
covered bond means:
(A) A debt obligation issued by an entity that meets the definition
of foreign banking organization, the payment obligations of which are
fully and unconditionally guaranteed by an entity that meets the
conditions set forth in paragraph (c)(10)(i) of this section; or
(B) A debt obligation of an entity that meets the conditions set
forth in paragraph (c)(10)(i) of this section, provided that the
payment obligations are fully and unconditionally guaranteed by an
entity that meets the definition of foreign banking organization and
the entity is a wholly-owned subsidiary, as defined in paragraph (c)(2)
of this section, of such foreign banking organization.
(11) SBICs and public welfare investment funds. An issuer:
(i) That is a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), or that has received from the Small Business Administration
notice to proceed to qualify for a license as a small business
investment company, which notice or license has not been revoked; or
(ii) The business of which is to make investments that are:
(A) Designed primarily to promote the public welfare, of the type
permitted under paragraph (11) of section 5136 of the Revised Statutes
of the United States (12 U.S.C. 24), including the welfare of low- and
moderate-income communities or families (such as providing housing,
services, or jobs); or
(B) Qualified rehabilitation expenditures with respect to a
qualified rehabilitated building or certified historic structure, as
such terms are defined in section 47 of the Internal Revenue Code of
1986 or a similar State historic tax credit program.
(12) Registered investment companies and excluded entities. An
issuer:
(i) That is registered as an investment company under section 8 of
the Investment Company Act of 1940 (15 U.S.C. 80a-8), or that is formed
and operated pursuant to a written plan to become a registered
investment company as described in Sec. 44.20(e)(3) of subpart D and
that complies with the requirements of section 18 of the Investment
Company Act of 1940 (15 U.S.C. 80a-18);
(ii) That may rely on an exclusion or exemption from the definition
of ``investment company'' under the Investment Company Act of 1940 (15
U.S.C. 80a-1 et seq.) other than the exclusions contained in section
3(c)(1) and 3(c)(7) of that Act; or
(iii) That has elected to be regulated as a business development
company pursuant to section 54(a) of that Act (15 U.S.C. 80a-53) and
has not withdrawn its election, or that is formed and operated pursuant
to a written plan to become a business development company as described
in Sec. 44.20(e)(3) of subpart D and that complies with the
requirements of section 61 of the Investment Company Act of 1940 (15
U.S.C. 80a-60).
(13) Issuers in conjunction with the FDIC's receivership or
conservatorship operations. An issuer that is an entity formed by or on
behalf of the FDIC for the purpose of facilitating the disposal of
assets acquired in the FDIC's capacity as conservator or receiver under
the Federal Deposit Insurance Act or Title II of the Dodd-Frank Wall
Street Reform and Consumer Protection Act.
(14) Other excluded issuers. (i) Any issuer that the appropriate
Federal banking agencies, the SEC, and the CFTC jointly determine the
exclusion of which is consistent with the purposes of section 13 of the
BHC Act.
(ii) A determination made under paragraph (c)(14)(i) of this
section will be promptly made public.
(d) Definition of other terms related to covered funds. For
purposes of this subpart:
(1) Applicable accounting standards means U.S. generally accepted
accounting principles, or such other accounting standards applicable to
a banking entity that the OCC determines are appropriate and that the
banking entity uses in the ordinary course of its business in preparing
its consolidated financial statements.
(2) Asset-backed security has the meaning specified in Section
3(a)(79) of the Exchange Act (15 U.S.C. 78c(a)(79)).
(3) Director has the same meaning as provided in section
215.2(d)(1) of the Board's Regulation O (12 CFR 215.2(d)(1)).
(4) Issuer has the same meaning as in section 2(a)(22) of the
Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(22)).
[[Page 62115]]
(5) Issuing entity means with respect to asset-backed securities
the special purpose vehicle that owns or holds the pool assets
underlying asset-backed securities and in whose name the asset-backed
securities supported or serviced by the pool assets are issued.
(6) Ownership interest--(i) Ownership interest means any equity,
partnership, or other similar interest. An ``other similar interest''
means an interest that:
(A) Has the right to participate in the selection or removal of a
general partner, managing member, member of the board of directors or
trustees, investment manager, investment adviser, or commodity trading
advisor of the covered fund (excluding the rights of a creditor to
exercise remedies upon the occurrence of an event of default or an
acceleration event);
(B) Has the right under the terms of the interest to receive a
share of the income, gains or profits of the covered fund;
(C) Has the right to receive the underlying assets of the covered
fund after all other interests have been redeemed and/or paid in full
(excluding the rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event);
(D) Has the right to receive all or a portion of excess spread (the
positive difference, if any, between the aggregate interest payments
received from the underlying assets of the covered fund and the
aggregate interest paid to the holders of other outstanding interests);
(E) Provides under the terms of the interest that the amounts
payable by the covered fund with respect to the interest could be
reduced based on losses arising from the underlying assets of the
covered fund, such as allocation of losses, write-downs or charge-offs
of the outstanding principal balance, or reductions in the amount of
interest due and payable on the interest;
(F) Receives income on a pass-through basis from the covered fund,
or has a rate of return that is determined by reference to the
performance of the underlying assets of the covered fund; or
(G) Any synthetic right to have, receive, or be allocated any of
the rights in paragraphs (d)(6)(i)(A) through (F) of this section.
(ii) Ownership interest does not include: Restricted profit
interest. An interest held by an entity (or an employee or former
employee thereof) in a covered fund for which the entity (or employee
thereof) serves as investment manager, investment adviser, commodity
trading advisor, or other service provider so long as:
(A) The sole purpose and effect of the interest is to allow the
entity (or employee or former employee thereof) to share in the profits
of the covered fund as performance compensation for the investment
management, investment advisory, commodity trading advisory, or other
services provided to the covered fund by the entity (or employee or
former employee thereof), provided that the entity (or employee or
former employee thereof) may be obligated under the terms of such
interest to return profits previously received;
(B) All such profit, once allocated, is distributed to the entity
(or employee or former employee thereof) promptly after being earned
or, if not so distributed, is retained by the covered fund for the sole
purpose of establishing a reserve amount to satisfy contractual
obligations with respect to subsequent losses of the covered fund and
such undistributed profit of the entity (or employee or former employee
thereof) does not share in the subsequent investment gains of the
covered fund;
(C) Any amounts invested in the covered fund, including any amounts
paid by the entity (or employee or former employee thereof) in
connection with obtaining the restricted profit interest, are within
the limits of Sec. 44.12 of this subpart; and
(D) The interest is not transferable by the entity (or employee or
former employee thereof) except to an affiliate thereof (or an employee
of the banking entity or affiliate), to immediate family members, or
through the intestacy, of the employee or former employee, or in
connection with a sale of the business that gave rise to the restricted
profit interest by the entity (or employee or former employee thereof)
to an unaffiliated party that provides investment management,
investment advisory, commodity trading advisory, or other services to
the fund.
(7) Prime brokerage transaction means any transaction that would be
a covered transaction, as defined in section 23A(b)(7) of the Federal
Reserve Act (12 U.S.C. 371c(b)(7)), that is provided in connection with
custody, clearance and settlement, securities borrowing or lending
services, trade execution, financing, or data, operational, and
administrative support.
(8) Resident of the United States means a person that is a ``U.S.
person'' as defined in rule 902(k) of the SEC's Regulation S (17 CFR
230.902(k)).
(9) Sponsor means, with respect to a covered fund:
(i) To serve as a general partner, managing member, or trustee of a
covered fund, or to serve as a commodity pool operator with respect to
a covered fund as defined in (b)(1)(ii) of this section;
(ii) In any manner to select or to control (or to have employees,
officers, or directors, or agents who constitute) a majority of the
directors, trustees, or management of a covered fund; or
(iii) To share with a covered fund, for corporate, marketing,
promotional, or other purposes, the same name or a variation of the
same name, except as permitted under Sec. 44.11(a)(6).
(10) Trustee. (i) For purposes of paragraph (d)(9) of this section
and Sec. 44.11 of subpart C, a trustee does not include:
(A) A trustee that does not exercise investment discretion with
respect to a covered fund, including a trustee that is subject to the
direction of an unaffiliated named fiduciary who is not a trustee
pursuant to section 403(a)(1) of the Employee's Retirement Income
Security Act (29 U.S.C. 1103(a)(1)); or
(B) A trustee that is subject to fiduciary standards imposed under
foreign law that are substantially equivalent to those described in
paragraph (d)(10)(i)(A) of this section;
(ii) Any entity that directs a person described in paragraph
(d)(10)(i) of this section, or that possesses authority and discretion
to manage and control the investment decisions of a covered fund for
which such person serves as trustee, shall be considered to be a
trustee of such covered fund.
Sec. 44.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
(a) Organizing and offering a covered fund in general.
Notwithstanding Sec. 44.10(a) of this subpart, a banking entity is not
prohibited from acquiring or retaining an ownership interest in, or
acting as sponsor to, a covered fund in connection with, directly or
indirectly, organizing and offering a covered fund, including serving
as a general partner, managing member, trustee, or commodity pool
operator of the covered fund and in any manner selecting or controlling
(or having employees, officers, directors, or agents who constitute) a
majority of the directors, trustees, or management of the covered fund,
including any necessary expenses for the foregoing, only if:
(1) The banking entity (or an affiliate thereof) provides bona fide
trust, fiduciary, investment advisory, or commodity trading advisory
services;
(2) The covered fund is organized and offered only in connection
with the provision of bona fide trust, fiduciary, investment advisory,
or commodity trading advisory services and only to persons that are
customers of such
[[Page 62116]]
services of the banking entity (or an affiliate thereof), pursuant to a
written plan or similar documentation outlining how the banking entity
or such affiliate intends to provide advisory or similar services to
its customers through organizing and offering such fund;
(3) The banking entity and its affiliates do not acquire or retain
an ownership interest in the covered fund except as permitted under
Sec. 44.12 of this subpart;
(4) The banking entity and its affiliates comply with the
requirements of Sec. 44.14 of this subpart;
(5) The banking entity and its affiliates do not, directly or
indirectly, guarantee, assume, or otherwise insure the obligations or
performance of the covered fund or of any covered fund in which such
covered fund invests;
(6) The covered fund, for corporate, marketing, promotional, or
other purposes:
(i) Does not share the same name or a variation of the same name
with the banking entity (or an affiliate thereof) except that a covered
fund may share the same name or a variation of the same name with a
banking entity that is an investment adviser to the covered fund if:
(A) The investment adviser is not an insured depository
institution, a company that controls an insured depository institution,
or a company that is treated as a bank holding company for purposes of
section 8 of the International Banking Act of 1978 (12 U.S.C. 3106);
and
(B) The investment adviser does not share the same name or a
variation of the same name as an insured depository institution, a
company that controls an insured depository institution, or a company
that is treated as a bank holding company for purposes of section 8 of
the International Banking Act of 1978 (12 U.S.C. 3106); and
(ii) Does not use the word ``bank'' in its name;
(7) No director or employee of the banking entity (or an affiliate
thereof) takes or retains an ownership interest in the covered fund,
except for any director or employee of the banking entity or such
affiliate who is directly engaged in providing investment advisory,
commodity trading advisory, or other services to the covered fund at
the time the director or employee takes the ownership interest; and
(8) The banking entity:
(i) Clearly and conspicuously discloses, in writing, to any
prospective and actual investor in the covered fund (such as through
disclosure in the covered fund's offering documents):
(A) That ``any losses in [such covered fund] will be borne solely
by investors in [the covered fund] and not by [the banking entity] or
its affiliates; therefore, [the banking entity's] losses in [such
covered fund] will be limited to losses attributable to the ownership
interests in the covered fund held by [the banking entity] and any
affiliate in its capacity as investor in the [covered fund] or as
beneficiary of a restricted profit interest held by [the banking
entity] or any affiliate'';
(B) That such investor should read the fund offering documents
before investing in the covered fund;
(C) That the ``ownership interests in the covered fund are not
insured by the FDIC, and are not deposits, obligations of, or endorsed
or guaranteed in any way, by any banking entity'' (unless that happens
to be the case); and
(D) The role of the banking entity and its affiliates and employees
in sponsoring or providing any services to the covered fund; and
(ii) Complies with any additional rules of the appropriate Federal
banking agencies, the SEC, or the CFTC, as provided in section 13(b)(2)
of the BHC Act, designed to ensure that losses in such covered fund are
borne solely by investors in the covered fund and not by the covered
banking entity and its affiliates.
(b) Organizing and offering an issuing entity of asset-backed
securities. (1) Notwithstanding Sec. 44.10(a) of this subpart, a
banking entity is not prohibited from acquiring or retaining an
ownership interest in, or acting as sponsor to, a covered fund that is
an issuing entity of asset-backed securities in connection with,
directly or indirectly, organizing and offering that issuing entity, so
long as the banking entity and its affiliates comply with all of the
requirements of paragraph (a)(3) through (8) of this section.
(2) For purposes of this paragraph (b), organizing and offering a
covered fund that is an issuing entity of asset-backed securities means
acting as the securitizer, as that term is used in section 15G(a)(3) of
the Exchange Act (15 U.S.C. 78o-11(a)(3)) of the issuing entity, or
acquiring or retaining an ownership interest in the issuing entity as
required by section 15G of that Act (15 U.S.C. 78o-11) and the
implementing regulations issued thereunder.
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 44.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 44.4(a) or Sec. 44.4(b) of subpart B,
respectively;
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in such covered fund in
compliance with section 15G of that Act (15 U.S.C. 78o-11) and the
implementing regulations issued thereunder each as permitted by
paragraph (b) of this section; or, directly or indirectly, guarantees,
assumes, or otherwise insures the obligations or performance of the
covered fund or of any covered fund in which such fund invests, then in
each such case any ownership interests acquired or retained by the
banking entity and its affiliates in connection with underwriting and
market making related activities for that particular covered fund are
included in the calculation of ownership interests permitted to be held
by the banking entity and its affiliates under the limitations of Sec.
44.12(a)(2)(ii) and Sec. 44.12(d) of this subpart; and
(3) With respect to any banking entity, the aggregate value of all
ownership interests of the banking entity and its affiliates in all
covered funds acquired and retained under Sec. 44.11 of this subpart,
including all covered funds in which the banking entity holds an
ownership interest in connection with underwriting and market making
related activities permitted under this paragraph (c), are included in
the calculation of all ownership interests under Sec. 44.12(a)(2)(iii)
and Sec. 44.12(d) of this subpart.
Sec. 44.12 Permitted investment in a covered fund.
(a) Authority and limitations on permitted investments in covered
funds. (1) Notwithstanding the prohibition contained in Sec. 44.10(a)
of this subpart, a banking entity may acquire and retain an ownership
interest in a covered fund that the banking entity or an affiliate
thereof organizes and offers pursuant to Sec. 44.11, for the purposes
of:
(i) Establishment. Establishing the fund and providing the fund
with sufficient initial equity for investment to
[[Page 62117]]
permit the fund to attract unaffiliated investors, subject to the
limits contained in paragraphs (a)(2)(i) and (iii) of this section; or
(ii) De minimis investment. Making and retaining an investment in
the covered fund subject to the limits contained in paragraphs
(a)(2)(ii) and (iii) of this section.
(2) Investment limits--(i) Seeding period. With respect to an
investment in any covered fund made or held pursuant to paragraph
(a)(1)(i) of this section, the banking entity and its affiliates:
(A) Must actively seek unaffiliated investors to reduce, through
redemption, sale, dilution, or other methods, the aggregate amount of
all ownership interests of the banking entity in the covered fund to
the amount permitted in paragraph (a)(2)(i)(B) of this section; and
(B) Must, no later than 1 year after the date of establishment of
the fund (or such longer period as may be provided by the Board
pursuant to paragraph (e) of this section), conform its ownership
interest in the covered fund to the limits in paragraph (a)(2)(ii) of
this section;
(ii) Per-fund limits. (A) Except as provided in paragraph
(a)(2)(ii)(B) of this section, an investment by a banking entity and
its affiliates in any covered fund made or held pursuant to paragraph
(a)(1)(ii) of this section may not exceed 3 percent of the total number
or value of the outstanding ownership interests of the fund.
(B) An investment by a banking entity and its affiliates in a
covered fund that is an issuing entity of asset-backed securities may
not exceed 3 percent of the total fair market value of the ownership
interests of the fund measured in accordance with paragraph (b)(3) of
this section, unless a greater percentage is retained by the banking
entity and its affiliates in compliance with the requirements of
section 15G of the Exchange Act (15 U.S.C. 78o-11) and the implementing
regulations issued thereunder, in which case the investment by the
banking entity and its affiliates in the covered fund may not exceed
the amount, number, or value of ownership interests of the fund
required under section 15G of the Exchange Act and the implementing
regulations issued thereunder.
(iii) Aggregate limit. The aggregate value of all ownership
interests of the banking entity and its affiliates in all covered funds
acquired or retained under this section may not exceed 3 percent of the
tier 1 capital of the banking entity, as provided under paragraph (c)
of this section, and shall be calculated as of the last day of each
calendar quarter.
(iv) Date of establishment. For purposes of this section, the date
of establishment of a covered fund shall be:
(A) In general. The date on which the investment adviser or similar
entity to the covered fund begins making investments pursuant to the
written investment strategy for the fund;
(B) Issuing entities of asset-backed securities. In the case of an
issuing entity of asset-backed securities, the date on which the assets
are initially transferred into the issuing entity of asset-backed
securities.
(b) Rules of construction--(1) Attribution of ownership interests
to a covered banking entity. (i) For purposes of paragraph (a)(2) of
this section, the amount and value of a banking entity's permitted
investment in any single covered fund shall include any ownership
interest held under Sec. 44.12 directly by the banking entity,
including any affiliate of the banking entity.
(ii) Treatment of registered investment companies, SEC-regulated
business development companies and foreign public funds. For purposes
of paragraph (b)(1)(i) of this section, a registered investment
company, SEC-regulated business development companies or foreign public
fund as described in Sec. 44.10(c)(1) of this subpart will not be
considered to be an affiliate of the banking entity so long as the
banking entity:
(A) Does not own, control, or hold with the power to vote 25
percent or more of the voting shares of the company or fund; and
(B) Provides investment advisory, commodity trading advisory,
administrative, and other services to the company or fund in compliance
with the limitations under applicable regulation, order, or other
authority.
(iii) Covered funds. For purposes of paragraph (b)(1)(i) of this
section, a covered fund will not be considered to be an affiliate of a
banking entity so long as the covered fund is held in compliance with
the requirements of this subpart.
(iv) Treatment of employee and director investments financed by the
banking entity. For purposes of paragraph (b)(1)(i) of this section, an
investment by a director or employee of a banking entity who acquires
an ownership interest in his or her personal capacity in a covered fund
sponsored by the banking entity will be attributed to the banking
entity if the banking entity, directly or indirectly, extends financing
for the purpose of enabling the director or employee to acquire the
ownership interest in the fund and the financing is used to acquire
such ownership interest in the covered fund.
(2) Calculation of permitted ownership interests in a single
covered fund. Except as provided in paragraph (b)(3) or (4), for
purposes of determining whether an investment in a single covered fund
complies with the restrictions on ownership interests under paragraphs
(a)(2)(i)(B) and (a)(2)(ii)(A) of this section:
(i) The aggregate number of the outstanding ownership interests
held by the banking entity shall be the total number of ownership
interests held under this section by the banking entity in a covered
fund divided by the total number of ownership interests held by all
entities in that covered fund, as of the last day of each calendar
quarter (both measured without regard to committed funds not yet called
for investment);
(ii) The aggregate value of the outstanding ownership interests
held by the banking entity shall be the aggregate fair market value of
all investments in and capital contributions made to the covered fund
by the banking entity, divided by the value of all investments in and
capital contributions made to that covered fund by all entities, as of
the last day of each calendar quarter (all measured without regard to
committed funds not yet called for investment). If fair market value
cannot be determined, then the value shall be the historical cost basis
of all investments in and contributions made by the banking entity to
the covered fund;
(iii) For purposes of the calculation under paragraph (b)(2)(ii) of
this section, once a valuation methodology is chosen, the banking
entity must calculate the value of its investment and the investments
of all others in the covered fund in the same manner and according to
the same standards.
(3) Issuing entities of asset-backed securities. In the case of an
ownership interest in an issuing entity of asset-backed securities, for
purposes of determining whether an investment in a single covered fund
complies with the restrictions on ownership interests under paragraphs
(a)(2)(i)(B) and (a)(2)(ii)(B) of this section:
(i) For securitizations subject to the requirements of section 15G
of the Exchange Act (15 U.S.C. 78o-11), the calculations shall be made
as of the date and according to the valuation methodology applicable
pursuant to the requirements of section 15G of the Exchange Act (15
U.S.C. 78o-11) and the implementing regulations issued thereunder; or
[[Page 62118]]
(ii) For securitization transactions completed prior to the
compliance date of such implementing regulations (or as to which such
implementing regulations do not apply), the calculations shall be made
as of the date of establishment as defined in paragraph (a)(2)(iv)(B)
of this section or such earlier date on which the transferred assets
have been valued for purposes of transfer to the covered fund, and
thereafter only upon the date on which additional securities of the
issuing entity of asset-backed securities are priced for purposes of
the sales of ownership interests to unaffiliated investors.
(iii) For securitization transactions completed prior to the
compliance date of such implementing regulations (or as to which such
implementing regulations do not apply), the aggregate value of the
outstanding ownership interests in the covered fund shall be the fair
market value of the assets transferred to the issuing entity of the
securitization and any other assets otherwise held by the issuing
entity at such time, determined in a manner that is consistent with its
determination of the fair market value of those assets for financial
statement purposes.
(iv) For purposes of the calculation under paragraph (b)(3)(iii) of
this section, the valuation methodology used to calculate the fair
market value of the ownership interests must be the same for both the
ownership interests held by a banking entity and the ownership
interests held by all others in the covered fund in the same manner and
according to the same standards.
(4) Multi-tier fund investments--(i) Master-feeder fund
investments. If the principal investment strategy of a covered fund
(the ``feeder fund'') is to invest substantially all of its assets in
another single covered fund (the ``master fund''), then for purposes of
the investment limitations in paragraphs (a)(2)(i)(B) and (a)(2)(ii) of
this section, the banking entity's permitted investment in such funds
shall be measured only by reference to the value of the master fund.
The banking entity's permitted investment in the master fund shall
include any investment by the banking entity in the master fund, as
well as the banking entity's pro-rata share of any ownership interest
of the master fund that is held through the feeder fund; and
(ii) Fund-of-funds investments. If a banking entity organizes and
offers a covered fund pursuant to Sec. 44.11 of this subpart for the
purpose of investing in other covered funds (a ``fund of funds'') and
that fund of funds itself invests in another covered fund that the
banking entity is permitted to own, then the banking entity's permitted
investment in that other fund shall include any investment by the
banking entity in that other fund, as well as the banking entity's pro-
rata share of any ownership interest of the fund that is held through
the fund of funds. The investment of the banking entity may not
represent more than 3 percent of the amount or value of any single
covered fund.
(c) Aggregate permitted investments in all covered funds. (1) For
purposes of paragraph (a)(2)(iii) of this section, the aggregate value
of all ownership interests held by a banking entity shall be the sum of
all amounts paid or contributed by the banking entity in connection
with acquiring or retaining an ownership interest in covered funds
(together with any amounts paid by the entity (or employee thereof) in
connection with obtaining a restricted profit interest under Sec.
44.10(d)(6)(ii) of this subpart), on a historical cost basis.
(2) Calculation of tier 1 capital. For purposes of paragraph
(a)(2)(iii) of this section:
(i) Entities that are required to hold and report tier 1 capital.
If a banking entity is required to calculate and report tier 1 capital,
the banking entity's tier 1 capital shall be equal to the amount of
tier 1 capital of the banking entity as of the last day of the most
recent calendar quarter, as reported to its primary financial
regulatory agency; and
(ii) If a banking entity is not required to calculate and report
tier 1 capital, the banking entity's tier 1 capital shall be determined
to be equal to:
(A) In the case of a banking entity that is controlled, directly or
indirectly, by a depository institution that calculates and reports
tier 1 capital, be equal to the amount of tier 1 capital reported by
such controlling depository institution in the manner described in
paragraph (c)(2)(i) of this section;
(B) In the case of a banking entity that is not controlled,
directly or indirectly, by a depository institution that calculates and
reports tier 1 capital:
(1) Bank holding company subsidiaries. If the banking entity is a
subsidiary of a bank holding company or company that is treated as a
bank holding company, be equal to the amount of tier 1 capital reported
by the top-tier affiliate of such covered banking entity that
calculates and reports tier 1 capital in the manner described in
paragraph (c)(2)(i) of this section; and
(2) Other holding companies and any subsidiary or affiliate
thereof. If the banking entity is not a subsidiary of a bank holding
company or a company that is treated as a bank holding company, be
equal to the total amount of shareholders' equity of the top-tier
affiliate within such organization as of the last day of the most
recent calendar quarter that has ended, as determined under applicable
accounting standards.
(iii) Treatment of foreign banking entities--(A) Foreign banking
entities. Except as provided in paragraph (c)(2)(iii)(B) of this
section, with respect to a banking entity that is not itself, and is
not controlled directly or indirectly by, a banking entity that is
located or organized under the laws of the United States or of any
State, the tier 1 capital of the banking entity shall be the
consolidated tier 1 capital of the entity as calculated under
applicable home country standards.
(B) U.S. affiliates of foreign banking entities. With respect to a
banking entity that is located or organized under the laws of the
United States or of any State and is controlled by a foreign banking
entity identified under paragraph (c)(2)(iii)(A) of this section, the
banking entity's tier 1 capital shall be as calculated under paragraphs
(c)(2)(i) or (ii) of this section.
(d) Capital treatment for a permitted investment in a covered fund.
For purposes of calculating compliance with the applicable regulatory
capital requirements, a banking entity shall deduct from the banking
entity's tier 1 capital (as determined under paragraph (c)(2) of this
section) the greater of:
(1) The sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
(together with any amounts paid by the entity (or employee thereof) in
connection with obtaining a restricted profit interest under Sec.
44.10(d)(6)(ii) of subpart C), on a historical cost basis, plus any
earnings received; and
(2) The fair market value of the banking entity's ownership
interests in the covered fund as determined under paragraph (b)(2)(ii)
or (b)(3) of this section (together with any amounts paid by the entity
(or employee thereof) in connection with obtaining a restricted profit
interest under Sec. 44.10(d)(6)(ii) of subpart C), if the banking
entity accounts for the profits (or losses) of the fund investment in
its financial statements.
(e) Extension of time to divest an ownership interest. (1) Upon
application by a banking entity, the Board may extend the period under
paragraph (a)(2)(i) of this section for up to 2 additional years if the
Board finds that an extension would be consistent with safety and
soundness and not detrimental to the public interest. An application
for extension must:
[[Page 62119]]
(i) Be submitted to the Board at least 90 days prior to the
expiration of the applicable time period;
(ii) Provide the reasons for application, including information
that addresses the factors in paragraph (e)(2) of this section; and
(iii) Explain the banking entity's plan for reducing the permitted
investment in a covered fund through redemption, sale, dilution or
other methods as required in paragraph (a)(2) of this section.
(2) Factors governing Board determinations. In reviewing any
application under paragraph (e)(1) of this section, the Board may
consider all the facts and circumstances related to the permitted
investment in a covered fund, including:
(i) Whether the investment would result, directly or indirectly, in
a material exposure by the banking entity to high-risk assets or high-
risk trading strategies;
(ii) The contractual terms governing the banking entity's interest
in the covered fund;
(iii) The date on which the covered fund is expected to have
attracted sufficient investments from investors unaffiliated with the
banking entity to enable the banking entity to comply with the
limitations in paragraph (a)(2)(i) of this section;
(iv) The total exposure of the covered banking entity to the
investment and the risks that disposing of, or maintaining, the
investment in the covered fund may pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of divesting or disposing of the
investment within the applicable period;
(vi) Whether the investment or the divestiture or conformance of
the investment would involve or result in a material conflict of
interest between the banking entity and unaffiliated parties, including
clients, customers or counterparties to which it owes a duty;
(vi) The banking entity's prior efforts to reduce through
redemption, sale, dilution, or other methods its ownership interests in
the covered fund, including activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board believes appropriate.
(3) Authority to impose restrictions on activities or investment
during any extension period. The Board may impose such conditions on
any extension approved under paragraph (e)(1) of this section as the
Board determines are necessary or appropriate to protect the safety and
soundness of the banking entity or the financial stability of the
United States, address material conflicts of interest or other unsound
banking practices, or otherwise further the purposes of section 13 of
the BHC Act and this part.
(4) Consultation. In the case of a banking entity that is primarily
regulated by another Federal banking agency, the SEC, or the CFTC, the
Board will consult with such agency prior to acting on an application
by the banking entity for an extension under paragraph (e)(1) of this
section.
Sec. 44.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 44.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to demonstrably reduce or
otherwise significantly mitigate the specific, identifiable risks to
the banking entity in connection with a compensation arrangement with
an employee of the banking entity or an affiliate thereof that directly
provides investment advisory, commodity trading advisory or other
services to the covered fund.
(2) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures and
internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate and demonstrably reduces or otherwise
significantly mitigates one or more specific, identifiable risks
arising in connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) The compensation arrangement relates solely to the covered
fund in which the banking entity or any affiliate has acquired an
ownership interest pursuant to this paragraph and such compensation
arrangement provides that any losses incurred by the banking entity on
such ownership interest will be offset by corresponding decreases in
amounts payable under such compensation arrangement.
(b) Certain permitted covered fund activities and investments
outside of the United States. (1) The prohibition contained in Sec.
44.10(a) of this subpart does not apply to the acquisition or retention
of any ownership interest in, or the sponsorship of, a covered fund by
a banking entity only if:
(i) The banking entity is not organized or directly or indirectly
controlled by a banking entity that is organized under the laws of the
United States or of one or more States;
(ii) The activity or investment by the banking entity is pursuant
to paragraph (9) or (13) of section 4(c) of the BHC Act;
(iii) No ownership interest in the covered fund is offered for sale
or sold to a resident of the United States; and
(iv) The activity or investment occurs solely outside of the United
States.
(2) An activity or investment by the banking entity is pursuant to
paragraph (9) or (13) of section 4(c) of the BHC Act for purposes of
paragraph (b)(1)(ii) of this section only if:
(i) The activity or investment is conducted in accordance with the
requirements of this section; and
(ii)(A) With respect to a banking entity that is a foreign banking
organization, the banking entity meets the qualifying foreign banking
organization requirements of section 211.23(a), (c) or (e) of the
Board's Regulation K (12 CFR 211.23(a), (c) or (e)), as applicable; or
(B) With respect to a banking entity that is not a foreign banking
organization, the banking entity is not organized under the laws of the
United States or of one or more States and the banking entity, on a
fully-consolidated basis, meets at least two of the following
requirements:
(1) Total assets of the banking entity held outside of the United
States exceed total assets of the banking entity held in the United
States;
(2) Total revenues derived from the business of the banking entity
outside of the United States exceed total revenues
[[Page 62120]]
derived from the business of the banking entity in the United States;
or
(3) Total net income derived from the business of the banking
entity outside of the United States exceeds total net income derived
from the business of the banking entity in the United States.
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is sold or has been sold
pursuant to an offering that does not target residents of the United
States.
(4) An activity or investment occurs solely outside of the United
States for purposes of paragraph (b)(1)(iv) of this section only if:
(i) The banking entity acting as sponsor, or engaging as principal
in the acquisition or retention of an ownership interest in the covered
fund, is not itself, and is not controlled directly or indirectly by, a
banking entity that is located in the United States or organized under
the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to acquire or retain the ownership interest or act as
sponsor to the covered fund is not located in the United States or
organized under the laws of the United States or of any State;
(iii) The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State; and
(iv) No financing for the banking entity's ownership or sponsorship
is provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State.
(5) For purposes of this section, a U.S. branch, agency, or
subsidiary of a foreign bank, or any subsidiary thereof, is located in
the United States; however, a foreign bank of which that branch,
agency, or subsidiary is a part is not considered to be located in the
United States solely by virtue of operation of the U.S. branch, agency,
or subsidiary.
(c) Permitted covered fund interests and activities by a regulated
insurance company. The prohibition contained in Sec. 44.10(a) of this
subpart does not apply to the acquisition or retention by an insurance
company, or an affiliate thereof, of any ownership interest in, or the
sponsorship of, a covered fund only if:
(1) The insurance company or its affiliate acquires and retains the
ownership interest solely for the general account of the insurance
company or for one or more separate accounts established by the
insurance company;
(2) The acquisition and retention of the ownership interest is
conducted in compliance with, and subject to, the insurance company
investment laws, regulations, and written guidance of the State or
jurisdiction in which such insurance company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law, regulation, or written guidance described in
paragraph (c)(2) of this section is insufficient to protect the safety
and soundness of the banking entity, or the financial stability of the
United States.
Sec. 44.14 Limitations on relationships with a covered fund.
(a) Relationships with a covered fund. (1) Except as provided for
in paragraph (a)(2) of this section, no banking entity that serves,
directly or indirectly, as the investment manager, investment adviser,
commodity trading advisor, or sponsor to a covered fund, that organizes
and offers a covered fund pursuant to Sec. 44.11 of this subpart, or
that continues to hold an ownership interest in accordance with Sec.
44.11(b) of this subpart, and no affiliate of such entity, may enter
into a transaction with the covered fund, or with any other covered
fund that is controlled by such covered fund, that would be a covered
transaction as defined in section 23A of the Federal Reserve Act (12
U.S.C. 371c(b)(7)), as if such banking entity and the affiliate thereof
were a member bank and the covered fund were an affiliate thereof.
(2) Notwithstanding paragraph (a)(1) of this section, a banking
entity may:
(i) Acquire and retain any ownership interest in a covered fund in
accordance with the requirements of Sec. 44.11, Sec. 44.12, or Sec.
44.13 of this subpart; and
(ii) Enter into any prime brokerage transaction with any covered
fund in which a covered fund managed, sponsored, or advised by such
banking entity (or an affiliate thereof) has taken an ownership
interest, if:
(A) The banking entity is in compliance with each of the
limitations set forth in Sec. 44.11 of this subpart with respect to a
covered fund organized and offered by such banking entity (or an
affiliate thereof);
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually to the OCC (with a duty to
update the certification if the information in the certification
materially changes) that the banking entity does not, directly or
indirectly, guarantee, assume, or otherwise insure the obligations or
performance of the covered fund or of any covered fund in which such
covered fund invests; and
(C) The Board has not determined that such transaction is
inconsistent with the safe and sound operation and condition of the
banking entity.
(b) Restrictions on transactions with covered funds. A banking
entity that serves, directly or indirectly, as the investment manager,
investment adviser, commodity trading advisor, or sponsor to a covered
fund, or that organizes and offers a covered fund pursuant to Sec.
44.11 of this subpart, or that continues to hold an ownership interest
in accordance with Sec. 44.11(b) of this subpart, shall be subject to
section 23B of the Federal Reserve Act (12 U.S.C. 371c-1), as if such
banking entity were a member bank and such covered fund were an
affiliate thereof.
(c) Restrictions on prime brokerage transactions. A prime brokerage
transaction permitted under paragraph (a)(2)(ii) of this section shall
be subject to section 23B of the Federal Reserve Act (12 U.S.C. 371c-1)
as if the counterparty were an affiliate of the banking entity.
Sec. 44.15 Other limitations on permitted covered fund activities
and investments.
(a) No transaction, class of transactions, or activity may be
deemed permissible under Sec. Sec. 44.11 through 44.13 of this subpart
if the transaction, class of transactions, or activity would:
(1) Involve or result in a material conflict of interest between
the banking entity and its clients, customers, or counterparties;
(2) Result, directly or indirectly, in a material exposure by the
banking entity to a high-risk asset or a high-risk trading strategy; or
(3) Pose a threat to the safety and soundness of the banking entity
or to the financial stability of the United States.
(b) Definition of material conflict of interest. (1) For purposes
of this section, a material conflict of interest between a banking
entity and its clients, customers, or counterparties exists if the
banking entity engages in any transaction, class of transactions, or
activity that would involve or result in the banking entity's interests
being materially adverse to the interests of its client, customer, or
counterparty with
[[Page 62121]]
respect to such transaction, class of transactions, or activity, and
the banking entity has not taken at least one of the actions in
paragraph (b)(2) of this section.
(2) Prior to effecting the specific transaction or class or type of
transactions, or engaging in the specific activity, the banking entity:
(i) Timely and effective disclosure. (A) Has made clear, timely,
and effective disclosure of the conflict of interest, together with
other necessary information, in reasonable detail and in a manner
sufficient to permit a reasonable client, customer, or counterparty to
meaningfully understand the conflict of interest; and
(B) Such disclosure is made in a manner that provides the client,
customer, or counterparty the opportunity to negate, or substantially
mitigate, any materially adverse effect on the client, customer, or
counterparty created by the conflict of interest; or
(ii) Information barriers. Has established, maintained, and
enforced information barriers that are memorialized in written policies
and procedures, such as physical separation of personnel, or functions,
or limitations on types of activity, that are reasonably designed,
taking into consideration the nature of the banking entity's business,
to prevent the conflict of interest from involving or resulting in a
materially adverse effect on a client, customer, or counterparty. A
banking entity may not rely on such information barriers if, in the
case of any specific transaction, class or type of transactions or
activity, the banking entity knows or should reasonably know that,
notwithstanding the banking entity's establishment of information
barriers, the conflict of interest may involve or result in a
materially adverse effect on a client, customer, or counterparty.
(c) Definition of high-risk asset and high-risk trading strategy.
For purposes of this section:
(1) High-risk asset means an asset or group of related assets that
would, if held by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
(2) High-risk trading strategy means a trading strategy that would,
if engaged in by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
Sec. 44.16 Ownership of interests in and sponsorship of issuers of
certain collateralized debt obligations backed by trust-preferred
securities.
(a) The prohibition contained in Sec. 44.10(a)(1) does not apply
to the ownership by a banking entity of an interest in, or sponsorship
of, any issuer if:
(1) The issuer was established, and the interest was issued, before
May 19, 2010;
(2) The banking entity reasonably believes that the offering
proceeds received by the issuer were invested primarily in Qualifying
TruPS Collateral; and
(3) The banking entity acquired such interest on or before December
10, 2013 (or acquired such interest in connection with a merger with or
acquisition of a banking entity that acquired the interest on or before
December 10, 2013).
(b) For purposes of this Sec. 44.16, Qualifying TruPS Collateral
shall mean any trust preferred security or subordinated debt instrument
issued prior to May 19, 2010 by a depository institution holding
company that, as of the end of any reporting period within 12 months
immediately preceding the issuance of such trust preferred security or
subordinated debt instrument, had total consolidated assets of less
than $15,000,000,000 or issued prior to May 19, 2010 by a mutual
holding company.
(c) Notwithstanding paragraph (a)(3) of this section, a banking
entity may act as a market maker with respect to the interests of an
issuer described in paragraph (a) of this section in accordance with
the applicable provisions of Sec. Sec. 44.4 and 44.11.
(d) Without limiting the applicability of paragraph (a) of this
section, the Board, the FDIC and the OCC will make public a non-
exclusive list of issuers that meet the requirements of paragraph (a).
A banking entity may rely on the list published by the Board, the FDIC
and the OCC.
Sec. Sec. 44.17-44.19 [Reserved]
Subpart D--Compliance Program Requirement; Violations
Sec. 44.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope and detail of the compliance program shall
be appropriate for the types, size, scope and complexity of activities
and business structure of the banking entity.
(b) Contents of compliance program. Except as provided in paragraph
(f) of this section, the compliance program required by paragraph (a)
of this section, at a minimum, shall include:
(1) Written policies and procedures reasonably designed to
document, describe, monitor and limit trading activities subject to
subpart B (including those permitted under Sec. Sec. 44.3 to 44.6 of
subpart B), including setting, monitoring and managing required limits
set out in Sec. Sec. 44.4 and 44.5, and activities and investments
with respect to a covered fund subject to subpart C (including those
permitted under Sec. Sec. 44.11 through 44.14 of subpart C) conducted
by the banking entity to ensure that all activities and investments
conducted by the banking entity that are subject to section 13 of the
BHC Act and this part comply with section 13 of the BHC Act and this
part;
(2) A system of internal controls reasonably designed to monitor
compliance with section 13 of the BHC Act and this part and to prevent
the occurrence of activities or investments that are prohibited by
section 13 of the BHC Act and this part;
(3) A management framework that clearly delineates responsibility
and accountability for compliance with section 13 of the BHC Act and
this part and includes appropriate management review of trading limits,
strategies, hedging activities, investments, incentive compensation and
other matters identified in this part or by management as requiring
attention;
(4) Independent testing and audit of the effectiveness of the
compliance program conducted periodically by qualified personnel of the
banking entity or by a qualified outside party;
(5) Training for trading personnel and managers, as well as other
appropriate personnel, to effectively implement and enforce the
compliance program; and
(6) Records sufficient to demonstrate compliance with section 13 of
the BHC Act and this part, which a banking entity must promptly provide
to the OCC upon request and retain for a period of no less than 5 years
or such longer period as required by the OCC.
(c) Additional standards. In addition to the requirements in
paragraph (b) of this section, the compliance program of a banking
entity must satisfy the requirements and other standards contained in
appendix B, if:
(1) The banking entity engages in proprietary trading permitted
under subpart B and is required to comply
[[Page 62122]]
with the reporting requirements of paragraph (d) of this section;
(2) The banking entity has reported total consolidated assets as of
the previous calendar year end of $50 billion or more or, in the case
of a foreign banking entity, has total U.S. assets as of the previous
calendar year end of $50 billion or more (including all subsidiaries,
affiliates, branches and agencies of the foreign banking entity
operating, located or organized in the United States); or
(3) The OCC notifies the banking entity in writing that it must
satisfy the requirements and other standards contained in appendix B to
this part.
(d) Reporting requirements under appendix A to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B shall comply with the reporting requirements described in
appendix A, if:
(i) The banking entity (other than a foreign banking entity as
provided in paragraph (d)(1)(ii) of this section) has, together with
its affiliates and subsidiaries, trading assets and liabilities
(excluding trading assets and liabilities involving obligations of or
guaranteed by the United States or any agency of the United States) the
average gross sum of which (on a worldwide consolidated basis) over the
previous consecutive four quarters, as measured as of the last day of
each of the four prior calendar quarters, equals or exceeds the
threshold established in paragraph (d)(2) of this section;
(ii) In the case of a foreign banking entity, the average gross sum
of the trading assets and liabilities of the combined U.S. operations
of the foreign banking entity (including all subsidiaries, affiliates,
branches and agencies of the foreign banking entity operating, located
or organized in the United States and excluding trading assets and
liabilities involving obligations of or guaranteed by the United States
or any agency of the United States) over the previous consecutive four
quarters, as measured as of the last day of each of the four prior
calendar quarters, equals or exceeds the threshold established in
paragraph (d)(2) of this section; or
(iii) The OCC notifies the banking entity in writing that it must
satisfy the reporting requirements contained in appendix A.
(2) The threshold for reporting under paragraph (d)(1) of this
section shall be $50 billion beginning on June 30, 2014; $25 billion
beginning on April 30, 2016; and $10 billion beginning on December 31,
2016.
(3) Frequency of reporting: Unless the OCC notifies the banking
entity in writing that it must report on a different basis, a banking
entity with $50 billion or more in trading assets and liabilities (as
calculated in accordance with paragraph (d)(1) of this section) shall
report the information required by appendix A for each calendar month
within 30 days of the end of the relevant calendar month; beginning
with information for the month of January 2015, such information shall
be reported within 10 days of the end of each calendar month. Any other
banking entity subject to appendix A shall report the information
required by appendix A for each calendar quarter within 30 days of the
end of that calendar quarter unless the OCC notifies the banking entity
in writing that it must report on a different basis.
(e) Additional documentation for covered funds. Any banking entity
that has more than $10 billion in total consolidated assets as reported
on December 31 of the previous two calendar years shall maintain
records that include:
(1) Documentation of the exclusions or exemptions other than
sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940
relied on by each fund sponsored by the banking entity (including all
subsidiaries and affiliates) in determining that such fund is not a
covered fund;
(2) For each fund sponsored by the banking entity (including all
subsidiaries and affiliates) for which the banking entity relies on one
or more of the exclusions from the definition of covered fund provided
by Sec. 44.10(c)(1), Sec. 44.10(c)(5), Sec. 44.10(c)(8), Sec.
44.10(c)(9), or Sec. 44.10(c)(10) of subpart C, documentation
supporting the banking entity's determination that the fund is not a
covered fund pursuant to one or more of those exclusions;
(3) For each seeding vehicle described in Sec. 44.10(c)(12)(i) or
(iii) of subpart C that will become a registered investment company or
SEC-regulated business development company, a written plan documenting
the banking entity's determination that the seeding vehicle will become
a registered investment company or SEC-regulated business development
company; the period of time during which the vehicle will operate as a
seeding vehicle; and the banking entity's plan to market the vehicle to
third-party investors and convert it into a registered investment
company or SEC-regulated business development company within the time
period specified in Sec. 44.12(a)(2)(i)(B) of subpart C;
(4) For any banking entity that is, or is controlled directly or
indirectly by a banking entity that is, located in or organized under
the laws of the United States or of any State, if the aggregate amount
of ownership interests in foreign public funds that are described in
Sec. 44.10(c)(1) of subpart C owned by such banking entity (including
ownership interests owned by any affiliate that is controlled directly
or indirectly by a banking entity that is located in or organized under
the laws of the United States or of any State) exceeds $50 million at
the end of two or more consecutive calendar quarters, beginning with
the next succeeding calendar quarter, documentation of the value of the
ownership interests owned by the banking entity (and such affiliates)
in each foreign public fund and each jurisdiction in which any such
foreign public fund is organized, calculated as of the end of each
calendar quarter, which documentation must continue until the banking
entity's aggregate amount of ownership interests in foreign public
funds is below $50 million for two consecutive calendar quarters; and
(5) For purposes of paragraph (e)(4) of this section, a U.S.
branch, agency, or subsidiary of a foreign banking entity is located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(f) Simplified programs for less active banking entities--(1)
Banking entities with no covered activities. A banking entity that does
not engage in activities or investments pursuant to subpart B or
subpart C (other than trading activities permitted pursuant to Sec.
44.6(a) of subpart B) may satisfy the requirements of this section by
establishing the required compliance program prior to becoming engaged
in such activities or making such investments (other than trading
activities permitted pursuant to Sec. 44.6(a) of subpart B).
(2) Banking entities with modest activities. A banking entity with
total consolidated assets of $10 billion or less as reported on
December 31 of the previous two calendar years that engages in
activities or investments pursuant to subpart B or subpart C (other
than trading activities permitted under Sec. 44.6(a) of subpart B) may
satisfy the requirements of this section by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act and this part and adjustments
as appropriate given the activities, size, scope and complexity of the
banking entity.
[[Page 62123]]
Sec. 44.21 Termination of activities or investments; penalties for
violations.
(a) Any banking entity that engages in an activity or makes an
investment in violation of section 13 of the BHC Act or this part, or
acts in a manner that functions as an evasion of the requirements of
section 13 of the BHC Act or this part, including through an abuse of
any activity or investment permitted under subparts B or C, or
otherwise violates the restrictions and requirements of section 13 of
the BHC Act or this part, shall, upon discovery, promptly terminate the
activity and, as relevant, dispose of the investment.
(b) Whenever the OCC finds reasonable cause to believe any banking
entity has engaged in an activity or made an investment in violation of
section 13 of the BHC Act or this part, or engaged in any activity or
made any investment that functions as an evasion of the requirements of
section 13 of the BHC Act or this part, the OCC may take any action
permitted by law to enforce compliance with section 13 of the BHC Act
and this part, including directing the banking entity to restrict,
limit, or terminate any or all activities under this part and dispose
of any investment.
Appendix A to Part 44--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
44.20(d), this appendix generally applies to a banking entity that,
together with its affiliates and subsidiaries, has significant
trading assets and liabilities. These entities are required to (i)
furnish periodic reports to the OCC regarding a variety of
quantitative measurements of their covered trading activities, which
vary depending on the scope and size of covered trading activities,
and (ii) create and maintain records documenting the preparation and
content of these reports. The requirements of this appendix must be
incorporated into the banking entity's internal compliance program
under Sec. 44.20 and Appendix B.
b. The purpose of this appendix is to assist banking entities
and the OCC in:
(i) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(ii) Monitoring the banking entity's covered trading activities;
(iii) Identifying covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading activities of
trading desks engaged in market making-related activities subject to
Sec. 44.4(b) are consistent with the requirements governing
permitted market making-related activities;
(v) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. Sec. 44.4, 44.5, or 44.6(a)-(b) (i.e., underwriting and market
making-related related activity, risk-mitigating hedging, or trading
in certain government obligations) are consistent with the
requirement that such activity not result, directly or indirectly,
in a material exposure to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by the OCC of such activities; and
(vii) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. The quantitative measurements that must be furnished pursuant
to this appendix are not intended to serve as a dispositive tool for
the identification of permissible or impermissible activities.
d. In order to allow banking entities and the Agencies to
evaluate the effectiveness of these metrics, banking entities must
collect and report these metrics for all trading desks beginning on
the dates established in Sec. 44.20 of the final rule. The Agencies
will review the data collected and revise this collection
requirement as appropriate based on a review of the data collected
prior to September 30, 2015.
e. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 44.20 and Appendix B to this part. The
effectiveness of particular quantitative measurements may differ
based on the profile of the banking entity's businesses in general
and, more specifically, of the particular trading desk, including
types of instruments traded, trading activities and strategies, and
history and experience (e.g., whether the trading desk is an
established, successful market maker or a new entrant to a
competitive market). In all cases, banking entities must ensure that
they have robust measures in place to identify and monitor the risks
taken in their trading activities, to ensure that the activities are
within risk tolerances established by the banking entity, and to
monitor and examine for compliance with the proprietary trading
restrictions in this part.
f. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 44.4 through 44.6(a) and (b), or that
result in a material exposure to high-risk assets or high-risk
trading strategies, must be escalated within the banking entity for
review, further analysis, explanation to the OCC, and remediation,
where appropriate. The quantitative measurements discussed in this
appendix should be helpful to banking entities in identifying and
managing the risks related to their covered trading activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 44.2 and 44.3. In addition, for purposes of this
appendix, the following definitions apply:
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of a trading desk's holdings, dividend income, and
interest income and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. Sec. 44.4, 44.5, 44.6(a), or 44.6(b). A banking
entity may include trading under Sec. Sec. 44.3(d), 44.6(c),
44.6(d) or 44.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading desk means the smallest discrete unit of organization of
a banking entity that purchases or sells financial instruments for
the trading account of the banking entity or an affiliate thereof.
III. Reporting and Recordkeeping of Quantitative Measurements
a. Scope of Required Reporting
General scope. Each banking entity made subject to this part by
Sec. 44.20 must furnish the following quantitative measurements for
each trading desk of the banking entity, calculated in accordance
with this appendix:
Risk and Position Limits and Usage;
Risk Factor Sensitivities;
Value-at-Risk and Stress VaR;
Comprehensive Profit and Loss Attribution;
Inventory Turnover;
Inventory Aging; and
Customer-Facing Trade Ratio.
b. Frequency of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report each
applicable quantitative measurement to the OCC on the reporting
schedule established in Sec. 44.20 unless otherwise requested by
the OCC. All quantitative measurements for any calendar month must
be reported within the time period required by Sec. 44.20.
c. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the OCC pursuant to this appendix and Sec. 44.20(d),
create and maintain records documenting the preparation and content
of these reports, as
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well as such information as is necessary to permit the OCC to verify
the accuracy of such reports, for a period of 5 years from the end
of the calendar year for which the measurement was taken.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Risk and Position Limits and Usage
i. Description: For purposes of this appendix, Risk and Position
Limits are the constraints that define the amount of risk that a
trading desk is permitted to take at a point in time, as defined by
the banking entity for a specific trading desk. Usage represents the
portion of the trading desk's limits that are accounted for by the
current activity of the desk. Risk and position limits and their
usage are key risk management tools used to control and monitor risk
taking and include, but are not limited, to the limits set out in
Sec. 44.4 and Sec. 44.5. A number of the metrics that are
described below, including ``Risk Factor Sensitivities'' and
``Value-at-Risk and Stress Value-at-Risk,'' relate to a trading
desk's risk and position limits and are useful in evaluating and
setting these limits in the broader context of the trading desk's
overall activities, particularly for the market making activities
under Sec. 44.4(b) and hedging activity under Sec. 44.5.
Accordingly, the limits required under Sec. 44.4(b)(2)(iii) and
Sec. 44.5(b)(1)(i) must meet the applicable requirements under
Sec. 44.4(b)(2)(iii) and Sec. 44.5(b)(1)(i) and also must include
appropriate metrics for the trading desk limits including, at a
minimum, the ``Risk Factor Sensitivities'' and ``Value-at-Risk and
Stress Value-at-Risk'' metrics except to the extent any of the
``Risk Factor Sensitivities'' or ``Value-at-Risk and Stress Value-
at-Risk'' metrics are demonstrably ineffective for measuring and
monitoring the risks of a trading desk based on the types of
positions traded by, and risk exposures of, that desk.
ii. General Calculation Guidance: Risk and Position Limits must
be reported in the format used by the banking entity for the
purposes of risk management of each trading desk. Risk and Position
Limits are often expressed in terms of risk measures, such as VaR
and Risk Factor Sensitivities, but may also be expressed in terms of
other observable criteria, such as net open positions. When criteria
other than VaR or Risk Factor Sensitivities are used to define the
Risk and Position Limits, both the value of the Risk and Position
Limits and the value of the variables used to assess whether these
limits have been reached must be reported.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
2. Risk Factor Sensitivities
i. Description: For purposes of this appendix, Risk Factor
Sensitivities are changes in a trading desk's Comprehensive Profit
and Loss that are expected to occur in the event of a change in one
or more underlying variables that are significant sources of the
trading desk's profitability and risk.
ii. General Calculation Guidance: A banking entity must report
the Risk Factor Sensitivities that are monitored and managed as part
of the trading desk's overall risk management policy. The underlying
data and methods used to compute a trading desk's Risk Factor
Sensitivities will depend on the specific function of the trading
desk and the internal risk management models employed. The number
and type of Risk Factor Sensitivities that are monitored and managed
by a trading desk, and furnished to the OCC, will depend on the
explicit risks assumed by the trading desk. In general, however,
reported Risk Factor Sensitivities must be sufficiently granular to
account for a preponderance of the expected price variation in the
trading desk's holdings.
A. Trading desks must take into account any relevant factors in
calculating Risk Factor Sensitivities, including, for example, the
following with respect to particular asset classes:
Commodity derivative positions: Risk factors with
respect to the related commodities set out in 17 CFR 20.2, the
maturity of the positions, volatility and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Credit positions: Risk factors with respect to credit
spreads that are sufficiently granular to account for specific
credit sectors and market segments, the maturity profile of the
positions, and risk factors with respect to interest rates of all
relevant maturities;
Credit-related derivative positions: Risk factor
sensitivities, for example credit spreads, shifts (parallel and non-
parallel) in credit spreads--volatility, and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Equity derivative positions: Risk factor sensitivities
such as equity positions, volatility, and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Equity positions: Risk factors for equity prices and
risk factors that differentiate between important equity market
sectors and segments, such as a small capitalization equities and
international equities;
Foreign exchange derivative positions: Risk factors
with respect to major currency pairs and maturities, exposure to
interest rates at relevant maturities, volatility, and/or
correlation sensitivities (expressed in a manner that demonstrates
any significant non-linearities), as well as the maturity profile of
the positions; and
Interest rate positions, including interest rate
derivative positions: Risk factors with respect to major interest
rate categories and maturities and volatility and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and shifts (parallel and non-parallel)
in the interest rate curve, as well as the maturity profile of the
positions.
B. The methods used by a banking entity to calculate
sensitivities to a common factor shared by multiple trading desks,
such as an equity price factor, must be applied consistently across
its trading desks so that the sensitivities can be compared from one
trading desk to another.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Value-at-Risk and Stress Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the commonly used percentile measurement of the risk of
future financial loss in the value of a given set of aggregated
positions over a specified period of time, based on current market
conditions. For purposes of this appendix, Stress Value-at-Risk
(``Stress VaR'') is the percentile measurement of the risk of future
financial loss in the value of a given set of aggregated positions
over a specified period of time, based on market conditions during a
period of significant financial stress.
ii. General Calculation Guidance: Banking entities must compute
and report VaR and Stress VaR by employing generally accepted
standards and methods of calculation. VaR should reflect a loss in a
trading desk that is expected to be exceeded less than one percent
of the time over a one-day period. For those banking entities that
are subject to regulatory capital requirements imposed by a Federal
banking agency, VaR and Stress VaR must be computed and reported in
a manner that is consistent with such regulatory capital
requirements. In cases where a trading desk does not have a
standalone VaR or Stress VaR calculation but is part of a larger
aggregation of positions for which a VaR or Stress VaR calculation
is performed, a VaR or Stress VaR calculation that includes only the
trading desk's holdings must be performed consistent with the VaR or
Stress VaR model and methodology used for the larger aggregation of
positions.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into three categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); (ii) profit and loss attributable to new
positions resulting from the current day's trading activity (``new
positions''); and (iii) residual profit and loss that cannot be
specifically attributed to existing positions or new positions. The
sum of (i), (ii), and (iii) must equal the trading desk's
comprehensive profit and loss at each point in time. In addition,
profit and loss measurements must calculate volatility of
comprehensive profit and loss (i.e., the standard deviation of the
trading desk's one-day profit and loss, in dollar terms) for the
reporting period for at least a 30-, 60- and 90-day lag period, from
the end of the reporting period, and any other period that the
banking entity deems necessary to meet the requirements of the rule.
A. The comprehensive profit and loss associated with existing
positions must reflect changes in the value of these positions on
the applicable day. The comprehensive profit and loss from existing
positions must
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be further attributed, as applicable, to changes in (i) the specific
Risk Factors and other factors that are monitored and managed as
part of the trading desk's overall risk management policies and
procedures; and (ii) any other applicable elements, such as cash
flows, carry, changes in reserves, and the correction, cancellation,
or exercise of a trade.
B. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
C. The portion of comprehensive profit and loss that cannot be
specifically attributed to known sources must be allocated to a
residual category identified as an unexplained portion of the
comprehensive profit and loss. Significant unexplained profit and
loss must be escalated for further investigation and analysis.
ii. General Calculation Guidance: The specific categories used
by a trading desk in the attribution analysis and amount of detail
for the analysis should be tailored to the type and amount of
trading activities undertaken by the trading desk. The new position
attribution must be computed by calculating the difference between
the prices at which instruments were bought and/or sold and the
prices at which those instruments are marked to market at the close
of business on that day multiplied by the notional or principal
amount of each purchase or sale. Any fees, commissions, or other
payments received (paid) that are associated with transactions
executed on that day must be added (subtracted) from such
difference. These factors must be measured consistently over time to
facilitate historical comparisons.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
c. Customer-Facing Activity Measurements
1. Inventory Turnover
i. Description: For purposes of this appendix, Inventory
Turnover is a ratio that measures the turnover of a trading desk's
inventory. The numerator of the ratio is the absolute value of all
transactions over the reporting period. The denominator of the ratio
is the value of the trading desk's inventory at the beginning of the
reporting period.
ii. General Calculation Guidance: For purposes of this appendix,
for derivatives, other than options and interest rate derivatives,
value means gross notional value, for options, value means delta
adjusted notional value, and for interest rate derivatives, value
means 10-year bond equivalent value.
iii. Calculation Period: 30 days, 60 days, and 90 days.
iv. Measurement Frequency: Daily.
2. Inventory Aging
i. Description: For purposes of this appendix, Inventory Aging
generally describes a schedule of the trading desk's aggregate
assets and liabilities and the amount of time that those assets and
liabilities have been held. Inventory Aging should measure the age
profile of the trading desk's assets and liabilities.
ii. General Calculation Guidance: In general, Inventory Aging
must be computed using a trading desk's trading activity data and
must identify the value of a trading desk's aggregate assets and
liabilities. Inventory Aging must include two schedules, an asset-
aging schedule and a liability-aging schedule. Each schedule must
record the value of assets or liabilities held over all holding
periods. For derivatives, other than options, and interest rate
derivatives, value means gross notional value, for options, value
means delta adjusted notional value and, for interest rate
derivatives, value means 10-year bond equivalent value.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Customer-Facing Trade Ratio--Trade Count Based and Value Based
i. Description: For purposes of this appendix, the Customer-
Facing Trade Ratio is a ratio comparing (i) the transactions
involving a counterparty that is a customer of the trading desk to
(ii) the transactions involving a counterparty that is not a
customer of the trading desk. A trade count based ratio must be
computed that records the number of transactions involving a
counterparty that is a customer of the trading desk and the number
of transactions involving a counterparty that is not a customer of
the trading desk. A value based ratio must be computed that records
the value of transactions involving a counterparty that is a
customer of the trading desk and the value of transactions involving
a counterparty that is not a customer of the trading desk.
ii. General Calculation Guidance: For purposes of calculating
the Customer-Facing Trade Ratio, a counterparty is considered to be
a customer of the trading desk if the counterparty is a market
participant that makes use of the banking entity's market making-
related services by obtaining such services, responding to
quotations, or entering into a continuing relationship with respect
to such services. However, a trading desk or other organizational
unit of another banking entity would not be a client, customer, or
counterparty of the trading desk if the other entity has trading
assets and liabilities of $50 billion or more as measured in
accordance with Sec. 44.20(d)(1) unless the trading desk documents
how and why a particular trading desk or other organizational unit
of the entity should be treated as a client, customer, or
counterparty of the trading desk. Transactions conducted anonymously
on an exchange or similar trading facility that permits trading on
behalf of a broad range of market participants would be considered
transactions with customers of the trading desk. For derivatives,
other than options, and interest rate derivatives, value means gross
notional value, for options, value means delta adjusted notional
value, and for interest rate derivatives, value means 10-year bond
equivalent value.
iii. Calculation Period: 30 days, 60 days, and 90 days.
iv. Measurement Frequency: Daily.
Appendix B to Part 44--Enhanced Minimum Standards for Compliance
Programs
I. Overview
Section 44.20(c) requires certain banking entities to establish,
maintain, and enforce an enhanced compliance program that includes
the requirements and standards in this Appendix as well as the
minimum written policies and procedures, internal controls,
management framework, independent testing, training, and
recordkeeping provisions outlined in Sec. 44.20. This Appendix sets
forth additional minimum standards with respect to the
establishment, oversight, maintenance, and enforcement by these
banking entities of an enhanced internal compliance program for
ensuring and monitoring compliance with the prohibitions and
restrictions on proprietary trading and covered fund activities and
investments set forth in section 13 of the BHC Act and this part.
a. This compliance program must:
1. Be reasonably designed to identify, document, monitor, and
report the permitted trading and covered fund activities and
investments of the banking entity; identify, monitor and promptly
address the risks of these covered activities and investments and
potential areas of noncompliance; and prevent activities or
investments prohibited by, or that do not comply with, section 13 of
the BHC Act and this part;
2. Establish and enforce appropriate limits on the covered
activities and investments of the banking entity, including limits
on the size, scope, complexity, and risks of the individual
activities or investments consistent with the requirements of
section 13 of the BHC Act and this part;
3. Subject the effectiveness of the compliance program to
periodic independent review and testing, and ensure that the
entity's internal audit, corporate compliance and internal control
functions involved in review and testing are effective and
independent;
4. Make senior management, and others as appropriate,
accountable for the effective implementation of the compliance
program, and ensure that the board of directors and chief executive
officer (or equivalent) of the banking entity review the
effectiveness of the compliance program; and
5. Facilitate supervision and examination by the Agencies of the
banking entity's permitted trading and covered fund activities and
investments.
II. Enhanced Compliance Program
a. Proprietary Trading Activities. A banking entity must
establish, maintain and enforce a compliance program that includes
written policies and procedures that are appropriate for the types,
size, and complexity of, and risks associated with, its permitted
trading activities. The compliance program may be tailored to the
types of trading activities conducted by the banking entity, and
must include a detailed description of controls established by the
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banking entity to reasonably ensure that its trading activities are
conducted in accordance with the requirements and limitations
applicable to those trading activities under section 13 of the BHC
Act and this part, and provide for appropriate revision of the
compliance program before expansion of the trading activities of the
banking entity. A banking entity must devote adequate resources and
use knowledgeable personnel in conducting, supervising and managing
its trading activities, and promote consistency, independence and
rigor in implementing its risk controls and compliance efforts. The
compliance program must be updated with a frequency sufficient to
account for changes in the activities of the banking entity, results
of independent testing of the program, identification of weaknesses
in the program, and changes in legal, regulatory or other
requirements.
1. Trading Desks: The banking entity must have written policies
and procedures governing each trading desk that include a
description of:
i. The process for identifying, authorizing and documenting
financial instruments each trading desk may purchase or sell, with
separate documentation for market making-related activities
conducted in reliance on Sec. 44.4(b) and for hedging activity
conducted in reliance on Sec. 44.5;
ii. A mapping for each trading desk to the division, business
line, or other organizational structure that is responsible for
managing and overseeing the trading desk's activities;
iii. The mission (i.e., the type of trading activity, such as
market-making, trading in sovereign debt, etc.) and strategy (i.e.,
methods for conducting authorized trading activities) of each
trading desk;
iv. The activities that the trading desk is authorized to
conduct, including (i) authorized instruments and products, and (ii)
authorized hedging strategies, techniques and instruments;
v. The types and amount of risks allocated by the banking entity
to each trading desk to implement the mission and strategy of the
trading desk, including an enumeration of material risks resulting
from the activities in which the trading desk is authorized to
engage (including but not limited to price risks, such as basis,
volatility and correlation risks, as well as counterparty credit
risk). Risk assessments must take into account both the risks
inherent in the trading activity and the strength and effectiveness
of controls designed to mitigate those risks;
vi. How the risks allocated to each trading desk will be
measured;
vii. Why the allocated risks levels are appropriate to the
activities authorized for the trading desk;
viii. The limits on the holding period of, and the risk
associated with, financial instruments under the responsibility of
the trading desk;
ix. The process for setting new or revised limits, as well as
escalation procedures for granting exceptions to any limits or to
any policies or procedures governing the desk, the analysis that
will be required to support revising limits or granting exceptions,
and the process for independently reviewing and documenting those
exceptions and the underlying analysis;
x. The process for identifying, documenting and approving new
products, trading strategies, and hedging strategies;
xi. The types of clients, customers, and counterparties with
whom the trading desk may trade; and
xii. The compensation arrangements, including incentive
arrangements, for employees associated with the trading desk, which
may not be designed to reward or incentivize prohibited proprietary
trading or excessive or imprudent risk-taking.
2. Description of risks and risk management processes: The
compliance program for the banking entity must include a
comprehensive description of the risk management program for the
trading activity of the banking entity. The compliance program must
also include a description of the governance, approval, reporting,
escalation, review and other processes the banking entity will use
to reasonably ensure that trading activity is conducted in
compliance with section 13 of the BHC Act and this part. Trading
activity in similar financial instruments should be subject to
similar governance, limits, testing, controls, and review, unless
the banking entity specifically determines to establish different
limits or processes and documents those differences. Descriptions
must include, at a minimum, the following elements:
i. A description of the supervisory and risk management
structure governing all trading activity, including a description of
processes for initial and senior-level review of new products and
new strategies;
ii. A description of the process for developing, documenting,
testing, approving and reviewing all models used for valuing,
identifying and monitoring the risks of trading activity and related
positions, including the process for periodic independent testing of
the reliability and accuracy of those models;
iii. A description of the process for developing, documenting,
testing, approving and reviewing the limits established for each
trading desk;
iv. A description of the process by which a security may be
purchased or sold pursuant to the liquidity management plan,
including the process for authorizing and monitoring such activity
to ensure compliance with the banking entity's liquidity management
plan and the restrictions on liquidity management activities in this
part;
v. A description of the management review process, including
escalation procedures, for approving any temporary exceptions or
permanent adjustments to limits on the activities, positions,
strategies, or risks associated with each trading desk; and
vi. The role of the audit, compliance, risk management and other
relevant units for conducting independent testing of trading and
hedging activities, techniques and strategies.
3. Authorized risks, instruments, and products. The banking
entity must implement and enforce limits and internal controls for
each trading desk that are reasonably designed to ensure that
trading activity is conducted in conformance with section 13 of the
BHC Act and this part and with the banking entity's written policies
and procedures. The banking entity must establish and enforce risk
limits appropriate for the activity of each trading desk. These
limits should be based on probabilistic and non-probabilistic
measures of potential loss (e.g., Value-at-Risk and notional
exposure, respectively), and measured under normal and stress market
conditions. At a minimum, these internal controls must monitor,
establish and enforce limits on:
i. The financial instruments (including, at a minimum, by type
and exposure) that the trading desk may trade;
ii. The types and levels of risks that may be taken by each
trading desk; and
iii. The types of hedging instruments used, hedging strategies
employed, and the amount of risk effectively hedged.
4. Hedging policies and procedures. The banking entity must
establish, maintain, and enforce written policies and procedures
regarding the use of risk-mitigating hedging instruments and
strategies that, at a minimum, describe:
i. The positions, techniques and strategies that each trading
desk may use to hedge the risk of its positions;
ii. The manner in which the banking entity will identify the
risks arising in connection with and related to the individual or
aggregated positions, contracts or other holdings of the banking
entity that are to be hedged and determine that those risks have
been properly and effectively hedged;
iii. The level of the organization at which hedging activity and
management will occur;
iv. The manner in which hedging strategies will be monitored and
the personnel responsible for such monitoring;
v. The risk management processes used to control unhedged or
residual risks; and
vi. The process for developing, documenting, testing, approving
and reviewing all hedging positions, techniques and strategies
permitted for each trading desk and for the banking entity in
reliance on Sec. 44.5.
5. Analysis and quantitative measurements. The banking entity
must perform robust analysis and quantitative measurement of its
trading activities that is reasonably designed to ensure that the
trading activity of each trading desk is consistent with the banking
entity's compliance program; monitor and assist in the
identification of potential and actual prohibited proprietary
trading activity; and prevent the occurrence of prohibited
proprietary trading. Analysis and models used to determine, measure
and limit risk must be rigorously tested and be reviewed by
management responsible for trading activity to ensure that trading
activities, limits, strategies, and hedging activities do not
understate the risk and exposure to the banking entity or allow
prohibited proprietary trading. This review should include periodic
and independent back-testing and revision of activities, limits,
strategies and hedging as appropriate to contain risk and ensure
compliance. In addition to the quantitative measurements reported by
any banking entity subject to Appendix A to this part, each banking
entity
[[Page 62127]]
must develop and implement, to the extent appropriate to facilitate
compliance with this part, additional quantitative measurements
specifically tailored to the particular risks, practices, and
strategies of its trading desks. The banking entity's analysis and
quantitative measurements must incorporate the quantitative
measurements reported by the banking entity pursuant to Appendix A
(if applicable) and include, at a minimum, the following:
i. Internal controls and written policies and procedures
reasonably designed to ensure the accuracy and integrity of
quantitative measurements;
ii. Ongoing, timely monitoring and review of calculated
quantitative measurements;
iii. The establishment of numerical thresholds and appropriate
trading measures for each trading desk and heightened review of
trading activity not consistent with those thresholds to ensure
compliance with section 13 of the BHC Act and this part, including
analysis of the measurement results or other information,
appropriate escalation procedures, and documentation related to the
review; and
iv. Immediate review and compliance investigation of the trading
desk's activities, escalation to senior management with oversight
responsibilities for the applicable trading desk, timely
notification to the OCC, appropriate remedial action (e.g.,
divesting of impermissible positions, cessation of impermissible
activity, disciplinary actions), and documentation of the
investigation findings and remedial action taken when quantitative
measurements or other information, considered together with the
facts and circumstances, or findings of internal audit, independent
testing or other review suggest a reasonable likelihood that the
trading desk has violated any part of section 13 of the BHC Act or
this part.
6. Other Compliance Matters. In addition to the requirements
specified above, the banking entity's compliance program must:
i. Identify activities of each trading desk that will be
conducted in reliance on exemptions contained in Sec. Sec. 44.4
through 44.6, including an explanation of:
A. How and where in the organization the activity occurs; and
B. Which exemption is being relied on and how the activity meets
the specific requirements for reliance on the applicable exemption;
ii. Include an explanation of the process for documenting,
approving and reviewing actions taken pursuant to the liquidity
management plan, where in the organization this activity occurs, the
securities permissible for liquidity management, the process for
ensuring that liquidity management activities are not conducted for
the purpose of prohibited proprietary trading, and the process for
ensuring that securities purchased as part of the liquidity
management plan are highly liquid and conform to the requirements of
this part;
iii. Describe how the banking entity monitors for and prohibits
potential or actual material exposure to high-risk assets or high-
risk trading strategies presented by each trading desk that relies
on the exemptions contained in Sec. Sec. 44.3(d)(3), and 44.4
through 44.6, which must take into account potential or actual
exposure to:
A. Assets whose values cannot be externally priced or, where
valuation is reliant on pricing models, whose model inputs cannot be
externally validated;
B. Assets whose changes in value cannot be adequately mitigated
by effective hedging;
C. New products with rapid growth, including those that do not
have a market history;
D. Assets or strategies that include significant embedded
leverage;
E. Assets or strategies that have demonstrated significant
historical volatility;
F. Assets or strategies for which the application of capital and
liquidity standards would not adequately account for the risk; and
G. Assets or strategies that result in large and significant
concentrations to sectors, risk factors, or counterparties;
iv. Establish responsibility for compliance with the reporting
and recordkeeping requirements of subpart B and Sec. 44.20; and
v. Establish policies for monitoring and prohibiting potential
or actual material conflicts of interest between the banking entity
and its clients, customers, or counterparties.
7. Remediation of violations. The banking entity's compliance
program must be reasonably designed and established to effectively
monitor and identify for further analysis any trading activity that
may indicate potential violations of section 13 of the BHC Act and
this part and to prevent actual violations of section 13 of the BHC
Act and this part. The compliance program must describe procedures
for identifying and remedying violations of section 13 of the BHC
Act and this part, and must include, at a minimum, a requirement to
promptly document, address and remedy any violation of section 13 of
the BHC Act or this part, and document all proposed and actual
remediation efforts. The compliance program must include specific
written policies and procedures that are reasonably designed to
assess the extent to which any activity indicates that modification
to the banking entity's compliance program is warranted and to
ensure that appropriate modifications are implemented. The written
policies and procedures must provide for prompt notification to
appropriate management, including senior management and the board of
directors, of any material weakness or significant deficiencies in
the design or implementation of the compliance program of the
banking entity.
b. Covered Fund Activities or Investments. A banking entity must
establish, maintain and enforce a compliance program that includes
written policies and procedures that are appropriate for the types,
size, complexity and risks of the covered fund and related
activities conducted and investments made, by the banking entity.
1. Identification of covered funds. The banking entity's
compliance program must provide a process, which must include
appropriate management review and independent testing, for
identifying and documenting covered funds that each unit within the
banking entity's organization sponsors or organizes and offers, and
covered funds in which each such unit invests. In addition to the
documentation requirements for covered funds, as specified under
Sec. 44.20(e), the documentation must include information that
identifies all pools that the banking entity sponsors or has an
interest in and the type of exemption from the Commodity Exchange
Act (whether or not the pool relies on section 4.7 of the
regulations under the Commodity Exchange Act), and the amount of
ownership interest the banking entity has in those pools.
2. Identification of covered fund activities and investments.
The banking entity's compliance program must identify, document and
map each unit within the organization that is permitted to acquire
or hold an interest in any covered fund or sponsor any covered fund
and map each unit to the division, business line, or other
organizational structure that will be responsible for managing and
overseeing that unit's activities and investments.
3. Explanation of compliance. The banking entity's compliance
program must explain how:
i. The banking entity monitors for and prohibits potential or
actual material conflicts of interest between the banking entity and
its clients, customers, or counterparties related to its covered
fund activities and investments;
ii. The banking entity monitors for and prohibits potential or
actual transactions or activities that may threaten the safety and
soundness of the banking entity related to its covered fund
activities and investments; and
iii. The banking entity monitors for and prohibits potential or
actual material exposure to high-risk assets or high-risk trading
strategies presented by its covered fund activities and investments,
taking into account potential or actual exposure to:
A. Assets whose values cannot be externally priced or, where
valuation is reliant on pricing models, whose model inputs cannot be
externally validated;
B. Assets whose changes in values cannot be adequately mitigated
by effective hedging;
C. New products with rapid growth, including those that do not
have a market history;
D. Assets or strategies that include significant embedded
leverage;
E. Assets or strategies that have demonstrated significant
historical volatility;
F. Assets or strategies for which the application of capital and
liquidity standards would not adequately account for the risk; and
G. Assets or strategies that expose the banking entity to large
and significant concentrations with respect to sectors, risk
factors, or counterparties;
4. Description and documentation of covered fund activities and
investments. For each organizational unit engaged in covered fund
activities and investments, the banking entity's compliance program
must document:
i. The covered fund activities and investments that the unit is
authorized to conduct;
ii. The banking entity's plan for actively seeking unaffiliated
investors to ensure that any investment by the banking entity
[[Page 62128]]
conforms to the limits contained in Sec. 44.12 or registered in
compliance with the securities laws and thereby exempt from those
limits within the time periods allotted in Sec. 44.12; and
iii. How it complies with the requirements of subpart C.
5. Internal Controls. A banking entity must establish, maintain,
and enforce internal controls that are reasonably designed to ensure
that its covered fund activities or investments comply with the
requirements of section 13 of the BHC Act and this part and are
appropriate given the limits on risk established by the banking
entity. These written internal controls must be reasonably designed
and established to effectively monitor and identify for further
analysis any covered fund activity or investment that may indicate
potential violations of section 13 of the BHC Act or this part. The
internal controls must, at a minimum require:
i. Monitoring and limiting the banking entity's individual and
aggregate investments in covered funds;
ii. Monitoring the amount and timing of seed capital investments
for compliance with the limitations under subpart C (including but
not limited to the redemption, sale or disposition requirements) of
Sec. 44.12, and the effectiveness of efforts to seek unaffiliated
investors to ensure compliance with those limits;
iii. Calculating the individual and aggregate levels of
ownership interests in one or more covered fund required by Sec.
44.12;
iv. Attributing the appropriate instruments to the individual
and aggregate ownership interest calculations above;
v. Making disclosures to prospective and actual investors in any
covered fund organized and offered or sponsored by the banking
entity, as provided under Sec. 44.11(a)(8);
vi. Monitoring for and preventing any relationship or
transaction between the banking entity and a covered fund that is
prohibited under Sec. 44.14, including where the banking entity has
been designated as the sponsor, investment manager, investment
adviser, or commodity trading advisor to a covered fund by another
banking entity; and
vii. Appropriate management review and supervision across legal
entities of the banking entity to ensure that services and products
provided by all affiliated entities comply with the limitation on
services and products contained in Sec. 44.14.
6. Remediation of violations. The banking entity's compliance
program must be reasonably designed and established to effectively
monitor and identify for further analysis any covered fund activity
or investment that may indicate potential violations of section 13
of the BHC Act or this part and to prevent actual violations of
section 13 of the BHC Act and this part. The banking entity's
compliance program must describe procedures for identifying and
remedying violations of section 13 of the BHC Act and this part, and
must include, at a minimum, a requirement to promptly document,
address and remedy any violation of section 13 of the BHC Act or
this part, including Sec. 44.21, and document all proposed and
actual remediation efforts. The compliance program must include
specific written policies and procedures that are reasonably
designed to assess the extent to which any activity or investment
indicates that modification to the banking entity's compliance
program is warranted and to ensure that appropriate modifications
are implemented. The written policies and procedures must provide
for prompt notification to appropriate management, including senior
management and the board of directors, of any material weakness or
significant deficiencies in the design or implementation of the
compliance program of the banking entity.
III. Responsibility and Accountability for the Compliance Program
a. A banking entity must establish, maintain, and enforce a
governance and management framework to manage its business and
employees with a view to preventing violations of section 13 of the
BHC Act and this part. A banking entity must have an appropriate
management framework reasonably designed to ensure that: Appropriate
personnel are responsible and accountable for the effective
implementation and enforcement of the compliance program; a clear
reporting line with a chain of responsibility is delineated; and the
compliance program is reviewed periodically by senior management.
The board of directors (or equivalent governance body) and senior
management should have the appropriate authority and access to
personnel and information within the organizations as well as
appropriate resources to conduct their oversight activities
effectively.
1. Corporate governance. The banking entity must adopt a written
compliance program approved by the board of directors, an
appropriate committee of the board, or equivalent governance body,
and senior management.
2. Management procedures. The banking entity must establish,
maintain, and enforce a governance framework that is reasonably
designed to achieve compliance with section 13 of the BHC Act and
this part, which, at a minimum, provides for:
i. The designation of appropriate senior management or committee
of senior management with authority to carry out the management
responsibilities of the banking entity for each trading desk and for
each organizational unit engaged in covered fund activities;
ii. Written procedures addressing the management of the
activities of the banking entity that are reasonably designed to
achieve compliance with section 13 of the BHC Act and this part,
including:
A. A description of the management system, including the titles,
qualifications, and locations of managers and the specific
responsibilities of each person with respect to the banking entity's
activities governed by section 13 of the BHC Act and this part; and
B. Procedures for determining compensation arrangements for
traders engaged in underwriting or market making-related activities
under Sec. 44.4 or risk-mitigating hedging activities under Sec.
44.5 so that such compensation arrangements are designed not to
reward or incentivize prohibited proprietary trading and
appropriately balance risk and financial results in a manner that
does not encourage employees to expose the banking entity to
excessive or imprudent risk.
3. Business line managers. Managers with responsibility for one
or more trading desks of the banking entity are accountable for the
effective implementation and enforcement of the compliance program
with respect to the applicable trading desk(s).
4. Board of directors, or similar corporate body, and senior
management. The board of directors, or similar corporate body, and
senior management are responsible for setting and communicating an
appropriate culture of compliance with section 13 of the BHC Act and
this part and ensuring that appropriate policies regarding the
management of trading activities and covered fund activities or
investments are adopted to comply with section 13 of the BHC Act and
this part. The board of directors or similar corporate body (such as
a designated committee of the board or an equivalent governance
body) must ensure that senior management is fully capable,
qualified, and properly motivated to manage compliance with this
part in light of the organization's business activities and the
expectations of the board of directors. The board of directors or
similar corporate body must also ensure that senior management has
established appropriate incentives and adequate resources to support
compliance with this part, including the implementation of a
compliance program meeting the requirements of this appendix into
management goals and compensation structures across the banking
entity.
5. Senior management. Senior management is responsible for
implementing and enforcing the approved compliance program. Senior
management must also ensure that effective corrective action is
taken when failures in compliance with section 13 of the BHC Act and
this part are identified. Senior management and control personnel
charged with overseeing compliance with section 13 of the BHC Act
and this part should review the compliance program for the banking
entity periodically and report to the board, or an appropriate
committee thereof, on the effectiveness of the compliance program
and compliance matters with a frequency appropriate to the size,
scope, and risk profile of the banking entity's trading activities
and covered fund activities or investments, which shall be at least
annually.
6. CEO attestation. Based on a review by the CEO of the banking
entity, the CEO of the banking entity must, annually, attest in
writing to the OCC that the banking entity has in place processes to
establish, maintain, enforce, review, test and modify the compliance
program established under this Appendix and Sec. 44.20 of this part
in a manner reasonably designed to achieve compliance with section
13 of the BHC Act and this part. In the case of a U.S. branch or
agency of a foreign banking entity, the attestation may be provided
for the entire U.S. operations of the foreign banking entity by the
senior management officer of the United States operations of the
foreign banking entity who is located in the United States.
[[Page 62129]]
IV. Independent Testing
a. Independent testing must occur with a frequency appropriate
to the size, scope, and risk profile of the banking entity's trading
and covered fund activities or investments, which shall be at least
annually. This independent testing must include an evaluation of:
1. The overall adequacy and effectiveness of the banking
entity's compliance program, including an analysis of the extent to
which the program contains all the required elements of this
appendix;
2. The effectiveness of the banking entity's internal controls,
including an analysis and documentation of instances in which such
internal controls have been breached, and how such breaches were
addressed and resolved; and
3. The effectiveness of the banking entity's management
procedures.
b. A banking entity must ensure that independent testing
regarding the effectiveness of the banking entity's compliance
program is conducted by a qualified independent party, such as the
banking entity's internal audit department, compliance personnel or
risk managers independent of the organizational unit being tested,
outside auditors, consultants, or other qualified independent
parties. A banking entity must promptly take appropriate action to
remedy any significant deficiencies or material weaknesses in its
compliance program and to terminate any violations of section 13 of
the BHC Act or this part.
V. Training
Banking entities must provide adequate training to personnel and
managers of the banking entity engaged in activities or investments
governed by section 13 of the BHC Act or this part, as well as other
appropriate supervisory, risk, independent testing, and audit
personnel, in order to effectively implement and enforce the
compliance program. This training should occur with a frequency
appropriate to the size and the risk profile of the banking entity's
trading activities and covered fund activities or investments.
VI. Recordkeeping
Banking entities must create and retain records sufficient to
demonstrate compliance and support the operations and effectiveness
of the compliance program. A banking entity must retain these
records for a period that is no less than 5 years or such longer
period as required by the OCC in a form that allows it to promptly
produce such records to the OCC on request.
BOARD OF GOVERNORS OF THE FEDERAL RESERVE
12 CFR Chapter II
Authority and Issuance
For the reasons stated in the Common Preamble, the Board amends
chapter I of Title 12, Code of Federal Regulations as follows:
PART 248--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS (Regulation VV)
0
16. The authority citation for part 248 continues to read as follows:
Authority: 12 U.S.C. 1851, 12 U.S.C. 221 et seq., 12 U.S.C.
1818, 12 U.S.C. 1841 et seq., and 12 U.S.C. 3103 et seq.
Subpart A--Authority and Definitions
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17. Section 248.2 is revised to read as follows:
Sec. 248.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(c) Banking entity. (1) Except as provided in paragraph (c)(2) of
this section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an insured depository institution;
(iii) Any company that is treated as a bank holding company for
purposes of section 8 of the International Banking Act of 1978 (12
U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any entity described in
paragraphs (c)(1)(i), (ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a banking entity under
paragraph (c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraph (c)(1)(i), (ii), or (iii) of
this section; or
(iii) The FDIC acting in its corporate capacity or as conservator
or receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(d) Board means the Board of Governors of the Federal Reserve
System.
(e) CFTC means the Commodity Futures Trading Commission.
(f) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(g) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(h) Derivative. (1) Except as provided in paragraph (h)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the immediate family of the
employee.
(j) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(k) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(l) FDIC means the Federal Deposit Insurance Corporation.
(m) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
[[Page 62130]]
(n) Foreign banking organization has the same meaning as in Sec.
211.21(o) of the Board's Regulation K (12 CFR 211.21(o)), but does not
include a foreign bank, as defined in section 1(b)(7) of the
International Banking Act of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the Commonwealth of Puerto Rico, Guam,
American Samoa, the United States Virgin Islands, or the Commonwealth
of the Northern Mariana Islands.
(o) Foreign insurance regulator means the insurance commissioner,
or a similar official or agency, of any country other than the United
States that is engaged in the supervision of insurance companies under
foreign insurance law.
(p) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(q) Insurance company means a company that is organized as an
insurance company, primarily and predominantly engaged in writing
insurance or reinsuring risks underwritten by insurance companies,
subject to supervision as such by a state insurance regulator or a
foreign insurance regulator, and not operated for the purpose of
evading the provisions of section 13 of the BHC Act (12 U.S.C. 1851).
(r) Insured depository institution has the same meaning as in
section 3(c) of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)),
but does not include:
(1) An insured depository institution that is described in section
2(c)(2)(D) of the BHC Act (12 U.S.C. 1841(c)(2)(D)); or
(2) An insured depository institution if it has, and if every
company that controls it has, total consolidated assets of $10 billion
or less and total trading assets and trading liabilities, on a
consolidated basis, that are 5 percent or less of total consolidated
assets.
(s) Limited trading assets and liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities (excluding trading assets
and liabilities attributable to trading activities permitted pursuant
to Sec. 248.6(a)(1) and (2) of subpart B) the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, is less
than $1 billion; and
(ii) The Board has not determined pursuant to Sec. 248.20(g) or
(h) of this part that the banking entity should not be treated as
having limited trading assets and liabilities.
(2) With respect to a banking entity other than a banking entity
described in paragraph (s)(3) of this section, trading assets and
liabilities for purposes of this paragraph (s) means trading assets and
liabilities (excluding trading assets and liabilities attributable to
trading activities permitted pursuant to Sec. 248.6(a)(1) and (2) of
subpart B) on a worldwide consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (s) means the
trading assets and liabilities (excluding trading assets and
liabilities attributable to trading activities permitted pursuant to
Sec. 248.6(a)(1) and (2) of subpart B) of the combined U.S. operations
of the top-tier foreign banking organization (including all
subsidiaries, affiliates, branches, and agencies of the foreign banking
organization operating, located, or organized in the United States).
(ii) For purposes of paragraph (s)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary. For purposes of paragraph (s)(3)(i) of
this section, all foreign operations of a U.S. agency, branch, or
subsidiary of a foreign banking organization are considered to be
located in the United States, including branches outside the United
States that are managed or controlled by a U.S. branch or agency of the
foreign banking organization, for purposes of calculating the banking
entity's U.S. trading assets and liabilities.
(t) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(u) Moderate trading assets and liabilities means, with respect to
a banking entity, that the banking entity does not have significant
trading assets and liabilities or limited trading assets and
liabilities.
(v) Primary financial regulatory agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 5301(12)).
(w) Purchase includes any contract to buy, purchase, or otherwise
acquire. For security futures products, purchase includes any contract,
agreement, or transaction for future delivery. With respect to a
commodity future, purchase includes any contract, agreement, or
transaction for future delivery. With respect to a derivative, purchase
includes the execution, termination (prior to its scheduled maturity
date), assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a derivative, as the
context may require.
(x) Qualifying foreign banking organization means a foreign banking
organization that qualifies as such under Sec. 211.23(a), (c) or (e)
of the Board's Regulation K (12 CFR 211.23(a), (c), or (e)).
(y) SEC means the Securities and Exchange Commission.
(z) Sale and sell each include any contract to sell or otherwise
dispose of. For security futures products, such terms include any
contract, agreement, or transaction for future delivery. With respect
to a commodity future, such terms include any contract, agreement, or
transaction for future delivery. With respect to a derivative, such
terms include the execution, termination (prior to its scheduled
maturity date), assignment, exchange, or similar transfer or conveyance
of, or extinguishing of rights or obligations under, a derivative, as
the context may require.
(aa) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(bb) Security-based swap dealer has the same meaning as in section
3(a)(71) of the Exchange Act (15 U.S.C. 78c(a)(71)).
(cc) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(dd) Separate account means an account established and maintained
by an insurance company in connection with one or more insurance
contracts to hold assets that are legally segregated from the insurance
company's other assets, under which income, gains, and losses, whether
or not realized, from assets allocated to such account, are, in
accordance with the applicable contract, credited to or charged against
such account without regard to other income, gains, or losses of the
insurance company.
(ee) Significant trading assets and liabilities means with respect
to a banking entity that:
(1)(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, equals or
exceeds $20 billion; or
[[Page 62131]]
(ii) The Board has determined pursuant to Sec. 248.20(h) of this
part that the banking entity should be treated as having significant
trading assets and liabilities.
(2) With respect to a banking entity, other than a banking entity
described in paragraph (ee)(3) of this section, trading assets and
liabilities for purposes of this paragraph (ee) means trading assets
and liabilities (excluding trading assets and liabilities attributable
to trading activities permitted pursuant to Sec. 248.6(a)(1) and (2)
of subpart B) on a worldwide consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (ee) means the
trading assets and liabilities (excluding trading assets and
liabilities attributable to trading activities permitted pursuant to
Sec. 248.6(a)(1) and (2) of subpart B) of the combined U.S. operations
of the top-tier foreign banking organization (including all
subsidiaries, affiliates, branches, and agencies of the foreign banking
organization operating, located, or organized in the United States as
well as branches outside the United States that are managed or
controlled by a branch or agency of the foreign banking entity
operating, located or organized in the United States).
(ii) For purposes of paragraph (ee)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary. For purposes of paragraph (ee)(3)(i) of
this section, all foreign operations of a U.S. agency, branch, or
subsidiary of a foreign banking organization are considered to be
located in the United States for purposes of calculating the banking
entity's U.S. trading assets and liabilities.
(ff) State means any State, the District of Columbia, the
Commonwealth of Puerto Rico, Guam, American Samoa, the United States
Virgin Islands, and the Commonwealth of the Northern Mariana Islands.
(gg) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(hh) State insurance regulator means the insurance commissioner, or
a similar official or agency, of a State that is engaged in the
supervision of insurance companies under State insurance law.
(ii) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
Subpart B--Proprietary Trading
0
18. Section 248.3 is amended by:
0
a. Revising paragraphs (b) and (d)(3), (8), and (9);
0
b. Adding paragraphs (d)(10) through (13);
0
c. Redesignating paragraphs (e)(5) through (13) as paragraphs (e)(6)
through (14);
0
d. Adding new paragraph (e)(5); and
0
e. Revising newly redesignated paragraphs (e)(11), (12), and (14).
The revisions and additions read as follows:
Sec. 248.3 Prohibition on proprietary trading.
* * * * *
(b) Definition of trading account. (1) Trading account. Trading
account means:
(i) Any account that is used by a banking entity to purchase or
sell one or more financial instruments principally for the purpose of
short-term resale, benefitting from actual or expected short-term price
movements, realizing short-term arbitrage profits, or hedging one or
more of the positions resulting from the purchases or sales of
financial instruments described in this paragraph;
(ii) Any account that is used by a banking entity to purchase or
sell one or more financial instruments that are both market risk
capital rule covered positions and trading positions (or hedges of
other market risk capital rule covered positions), if the banking
entity, or any affiliate with which the banking entity is consolidated
for regulatory reporting purposes, calculates risk-based capital ratios
under the market risk capital rule; or
(iii) Any account that is used by a banking entity to purchase or
sell one or more financial instruments, if the banking entity:
(A) Is licensed or registered, or is required to be licensed or
registered, to engage in the business of a dealer, swap dealer, or
security-based swap dealer, to the extent the instrument is purchased
or sold in connection with the activities that require the banking
entity to be licensed or registered as such; or
(B) Is engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
the instrument is purchased or sold in connection with the activities
of such business.
(2) Trading account application for certain banking entities. (i) A
banking entity that is subject to paragraph (b)(1)(ii) of this section
in determining the scope of its trading account is not subject to
paragraph (b)(1)(i) of this section.
(ii) A banking entity that does not calculate risk-based capital
ratios under the market risk capital rule and is not a consolidated
affiliate for regulatory reporting purposes of a banking entity that
calculates risk based capital ratios under the market risk capital rule
may elect to apply paragraph (b)(1)(ii) of this section in determining
the scope of its trading account as if it were subject to that
paragraph. A banking entity that elects under this subsection to apply
paragraph (b)(1)(ii) of this section in determining the scope of its
trading account as if it were subject to that paragraph is not required
to apply paragraph (b)(1)(i) of this section.
(3) Consistency of account election for certain banking entities.
(i) Any election or change to an election under paragraph (b)(2)(ii) of
this section must apply to the electing banking entity and all of its
wholly owned subsidiaries. The primary financial regulatory agency of a
banking entity that is affiliated with but is not a wholly owned
subsidiary of such electing banking entity may require that the banking
entity be subject to this uniform application requirement if the
primary financial regulatory agency determines that it is necessary to
prevent evasion of the requirements of this part after notice and
opportunity for response as provided in subpart D of this part.
(ii) A banking entity that does not elect under paragraph
(b)(2)(ii) of this section to be subject to the trading account
definition in (b)(1)(ii) may continue to apply the trading account
definition in paragraph (b)(1)(i) of this section for one year from the
date on which it becomes, or becomes a consolidated affiliate for
regulatory reporting purposes with, a banking entity that calculates
risk-based capital ratios under the market risk capital rule.
(4) Rebuttable presumption for certain purchases and sales. The
purchase (or sale) of a financial instrument by a banking entity shall
be presumed not to be for the trading account of the banking entity
under paragraph (b)(1)(i) of this section if the banking entity holds
the financial instrument for sixty days or longer and does not transfer
substantially all of the risk of the financial instrument within sixty
days of the purchase (or sale).
* * * * *
(d) * * *
(3) Any purchase or sale of a security, foreign exchange forward
(as that term
[[Page 62132]]
is defined in section 1a(24) of the Commodity Exchange Act (7 U.S.C.
1a(24)), foreign exchange swap (as that term is defined in section
1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)), or cross-
currency swap by a banking entity for the purpose of liquidity
management in accordance with a documented liquidity management plan of
the banking entity that:
(i) Specifically contemplates and authorizes the particular
financial instruments to be used for liquidity management purposes, the
amount, types, and risks of these financial instruments that are
consistent with liquidity management, and the liquidity circumstances
in which the particular financial instruments may or must be used;
(ii) Requires that any purchase or sale of financial instruments
contemplated and authorized by the plan be principally for the purpose
of managing the liquidity of the banking entity, and not for the
purpose of short-term resale, benefitting from actual or expected
short-term price movements, realizing short-term arbitrage profits, or
hedging a position taken for such short-term purposes;
(iii) Requires that any financial instruments purchased or sold for
liquidity management purposes be highly liquid and limited to financial
instruments the market, credit, and other risks of which the banking
entity does not reasonably expect to give rise to appreciable profits
or losses as a result of short-term price movements;
(iv) Limits any financial instruments purchased or sold for
liquidity management purposes, together with any other financial
instruments purchased or sold for such purposes, to an amount that is
consistent with the banking entity's near-term funding needs, including
deviations from normal operations of the banking entity or any
affiliate thereof, as estimated and documented pursuant to methods
specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of financial instruments that are not permitted under Sec. 248.6(a) or
(b) of this subpart are for the purpose of liquidity management and in
accordance with the liquidity management plan described in this
paragraph (d)(3); and
(vi) Is consistent with the Board's supervisory requirements
regarding liquidity management;
* * * * *
(8) Any purchase or sale of one or more financial instruments by a
banking entity through a deferred compensation, stock-bonus, profit-
sharing, or pension plan of the banking entity that is established and
administered in accordance with the law of the United States or a
foreign sovereign, if the purchase or sale is made directly or
indirectly by the banking entity as trustee for the benefit of persons
who are or were employees of the banking entity;
(9) Any purchase or sale of one or more financial instruments by a
banking entity in the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
financial instrument as soon as practicable, and in no event may the
banking entity retain such instrument for longer than such period
permitted by the Board;
(10) Any purchase or sale of one or more financial instruments that
was made in error by a banking entity in the course of conducting a
permitted or excluded activity or is a subsequent transaction to
correct such an error;
(11) Contemporaneously entering into a customer-driven swap or
customer-driven security-based swap and a matched swap or security-
based swap if:
(i) The banking entity retains no more than minimal price risk; and
(ii) The banking entity is not a registered dealer, swap dealer, or
security-based swap dealer;
(12) Any purchase or sale of one or more financial instruments that
the banking entity uses to hedge mortgage servicing rights or mortgage
servicing assets in accordance with a documented hedging strategy; or
(13) Any purchase or sale of a financial instrument that does not
meet the definition of trading asset or trading liability under the
applicable reporting form for a banking entity as of January 1, 2020.
(e) * * *
(5) Cross-currency swap means a swap in which one party exchanges
with another party principal and interest rate payments in one currency
for principal and interest rate payments in another currency, and the
exchange of principal occurs on the date the swap is entered into, with
a reversal of the exchange of principal at a later date that is agreed
upon when the swap is entered into.
* * * * *
(11) Market risk capital rule covered position and trading position
means a financial instrument that meets the criteria to be a covered
position and a trading position, as those terms are respectively
defined, without regard to whether the financial instrument is reported
as a covered position or trading position on any applicable regulatory
reporting forms:
(i) In the case of a banking entity that is a bank holding company,
savings and loan holding company, or insured depository institution,
under the market risk capital rule that is applicable to the banking
entity; and
(ii) In the case of a banking entity that is affiliated with a bank
holding company or savings and loan holding company, other than a
banking entity to which a market risk capital rule is applicable, under
the market risk capital rule that is applicable to the affiliated bank
holding company or savings and loan holding company.
(12) Market risk capital rule means the market risk capital rule
that is contained in 12 CFR part 3 with respect to a banking entity for
which the OCC is the primary financial regulatory agency, 12 CFR part
217 with respect to a banking entity for which the Board is the primary
financial regulatory agency, or 12 CFR part 324 with respect to a
banking entity for which the FDIC is the primary financial regulatory
agency.
* * * * *
(14) Trading desk means a unit of organization of a banking entity
that purchases or sells financial instruments for the trading account
of the banking entity or an affiliate thereof that is:
(i)(A) Structured by the banking entity to implement a well-defined
business strategy;
(B) Organized to ensure appropriate setting, monitoring, and
management review of the desk's trading and hedging limits, current and
potential future loss exposures, and strategies; and
(C) Characterized by a clearly defined unit that:
(1) Engages in coordinated trading activity with a unified approach
to its key elements;
(2) Operates subject to a common and calibrated set of risk
metrics, risk levels, and joint trading limits;
(3) Submits compliance reports and other information as a unit for
monitoring by management; and
(4) Books its trades together; or
(ii) For a banking entity that calculates risk-based capital ratios
under the market risk capital rule, or a consolidated affiliate for
regulatory reporting purposes of a banking entity that calculates risk-
based capital ratios under the market risk capital rule, established by
the banking entity or its affiliate for purposes of market risk capital
calculations under the market risk capital rule.
0
19. Section 248.4 is revised to read as follows:
[[Page 62133]]
Sec. 248.4 Permitted underwriting and market making-related
activities.
(a) Underwriting activities--(1) Permitted underwriting activities.
The prohibition contained in Sec. 248.3(a) does not apply to a banking
entity's underwriting activities conducted in accordance with this
paragraph (a).
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii)(A) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
taking into account the liquidity, maturity, and depth of the market
for the relevant types of securities; and
(B) Reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity, maturity, and depth of the market for the relevant types
of securities;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (a) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, in accordance with paragraph
(a)(2)(ii)(A) of this section;
(C) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
(D) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
(iv) A banking entity with significant trading assets and
liabilities may satisfy the requirements in paragraphs (a)(2)(iii)(B)
and (C) of this section by complying with the requirements set forth in
paragraph (c) of this section;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
(3) Definition of distribution. For purposes of this paragraph (a),
a distribution of securities means:
(i) An offering of securities, whether or not subject to
registration under the Securities Act of 1933, that is distinguished
from ordinary trading transactions by the presence of special selling
efforts and selling methods; or
(ii) An offering of securities made pursuant to an effective
registration statement under the Securities Act of 1933.
(4) Definition of underwriter. For purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an issuer or selling security
holder to:
(A) Purchase securities from the issuer or selling security holder
for distribution;
(B) Engage in a distribution of securities for or on behalf of the
issuer or selling security holder; or
(C) Manage a distribution of securities for or on behalf of the
issuer or selling security holder; or
(ii) A person who has agreed to participate or is participating in
a distribution of such securities for or on behalf of the issuer or
selling security holder.
(5) Definition of selling security holder. For purposes of this
paragraph (a), selling security holder means any person, other than an
issuer, on whose behalf a distribution is made.
(6) Definition of underwriting position. For purposes of this
section, underwriting position means the long or short positions in one
or more securities held by a banking entity or its affiliate, and
managed by a particular trading desk, in connection with a particular
distribution of securities for which such banking entity or affiliate
is acting as an underwriter.
(7) Definition of client, customer, and counterparty. For purposes
of this paragraph (a), the terms client, customer, and counterparty, on
a collective or individual basis, refer to market participants that may
transact with the banking entity in connection with a particular
distribution for which the banking entity is acting as underwriter.
(b) Market making-related activities--(1) Permitted market making-
related activities. The prohibition contained in Sec. 248.3(a) does
not apply to a banking entity's market making-related activities
conducted in accordance with this paragraph (b).
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure, routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure, and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The trading desk's market-making related activities are
designed not to exceed, on an ongoing basis, the reasonably expected
near term demands of clients, customers, or counterparties, taking into
account the liquidity, maturity, and depth of the market for the
relevant types of financial instruments;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of this
paragraph (b), including reasonably designed written policies and
procedures, internal controls, analysis and independent testing
identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and positions; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading
[[Page 62134]]
desk to mitigate these risks are and continue to be effective;
(C) Limits for each trading desk, in accordance with paragraph
(b)(2)(ii) of this section;
(D) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
(E) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
(iv) A banking entity with significant trading assets and
liabilities may satisfy the requirements in paragraphs (b)(2)(iii)(C)
and (D) of this section by complying with the requirements set forth in
paragraph (c) of this section.
(v) The compensation arrangements of persons performing the
activities described in this paragraph (b) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in
activity described in this paragraph (b) in accordance with applicable
law.
(3) Definition of client, customer, and counterparty. For purposes
of this paragraph (b), the terms client, customer, and counterparty, on
a collective or individual basis refer to market participants that make
use of the banking entity's market making-related services by obtaining
such services, responding to quotations, or entering into a continuing
relationship with respect to such services, provided that:
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with the methodology described in
Sec. 248.2(ee) of this part, unless:
(A) The trading desk documents how and why a particular trading
desk or other organizational unit of the entity should be treated as a
client, customer, or counterparty of the trading desk for purposes of
paragraph (b)(2) of this section; or
(B) The purchase or sale by the trading desk is conducted
anonymously on an exchange or similar trading facility that permits
trading on behalf of a broad range of market participants.
(ii) [Reserved]
(4) Definition of financial exposure. For purposes of this section,
financial exposure means the aggregate risks of one or more financial
instruments and any associated loans, commodities, or foreign exchange
or currency, held by a banking entity or its affiliate and managed by a
particular trading desk as part of the trading desk's market making-
related activities.
(5) Definition of market-maker positions. For the purposes of this
section, market-maker positions means all of the positions in the
financial instruments for which the trading desk stands ready to make a
market in accordance with paragraph (b)(2)(i) of this section, that are
managed by the trading desk, including the trading desk's open
positions or exposures arising from open transactions.
(c) Rebuttable presumption of compliance--(1) Internal limits. (i)
A banking entity shall be presumed to meet the requirement in paragraph
(a)(2)(ii)(A) or (b)(2)(ii) of this section with respect to the
purchase or sale of a financial instrument if the banking entity has
established and implements, maintains, and enforces the internal limits
for the relevant trading desk as described in paragraph (c)(1)(ii) of
this section.
(ii)(A) With respect to underwriting activities conducted pursuant
to paragraph (a) of this section, the presumption described in
paragraph (c)(1)(i) of this section shall be available to each trading
desk that establishes, implements, maintains, and enforces internal
limits that should take into account the liquidity, maturity, and depth
of the market for the relevant types of securities and are designed not
to exceed the reasonably expected near term demands of clients,
customers, or counterparties, based on the nature and amount of the
trading desk's underwriting activities, on the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.
(B) With respect to market making-related activities conducted
pursuant to paragraph (b) of this section, the presumption described in
paragraph (c)(1)(i) of this section shall be available to each trading
desk that establishes, implements, maintains, and enforces internal
limits that should take into account the liquidity, maturity, and depth
of the market for the relevant types of financial instruments and are
designed not to exceed the reasonably expected near term demands of
clients, customers, or counterparties, based on the nature and amount
of the trading desk's market-making related activities, that address
the:
(1) Amount, types, and risks of its market-maker positions;
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
(4) Period of time a financial instrument may be held.
(2) Supervisory review and oversight. The limits described in
paragraph (c)(1) of this section shall be subject to supervisory review
and oversight by the Board on an ongoing basis.
(3) Limit breaches and increases. (i) With respect to any limit set
pursuant to paragraph (c)(1)(ii)(A) or (B) of this section, a banking
entity shall maintain and make available to the Board upon request
records regarding:
(A) Any limit that is exceeded; and
(B) Any temporary or permanent increase to any limit(s), in each
case in the form and manner as directed by the Board.
(ii) In the event of a breach or increase of any limit set pursuant
to paragraph (c)(1)(ii)(A) or (B) of this section, the presumption
described in paragraph (c)(1)(i) of this section shall continue to be
available only if the banking entity:
(A) Takes action as promptly as possible after a breach to bring
the trading desk into compliance; and
(B) Follows established written authorization procedures, including
escalation procedures that require review and approval of any trade
that exceeds a trading desk's limit(s), demonstrable analysis of the
basis for any temporary or permanent increase to a trading desk's
limit(s), and independent review of such demonstrable analysis and
approval.
(4) Rebutting the presumption. The presumption in paragraph
(c)(1)(i) of this section may be rebutted by the Board if the Board
determines, taking into account the liquidity, maturity, and depth of
the market for the relevant types of financial instruments and based on
all relevant facts and circumstances, that a trading desk is engaging
in activity that is not based on the reasonably expected near term
demands of clients, customers, or counterparties. The Board's rebuttal
of the presumption in paragraph (c)(1)(i) must be made in accordance
with the notice and response procedures in subpart D of this part.
0
20. Section 248.5 is amended by revising paragraphs (b) and (c)(1)
introductory text and adding paragraph (c)(4) to read as follows:
[[Page 62135]]
Sec. 248.5 Permitted risk-mitigating hedging activities.
* * * * *
(b) Requirements. (1) The risk-mitigating hedging activities of a
banking entity that has significant trading assets and liabilities are
permitted under paragraph (a) of this section only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(C) The conduct of analysis and independent testing designed to
ensure that the positions, techniques and strategies that may be used
for hedging may reasonably be expected to reduce or otherwise
significantly mitigate the specific, identifiable risk(s) being hedged;
(ii) The risk-mitigating hedging activity:
(A) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(B) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(D) Is subject to continuing review, monitoring and management by
the banking entity that:
(1) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1)(i) of this section;
(2) Is designed to reduce or otherwise significantly mitigate the
specific, identifiable risks that develop over time from the risk-
mitigating hedging activities undertaken under this section and the
underlying positions, contracts, and other holdings of the banking
entity, based upon the facts and circumstances of the underlying and
hedging positions, contracts and other holdings of the banking entity
and the risks and liquidity thereof; and
(3) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(1)(ii) of this section and is not
prohibited proprietary trading; and
(iii) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(2) The risk-mitigating hedging activities of a banking entity that
does not have significant trading assets and liabilities are permitted
under paragraph (a) of this section only if the risk-mitigating hedging
activity:
(i) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to ongoing recalibration by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading.
(c) * * *
(1) A banking entity that has significant trading assets and
liabilities must comply with the requirements of paragraphs (c)(2) and
(3) of this section, unless the requirements of paragraph (c)(4) of
this section are met, with respect to any purchase or sale of financial
instruments made in reliance on this section for risk-mitigating
hedging purposes that is:
* * * * *
(4) The requirements of paragraphs (c)(2) and (3) of this section
do not apply to the purchase or sale of a financial instrument
described in paragraph (c)(1) of this section if:
(i) The financial instrument purchased or sold is identified on a
written list of pre-approved financial instruments that are commonly
used by the trading desk for the specific type of hedging activity for
which the financial instrument is being purchased or sold; and
(ii) At the time the financial instrument is purchased or sold, the
hedging activity (including the purchase or sale of the financial
instrument) complies with written, pre-approved limits for the trading
desk purchasing or selling the financial instrument for hedging
activities undertaken for one or more other trading desks. The limits
shall be appropriate for the:
(A) Size, types, and risks of the hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased and sold for hedging activities
by the trading desk; and
(C) Levels and duration of the risk exposures being hedged.
0
21. Section 248.6 is amended by revising paragraph (e)(3), removing
paragraphs (e)(4) and (6), and redesignating paragraph (e)(5) as
paragraph (e)(4).
The revision reads as follows:
Sec. 248.6 Other permitted proprietary trading activities.
* * * * *
(e) * * *
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United
[[Page 62136]]
States or organized under the laws of the United States or of any
State.
* * * * *
Subpart C--Covered Funds Activities and Investments
0
22. Section 248.10 is amended by revising paragraphs (c)(7)(ii) and
(c)(8)(i)(A) to read as follows:
Sec. 248.10 Prohibition on Acquiring or Retaining an Ownership
Interest in and Having Certain Relationships with a Covered Fund.
* * * * *
(c) * * *
(7) * * *
(ii) Participates in the profits and losses of the separate account
other than in compliance with applicable requirements regarding bank
owned life insurance.
(8) * * *
(i) * * *
(A) Loans as defined in Sec. 248.2(t) of subpart A;
* * * * *
0
23. Section 248.11 is amended by revising paragraph (c) to read as
follows:
Sec. 248.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
* * * * *
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 248.10(a) does not
apply to a banking entity's underwriting activities or market making-
related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 248.4(a) or (b), respectively; and
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; or acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in such covered fund in
compliance with section 15G of that Act (15 U.S.C.78o-11) and the
implementing regulations issued thereunder each as permitted by
paragraph (b) of this section, then in each such case any ownership
interests acquired or retained by the banking entity and its affiliates
in connection with underwriting and market making related activities
for that particular covered fund are included in the calculation of
ownership interests permitted to be held by the banking entity and its
affiliates under the limitations of Sec. 248.12(a)(2)(ii) and (iii)
and (d).
Sec. 248.12 [Amended]
0
24. Section 248.12 is amended by redesignating the second instance of
paragraph (e)(2)(vi) as paragraph (e)(2)(vii).
0
25. Section 248.13 is amended by revising paragraphs (a), (b)(3) and
(4), and (c) to read as follows:
Sec. 248.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 248.10(a) does not apply with respect to
an ownership interest in a covered fund acquired or retained by a
banking entity that is designed to reduce or otherwise significantly
mitigate the specific, identifiable risks to the banking entity in
connection with:
(i) A compensation arrangement with an employee of the banking
entity or an affiliate thereof that directly provides investment
advisory, commodity trading advisory or other services to the covered
fund; or
(ii) A position taken by the banking entity when acting as
intermediary on behalf of a customer that is not itself a banking
entity to facilitate the exposure by the customer to the profits and
losses of the covered fund.
(2) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program in accordance with subpart
D of this part that is reasonably designed to ensure the banking
entity's compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures,
and internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks arising:
(1) Out of a transaction conducted solely to accommodate a specific
customer request with respect to the covered fund; or
(2) In connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) With respect to risk-mitigating hedging activity conducted
pursuant to paragraph (a)(1)(i), the compensation arrangement relates
solely to the covered fund in which the banking entity or any affiliate
has acquired an ownership interest pursuant to paragraph (a)(1)(i) and
such compensation arrangement provides that any losses incurred by the
banking entity on such ownership interest will be offset by
corresponding decreases in amounts payable under such compensation
arrangement.
(b) * * *
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is not sold and has not been
sold pursuant to an offering that targets residents of the United
States in which the banking entity or any affiliate of the banking
entity participates. If the banking entity or an affiliate sponsors or
serves, directly or indirectly, as the investment manager, investment
adviser, commodity pool operator or commodity trading advisor to a
covered fund, then the banking entity or affiliate will be deemed for
purposes of this paragraph (b)(3) to participate in any offer or sale
by the covered fund of ownership interests in the covered fund.
(4) An activity or investment occurs solely outside of the United
States for purposes of paragraph (b)(1)(iv) of this section only if:
(i) The banking entity acting as sponsor, or engaging as principal
in the acquisition or retention of an ownership interest in the covered
fund, is not itself, and is not controlled directly or indirectly by, a
banking entity that is located in the United States or organized under
the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to acquire or retain the ownership interest or act as
sponsor to the covered fund is not located in the United States or
organized under the
[[Page 62137]]
laws of the United States or of any State; and
(iii) The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State.
* * * * *
(c) Permitted covered fund interests and activities by a regulated
insurance company. The prohibition contained in Sec. 248.10(a) of this
subpart does not apply to the acquisition or retention by an insurance
company, or an affiliate thereof, of any ownership interest in, or the
sponsorship of, a covered fund only if:
(1) The insurance company or its affiliate acquires and retains the
ownership interest solely for the general account of the insurance
company or for one or more separate accounts established by the
insurance company;
(2) The acquisition and retention of the ownership interest is
conducted in compliance with, and subject to, the insurance company
investment laws and regulations of the State or jurisdiction in which
such insurance company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law or regulation described in paragraph (c)(2) of
this section is insufficient to protect the safety and soundness of the
banking entity, or the financial stability of the United States.
0
26. Section 248.14 is amended by revising paragraph (a)(2)(ii)(B) to
read as follows:
Sec. 248.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually no later than March 31 to
the Board (with a duty to update the certification if the information
in the certification materially changes) that the banking entity does
not, directly or indirectly, guarantee, assume, or otherwise insure the
obligations or performance of the covered fund or of any covered fund
in which such covered fund invests; and
* * * * *
Subpart D--Compliance Program Requirement; Violations
0
27. Section 248.20 is amended by revising paragraphs (a), (b)
introductory text, (c), (d), (e) introductory text, and (f)(2) and
adding paragraphs (g), (h), and (i) to read as follows:
Sec. 248.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities) shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
(b) Banking entities with significant trading assets and
liabilities. With respect to a banking entity with significant trading
assets and liabilities, the compliance program required by paragraph
(a) of this section, at a minimum, shall include:
* * * * *
(c) CEO attestation. The CEO of a banking entity that has
significant trading assets and liabilities must, based on a review by
the CEO of the banking entity, attest in writing to the Board, each
year no later than March 31, that the banking entity has in place
processes to establish, maintain, enforce, review, test and modify the
compliance program required by paragraph (b) of this section in a
manner reasonably designed to achieve compliance with section 13 of the
BHC Act and this part. In the case of a U.S. branch or agency of a
foreign banking entity, the attestation may be provided for the entire
U.S. operations of the foreign banking entity by the senior management
officer of the U.S. operations of the foreign banking entity who is
located in the United States.
(d) Reporting requirements under appendix A to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B shall comply with the reporting requirements described in
appendix A to this part, if:
(i) The banking entity has significant trading assets and
liabilities; or
(ii) The Board notifies the banking entity in writing that it must
satisfy the reporting requirements contained in appendix A to this
part.
(2) Frequency of reporting: Unless the Board notifies the banking
entity in writing that it must report on a different basis, a banking
entity subject to appendix A to this part shall report the information
required by appendix A for each quarter within 30 days of the end of
the quarter.
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities shall maintain records
that include:
* * * * *
(f) * * *
(2) Banking entities with moderate trading assets and liabilities.
A banking entity with moderate trading assets and liabilities may
satisfy the requirements of this section by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act and this part and adjustments
as appropriate given the activities, size, scope, and complexity of the
banking entity.
(g) Rebuttable presumption of compliance for banking entities with
limited trading assets and liabilities--(1) Rebuttable presumption.
Except as otherwise provided in this paragraph, a banking entity with
limited trading assets and liabilities shall be presumed to be
compliant with subpart B and subpart C of this part and shall have no
obligation to demonstrate compliance with this part on an ongoing
basis.
(2) Rebuttal of presumption. If upon examination or audit, the
Board determines that the banking entity has engaged in proprietary
trading or covered fund activities that are otherwise prohibited under
subpart B or subpart C of this part, the Board may require the banking
entity to be treated under this part as if it did not have limited
trading assets and liabilities. The Board's rebuttal of the presumption
in this paragraph must be made in accordance with the notice and
response procedures in paragraph (i) of this section.
(h) Reservation of authority. Notwithstanding any other provision
of this part, the Board retains its authority to require a banking
entity without significant trading assets and liabilities to apply any
requirements of this part that would otherwise apply if the banking
entity had significant or moderate trading assets and liabilities if
the Board determines that the size or complexity of the banking
entity's trading or investment activities, or the risk of evasion of
subpart B or subpart C of this part, does not warrant a presumption of
compliance under paragraph (g) of this section or treatment
[[Page 62138]]
as a banking entity with moderate trading assets and liabilities, as
applicable. The Board's exercise of this reservation of authority must
be made in accordance with the notice and response procedures in
paragraph (i) of this section.
(i) Notice and response procedures--(1) Notice. The Board will
notify the banking entity in writing of any determination requiring
notice under this part and will provide an explanation of the
determination.
(2) Response. The banking entity may respond to any or all items in
the notice described in paragraph (i)(1) of this section. The response
should include any matters that the banking entity would have the Board
consider in deciding whether to make the determination. The response
must be in writing and delivered to the designated Board official
within 30 days after the date on which the banking entity received the
notice. The Board may shorten the time period when, in the opinion of
the Board, the activities or condition of the banking entity so
requires, provided that the banking entity is informed of the time
period at the time of notice, or with the consent of the banking
entity. In its discretion, the Board may extend the time period for
good cause.
(3) Waiver. Failure to respond within 30 days or such other time
period as may be specified by the Board shall constitute a waiver of
any objections to the Board's determination.
(4) Decision. The Board will notify the banking entity of the
decision in writing. The notice will include an explanation of the
decision.
0
28. Revise appendix A to part 248 to read as follows:
Appendix A to Part 248--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
248.20(d), this appendix applies to a banking entity that, together
with its affiliates and subsidiaries, has significant trading assets
and liabilities. These entities are required to (i) furnish periodic
reports to the Board regarding a variety of quantitative
measurements of their covered trading activities, which vary
depending on the scope and size of covered trading activities, and
(ii) create and maintain records documenting the preparation and
content of these reports. The requirements of this appendix must be
incorporated into the banking entity's internal compliance program
under Sec. 248.20.
b. The purpose of this appendix is to assist banking entities
and the Board in:
(1) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(2) Monitoring the banking entity's covered trading activities;
(3) Identifying covered trading activities that warrant further
review or examination by the banking entity to verify compliance
with the proprietary trading restrictions;
(4) Evaluating whether the covered trading activities of trading
desks engaged in market making-related activities subject to Sec.
248.4(b) are consistent with the requirements governing permitted
market making-related activities;
(5) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. 248.4, 248.5, or 248.6(a)-(b) (i.e., underwriting and market
making-related activity, risk-mitigating hedging, or trading in
certain government obligations) are consistent with the requirement
that such activity not result, directly or indirectly, in a material
exposure to high-risk assets or high-risk trading strategies;
(6) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by Board of such activities; and
(7) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. Information that must be furnished pursuant to this appendix
is not intended to serve as a dispositive tool for the
identification of permissible or impermissible activities.
d. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 248.20. The effectiveness of particular
quantitative measurements may differ based on the profile of the
banking entity's businesses in general and, more specifically, of
the particular trading desk, including types of instruments traded,
trading activities and strategies, and history and experience (e.g.,
whether the trading desk is an established, successful market maker
or a new entrant to a competitive market). In all cases, banking
entities must ensure that they have robust measures in place to
identify and monitor the risks taken in their trading activities, to
ensure that the activities are within risk tolerances established by
the banking entity, and to monitor and examine for compliance with
the proprietary trading restrictions in this part.
e. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. 248.4 through 248.6(a)-(b), or that result in
a material exposure to high-risk assets or high-risk trading
strategies, must be escalated within the banking entity for review,
further analysis, explanation to Board, and remediation, where
appropriate. The quantitative measurements discussed in this
appendix should be helpful to banking entities in identifying and
managing the risks related to their covered trading activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. 248.2 and Sec. 248.3. In addition, for purposes of
this appendix, the following definitions apply:
Applicability identifies the trading desks for which a banking
entity is required to calculate and report a particular quantitative
measurement based on the type of covered trading activity conducted
by the trading desk.
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of a trading desk's holdings, dividend income, and
interest income and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. 248.4, Sec. 248.5, Sec. 248.6(a), or Sec.
248.6(b). A banking entity may include in its covered trading
activity trading conducted under Sec. 248.3(d), Sec. 248.6(c),
Sec. 248.6(d) or Sec. 248.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading day means a calendar day on which a trading desk is open
for trading.
III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each banking entity made subject
to this appendix by Sec. 248.20 must furnish the following
quantitative measurements, as applicable, for each trading desk of
the banking entity engaged in covered trading activities and
calculate these quantitative measurements in accordance with this
appendix:
i. Internal Limits and Usage;
ii. Value-at-Risk;
iii. Comprehensive Profit and Loss Attribution;
iv. Positions; and
v. Transaction Volumes.
2. Trading desk information. Each banking entity made subject to
this appendix by Sec. 248.20 must provide certain descriptive
information, as further described in this appendix, regarding each
trading desk engaged in covered trading activities.
3. Quantitative measurements identifying information. Each
banking entity made subject to this appendix by Sec. 248.20 must
provide certain identifying and descriptive information, as further
described in this appendix, regarding its quantitative measurements.
[[Page 62139]]
4. Narrative statement. Each banking entity made subject to this
appendix by Sec. 248.20 may provide an optional narrative
statement, as further described in this appendix.
5. File identifying information. Each banking entity made
subject to this appendix by Sec. 248.20 must provide file
identifying information in each submission to the Board pursuant to
this appendix, including the name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the Board, and
identification of the reporting period and creation date and time.
b. Trading Desk Information
1. Each banking entity must provide descriptive information
regarding each trading desk engaged in covered trading activities,
including:
i. Name of the trading desk used internally by the banking
entity and a unique identification label for the trading desk;
ii. Identification of each type of covered trading activity in
which the trading desk is engaged;
iii. Brief description of the general strategy of the trading
desk;
v. A list identifying each Agency receiving the submission of
the trading desk;
2. Indication of whether each calendar date is a trading day or
not a trading day for the trading desk; and
3. Currency reported and daily currency conversion rate.
c. Quantitative Measurements Identifying Information
Each banking entity must provide the following information
regarding the quantitative measurements:
1. An Internal Limits Information Schedule that provides
identifying and descriptive information for each limit reported
pursuant to the Internal Limits and Usage quantitative measurement,
including the name of the limit, a unique identification label for
the limit, a description of the limit, the unit of measurement for
the limit, the type of limit, and identification of the
corresponding risk factor attribution in the particular case that
the limit type is a limit on a risk factor sensitivity and profit
and loss attribution to the same risk factor is reported; and
2. A Risk Factor Attribution Information Schedule that provides
identifying and descriptive information for each risk factor
attribution reported pursuant to the Comprehensive Profit and Loss
Attribution quantitative measurement, including the name of the risk
factor or other factor, a unique identification label for the risk
factor or other factor, a description of the risk factor or other
factor, and the risk factor or other factor's change unit.
d. Narrative Statement
Each banking entity made subject to this appendix by Sec.
248.20 may submit in a separate electronic document a Narrative
Statement to the Board with any information the banking entity views
as relevant for assessing the information reported. The Narrative
Statement may include further description of or changes to
calculation methods, identification of material events, description
of and reasons for changes in the banking entity's trading desk
structure or trading desk strategies, and when any such changes
occurred.
e. Frequency and Method of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report the
Trading Desk Information, the Quantitative Measurements Identifying
Information, and each applicable quantitative measurement
electronically to the Board on the reporting schedule established in
Sec. 248.20 unless otherwise requested by the Board. A banking
entity must report the Trading Desk Information, the Quantitative
Measurements Identifying Information, and each applicable
quantitative measurement to the Board in accordance with the XML
Schema specified and published on the Board's website.
f. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the Board pursuant to this appendix and Sec.
248.20(d), create and maintain records documenting the preparation
and content of these reports, as well as such information as is
necessary to permit the Board to verify the accuracy of such
reports, for a period of five years from the end of the calendar
year for which the measurement was taken. A banking entity must
retain the Narrative Statement, the Trading Desk Information, and
the Quantitative Measurements Identifying Information for a period
of five years from the end of the calendar year for which the
information was reported to the Board.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Internal Limits and Usage
i. Description: For purposes of this appendix, Internal Limits
are the constraints that define the amount of risk and the positions
that a trading desk is permitted to take at a point in time, as
defined by the banking entity for a specific trading desk. Usage
represents the value of the trading desk's risk or positions that
are accounted for by the current activity of the desk. Internal
limits and their usage are key compliance and risk management tools
used to control and monitor risk taking and include, but are not
limited to, the limits set out in Sec. Sec. 248.4 and 248.5. A
trading desk's risk limits, commonly including a limit on ``Value-
at-Risk,'' are useful in the broader context of the trading desk's
overall activities, particularly for the market making activities
under Sec. 248.4(b) and hedging activity under Sec. 248.5.
Accordingly, the limits required under Sec. Sec.
248.4(b)(2)(iii)(C) and 248.5(b)(1)(i)(A) must meet the applicable
requirements under Sec. Sec. 248.4(b)(2)(iii)(C) and
248.5(b)(1)(i)(A) and also must include appropriate metrics for the
trading desk limits including, at a minimum, ``Value-at-Risk''
except to the extent the ``Value-at-Risk'' metric is demonstrably
ineffective for measuring and monitoring the risks of a trading desk
based on the types of positions traded by, and risk exposures of,
that desk.
A. A banking entity must provide the following information for
each limit reported pursuant to this quantitative measurement: The
unique identification label for the limit reported in the Internal
Limits Information Schedule, the limit size (distinguishing between
an upper and a lower limit), and the value of usage of the limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
2. Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the measurement of the risk of future financial loss in
the value of a trading desk's aggregated positions at the ninety-
nine percent confidence level over a one-day period, based on
current market conditions.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into two categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); and (ii) profit and loss attributable to
new positions resulting from the current day's trading activity
(``new positions'').
A. The comprehensive profit and loss associated with existing
positions must reflect changes in the value of these positions on
the applicable day. The comprehensive profit and loss from existing
positions must be further attributed, as applicable, to (i) changes
in the specific risk factors and other factors that are monitored
and managed as part of the trading desk's overall risk management
policies and procedures; and (ii) any other applicable elements,
such as cash flows, carry, changes in reserves, and the correction,
cancellation, or exercise of a trade.
B. For the attribution of comprehensive profit and loss from
existing positions to specific risk factors and other factors, a
banking entity must provide the following information for the
factors that explain the preponderance of the profit or loss changes
due to risk factor changes: The unique identification label for the
risk factor or other factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss due to the risk factor
or other factor change.
C. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
[[Page 62140]]
D. The portion of comprehensive profit and loss from existing
positions that is not attributed to changes in specific risk factors
and other factors must be allocated to a residual category.
Significant unexplained profit and loss must be escalated for
further investigation and analysis.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
c. Positions and Transaction Volumes Measurements
1. Positions
i. Description: For purposes of this appendix, Positions is the
value of securities and derivatives positions managed by the trading
desk. For purposes of the Positions quantitative measurement, do not
include in the Positions calculation for ``securities'' those
securities that are also ``derivatives,'' as those terms are defined
under subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \1\ A banking entity must separately
report the trading desk's market value of long securities positions,
short securities positions, derivatives receivables, and derivatives
payables.
---------------------------------------------------------------------------
\1\ See Sec. 248.2(h), (aa). For example, under this part, a
security-based swap is both a ``security'' and a ``derivative.'' For
purposes of the Positions quantitative measurement, security-based
swaps are reported as derivatives rather than securities.
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 248.4(a)
or Sec. 248.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
2. Transaction Volumes
i. Description: For purposes of this appendix, Transaction
Volumes measures three exclusive categories of covered trading
activity conducted by a trading desk. A banking entity is required
to report the value and number of security and derivative
transactions conducted by the trading desk with: (i) Customers,
excluding internal transactions; (ii) non-customers, excluding
internal transactions; and (iii) trading desks and other
organizational units where the transaction is booked into either the
same banking entity or an affiliated banking entity. For securities,
value means gross market value. For derivatives, value means gross
notional value. For purposes of calculating the Transaction Volumes
quantitative measurement, do not include in the Transaction Volumes
calculation for ``securities'' those securities that are also
``derivatives,'' as those terms are defined under subpart A;
instead, report those securities that are also derivatives as
``derivatives.'' \2\ Further, for purposes of the Transaction
Volumes quantitative measurement, a customer of a trading desk that
relies on Sec. 248.4(a) to conduct underwriting activity is a
market participant identified in Sec. 248.4(a)(7), and a customer
of a trading desk that relies on Sec. 248.4(b) to conduct market
making-related activity is a market participant identified in Sec.
248.4(b)(3).
---------------------------------------------------------------------------
\2\ See Sec. 248.2(h), (aa).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 248.4(a)
or Sec. 248.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
Appendix B to Part 248 [Removed]
0
29. Appendix B to part 248 is removed.
0
30. Effective January 1, 2020, until December 31, 2020, appendix Z to
part 248 is added to read as follows:
Appendix Z to Part 248--Proprietary Trading and Certain Interests in
and Relationships With Covered Funds (Alternative Compliance)
Note: The content of this appendix reproduces the regulation
implementing Section 13 of the Bank Holding Company Act as of
November 13, 2019.
Subpart A--Authority and Definitions
Sec. 248.1 Authority, purpose, scope, and relationship to other
authorities.
(a) Authority. This part (Regulation VV) is issued by the Board
under section 13 of the Bank Holding Company Act of 1956, as amended
(12 U.S.C. 1851), as well as under the Federal Reserve Act, as amended
(12 U.S.C. 221 et seq.); section 8 of the Federal Deposit Insurance
Act, as amended (12 U.S.C. 1818); the Bank Holding Company Act of 1956,
as amended (12 U.S.C. 1841 et seq.); and the International Banking Act
of 1978, as amended (12 U.S.C. 3101 et seq.).
(b) Purpose. Section 13 of the Bank Holding Company Act establishes
prohibitions and restrictions on proprietary trading and on investments
in or relationships with covered funds by certain banking entities,
including state member banks, bank holding companies, savings and loan
holding companies, other companies that control an insured depository
institution, foreign banking organizations, and certain subsidiaries
thereof. This part implements section 13 of the Bank Holding Company
Act by defining terms used in the statute and related terms,
establishing prohibitions and restrictions on proprietary trading and
on investments in or relationships with covered funds, and explaining
the statute's requirements.
(c) Scope. This part implements section 13 of the Bank Holding
Company Act with respect to banking entities for which the Board is
authorized to issue regulations under section 13(b)(2) of the Bank
Holding Company Act (12 U.S.C. 1851(b)(2)) and take actions under
section 13(e) of that Act (12 U.S.C. 1851(e)). These include any state
bank that is a member of the Federal Reserve System, any company that
controls an insured depository institution (including a bank holding
company and savings and loan holding company), any company that is
treated as a bank holding company for purposes of section 8 of the
International Banking Act (12 U.S.C. 3106), and any subsidiary of the
foregoing other than a subsidiary for which the OCC, FDIC, CFTC, or SEC
is the primary financial regulatory agency (as defined in section 2(12)
of the Dodd-Frank Wall Street Reform and Consumer Protection Act of
2010 (12 U.S.C. 5301(12)), but do not include such entities to the
extent they are not within the definition of banking entity in Sec.
248.2(c).
(d) Relationship to other authorities. Except as otherwise provided
under section 13 of the BHC Act or this part, and notwithstanding any
other provision of law, the prohibitions and restrictions under section
13 of BHC Act and this part shall apply to the activities of a banking
entity, even if such activities are authorized for the banking entity
under other applicable provisions of law.
(e) Preservation of authority. Nothing in this part limits in any
way the authority of the Board to impose on a banking entity identified
in paragraph (c) of this section additional requirements or
restrictions with respect to any activity, investment, or relationship
covered under section 13 of the Bank Holding Company Act or this part,
or additional penalties for violation of this part provided under any
other applicable provision of law.
Sec. 248.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(c) Banking entity. (1) Except as provided in paragraph (c)(2) of
this section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an insured depository institution;
(iii) Any company that is treated as a bank holding company for
purposes of section 8 of the International Banking Act of 1978 (12
U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any entity described in
paragraphs (c)(1)(i), (ii), or (iii) of this section.
(2) Banking entity does not include:
[[Page 62141]]
(i) A covered fund that is not itself a banking entity under
paragraphs (c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraphs (c)(1)(i), (ii), or (iii) of
this section; or
(iii) The FDIC acting in its corporate capacity or as conservator
or receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(d) Board means the Board of Governors of the Federal Reserve
System.
(e) CFTC means the Commodity Futures Trading Commission.
(f) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(g) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(h) Derivative. (1) Except as provided in paragraph (h)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, guidance, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the immediate family of the
employee.
(j) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(k) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(l) FDIC means the Federal Deposit Insurance Corporation.
(m) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(n) Foreign banking organization has the same meaning as in section
211.21(o) of the Board's Regulation K (12 CFR 211.21(o)), but does not
include a foreign bank, as defined in section 1(b)(7) of the
International Banking Act of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the Commonwealth of Puerto Rico, Guam,
American Samoa, the United States Virgin Islands, or the Commonwealth
of the Northern Mariana Islands.
(o) Foreign insurance regulator means the insurance commissioner,
or a similar official or agency, of any country other than the United
States that is engaged in the supervision of insurance companies under
foreign insurance law.
(p) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(q) Insurance company means a company that is organized as an
insurance company, primarily and predominantly engaged in writing
insurance or reinsuring risks underwritten by insurance companies,
subject to supervision as such by a state insurance regulator or a
foreign insurance regulator, and not operated for the purpose of
evading the provisions of section 13 of the BHC Act (12 U.S.C. 1851).
(r) Insured depository institution, unless otherwise indicated, has
the same meaning as in section 3(c) of the Federal Deposit Insurance
Act (12 U.S.C. 1813(c)), but does not include:
(1) An insured depository institution that is described in section
2(c)(2)(D) of the BHC Act (12 U.S.C. 1841(c)(2)(D)); or
(2) An insured depository institution if it has, and if every
company that controls it has, total consolidated assets of $10 billion
or less and total trading assets and trading liabilities, on a
consolidated basis, that are 5 percent or less of total consolidated
assets.
(s) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(t) Primary financial regulatory agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 5301(12)).
(u) Purchase includes any contract to buy, purchase, or otherwise
acquire. For security futures products, purchase includes any contract,
agreement, or transaction for future delivery. With respect to a
commodity future, purchase includes any contract, agreement, or
transaction for future delivery. With respect to a derivative, purchase
includes the execution, termination (prior to its scheduled maturity
date), assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a derivative, as the
context may require.
(v) Qualifying foreign banking organization means a foreign banking
organization that qualifies as such under section 211.23(a), (c) or (e)
of the Board's Regulation K (12 CFR 211.23(a), (c), or (e)).
(w) SEC means the Securities and Exchange Commission.
(x) Sale and sell each include any contract to sell or otherwise
dispose of. For security futures products, such terms include any
contract, agreement, or transaction for future delivery. With respect
to a commodity future, such terms include any contract, agreement, or
transaction for future delivery. With respect to a derivative, such
terms include the execution, termination (prior to its scheduled
maturity date), assignment, exchange, or similar transfer or conveyance
of, or extinguishing of rights or obligations under, a derivative, as
the context may require.
(y) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(z) Security-based swap dealer has the same meaning as in section
3(a)(71) of the Exchange Act (15 U.S.C. 78c(a)(71)).
(aa) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
[[Page 62142]]
(bb) Separate account means an account established and maintained
by an insurance company in connection with one or more insurance
contracts to hold assets that are legally segregated from the insurance
company's other assets, under which income, gains, and losses, whether
or not realized, from assets allocated to such account, are, in
accordance with the applicable contract, credited to or charged against
such account without regard to other income, gains, or losses of the
insurance company.
(cc) State means any State, the District of Columbia, the
Commonwealth of Puerto Rico, Guam, American Samoa, the United States
Virgin Islands, and the Commonwealth of the Northern Mariana Islands.
(dd) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(ee) State insurance regulator means the insurance commissioner, or
a similar official or agency, of a State that is engaged in the
supervision of insurance companies under State insurance law.
(ff) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
Subpart B--Proprietary Trading
Sec. 248.3 Prohibition on proprietary trading.
(a) Prohibition. Except as otherwise provided in this subpart, a
banking entity may not engage in proprietary trading. Proprietary
trading means engaging as principal for the trading account of the
banking entity in any purchase or sale of one or more financial
instruments.
(b) Definition of trading account. (1) Trading account means any
account that is used by a banking entity to:
(i) Purchase or sell one or more financial instruments principally
for the purpose of:
(A) Short-term resale;
(B) Benefitting from actual or expected short-term price movements;
(C) Realizing short-term arbitrage profits; or
(D) Hedging one or more positions resulting from the purchases or
sales of financial instruments described in paragraphs (b)(1)(i)(A),
(B), or (C) of this section;
(ii) Purchase or sell one or more financial instruments that are
both market risk capital rule covered positions and trading positions
(or hedges of other market risk capital rule covered positions), if the
banking entity, or any affiliate of the banking entity, is an insured
depository institution, bank holding company, or savings and loan
holding company, and calculates risk-based capital ratios under the
market risk capital rule; or
(iii) Purchase or sell one or more financial instruments for any
purpose, if the banking entity:
(A) Is licensed or registered, or is required to be licensed or
registered, to engage in the business of a dealer, swap dealer, or
security-based swap dealer, to the extent the instrument is purchased
or sold in connection with the activities that require the banking
entity to be licensed or registered as such; or
(B) Is engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
the instrument is purchased or sold in connection with the activities
of such business.
(2) Rebuttable presumption for certain purchases and sales. The
purchase (or sale) of a financial instrument by a banking entity shall
be presumed to be for the trading account of the banking entity under
paragraph (b)(1)(i) of this section if the banking entity holds the
financial instrument for fewer than sixty days or substantially
transfers the risk of the financial instrument within sixty days of the
purchase (or sale), unless the banking entity can demonstrate, based on
all relevant facts and circumstances, that the banking entity did not
purchase (or sell) the financial instrument principally for any of the
purposes described in paragraph (b)(1)(i) of this section.
(c) Financial instrument. (1) Financial instrument means:
(i) A security, including an option on a security;
(ii) A derivative, including an option on a derivative; or
(iii) A contract of sale of a commodity for future delivery, or
option on a contract of sale of a commodity for future delivery.
(2) A financial instrument does not include:
(i) A loan;
(ii) A commodity that is not:
(A) An excluded commodity (other than foreign exchange or
currency);
(B) A derivative;
(C) A contract of sale of a commodity for future delivery; or
(D) An option on a contract of sale of a commodity for future
delivery; or
(iii) Foreign exchange or currency.
(d) Proprietary trading. Proprietary trading does not include:
(1) Any purchase or sale of one or more financial instruments by a
banking entity that arises under a repurchase or reverse repurchase
agreement pursuant to which the banking entity has simultaneously
agreed, in writing, to both purchase and sell a stated asset, at stated
prices, and on stated dates or on demand with the same counterparty;
(2) Any purchase or sale of one or more financial instruments by a
banking entity that arises under a transaction in which the banking
entity lends or borrows a security temporarily to or from another party
pursuant to a written securities lending agreement under which the
lender retains the economic interests of an owner of such security, and
has the right to terminate the transaction and to recall the loaned
security on terms agreed by the parties;
(3) Any purchase or sale of a security by a banking entity for the
purpose of liquidity management in accordance with a documented
liquidity management plan of the banking entity that:
(i) Specifically contemplates and authorizes the particular
securities to be used for liquidity management purposes, the amount,
types, and risks of these securities that are consistent with liquidity
management, and the liquidity circumstances in which the particular
securities may or must be used;
(ii) Requires that any purchase or sale of securities contemplated
and authorized by the plan be principally for the purpose of managing
the liquidity of the banking entity, and not for the purpose of short-
term resale, benefitting from actual or expected short-term price
movements, realizing short-term arbitrage profits, or hedging a
position taken for such short-term purposes;
(iii) Requires that any securities purchased or sold for liquidity
management purposes be highly liquid and limited to securities the
market, credit, and other risks of which the banking entity does not
reasonably expect to give rise to appreciable profits or losses as a
result of short-term price movements;
(iv) Limits any securities purchased or sold for liquidity
management purposes, together with any other instruments purchased or
sold for such purposes, to an amount that is consistent with the
banking entity's near-term funding needs, including deviations from
normal operations of the banking entity or any affiliate thereof, as
estimated and documented pursuant to methods specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of securities that are not permitted under Sec. Sec. 248.6(a) or (b)
of this subpart are for the purpose of liquidity management and in
accordance with the liquidity
[[Page 62143]]
management plan described in paragraph (d)(3) of this section; and
(vi) Is consistent with The Board's supervisory requirements,
guidance, and expectations regarding liquidity management;
(4) Any purchase or sale of one or more financial instruments by a
banking entity that is a derivatives clearing organization or a
clearing agency in connection with clearing financial instruments;
(5) Any excluded clearing activities by a banking entity that is a
member of a clearing agency, a member of a derivatives clearing
organization, or a member of a designated financial market utility;
(6) Any purchase or sale of one or more financial instruments by a
banking entity, so long as:
(i) The purchase (or sale) satisfies an existing delivery
obligation of the banking entity or its customers, including to prevent
or close out a failure to deliver, in connection with delivery,
clearing, or settlement activity; or
(ii) The purchase (or sale) satisfies an obligation of the banking
entity in connection with a judicial, administrative, self-regulatory
organization, or arbitration proceeding;
(7) Any purchase or sale of one or more financial instruments by a
banking entity that is acting solely as agent, broker, or custodian;
(8) Any purchase or sale of one or more financial instruments by a
banking entity through a deferred compensation, stock-bonus, profit-
sharing, or pension plan of the banking entity that is established and
administered in accordance with the law of the United States or a
foreign sovereign, if the purchase or sale is made directly or
indirectly by the banking entity as trustee for the benefit of persons
who are or were employees of the banking entity; or
(9) Any purchase or sale of one or more financial instruments by a
banking entity in the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
financial instrument as soon as practicable, and in no event may the
banking entity retain such instrument for longer than such period
permitted by the Board.
(e) Definition of other terms related to proprietary trading. For
purposes of this subpart:
(1) Anonymous means that each party to a purchase or sale is
unaware of the identity of the other party(ies) to the purchase or
sale.
(2) Clearing agency has the same meaning as in section 3(a)(23) of
the Exchange Act (15 U.S.C. 78c(a)(23)).
(3) Commodity has the same meaning as in section 1a(9) of the
Commodity Exchange Act (7 U.S.C. 1a(9)), except that a commodity does
not include any security;
(4) Contract of sale of a commodity for future delivery means a
contract of sale (as that term is defined in section 1a(13) of the
Commodity Exchange Act (7 U.S.C. 1a(13)) for future delivery (as that
term is defined in section 1a(27) of the Commodity Exchange Act (7
U.S.C. 1a(27))).
(5) Derivatives clearing organization means:
(i) A derivatives clearing organization registered under section 5b
of the Commodity Exchange Act (7 U.S.C. 7a-1);
(ii) A derivatives clearing organization that, pursuant to CFTC
regulation, is exempt from the registration requirements under section
5b of the Commodity Exchange Act (7 U.S.C. 7a-1); or
(iii) A foreign derivatives clearing organization that, pursuant to
CFTC regulation, is permitted to clear for a foreign board of trade
that is registered with the CFTC.
(6) Exchange, unless the context otherwise requires, means any
designated contract market, swap execution facility, or foreign board
of trade registered with the CFTC, or, for purposes of securities or
security-based swaps, an exchange, as defined under section 3(a)(1) of
the Exchange Act (15 U.S.C. 78c(a)(1)), or security-based swap
execution facility, as defined under section 3(a)(77) of the Exchange
Act (15 U.S.C. 78c(a)(77)).
(7) Excluded clearing activities means:
(i) With respect to customer transactions cleared on a derivatives
clearing organization, a clearing agency, or a designated financial
market utility, any purchase or sale necessary to correct trading
errors made by or on behalf of a customer provided that such purchase
or sale is conducted in accordance with, for transactions cleared on a
derivatives clearing organization, the Commodity Exchange Act, CFTC
regulations, and the rules or procedures of the derivatives clearing
organization, or, for transactions cleared on a clearing agency, the
rules or procedures of the clearing agency, or, for transactions
cleared on a designated financial market utility that is neither a
derivatives clearing organization nor a clearing agency, the rules or
procedures of the designated financial market utility;
(ii) Any purchase or sale in connection with and related to the
management of a default or threatened imminent default of a customer
provided that such purchase or sale is conducted in accordance with,
for transactions cleared on a derivatives clearing organization, the
Commodity Exchange Act, CFTC regulations, and the rules or procedures
of the derivatives clearing organization, or, for transactions cleared
on a clearing agency, the rules or procedures of the clearing agency,
or, for transactions cleared on a designated financial market utility
that is neither a derivatives clearing organization nor a clearing
agency, the rules or procedures of the designated financial market
utility;
(iii) Any purchase or sale in connection with and related to the
management of a default or threatened imminent default of a member of a
clearing agency, a member of a derivatives clearing organization, or a
member of a designated financial market utility;
(iv) Any purchase or sale in connection with and related to the
management of the default or threatened default of a clearing agency, a
derivatives clearing organization, or a designated financial market
utility; and
(v) Any purchase or sale that is required by the rules or
procedures of a clearing agency, a derivatives clearing organization,
or a designated financial market utility to mitigate the risk to the
clearing agency, derivatives clearing organization, or designated
financial market utility that would result from the clearing by a
member of security-based swaps that reference the member or an
affiliate of the member.
(8) Designated financial market utility has the same meaning as in
section 803(4) of the Dodd-Frank Act (12 U.S.C. 5462(4)).
(9) Issuer has the same meaning as in section 2(a)(4) of the
Securities Act of 1933 (15 U.S.C. 77b(a)(4)).
(10) Market risk capital rule covered position and trading position
means a financial instrument that is both a covered position and a
trading position, as those terms are respectively defined:
(i) In the case of a banking entity that is a bank holding company,
savings and loan holding company, or insured depository institution,
under the market risk capital rule that is applicable to the banking
entity; and
(ii) In the case of a banking entity that is affiliated with a bank
holding company or savings and loan holding company, other than a
banking entity to which a market risk capital rule is applicable, under
the market risk capital rule that is applicable to the affiliated
[[Page 62144]]
bank holding company or savings and loan holding company.
(11) Market risk capital rule means the market risk capital rule
that is contained in subpart F of 12 CFR part 3, 12 CFR parts 208 and
225, or 12 CFR part 324, as applicable.
(12) Municipal security means a security that is a direct
obligation of or issued by, or an obligation guaranteed as to principal
or interest by, a State or any political subdivision thereof, or any
agency or instrumentality of a State or any political subdivision
thereof, or any municipal corporate instrumentality of one or more
States or political subdivisions thereof.
(13) Trading desk means the smallest discrete unit of organization
of a banking entity that purchases or sells financial instruments for
the trading account of the banking entity or an affiliate thereof.
Sec. 248.4 Permitted underwriting and market making-related
activities.
(a) Underwriting activities--(1) Permitted underwriting activities.
The prohibition contained in Sec. 248.3(a) does not apply to a banking
entity's underwriting activities conducted in accordance with this
paragraph (a).
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
and reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity, maturity, and depth of the market for the relevant type
of security;
(iii) The banking entity has established and implements, maintains,
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of paragraph (a) of this section,
including reasonably designed written policies and procedures, internal
controls, analysis and independent testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, based on the nature and amount of
the trading desk's underwriting activities, including the reasonably
expected near term demands of clients, customers, or counterparties, on
the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held;
(C) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(D) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis of the basis for any temporary
or permanent increase to a trading desk's limit(s), and independent
review of such demonstrable analysis and approval;
(iv) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(v) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
(3) Definition of distribution. For purposes of this paragraph (a),
a distribution of securities means:
(i) An offering of securities, whether or not subject to
registration under the Securities Act of 1933, that is distinguished
from ordinary trading transactions by the presence of special selling
efforts and selling methods; or
(ii) An offering of securities made pursuant to an effective
registration statement under the Securities Act of 1933.
(4) Definition of underwriter. For purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an issuer or selling security
holder to:
(A) Purchase securities from the issuer or selling security holder
for distribution;
(B) Engage in a distribution of securities for or on behalf of the
issuer or selling security holder; or
(C) Manage a distribution of securities for or on behalf of the
issuer or selling security holder; or
(ii) A person who has agreed to participate or is participating in
a distribution of such securities for or on behalf of the issuer or
selling security holder.
(5) Definition of selling security holder. For purposes of this
paragraph (a), selling security holder means any person, other than an
issuer, on whose behalf a distribution is made.
(6) Definition of underwriting position. For purposes of this
paragraph (a), underwriting position means the long or short positions
in one or more securities held by a banking entity or its affiliate,
and managed by a particular trading desk, in connection with a
particular distribution of securities for which such banking entity or
affiliate is acting as an underwriter.
(7) Definition of client, customer, and counterparty. For purposes
of this paragraph (a), the terms client, customer, and counterparty, on
a collective or individual basis, refer to market participants that may
transact with the banking entity in connection with a particular
distribution for which the banking entity is acting as underwriter.
(b) Market making-related activities--(1) Permitted market making-
related activities. The prohibition contained in Sec. 248.3(a) does
not apply to a banking entity's market making-related activities
conducted in accordance with this paragraph (b).
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The amount, types, and risks of the financial instruments in
the trading desk's market-maker inventory are designed not to exceed,
on an ongoing basis, the reasonably expected near term demands of
clients, customers, or counterparties, based on:
(A) The liquidity, maturity, and depth of the market for the
relevant types of financial instrument(s); and
(B) Demonstrable analysis of historical customer demand, current
inventory of financial instruments, and market and other factors
regarding the amount, types, and risks, of or associated with financial
instruments in which the trading desk makes a market, including through
block trades;
(iii) The banking entity has established and implements, maintains,
and enforces an internal compliance
[[Page 62145]]
program required by subpart D of this part that is reasonably designed
to ensure the banking entity's compliance with the requirements of
paragraph (b) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and inventory; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, based on the nature and amount of
the trading desk's market making-related activities, that address the
factors prescribed by paragraph (b)(2)(ii) of this section, on:
(1) The amount, types, and risks of its market-maker inventory;
(2) The amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) The level of exposures to relevant risk factors arising from
its financial exposure; and
(4) The period of time a financial instrument may be held;
(D) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(E) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis that the basis for any temporary
or permanent increase to a trading desk's limit(s) is consistent with
the requirements of this paragraph (b), and independent review of such
demonstrable analysis and approval;
(iv) To the extent that any limit identified pursuant to paragraph
(b)(2)(iii)(C) of this section is exceeded, the trading desk takes
action to bring the trading desk into compliance with the limits as
promptly as possible after the limit is exceeded;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (b) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in
activity described in this paragraph (b) in accordance with applicable
law.
(3) Definition of client, customer, and counterparty. For purposes
of paragraph (b) of this section, the terms client, customer, and
counterparty, on a collective or individual basis refer to market
participants that make use of the banking entity's market making-
related services by obtaining such services, responding to quotations,
or entering into a continuing relationship with respect to such
services, provided that:
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with Sec. 248.20(d)(1) of subpart D,
unless:
(A) The trading desk documents how and why a particular trading
desk or other organizational unit of the entity should be treated as a
client, customer, or counterparty of the trading desk for purposes of
paragraph (b)(2) of this section; or
(B) The purchase or sale by the trading desk is conducted
anonymously on an exchange or similar trading facility that permits
trading on behalf of a broad range of market participants.
(4) Definition of financial exposure. For purposes of this
paragraph (b), financial exposure means the aggregate risks of one or
more financial instruments and any associated loans, commodities, or
foreign exchange or currency, held by a banking entity or its affiliate
and managed by a particular trading desk as part of the trading desk's
market making-related activities.
(5) Definition of market-maker inventory. For the purposes of this
paragraph (b), market-maker inventory means all of the positions in the
financial instruments for which the trading desk stands ready to make a
market in accordance with paragraph (b)(2)(i) of this section, that are
managed by the trading desk, including the trading desk's open
positions or exposures arising from open transactions.
Sec. 248.5 Permitted risk-mitigating hedging activities.
(a) Permitted risk-mitigating hedging activities. The prohibition
contained in Sec. 248.3(a) does not apply to the risk-mitigating
hedging activities of a banking entity in connection with and related
to individual or aggregated positions, contracts, or other holdings of
the banking entity and designed to reduce the specific risks to the
banking entity in connection with and related to such positions,
contracts, or other holdings.
(b) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under paragraph (a) of this section only
if:
(1) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(i) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(ii) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(iii) The conduct of analysis, including correlation analysis, and
independent testing designed to ensure that the positions, techniques
and strategies that may be used for hedging may reasonably be expected
to demonstrably reduce or otherwise significantly mitigate the
specific, identifiable risk(s) being hedged, and such correlation
analysis demonstrates that the hedging activity demonstrably reduces or
otherwise significantly mitigates the specific, identifiable risk(s)
being hedged;
(2) The risk-mitigating hedging activity:
(i) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(ii) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate and demonstrably reduces or
otherwise significantly mitigates one or more specific, identifiable
risks, including market risk, counterparty or other credit risk,
currency or foreign exchange risk, interest rate risk, commodity price
risk, basis risk, or similar risks, arising in connection with and
related to identified positions, contracts, or other holdings of the
banking entity, based upon the facts and circumstances of the
identified underlying and hedging
[[Page 62146]]
positions, contracts or other holdings and the risks and liquidity
thereof;
(iii) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(iv) Is subject to continuing review, monitoring and management by
the banking entity that:
(A) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1) of this section;
(B) Is designed to reduce or otherwise significantly mitigate and
demonstrably reduces or otherwise significantly mitigates the specific,
identifiable risks that develop over time from the risk-mitigating
hedging activities undertaken under this section and the underlying
positions, contracts, and other holdings of the banking entity, based
upon the facts and circumstances of the underlying and hedging
positions, contracts and other holdings of the banking entity and the
risks and liquidity thereof; and
(C) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading; and
(3) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(c) Documentation requirement. (1) A banking entity must comply
with the requirements of paragraphs (c)(2) and (3) of this section with
respect to any purchase or sale of financial instruments made in
reliance on this section for risk-mitigating hedging purposes that is:
(i) Not established by the specific trading desk establishing or
responsible for the underlying positions, contracts, or other holdings
the risks of which the hedging activity is designed to reduce;
(ii) Established by the specific trading desk establishing or
responsible for the underlying positions, contracts, or other holdings
the risks of which the purchases or sales are designed to reduce, but
that is effected through a financial instrument, exposure, technique,
or strategy that is not specifically identified in the trading desk's
written policies and procedures established under paragraph (b)(1) of
this section or under Sec. 248.4(b)(2)(iii)(B) of this subpart as a
product, instrument, exposure, technique, or strategy such trading desk
may use for hedging; or
(iii) Established to hedge aggregated positions across two or more
trading desks.
(2) In connection with any purchase or sale identified in paragraph
(c)(1) of this section, a banking entity must, at a minimum, and
contemporaneously with the purchase or sale, document:
(i) The specific, identifiable risk(s) of the identified positions,
contracts, or other holdings of the banking entity that the purchase or
sale is designed to reduce;
(ii) The specific risk-mitigating strategy that the purchase or
sale is designed to fulfill; and
(iii) The trading desk or other business unit that is establishing
and responsible for the hedge.
(3) A banking entity must create and retain records sufficient to
demonstrate compliance with the requirements of this paragraph (c) for
a period that is no less than five years in a form that allows the
banking entity to promptly produce such records to the Board on
request, or such longer period as required under other law or this
part.
Sec. 248.6 Other permitted proprietary trading activities.
(a) Permitted trading in domestic government obligations. The
prohibition contained in Sec. 248.3(a) does not apply to the purchase
or sale by a banking entity of a financial instrument that is:
(1) An obligation of, or issued or guaranteed by, the United
States;
(2) An obligation, participation, or other instrument of, or issued
or guaranteed by, an agency of the United States, the Government
National Mortgage Association, the Federal National Mortgage
Association, the Federal Home Loan Mortgage Corporation, a Federal Home
Loan Bank, the Federal Agricultural Mortgage Corporation or a Farm
Credit System institution chartered under and subject to the provisions
of the Farm Credit Act of 1971 (12 U.S.C. 2001 et seq.);
(3) An obligation of any State or any political subdivision
thereof, including any municipal security; or
(4) An obligation of the FDIC, or any entity formed by or on behalf
of the FDIC for purpose of facilitating the disposal of assets acquired
or held by the FDIC in its corporate capacity or as conservator or
receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(b) Permitted trading in foreign government obligations--(1)
Affiliates of foreign banking entities in the United States. The
prohibition contained in Sec. 248.3(a) does not apply to the purchase
or sale of a financial instrument that is an obligation of, or issued
or guaranteed by, a foreign sovereign (including any multinational
central bank of which the foreign sovereign is a member), or any agency
or political subdivision of such foreign sovereign, by a banking
entity, so long as:
(i) The banking entity is organized under or is directly or
indirectly controlled by a banking entity that is organized under the
laws of a foreign sovereign and is not directly or indirectly
controlled by a top-tier banking entity that is organized under the
laws of the United States;
(ii) The financial instrument is an obligation of, or issued or
guaranteed by, the foreign sovereign under the laws of which the
foreign banking entity referred to in paragraph (b)(1)(i) of this
section is organized (including any multinational central bank of which
the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign; and
(iii) The purchase or sale as principal is not made by an insured
depository institution.
(2) Foreign affiliates of a U.S. banking entity. The prohibition
contained in Sec. 248.3(a) does not apply to the purchase or sale of a
financial instrument that is an obligation of, or issued or guaranteed
by, a foreign sovereign (including any multinational central bank of
which the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign, by a foreign entity that is
owned or controlled by a banking entity organized or established under
the laws of the United States or any State, so long as:
(i) The foreign entity is a foreign bank, as defined in section
211.2(j) of the Board's Regulation K (12 CFR 211.2(j)), or is regulated
by the foreign sovereign as a securities dealer;
(ii) The financial instrument is an obligation of, or issued or
guaranteed by, the foreign sovereign under the laws of which the
foreign entity is organized (including any multinational central bank
of which the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign; and
(iii) The financial instrument is owned by the foreign entity and
is not financed by an affiliate that is located in the United States or
organized under the laws of the United States or of any State.
(c) Permitted trading on behalf of customers--(1) Fiduciary
transactions. The prohibition contained in Sec. 248.3(a) does not
apply to the purchase or sale of financial instruments by a banking
[[Page 62147]]
entity acting as trustee or in a similar fiduciary capacity, so long
as:
(i) The transaction is conducted for the account of, or on behalf
of, a customer; and
(ii) The banking entity does not have or retain beneficial
ownership of the financial instruments.
(2) Riskless principal transactions. The prohibition contained in
Sec. 248.3(a) does not apply to the purchase or sale of financial
instruments by a banking entity acting as riskless principal in a
transaction in which the banking entity, after receiving an order to
purchase (or sell) a financial instrument from a customer, purchases
(or sells) the financial instrument for its own account to offset a
contemporaneous sale to (or purchase from) the customer.
(d) Permitted trading by a regulated insurance company. The
prohibition contained in Sec. 248.3(a) does not apply to the purchase
or sale of financial instruments by a banking entity that is an
insurance company or an affiliate of an insurance company if:
(1) The insurance company or its affiliate purchases or sells the
financial instruments solely for:
(i) The general account of the insurance company; or
(ii) A separate account established by the insurance company;
(2) The purchase or sale is conducted in compliance with, and
subject to, the insurance company investment laws, regulations, and
written guidance of the State or jurisdiction in which such insurance
company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law, regulation, or written guidance described in
paragraph (d)(2) of this section is insufficient to protect the safety
and soundness of the covered banking entity, or the financial stability
of the United States.
(e) Permitted trading activities of foreign banking entities. (1)
The prohibition contained in Sec. 248.3(a) does not apply to the
purchase or sale of financial instruments by a banking entity if:
(i) The banking entity is not organized or directly or indirectly
controlled by a banking entity that is organized under the laws of the
United States or of any State;
(ii) The purchase or sale by the banking entity is made pursuant to
paragraph (9) or (13) of section 4(c) of the BHC Act; and
(iii) The purchase or sale meets the requirements of paragraph
(e)(3) of this section.
(2) A purchase or sale of financial instruments by a banking entity
is made pursuant to paragraph (9) or (13) of section 4(c) of the BHC
Act for purposes of paragraph (e)(1)(ii) of this section only if:
(i) The purchase or sale is conducted in accordance with the
requirements of paragraph (e) of this section; and
(ii)(A) With respect to a banking entity that is a foreign banking
organization, the banking entity meets the qualifying foreign banking
organization requirements of section 211.23(a), (c) or (e) of the
Board's Regulation K (12 CFR 211.23(a), (c) or (e)), as applicable; or
(B) With respect to a banking entity that is not a foreign banking
organization, the banking entity is not organized under the laws of the
United States or of any State and the banking entity, on a fully-
consolidated basis, meets at least two of the following requirements:
(1) Total assets of the banking entity held outside of the United
States exceed total assets of the banking entity held in the United
States;
(2) Total revenues derived from the business of the banking entity
outside of the United States exceed total revenues derived from the
business of the banking entity in the United States; or
(3) Total net income derived from the business of the banking
entity outside of the United States exceeds total net income derived
from the business of the banking entity in the United States.
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including any personnel of the banking entity or its affiliate
that arrange, negotiate or execute such purchase or sale) is not
located in the United States or organized under the laws of the United
States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State;
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State;
(iv) No financing for the banking entity's purchases or sales is
provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State; and
(v) The purchase or sale is not conducted with or through any U.S.
entity, other than:
(A) A purchase or sale with the foreign operations of a U.S. entity
if no personnel of such U.S. entity that are located in the United
States are involved in the arrangement, negotiation, or execution of
such purchase or sale;
(B) A purchase or sale with an unaffiliated market intermediary
acting as principal, provided the purchase or sale is promptly cleared
and settled through a clearing agency or derivatives clearing
organization acting as a central counterparty; or
(C) A purchase or sale through an unaffiliated market intermediary
acting as agent, provided the purchase or sale is conducted anonymously
on an exchange or similar trading facility and is promptly cleared and
settled through a clearing agency or derivatives clearing organization
acting as a central counterparty.
(4) For purposes of this paragraph (e), a U.S. entity is any entity
that is, or is controlled by, or is acting on behalf of, or at the
direction of, any other entity that is, located in the United States or
organized under the laws of the United States or of any State.
(5) For purposes of this paragraph (e), a U.S. branch, agency, or
subsidiary of a foreign banking entity is considered to be located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(6) For purposes of this paragraph (e), unaffiliated market
intermediary means an unaffiliated entity, acting as an intermediary,
that is:
(i) A broker or dealer registered with the SEC under section 15 of
the Exchange Act or exempt from registration or excluded from
regulation as such;
(ii) A swap dealer registered with the CFTC under section 4s of the
Commodity Exchange Act or exempt from registration or excluded from
regulation as such;
(iii) A security-based swap dealer registered with the SEC under
section 15F of the Exchange Act or exempt from registration or excluded
from regulation as such; or
[[Page 62148]]
(iv) A futures commission merchant registered with the CFTC under
section 4f of the Commodity Exchange Act or exempt from registration or
excluded from regulation as such.
Sec. 248.7 Limitations on permitted proprietary trading activities.
(a) No transaction, class of transactions, or activity may be
deemed permissible under Sec. Sec. 248.4 through 248.6 if the
transaction, class of transactions, or activity would:
(1) Involve or result in a material conflict of interest between
the banking entity and its clients, customers, or counterparties;
(2) Result, directly or indirectly, in a material exposure by the
banking entity to a high-risk asset or a high-risk trading strategy; or
(3) Pose a threat to the safety and soundness of the banking entity
or to the financial stability of the United States.
(b) Definition of material conflict of interest. (1) For purposes
of this section, a material conflict of interest between a banking
entity and its clients, customers, or counterparties exists if the
banking entity engages in any transaction, class of transactions, or
activity that would involve or result in the banking entity's interests
being materially adverse to the interests of its client, customer, or
counterparty with respect to such transaction, class of transactions,
or activity, and the banking entity has not taken at least one of the
actions in paragraph (b)(2) of this section.
(2) Prior to effecting the specific transaction or class or type of
transactions, or engaging in the specific activity, the banking entity:
(i) Timely and effective disclosure. (A) Has made clear, timely,
and effective disclosure of the conflict of interest, together with
other necessary information, in reasonable detail and in a manner
sufficient to permit a reasonable client, customer, or counterparty to
meaningfully understand the conflict of interest; and
(B) Such disclosure is made in a manner that provides the client,
customer, or counterparty the opportunity to negate, or substantially
mitigate, any materially adverse effect on the client, customer, or
counterparty created by the conflict of interest; or
(ii) Information barriers. Has established, maintained, and
enforced information barriers that are memorialized in written policies
and procedures, such as physical separation of personnel, or functions,
or limitations on types of activity, that are reasonably designed,
taking into consideration the nature of the banking entity's business,
to prevent the conflict of interest from involving or resulting in a
materially adverse effect on a client, customer, or counterparty. A
banking entity may not rely on such information barriers if, in the
case of any specific transaction, class or type of transactions or
activity, the banking entity knows or should reasonably know that,
notwithstanding the banking entity's establishment of information
barriers, the conflict of interest may involve or result in a
materially adverse effect on a client, customer, or counterparty.
(c) Definition of high-risk asset and high-risk trading strategy.
For purposes of this section:
(1) High-risk asset means an asset or group of related assets that
would, if held by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
(2) High-risk trading strategy means a trading strategy that would,
if engaged in by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
Sec. Sec. 248.8-248.9 [Reserved]
Subpart C--Covered Funds Activities and Investments
Sec. 248.10 Prohibition on acquiring or retaining an ownership
interest in and having certain relationships with a covered fund.
(a) Prohibition. (1) Except as otherwise provided in this subpart,
a banking entity may not, as principal, directly or indirectly, acquire
or retain any ownership interest in or sponsor a covered fund.
(2) Paragraph (a)(1) of this section does not include acquiring or
retaining an ownership interest in a covered fund by a banking entity:
(i) Acting solely as agent, broker, or custodian, so long as;
(A) The activity is conducted for the account of, or on behalf of,
a customer; and
(B) The banking entity and its affiliates do not have or retain
beneficial ownership of such ownership interest;
(ii) Through a deferred compensation, stock-bonus, profit-sharing,
or pension plan of the banking entity (or an affiliate thereof) that is
established and administered in accordance with the law of the United
States or a foreign sovereign, if the ownership interest is held or
controlled directly or indirectly by the banking entity as trustee for
the benefit of persons who are or were employees of the banking entity
(or an affiliate thereof);
(iii) In the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
ownership interest as soon as practicable, and in no event may the
banking entity retain such ownership interest for longer than such
period permitted by the Board; or
(iv) On behalf of customers as trustee or in a similar fiduciary
capacity for a customer that is not a covered fund, so long as:
(A) The activity is conducted for the account of, or on behalf of,
the customer; and
(B) The banking entity and its affiliates do not have or retain
beneficial ownership of such ownership interest.
(b) Definition of covered fund. (1) Except as provided in paragraph
(c) of this section, covered fund means:
(i) An issuer that would be an investment company, as defined in
the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.), but for
section 3(c)(1) or 3(c)(7) of that Act (15 U.S.C. 80a-3(c)(1) or (7));
(ii) Any commodity pool under section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10)) for which:
(A) The commodity pool operator has claimed an exemption under 17
CFR 4.7; or
(B)(1) A commodity pool operator is registered with the CFTC as a
commodity pool operator in connection with the operation of the
commodity pool;
(2) Substantially all participation units of the commodity pool are
owned by qualified eligible persons under 17 CFR 4.7(a)(2) and (3); and
(3) Participation units of the commodity pool have not been
publicly offered to persons who are not qualified eligible persons
under 17 CFR 4.7(a)(2) and (3); or
(iii) For any banking entity that is, or is controlled directly or
indirectly by a banking entity that is, located in or organized under
the laws of the United States or of any State, an entity that:
(A) Is organized or established outside the United States and the
ownership interests of which are offered and sold solely outside the
United States;
(B) Is, or holds itself out as being, an entity or arrangement that
raises money from investors primarily for the purpose of investing in
securities for resale or other disposition or otherwise trading in
securities; and
(C)(1) Has as its sponsor that banking entity (or an affiliate
thereof); or
[[Page 62149]]
(2) Has issued an ownership interest that is owned directly or
indirectly by that banking entity (or an affiliate thereof).
(2) An issuer shall not be deemed to be a covered fund under
paragraph (b)(1)(iii) of this section if, were the issuer subject to
U.S. securities laws, the issuer could rely on an exclusion or
exemption from the definition of ``investment company'' under the
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) other than the
exclusions contained in section 3(c)(1) and 3(c)(7) of that Act.
(3) For purposes of paragraph (b)(1)(iii) of this section, a U.S.
branch, agency, or subsidiary of a foreign banking entity is located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(c) Notwithstanding paragraph (b) of this section, unless the
appropriate Federal banking agencies, the SEC, and the CFTC jointly
determine otherwise, a covered fund does not include:
(1) Foreign public funds. (i) Subject to paragraphs (ii) and (iii)
below, an issuer that:
(A) Is organized or established outside of the United States;
(B) Is authorized to offer and sell ownership interests to retail
investors in the issuer's home jurisdiction; and
(C) Sells ownership interests predominantly through one or more
public offerings outside of the United States.
(ii) With respect to a banking entity that is, or is controlled
directly or indirectly by a banking entity that is, located in or
organized under the laws of the United States or of any State and any
issuer for which such banking entity acts as sponsor, the sponsoring
banking entity may not rely on the exemption in paragraph (c)(1)(i) of
this section for such issuer unless ownership interests in the issuer
are sold predominantly to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring banking entity or such issuer;
and
(D) Directors and employees of such entities.
(iii) For purposes of paragraph (c)(1)(i)(C) of this section, the
term ``public offering'' means a distribution (as defined in Sec.
248.4(a)(3) of subpart B) of securities in any jurisdiction outside the
United States to investors, including retail investors, provided that:
(A) The distribution complies with all applicable requirements in
the jurisdiction in which such distribution is being made;
(B) The distribution does not restrict availability to investors
having a minimum level of net worth or net investment assets; and
(C) The issuer has filed or submitted, with the appropriate
regulatory authority in such jurisdiction, offering disclosure
documents that are publicly available.
(2) Wholly-owned subsidiaries. An entity, all of the outstanding
ownership interests of which are owned directly or indirectly by the
banking entity (or an affiliate thereof), except that:
(i) Up to five percent of the entity's outstanding ownership
interests, less any amounts outstanding under paragraph (c)(2)(ii) of
this section, may be held by employees or directors of the banking
entity or such affiliate (including former employees or directors if
their ownership interest was acquired while employed by or in the
service of the banking entity); and
(ii) Up to 0.5 percent of the entity's outstanding ownership
interests may be held by a third party if the ownership interest is
acquired or retained by the third party for the purpose of establishing
corporate separateness or addressing bankruptcy, insolvency, or similar
concerns.
(3) Joint ventures. A joint venture between a banking entity or any
of its affiliates and one or more unaffiliated persons, provided that
the joint venture:
(i) Is comprised of no more than 10 unaffiliated co-venturers;
(ii) Is in the business of engaging in activities that are
permissible for the banking entity or affiliate, other than investing
in securities for resale or other disposition; and
(iii) Is not, and does not hold itself out as being, an entity or
arrangement that raises money from investors primarily for the purpose
of investing in securities for resale or other disposition or otherwise
trading in securities.
(4) Acquisition vehicles. An issuer:
(i) Formed solely for the purpose of engaging in a bona fide merger
or acquisition transaction; and
(ii) That exists only for such period as necessary to effectuate
the transaction.
(5) Foreign pension or retirement funds. A plan, fund, or program
providing pension, retirement, or similar benefits that is:
(i) Organized and administered outside the United States;
(ii) A broad-based plan for employees or citizens that is subject
to regulation as a pension, retirement, or similar plan under the laws
of the jurisdiction in which the plan, fund, or program is organized
and administered; and
(iii) Established for the benefit of citizens or residents of one
or more foreign sovereigns or any political subdivision thereof.
(6) Insurance company separate accounts. A separate account,
provided that no banking entity other than the insurance company
participates in the account's profits and losses.
(7) Bank owned life insurance. A separate account that is used
solely for the purpose of allowing one or more banking entities to
purchase a life insurance policy for which the banking entity or
entities is beneficiary, provided that no banking entity that purchases
the policy:
(i) Controls the investment decisions regarding the underlying
assets or holdings of the separate account; or
(ii) Participates in the profits and losses of the separate account
other than in compliance with applicable supervisory guidance regarding
bank owned life insurance.
(8) Loan securitizations--(i) Scope. An issuing entity for asset-
backed securities that satisfies all the conditions of this paragraph
(c)(8) and the assets or holdings of which are comprised solely of:
(A) Loans as defined in Sec. 248.2(s) of subpart A;
(B) Rights or other assets designed to assure the servicing or
timely distribution of proceeds to holders of such securities and
rights or other assets that are related or incidental to purchasing or
otherwise acquiring and holding the loans, provided that each asset
meets the requirements of paragraph (c)(8)(iii) of this section;
(C) Interest rate or foreign exchange derivatives that meet the
requirements of paragraph (c)(8)(iv) of this section; and
(D) Special units of beneficial interest and collateral
certificates that meet the requirements of paragraph (c)(8)(v) of this
section.
(ii) Impermissible assets. For purposes of this paragraph (c)(8),
the assets or holdings of the issuing entity shall not include any of
the following:
(A) A security, including an asset-backed security, or an interest
in an equity or debt security other than as permitted in paragraph
(c)(8)(iii) of this section;
(B) A derivative, other than a derivative that meets the
requirements of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities. Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may hold securities if those
securities are:
[[Page 62150]]
(A) Cash equivalents for purposes of the rights and assets in
paragraph (c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts previously contracted with
respect to the loans supporting the asset-backed securities.
(iv) Derivatives. The holdings of derivatives by the issuing entity
shall be limited to interest rate or foreign exchange derivatives that
satisfy all of the following conditions:
(A) The written terms of the derivative directly relate to the
loans, the asset-backed securities, or the contractual rights of other
assets described in paragraph (c)(8)(i)(B) of this section; and
(B) The derivatives reduce the interest rate and/or foreign
exchange risks related to the loans, the asset-backed securities, or
the contractual rights or other assets described in paragraph
(c)(8)(i)(B) of this section.
(v) Special units of beneficial interest and collateral
certificates. The assets or holdings of the issuing entity may include
collateral certificates and special units of beneficial interest issued
by a special purpose vehicle, provided that:
(A) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate meets the requirements in
this paragraph (c)(8);
(B) The special unit of beneficial interest or collateral
certificate is used for the sole purpose of transferring to the issuing
entity for the loan securitization the economic risks and benefits of
the assets that are permissible for loan securitizations under this
paragraph (c)(8) and does not directly or indirectly transfer any
interest in any other economic or financial exposure;
(C) The special unit of beneficial interest or collateral
certificate is created solely to satisfy legal requirements or
otherwise facilitate the structuring of the loan securitization; and
(D) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate and the issuing entity
are established under the direction of the same entity that initiated
the loan securitization.
(9) Qualifying asset-backed commercial paper conduits. (i) An
issuing entity for asset-backed commercial paper that satisfies all of
the following requirements:
(A) The asset-backed commercial paper conduit holds only:
(1) Loans and other assets permissible for a loan securitization
under paragraph (c)(8)(i) of this section; and
(2) Asset-backed securities supported solely by assets that are
permissible for loan securitizations under paragraph (c)(8)(i) of this
section and acquired by the asset-backed commercial paper conduit as
part of an initial issuance either directly from the issuing entity of
the asset-backed securities or directly from an underwriter in the
distribution of the asset-backed securities;
(B) The asset-backed commercial paper conduit issues only asset-
backed securities, comprised of a residual interest and securities with
a legal maturity of 397 days or less; and
(C) A regulated liquidity provider has entered into a legally
binding commitment to provide full and unconditional liquidity coverage
with respect to all of the outstanding asset-backed securities issued
by the asset-backed commercial paper conduit (other than any residual
interest) in the event that funds are required to redeem maturing
asset-backed securities.
(ii) For purposes of this paragraph (c)(9), a regulated liquidity
provider means:
(A) A depository institution, as defined in section 3(c) of the
Federal Deposit Insurance Act (12 U.S.C. 1813(c));
(B) A bank holding company, as defined in section 2(a) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(a)), or a subsidiary
thereof;
(C) A savings and loan holding company, as defined in section 10a
of the Home Owners' Loan Act (12 U.S.C. 1467a), provided all or
substantially all of the holding company's activities are permissible
for a financial holding company under section 4(k) of the Bank Holding
Company Act of 1956 (12 U.S.C. 1843(k)), or a subsidiary thereof;
(D) A foreign bank whose home country supervisor, as defined in
Sec. 211.21(q) of the Board's Regulation K (12 CFR 211.21(q)), has
adopted capital standards consistent with the Capital Accord for the
Basel Committee on banking Supervision, as amended, and that is subject
to such standards, or a subsidiary thereof; or
(E) The United States or a foreign sovereign.
(10) Qualifying covered bonds--(i) Scope. An entity owning or
holding a dynamic or fixed pool of loans or other assets as provided in
paragraph (c)(8) of this section for the benefit of the holders of
covered bonds, provided that the assets in the pool are comprised
solely of assets that meet the conditions in paragraph (c)(8)(i) of
this section.
(ii) Covered bond. For purposes of this paragraph (c)(10), a
covered bond means:
(A) A debt obligation issued by an entity that meets the definition
of foreign banking organization, the payment obligations of which are
fully and unconditionally guaranteed by an entity that meets the
conditions set forth in paragraph (c)(10)(i) of this section; or
(B) A debt obligation of an entity that meets the conditions set
forth in paragraph (c)(10)(i) of this section, provided that the
payment obligations are fully and unconditionally guaranteed by an
entity that meets the definition of foreign banking organization and
the entity is a wholly-owned subsidiary, as defined in paragraph (c)(2)
of this section, of such foreign banking organization.
(11) SBICs and public welfare investment funds. An issuer:
(i) That is a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), or that has received from the Small Business Administration
notice to proceed to qualify for a license as a small business
investment company, which notice or license has not been revoked; or
(ii) The business of which is to make investments that are:
(A) Designed primarily to promote the public welfare, of the type
permitted under paragraph (11) of section 5136 of the Revised Statutes
of the United States (12 U.S.C. 24), including the welfare of low- and
moderate-income communities or families (such as providing housing,
services, or jobs); or
(B) Qualified rehabilitation expenditures with respect to a
qualified rehabilitated building or certified historic structure, as
such terms are defined in section 47 of the Internal Revenue Code of
1986 or a similar State historic tax credit program.
(12) Registered investment companies and excluded entities. An
issuer:
(i) That is registered as an investment company under section 8 of
the Investment Company Act of 1940 (15 U.S.C. 80a-8), or that is formed
and operated pursuant to a written plan to become a registered
investment company as described in Sec. 248.20(e)(3) of subpart D and
that complies with the requirements of section 18 of the Investment
Company Act of 1940 (15 U.S.C. 80a-18);
(ii) That may rely on an exclusion or exemption from the definition
of ``investment company'' under the Investment Company Act of 1940 (15
U.S.C. 80a-1 et seq.) other than the exclusions contained in section
3(c)(1) and 3(c)(7) of that Act; or
(iii) That has elected to be regulated as a business development
company pursuant to section 54(a) of that Act (15
[[Page 62151]]
U.S.C. 80a-53) and has not withdrawn its election, or that is formed
and operated pursuant to a written plan to become a business
development company as described in Sec. 248.20(e)(3) of subpart D and
that complies with the requirements of section 61 of the Investment
Company Act of 1940 (15 U.S.C. 80a-60).
(13) Issuers in conjunction with the FDIC's receivership or
conservatorship operations. An issuer that is an entity formed by or on
behalf of the FDIC for the purpose of facilitating the disposal of
assets acquired in the FDIC's capacity as conservator or receiver under
the Federal Deposit Insurance Act or Title II of the Dodd-Frank Wall
Street Reform and Consumer Protection Act.
(14) Other excluded issuers. (i) Any issuer that the appropriate
Federal banking agencies, the SEC, and the CFTC jointly determine the
exclusion of which is consistent with the purposes of section 13 of the
BHC Act.
(ii) A determination made under paragraph (c)(14)(i) of this
section will be promptly made public.
(d) Definition of other terms related to covered funds. For
purposes of this subpart:
(1) Applicable accounting standards means U.S. generally accepted
accounting principles, or such other accounting standards applicable to
a banking entity that the Board determines are appropriate and that the
banking entity uses in the ordinary course of its business in preparing
its consolidated financial statements.
(2) Asset-backed security has the meaning specified in Section
3(a)(79) of the Exchange Act (15 U.S.C. 78c(a)(79)).
(3) Director has the same meaning as provided in section
215.2(d)(1) of the Board's Regulation O (12 CFR 215.2(d)(1)).
(4) Issuer has the same meaning as in section 2(a)(22) of the
Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(22)).
(5) Issuing entity means with respect to asset-backed securities
the special purpose vehicle that owns or holds the pool assets
underlying asset-backed securities and in whose name the asset-backed
securities supported or serviced by the pool assets are issued.
(6) Ownership interest--(i) Ownership interest means any equity,
partnership, or other similar interest. An ``other similar interest''
means an interest that:
(A) Has the right to participate in the selection or removal of a
general partner, managing member, member of the board of directors or
trustees, investment manager, investment adviser, or commodity trading
advisor of the covered fund (excluding the rights of a creditor to
exercise remedies upon the occurrence of an event of default or an
acceleration event);
(B) Has the right under the terms of the interest to receive a
share of the income, gains or profits of the covered fund;
(C) Has the right to receive the underlying assets of the covered
fund after all other interests have been redeemed and/or paid in full
(excluding the rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event);
(D) Has the right to receive all or a portion of excess spread (the
positive difference, if any, between the aggregate interest payments
received from the underlying assets of the covered fund and the
aggregate interest paid to the holders of other outstanding interests);
(E) Provides under the terms of the interest that the amounts
payable by the covered fund with respect to the interest could be
reduced based on losses arising from the underlying assets of the
covered fund, such as allocation of losses, write-downs or charge-offs
of the outstanding principal balance, or reductions in the amount of
interest due and payable on the interest;
(F) Receives income on a pass-through basis from the covered fund,
or has a rate of return that is determined by reference to the
performance of the underlying assets of the covered fund; or
(G) Any synthetic right to have, receive, or be allocated any of
the rights in paragraphs (d)(6)(i)(A) through (F) of this section.
(ii) Ownership interest does not include: Restricted profit
interest. An interest held by an entity (or an employee or former
employee thereof) in a covered fund for which the entity (or employee
thereof) serves as investment manager, investment adviser, commodity
trading advisor, or other service provider so long as:
(A) The sole purpose and effect of the interest is to allow the
entity (or employee or former employee thereof) to share in the profits
of the covered fund as performance compensation for the investment
management, investment advisory, commodity trading advisory, or other
services provided to the covered fund by the entity (or employee or
former employee thereof), provided that the entity (or employee or
former employee thereof) may be obligated under the terms of such
interest to return profits previously received;
(B) All such profit, once allocated, is distributed to the entity
(or employee or former employee thereof) promptly after being earned
or, if not so distributed, is retained by the covered fund for the sole
purpose of establishing a reserve amount to satisfy contractual
obligations with respect to subsequent losses of the covered fund and
such undistributed profit of the entity (or employee or former employee
thereof) does not share in the subsequent investment gains of the
covered fund;
(C) Any amounts invested in the covered fund, including any amounts
paid by the entity (or employee or former employee thereof) in
connection with obtaining the restricted profit interest, are within
the limits of Sec. 248.12 of this subpart; and
(D) The interest is not transferable by the entity (or employee or
former employee thereof) except to an affiliate thereof (or an employee
of the banking entity or affiliate), to immediate family members, or
through the intestacy, of the employee or former employee, or in
connection with a sale of the business that gave rise to the restricted
profit interest by the entity (or employee or former employee thereof)
to an unaffiliated party that provides investment management,
investment advisory, commodity trading advisory, or other services to
the fund.
(7) Prime brokerage transaction means any transaction that would be
a covered transaction, as defined in section 23A(b)(7) of the Federal
Reserve Act (12 U.S.C. 371c(b)(7)), that is provided in connection with
custody, clearance and settlement, securities borrowing or lending
services, trade execution, financing, or data, operational, and
administrative support.
(8) Resident of the United States means a person that is a ``U.S.
person'' as defined in rule 902(k) of the SEC's Regulation S (17 CFR
230.902(k)).
(9) Sponsor means, with respect to a covered fund:
(i) To serve as a general partner, managing member, or trustee of a
covered fund, or to serve as a commodity pool operator with respect to
a covered fund as defined in (b)(1)(ii) of this section;
(ii) In any manner to select or to control (or to have employees,
officers, or directors, or agents who constitute) a majority of the
directors, trustees, or management of a covered fund; or
(iii) To share with a covered fund, for corporate, marketing,
promotional, or other purposes, the same name or a variation of the
same name, except as permitted under Sec. 248.11(a)(6).
(10) Trustee. (i) For purposes of paragraph (d)(9) of this section
and Sec. 248.11 of subpart C, a trustee does not include:
(A) A trustee that does not exercise investment discretion with
respect to a
[[Page 62152]]
covered fund, including a trustee that is subject to the direction of
an unaffiliated named fiduciary who is not a trustee pursuant to
section 403(a)(1) of the Employee's Retirement Income Security Act (29
U.S.C. 1103(a)(1)); or
(B) A trustee that is subject to fiduciary standards imposed under
foreign law that are substantially equivalent to those described in
paragraph (d)(10)(i)(A) of this section;
(ii) Any entity that directs a person described in paragraph
(d)(10)(i) of this section, or that possesses authority and discretion
to manage and control the investment decisions of a covered fund for
which such person serves as trustee, shall be considered to be a
trustee of such covered fund.
Sec. 248.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
(a) Organizing and offering a covered fund in general.
Notwithstanding Sec. 248.10(a) of this subpart, a banking entity is
not prohibited from acquiring or retaining an ownership interest in, or
acting as sponsor to, a covered fund in connection with, directly or
indirectly, organizing and offering a covered fund, including serving
as a general partner, managing member, trustee, or commodity pool
operator of the covered fund and in any manner selecting or controlling
(or having employees, officers, directors, or agents who constitute) a
majority of the directors, trustees, or management of the covered fund,
including any necessary expenses for the foregoing, only if:
(1) The banking entity (or an affiliate thereof) provides bona fide
trust, fiduciary, investment advisory, or commodity trading advisory
services;
(2) The covered fund is organized and offered only in connection
with the provision of bona fide trust, fiduciary, investment advisory,
or commodity trading advisory services and only to persons that are
customers of such services of the banking entity (or an affiliate
thereof), pursuant to a written plan or similar documentation outlining
how the banking entity or such affiliate intends to provide advisory or
similar services to its customers through organizing and offering such
fund;
(3) The banking entity and its affiliates do not acquire or retain
an ownership interest in the covered fund except as permitted under
Sec. 248.12 of this subpart;
(4) The banking entity and its affiliates comply with the
requirements of Sec. 248.14 of this subpart;
(5) The banking entity and its affiliates do not, directly or
indirectly, guarantee, assume, or otherwise insure the obligations or
performance of the covered fund or of any covered fund in which such
covered fund invests;
(6) The covered fund, for corporate, marketing, promotional, or
other purposes:
(i) Does not share the same name or a variation of the same name
with the banking entity (or an affiliate thereof) except that a covered
fund may share the same name or a variation of the same name with a
banking entity that is an investment adviser to the covered fund if:
(A) The investment adviser is not an insured depository
institution, a company that controls an insured depository institution,
or a company that is treated as a bank holding company for purposes of
section 8 of the International Banking Act of 1978 (12 U.S.C. 3106);
and
(B) The investment adviser does not share the same name or a
variation of the same name as an insured depository institution, a
company that controls an insured depository institution, or a company
that is treated as a bank holding company for purposes of section 8 of
the International Banking Act of 1978 (12 U.S.C. 3106); and
(ii) Does not use the word ``bank'' in its name;
(7) No director or employee of the banking entity (or an affiliate
thereof) takes or retains an ownership interest in the covered fund,
except for any director or employee of the banking entity or such
affiliate who is directly engaged in providing investment advisory,
commodity trading advisory, or other services to the covered fund at
the time the director or employee takes the ownership interest; and
(8) The banking entity:
(i) Clearly and conspicuously discloses, in writing, to any
prospective and actual investor in the covered fund (such as through
disclosure in the covered fund's offering documents):
(A) That ``any losses in [such covered fund] will be borne solely
by investors in [the covered fund] and not by [the banking entity] or
its affiliates; therefore, [the banking entity's] losses in [such
covered fund] will be limited to losses attributable to the ownership
interests in the covered fund held by [the banking entity] and any
affiliate in its capacity as investor in the [covered fund] or as
beneficiary of a restricted profit interest held by [the banking
entity] or any affiliate'';
(B) That such investor should read the fund offering documents
before investing in the covered fund;
(C) That the ``ownership interests in the covered fund are not
insured by the FDIC, and are not deposits, obligations of, or endorsed
or guaranteed in any way, by any banking entity'' (unless that happens
to be the case); and
(D) The role of the banking entity and its affiliates and employees
in sponsoring or providing any services to the covered fund; and
(ii) Complies with any additional rules of the appropriate Federal
banking agencies, the SEC, or the CFTC, as provided in section 13(b)(2)
of the BHC Act, designed to ensure that losses in such covered fund are
borne solely by investors in the covered fund and not by the covered
banking entity and its affiliates.
(b) Organizing and offering an issuing entity of asset-backed
securities. (1) Notwithstanding Sec. 248.10(a) of this subpart, a
banking entity is not prohibited from acquiring or retaining an
ownership interest in, or acting as sponsor to, a covered fund that is
an issuing entity of asset-backed securities in connection with,
directly or indirectly, organizing and offering that issuing entity, so
long as the banking entity and its affiliates comply with all of the
requirements of paragraph (a)(3) through (8) of this section.
(2) For purposes of this paragraph (b), organizing and offering a
covered fund that is an issuing entity of asset-backed securities means
acting as the securitizer, as that term is used in section 15G(a)(3) of
the Exchange Act (15 U.S.C. 78o-11(a)(3)) of the issuing entity, or
acquiring or retaining an ownership interest in the issuing entity as
required by section 15G of that Act (15 U.S.C. 78o-11) and the
implementing regulations issued thereunder.
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 248.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 248.4(a) or Sec. 248.4(b) of subpart B,
respectively;
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in
[[Page 62153]]
such covered fund in compliance with section 15G of that Act (15 U.S.C.
78o-11) and the implementing regulations issued thereunder each as
permitted by paragraph (b) of this section; or, directly or indirectly,
guarantees, assumes, or otherwise insures the obligations or
performance of the covered fund or of any covered fund in which such
fund invests, then in each such case any ownership interests acquired
or retained by the banking entity and its affiliates in connection with
underwriting and market making related activities for that particular
covered fund are included in the calculation of ownership interests
permitted to be held by the banking entity and its affiliates under the
limitations of Sec. 248.12(a)(2)(ii) and Sec. 248.12(d) of this
subpart; and
(3) With respect to any banking entity, the aggregate value of all
ownership interests of the banking entity and its affiliates in all
covered funds acquired and retained under Sec. 248.11 of this subpart,
including all covered funds in which the banking entity holds an
ownership interest in connection with underwriting and market making
related activities permitted under this paragraph (c), are included in
the calculation of all ownership interests under Sec.
248.12(a)(2)(iii) and Sec. 248.12(d) of this subpart.
Sec. 248.12 Permitted investment in a covered fund.
(a) Authority and limitations on permitted investments in covered
funds. (1) Notwithstanding the prohibition contained in Sec. 248.10(a)
of this subpart, a banking entity may acquire and retain an ownership
interest in a covered fund that the banking entity or an affiliate
thereof organizes and offers pursuant to Sec. 248.11, for the purposes
of:
(i) Establishment. Establishing the fund and providing the fund
with sufficient initial equity for investment to permit the fund to
attract unaffiliated investors, subject to the limits contained in
paragraphs (a)(2)(i) and (iii) of this section; or
(ii) De minimis investment. Making and retaining an investment in
the covered fund subject to the limits contained in paragraphs
(a)(2)(ii) and (iii) of this section.
(2) Investment limits--(i) Seeding period. With respect to an
investment in any covered fund made or held pursuant to paragraph
(a)(1)(i) of this section, the banking entity and its affiliates:
(A) Must actively seek unaffiliated investors to reduce, through
redemption, sale, dilution, or other methods, the aggregate amount of
all ownership interests of the banking entity in the covered fund to
the amount permitted in paragraph (a)(2)(i)(B) of this section; and
(B) Must, no later than 1 year after the date of establishment of
the fund (or such longer period as may be provided by the Board
pursuant to paragraph (e) of this section), conform its ownership
interest in the covered fund to the limits in paragraph (a)(2)(ii) of
this section;
(ii) Per-fund limits. (A) Except as provided in paragraph
(a)(2)(ii)(B) of this section, an investment by a banking entity and
its affiliates in any covered fund made or held pursuant to paragraph
(a)(1)(ii) of this section may not exceed 3 percent of the total number
or value of the outstanding ownership interests of the fund.
(B) An investment by a banking entity and its affiliates in a
covered fund that is an issuing entity of asset-backed securities may
not exceed 3 percent of the total fair market value of the ownership
interests of the fund measured in accordance with paragraph (b)(3) of
this section, unless a greater percentage is retained by the banking
entity and its affiliates in compliance with the requirements of
section 15G of the Exchange Act (15 U.S.C. 78o-11) and the implementing
regulations issued thereunder, in which case the investment by the
banking entity and its affiliates in the covered fund may not exceed
the amount, number, or value of ownership interests of the fund
required under section 15G of the Exchange Act and the implementing
regulations issued thereunder.
(iii) Aggregate limit. The aggregate value of all ownership
interests of the banking entity and its affiliates in all covered funds
acquired or retained under this section may not exceed 3 percent of the
tier 1 capital of the banking entity, as provided under paragraph (c)
of this section, and shall be calculated as of the last day of each
calendar quarter.
(iv) Date of establishment. For purposes of this section, the date
of establishment of a covered fund shall be:
(A) In general. The date on which the investment adviser or similar
entity to the covered fund begins making investments pursuant to the
written investment strategy for the fund;
(B) Issuing entities of asset-backed securities. In the case of an
issuing entity of asset-backed securities, the date on which the assets
are initially transferred into the issuing entity of asset-backed
securities.
(b) Rules of construction--(1) Attribution of ownership interests
to a covered banking entity. (i) For purposes of paragraph (a)(2) of
this section, the amount and value of a banking entity's permitted
investment in any single covered fund shall include any ownership
interest held under Sec. 248.12 directly by the banking entity,
including any affiliate of the banking entity.
(ii) Treatment of registered investment companies, SEC-regulated
business development companies and foreign public funds. For purposes
of paragraph (b)(1)(i) of this section, a registered investment
company, SEC-regulated business development companies or foreign public
fund as described in Sec. 248.10(c)(1) of this subpart will not be
considered to be an affiliate of the banking entity so long as the
banking entity:
(A) Does not own, control, or hold with the power to vote 25
percent or more of the voting shares of the company or fund; and
(B) Provides investment advisory, commodity trading advisory,
administrative, and other services to the company or fund in compliance
with the limitations under applicable regulation, order, or other
authority.
(iii) Covered funds. For purposes of paragraph (b)(1)(i) of this
section, a covered fund will not be considered to be an affiliate of a
banking entity so long as the covered fund is held in compliance with
the requirements of this subpart.
(iv) Treatment of employee and director investments financed by the
banking entity. For purposes of paragraph (b)(1)(i) of this section, an
investment by a director or employee of a banking entity who acquires
an ownership interest in his or her personal capacity in a covered fund
sponsored by the banking entity will be attributed to the banking
entity if the banking entity, directly or indirectly, extends financing
for the purpose of enabling the director or employee to acquire the
ownership interest in the fund and the financing is used to acquire
such ownership interest in the covered fund.
(2) Calculation of permitted ownership interests in a single
covered fund. Except as provided in paragraph (b)(3) or (4), for
purposes of determining whether an investment in a single covered fund
complies with the restrictions on ownership interests under paragraphs
(a)(2)(i)(B) and (a)(2)(ii)(A) of this section:
(i) The aggregate number of the outstanding ownership interests
held by the banking entity shall be the total number of ownership
interests held under this section by the banking entity in a covered
fund divided by the total number of ownership interests held by all
entities in that covered fund, as of
[[Page 62154]]
the last day of each calendar quarter (both measured without regard to
committed funds not yet called for investment);
(ii) The aggregate value of the outstanding ownership interests
held by the banking entity shall be the aggregate fair market value of
all investments in and capital contributions made to the covered fund
by the banking entity, divided by the value of all investments in and
capital contributions made to that covered fund by all entities, as of
the last day of each calendar quarter (all measured without regard to
committed funds not yet called for investment). If fair market value
cannot be determined, then the value shall be the historical cost basis
of all investments in and contributions made by the banking entity to
the covered fund;
(iii) For purposes of the calculation under paragraph (b)(2)(ii) of
this section, once a valuation methodology is chosen, the banking
entity must calculate the value of its investment and the investments
of all others in the covered fund in the same manner and according to
the same standards.
(3) Issuing entities of asset-backed securities. In the case of an
ownership interest in an issuing entity of asset-backed securities, for
purposes of determining whether an investment in a single covered fund
complies with the restrictions on ownership interests under paragraphs
(a)(2)(i)(B) and (a)(2)(ii)(B) of this section:
(i) For securitizations subject to the requirements of section 15G
of the Exchange Act (15 U.S.C. 78o-11), the calculations shall be made
as of the date and according to the valuation methodology applicable
pursuant to the requirements of section 15G of the Exchange Act (15
U.S.C. 78o-11) and the implementing regulations issued thereunder; or
(ii) For securitization transactions completed prior to the
compliance date of such implementing regulations (or as to which such
implementing regulations do not apply), the calculations shall be made
as of the date of establishment as defined in paragraph (a)(2)(iv)(B)
of this section or such earlier date on which the transferred assets
have been valued for purposes of transfer to the covered fund, and
thereafter only upon the date on which additional securities of the
issuing entity of asset-backed securities are priced for purposes of
the sales of ownership interests to unaffiliated investors.
(iii) For securitization transactions completed prior to the
compliance date of such implementing regulations (or as to which such
implementing regulations do not apply), the aggregate value of the
outstanding ownership interests in the covered fund shall be the fair
market value of the assets transferred to the issuing entity of the
securitization and any other assets otherwise held by the issuing
entity at such time, determined in a manner that is consistent with its
determination of the fair market value of those assets for financial
statement purposes.
(iv) For purposes of the calculation under paragraph (b)(3)(iii) of
this section, the valuation methodology used to calculate the fair
market value of the ownership interests must be the same for both the
ownership interests held by a banking entity and the ownership
interests held by all others in the covered fund in the same manner and
according to the same standards.
(4) Multi-tier fund investments--(i) Master-feeder fund
investments. If the principal investment strategy of a covered fund
(the ``feeder fund'') is to invest substantially all of its assets in
another single covered fund (the ``master fund''), then for purposes of
the investment limitations in paragraphs (a)(2)(i)(B) and (a)(2)(ii) of
this section, the banking entity's permitted investment in such funds
shall be measured only by reference to the value of the master fund.
The banking entity's permitted investment in the master fund shall
include any investment by the banking entity in the master fund, as
well as the banking entity's pro-rata share of any ownership interest
of the master fund that is held through the feeder fund; and
(ii) Fund-of-funds investments. If a banking entity organizes and
offers a covered fund pursuant to Sec. 248.11 of this subpart for the
purpose of investing in other covered funds (a ``fund of funds'') and
that fund of funds itself invests in another covered fund that the
banking entity is permitted to own, then the banking entity's permitted
investment in that other fund shall include any investment by the
banking entity in that other fund, as well as the banking entity's pro-
rata share of any ownership interest of the fund that is held through
the fund of funds. The investment of the banking entity may not
represent more than 3 percent of the amount or value of any single
covered fund.
(c) Aggregate permitted investments in all covered funds. (1) For
purposes of paragraph (a)(2)(iii) of this section, the aggregate value
of all ownership interests held by a banking entity shall be the sum of
all amounts paid or contributed by the banking entity in connection
with acquiring or retaining an ownership interest in covered funds
(together with any amounts paid by the entity (or employee thereof) in
connection with obtaining a restricted profit interest under Sec.
248.10(d)(6)(ii) of this subpart), on a historical cost basis.
(2) Calculation of tier 1 capital. For purposes of paragraph
(a)(2)(iii) of this section:
(i) Entities that are required to hold and report tier 1 capital.
If a banking entity is required to calculate and report tier 1 capital,
the banking entity's tier 1 capital shall be equal to the amount of
tier 1 capital of the banking entity as of the last day of the most
recent calendar quarter, as reported to its primary financial
regulatory agency; and
(ii) If a banking entity is not required to calculate and report
tier 1 capital, the banking entity's tier 1 capital shall be determined
to be equal to:
(A) In the case of a banking entity that is controlled, directly or
indirectly, by a depository institution that calculates and reports
tier 1 capital, be equal to the amount of tier 1 capital reported by
such controlling depository institution in the manner described in
paragraph (c)(2)(i) of this section;
(B) In the case of a banking entity that is not controlled,
directly or indirectly, by a depository institution that calculates and
reports tier 1 capital:
(1) Bank holding company subsidiaries. If the banking entity is a
subsidiary of a bank holding company or company that is treated as a
bank holding company, be equal to the amount of tier 1 capital reported
by the top-tier affiliate of such covered banking entity that
calculates and reports tier 1 capital in the manner described in
paragraph (c)(2)(i) of this section; and
(2) Other holding companies and any subsidiary or affiliate
thereof. If the banking entity is not a subsidiary of a bank holding
company or a company that is treated as a bank holding company, be
equal to the total amount of shareholders' equity of the top-tier
affiliate within such organization as of the last day of the most
recent calendar quarter that has ended, as determined under applicable
accounting standards.
(iii) Treatment of foreign banking entities--(A) Foreign banking
entities. Except as provided in paragraph (c)(2)(iii)(B) of this
section, with respect to a banking entity that is not itself, and is
not controlled directly or indirectly by, a banking entity that is
located or organized under the laws of the United States or of any
State, the tier 1 capital of the banking entity shall be the
consolidated tier 1 capital of the entity as calculated under
applicable home country standards.
(B) U.S. affiliates of foreign banking entities. With respect to a
banking entity that is located or organized under the
[[Page 62155]]
laws of the United States or of any State and is controlled by a
foreign banking entity identified under paragraph (c)(2)(iii)(A) of
this section, the banking entity's tier 1 capital shall be as
calculated under paragraphs (c)(2)(i) or (ii) of this section.
(d) Capital treatment for a permitted investment in a covered fund.
For purposes of calculating compliance with the applicable regulatory
capital requirements, a banking entity shall deduct from the banking
entity's tier 1 capital (as determined under paragraph (c)(2) of this
section) the greater of:
(1) The sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
(together with any amounts paid by the entity (or employee thereof) in
connection with obtaining a restricted profit interest under Sec.
248.10(d)(6)(ii) of subpart C), on a historical cost basis, plus any
earnings received; and
(2) The fair market value of the banking entity's ownership
interests in the covered fund as determined under paragraph (b)(2)(ii)
or (b)(3) of this section (together with any amounts paid by the entity
(or employee thereof) in connection with obtaining a restricted profit
interest under Sec. 248.10(d)(6)(ii) of subpart C), if the banking
entity accounts for the profits (or losses) of the fund investment in
its financial statements.
(e) Extension of time to divest an ownership interest. (1) Upon
application by a banking entity, the Board may extend the period under
paragraph (a)(2)(i) of this section for up to 2 additional years if the
Board finds that an extension would be consistent with safety and
soundness and not detrimental to the public interest. An application
for extension must:
(i) Be submitted to the Board at least 90 days prior to the
expiration of the applicable time period;
(ii) Provide the reasons for application, including information
that addresses the factors in paragraph (e)(2) of this section; and
(iii) Explain the banking entity's plan for reducing the permitted
investment in a covered fund through redemption, sale, dilution or
other methods as required in paragraph (a)(2) of this section.
(2) Factors governing the Board determinations. In reviewing any
application under paragraph (e)(1) of this section, the Board may
consider all the facts and circumstances related to the permitted
investment in a covered fund, including:
(i) Whether the investment would result, directly or indirectly, in
a material exposure by the banking entity to high-risk assets or high-
risk trading strategies;
(ii) The contractual terms governing the banking entity's interest
in the covered fund;
(iii) The date on which the covered fund is expected to have
attracted sufficient investments from investors unaffiliated with the
banking entity to enable the banking entity to comply with the
limitations in paragraph (a)(2)(i) of this section;
(iv) The total exposure of the covered banking entity to the
investment and the risks that disposing of, or maintaining, the
investment in the covered fund may pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of divesting or disposing of the
investment within the applicable period;
(vi) Whether the investment or the divestiture or conformance of
the investment would involve or result in a material conflict of
interest between the banking entity and unaffiliated parties, including
clients, customers or counterparties to which it owes a duty;
(vi) The banking entity's prior efforts to reduce through
redemption, sale, dilution, or other methods its ownership interests in
the covered fund, including activities related to the marketing of
interests in such covered fund;
(vii) [Reserved]
(viii) Market conditions; and
(ix) Any other factor that the Board believes appropriate.
(3) Authority to impose restrictions on activities or investment
during any extension period. The Board may impose such conditions on
any extension approved under paragraph (e)(1) of this section as the
Board determines are necessary or appropriate to protect the safety and
soundness of the banking entity or the financial stability of the
United States, address material conflicts of interest or other unsound
banking practices, or otherwise further the purposes of section 13 of
the BHC Act and this part.
(4) Consultation. In the case of a banking entity that is primarily
regulated by another Federal banking agency, the SEC, or the CFTC, the
Board will consult with such agency prior to acting on an application
by the banking entity for an extension under paragraph (e)(1) of this
section.
Sec. 248.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 248.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to demonstrably reduce or
otherwise significantly mitigate the specific, identifiable risks to
the banking entity in connection with a compensation arrangement with
an employee of the banking entity or an affiliate thereof that directly
provides investment advisory, commodity trading advisory or other
services to the covered fund.
(2) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures and
internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate and demonstrably reduces or otherwise
significantly mitigates one or more specific, identifiable risks
arising in connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) The compensation arrangement relates solely to the covered
fund in which the banking entity or any affiliate has acquired an
ownership interest pursuant to this paragraph and such compensation
arrangement provides that any losses incurred by the banking entity on
such ownership interest will be offset by corresponding decreases in
amounts payable under such compensation arrangement.
(b) Certain permitted covered fund activities and investments
outside of the United States. (1) The prohibition contained in Sec.
248.10(a) of this subpart does not apply to the acquisition or
[[Page 62156]]
retention of any ownership interest in, or the sponsorship of, a
covered fund by a banking entity only if:
(i) The banking entity is not organized or directly or indirectly
controlled by a banking entity that is organized under the laws of the
United States or of one or more States;
(ii) The activity or investment by the banking entity is pursuant
to paragraph (9) or (13) of section 4(c) of the BHC Act;
(iii) No ownership interest in the covered fund is offered for sale
or sold to a resident of the United States; and
(iv) The activity or investment occurs solely outside of the United
States.
(2) An activity or investment by the banking entity is pursuant to
paragraph (9) or (13) of section 4(c) of the BHC Act for purposes of
paragraph (b)(1)(ii) of this section only if:
(i) The activity or investment is conducted in accordance with the
requirements of this section; and
(ii)(A) With respect to a banking entity that is a foreign banking
organization, the banking entity meets the qualifying foreign banking
organization requirements of section 211.23(a), (c) or (e) of the
Board's Regulation K (12 CFR 211.23(a), (c) or (e)), as applicable; or
(B) With respect to a banking entity that is not a foreign banking
organization, the banking entity is not organized under the laws of the
United States or of one or more States and the banking entity, on a
fully-consolidated basis, meets at least two of the following
requirements:
(1) Total assets of the banking entity held outside of the United
States exceed total assets of the banking entity held in the United
States;
(2) Total revenues derived from the business of the banking entity
outside of the United States exceed total revenues derived from the
business of the banking entity in the United States; or
(3) Total net income derived from the business of the banking
entity outside of the United States exceeds total net income derived
from the business of the banking entity in the United States.
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is sold or has been sold
pursuant to an offering that does not target residents of the United
States.
(4) An activity or investment occurs solely outside of the United
States for purposes of paragraph (b)(1)(iv) of this section only if:
(i) The banking entity acting as sponsor, or engaging as principal
in the acquisition or retention of an ownership interest in the covered
fund, is not itself, and is not controlled directly or indirectly by, a
banking entity that is located in the United States or organized under
the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to acquire or retain the ownership interest or act as
sponsor to the covered fund is not located in the United States or
organized under the laws of the United States or of any State;
(iii) The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State; and
(iv) No financing for the banking entity's ownership or sponsorship
is provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State.
(5) For purposes of this section, a U.S. branch, agency, or
subsidiary of a foreign bank, or any subsidiary thereof, is located in
the United States; however, a foreign bank of which that branch,
agency, or subsidiary is a part is not considered to be located in the
United States solely by virtue of operation of the U.S. branch, agency,
or subsidiary.
(c) Permitted covered fund interests and activities by a regulated
insurance company. The prohibition contained in Sec. 248.10(a) of this
subpart does not apply to the acquisition or retention by an insurance
company, or an affiliate thereof, of any ownership interest in, or the
sponsorship of, a covered fund only if:
(1) The insurance company or its affiliate acquires and retains the
ownership interest solely for the general account of the insurance
company or for one or more separate accounts established by the
insurance company;
(2) The acquisition and retention of the ownership interest is
conducted in compliance with, and subject to, the insurance company
investment laws, regulations, and written guidance of the State or
jurisdiction in which such insurance company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law, regulation, or written guidance described in
paragraph (c)(2) of this section is insufficient to protect the safety
and soundness of the banking entity, or the financial stability of the
United States.
Sec. 248.14 Limitations on relationships with a covered fund.
(a) Relationships with a covered fund. (1) Except as provided for
in paragraph (a)(2) of this section, no banking entity that serves,
directly or indirectly, as the investment manager, investment adviser,
commodity trading advisor, or sponsor to a covered fund, that organizes
and offers a covered fund pursuant to Sec. 248.11 of this subpart, or
that continues to hold an ownership interest in accordance with Sec.
248.11(b) of this subpart, and no affiliate of such entity, may enter
into a transaction with the covered fund, or with any other covered
fund that is controlled by such covered fund, that would be a covered
transaction as defined in section 23A of the Federal Reserve Act (12
U.S.C. 371c(b)(7)), as if such banking entity and the affiliate thereof
were a member bank and the covered fund were an affiliate thereof.
(2) Notwithstanding paragraph (a)(1) of this section, a banking
entity may:
(i) Acquire and retain any ownership interest in a covered fund in
accordance with the requirements of Sec. 248.11, Sec. 248.12, or
Sec. 248.13 of this subpart; and
(ii) Enter into any prime brokerage transaction with any covered
fund in which a covered fund managed, sponsored, or advised by such
banking entity (or an affiliate thereof) has taken an ownership
interest, if:
(A) The banking entity is in compliance with each of the
limitations set forth in Sec. 248.11 of this subpart with respect to a
covered fund organized and offered by such banking entity (or an
affiliate thereof);
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually to the Board (with a duty
to update the certification if the information in the certification
materially changes) that the banking entity does not, directly or
indirectly, guarantee, assume, or otherwise insure the obligations or
performance of the covered fund or of any covered fund in which such
covered fund invests; and
(C) The Board has not determined that such transaction is
inconsistent with the safe and sound operation and condition of the
banking entity.
(b) Restrictions on transactions with covered funds. A banking
entity that serves, directly or indirectly, as the investment manager,
investment adviser, commodity trading advisor, or sponsor to a covered
fund, or that organizes and offers a covered fund
[[Page 62157]]
pursuant to Sec. 248.11 of this subpart, or that continues to hold an
ownership interest in accordance with Sec. 248.11(b) of this subpart,
shall be subject to section 23B of the Federal Reserve Act (12 U.S.C.
371c-1), as if such banking entity were a member bank and such covered
fund were an affiliate thereof.
(c) Restrictions on prime brokerage transactions. A prime brokerage
transaction permitted under paragraph (a)(2)(ii) of this section shall
be subject to section 23B of the Federal Reserve Act (12 U.S.C. 371c-1)
as if the counterparty were an affiliate of the banking entity.
Sec. 248.15 Other limitations on permitted covered fund activities.
(a) No transaction, class of transactions, or activity may be
deemed permissible under Sec. Sec. 248.11 through 248.13 of this
subpart if the transaction, class of transactions, or activity would:
(1) Involve or result in a material conflict of interest between
the banking entity and its clients, customers, or counterparties;
(2) Result, directly or indirectly, in a material exposure by the
banking entity to a high-risk asset or a high-risk trading strategy; or
(3) Pose a threat to the safety and soundness of the banking entity
or to the financial stability of the United States.
(b) Definition of material conflict of interest. (1) For purposes
of this section, a material conflict of interest between a banking
entity and its clients, customers, or counterparties exists if the
banking entity engages in any transaction, class of transactions, or
activity that would involve or result in the banking entity's interests
being materially adverse to the interests of its client, customer, or
counterparty with respect to such transaction, class of transactions,
or activity, and the banking entity has not taken at least one of the
actions in paragraph (b)(2) of this section.
(2) Prior to effecting the specific transaction or class or type of
transactions, or engaging in the specific activity, the banking entity:
(i) Timely and effective disclosure. (A) Has made clear, timely,
and effective disclosure of the conflict of interest, together with
other necessary information, in reasonable detail and in a manner
sufficient to permit a reasonable client, customer, or counterparty to
meaningfully understand the conflict of interest; and
(B) Such disclosure is made in a manner that provides the client,
customer, or counterparty the opportunity to negate, or substantially
mitigate, any materially adverse effect on the client, customer, or
counterparty created by the conflict of interest; or
(ii) Information barriers. Has established, maintained, and
enforced information barriers that are memorialized in written policies
and procedures, such as physical separation of personnel, or functions,
or limitations on types of activity, that are reasonably designed,
taking into consideration the nature of the banking entity's business,
to prevent the conflict of interest from involving or resulting in a
materially adverse effect on a client, customer, or counterparty. A
banking entity may not rely on such information barriers if, in the
case of any specific transaction, class or type of transactions or
activity, the banking entity knows or should reasonably know that,
notwithstanding the banking entity's establishment of information
barriers, the conflict of interest may involve or result in a
materially adverse effect on a client, customer, or counterparty.
(c) Definition of high-risk asset and high-risk trading strategy.
For purposes of this section:
(1) High-risk asset means an asset or group of related assets that
would, if held by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
(2) High-risk trading strategy means a trading strategy that would,
if engaged in by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
Sec. 248.16 Ownership of interests in and sponsorship of issuers of
certain collateralized debt obligations backed by trust-preferred
securities.
(a) The prohibition contained in Sec. 248.10(a)(1) does not apply
to the ownership by a banking entity of an interest in, or sponsorship
of, any issuer if:
(1) The issuer was established, and the interest was issued, before
May 19, 2010;
(2) The banking entity reasonably believes that the offering
proceeds received by the issuer were invested primarily in Qualifying
TruPS Collateral; and
(3) The banking entity acquired such interest on or before December
10, 2013 (or acquired such interest in connection with a merger with or
acquisition of a banking entity that acquired the interest on or before
December 10, 2013).
(b) For purposes of this Sec. 248.16, Qualifying TruPS Collateral
shall mean any trust preferred security or subordinated debt instrument
issued prior to May 19, 2010 by a depository institution holding
company that, as of the end of any reporting period within 12 months
immediately preceding the issuance of such trust preferred security or
subordinated debt instrument, had total consolidated assets of less
than $15,000,000,000 or issued prior to May 19, 2010 by a mutual
holding company.
(c) Notwithstanding paragraph (a)(3) of this section, a banking
entity may act as a market maker with respect to the interests of an
issuer described in paragraph (a) of this section in accordance with
the applicable provisions of Sec. Sec. 248.4 and 248.11.
(d) Without limiting the applicability of paragraph (a) of this
section, the Board, the FDIC and the OCC will make public a non-
exclusive list of issuers that meet the requirements of paragraph (a).
A banking entity may rely on the list published by the Board, the FDIC
and the OCC.
Sec. Sec. 248.17-248.19 [Reserved]
Subpart D--Compliance Program Requirement; Violations
Sec. 248.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope and detail of the compliance program shall
be appropriate for the types, size, scope and complexity of activities
and business structure of the banking entity.
(b) Contents of compliance program. Except as provided in paragraph
(f) of this section, the compliance program required by paragraph (a)
of this section, at a minimum, shall include:
(1) Written policies and procedures reasonably designed to
document, describe, monitor and limit trading activities subject to
subpart B (including those permitted under Sec. Sec. 248.3 to 248.6 of
subpart B), including setting, monitoring and managing required limits
set out in Sec. Sec. 248.4 and 248.5, and activities and investments
with respect to a covered fund subject to subpart C (including those
permitted under Sec. Sec. 248.11 through 248.14 of subpart C)
conducted by the banking entity to ensure that all activities and
[[Page 62158]]
investments conducted by the banking entity that are subject to section
13 of the BHC Act and this part comply with section 13 of the BHC Act
and this part;
(2) A system of internal controls reasonably designed to monitor
compliance with section 13 of the BHC Act and this part and to prevent
the occurrence of activities or investments that are prohibited by
section 13 of the BHC Act and this part;
(3) A management framework that clearly delineates responsibility
and accountability for compliance with section 13 of the BHC Act and
this part and includes appropriate management review of trading limits,
strategies, hedging activities, investments, incentive compensation and
other matters identified in this part or by management as requiring
attention;
(4) Independent testing and audit of the effectiveness of the
compliance program conducted periodically by qualified personnel of the
banking entity or by a qualified outside party;
(5) Training for trading personnel and managers, as well as other
appropriate personnel, to effectively implement and enforce the
compliance program; and
(6) Records sufficient to demonstrate compliance with section 13 of
the BHC Act and this part, which a banking entity must promptly provide
to the Board upon request and retain for a period of no less than 5
years or such longer period as required by the Board.
(c) Additional standards. In addition to the requirements in
paragraph (b) of this section, the compliance program of a banking
entity must satisfy the requirements and other standards contained in
appendix B, if:
(1) The banking entity engages in proprietary trading permitted
under subpart B and is required to comply with the reporting
requirements of paragraph (d) of this section;
(2) The banking entity has reported total consolidated assets as of
the previous calendar year end of $50 billion or more or, in the case
of a foreign banking entity, has total U.S. assets as of the previous
calendar year end of $50 billion or more (including all subsidiaries,
affiliates, branches and agencies of the foreign banking entity
operating, located or organized in the United States); or
(3) The Board notifies the banking entity in writing that it must
satisfy the requirements and other standards contained in appendix B to
this part.
(d) Reporting requirements under appendix A to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B shall comply with the reporting requirements described in
appendix A, if:
(i) The banking entity (other than a foreign banking entity as
provided in paragraph (d)(1)(ii) of this section) has, together with
its affiliates and subsidiaries, trading assets and liabilities
(excluding trading assets and liabilities involving obligations of or
guaranteed by the United States or any agency of the United States) the
average gross sum of which (on a worldwide consolidated basis) over the
previous consecutive four quarters, as measured as of the last day of
each of the four prior calendar quarters, equals or exceeds the
threshold established in paragraph (d)(2) of this section;
(ii) In the case of a foreign banking entity, the average gross sum
of the trading assets and liabilities of the combined U.S. operations
of the foreign banking entity (including all subsidiaries, affiliates,
branches and agencies of the foreign banking entity operating, located
or organized in the United States and excluding trading assets and
liabilities involving obligations of or guaranteed by the United States
or any agency of the United States) over the previous consecutive four
quarters, as measured as of the last day of each of the four prior
calendar quarters, equals or exceeds the threshold established in
paragraph (d)(2) of this section; or
(iii) The Board notifies the banking entity in writing that it must
satisfy the reporting requirements contained in appendix A.
(2) The threshold for reporting under paragraph (d)(1) of this
section shall be $50 billion beginning on June 30, 2014; $25 billion
beginning on April 30, 2016; and $10 billion beginning on December 31,
2016.
(3) Frequency of reporting: Unless the Board notifies the banking
entity in writing that it must report on a different basis, a banking
entity with $50 billion or more in trading assets and liabilities (as
calculated in accordance with paragraph (d)(1) of this section) shall
report the information required by appendix A for each calendar month
within 30 days of the end of the relevant calendar month; beginning
with information for the month of January 2015, such information shall
be reported within 10 days of the end of each calendar month. Any other
banking entity subject to appendix A shall report the information
required by appendix A for each calendar quarter within 30 days of the
end of that calendar quarter unless the Board notifies the banking
entity in writing that it must report on a different basis.
(e) Additional documentation for covered funds. Any banking entity
that has more than $10 billion in total consolidated assets as reported
on December 31 of the previous two calendar years shall maintain
records that include:
(1) Documentation of the exclusions or exemptions other than
sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940
relied on by each fund sponsored by the banking entity (including all
subsidiaries and affiliates) in determining that such fund is not a
covered fund;
(2) For each fund sponsored by the banking entity (including all
subsidiaries and affiliates) for which the banking entity relies on one
or more of the exclusions from the definition of covered fund provided
by Sec. Sec. 248.10(c)(1), 248.10(c)(5), 248.10(c)(8), 248.10(c)(9),
or 248.10(c)(10) of subpart C, documentation supporting the banking
entity's determination that the fund is not a covered fund pursuant to
one or more of those exclusions;
(3) For each seeding vehicle described in Sec. 248.10(c)(12)(i) or
(iii) of subpart C that will become a registered investment company or
SEC-regulated business development company, a written plan documenting
the banking entity's determination that the seeding vehicle will become
a registered investment company or SEC-regulated business development
company; the period of time during which the vehicle will operate as a
seeding vehicle; and the banking entity's plan to market the vehicle to
third-party investors and convert it into a registered investment
company or SEC-regulated business development company within the time
period specified in Sec. 248.12(a)(2)(i)(B) of subpart C;
(4) For any banking entity that is, or is controlled directly or
indirectly by a banking entity that is, located in or organized under
the laws of the United States or of any State, if the aggregate amount
of ownership interests in foreign public funds that are described in
Sec. 248.10(c)(1) of subpart C owned by such banking entity (including
ownership interests owned by any affiliate that is controlled directly
or indirectly by a banking entity that is located in or organized under
the laws of the United States or of any State) exceeds $50 million at
the end of two or more consecutive calendar quarters, beginning with
the next succeeding calendar quarter, documentation of the value of the
ownership interests owned by the banking entity (and such affiliates)
in each foreign public fund and each jurisdiction in which any such
foreign public fund is organized, calculated as of the end of each
calendar quarter, which documentation must
[[Page 62159]]
continue until the banking entity's aggregate amount of ownership
interests in foreign public funds is below $50 million for two
consecutive calendar quarters; and
(5) For purposes of paragraph (e)(4) of this section, a U.S.
branch, agency, or subsidiary of a foreign banking entity is located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(f) Simplified programs for less active banking entities--(1)
Banking entities with no covered activities. A banking entity that does
not engage in activities or investments pursuant to subpart B or
subpart C (other than trading activities permitted pursuant to Sec.
248.6(a) of subpart B) may satisfy the requirements of this section by
establishing the required compliance program prior to becoming engaged
in such activities or making such investments (other than trading
activities permitted pursuant to Sec. 248.6(a) of subpart B).
(2) Banking entities with modest activities. A banking entity with
total consolidated assets of $10 billion or less as reported on
December 31 of the previous two calendar years that engages in
activities or investments pursuant to subpart B or subpart C (other
than trading activities permitted under Sec. 248.6(a) of subpart B)
may satisfy the requirements of this section by including in its
existing compliance policies and procedures appropriate references to
the requirements of section 13 of the BHC Act and this part and
adjustments as appropriate given the activities, size, scope and
complexity of the banking entity.
Sec. 248.21 Termination of activities or investments; penalties for
violations.
(a) Any banking entity that engages in an activity or makes an
investment in violation of section 13 of the BHC Act or this part, or
acts in a manner that functions as an evasion of the requirements of
section 13 of the BHC Act or this part, including through an abuse of
any activity or investment permitted under subparts B or C, or
otherwise violates the restrictions and requirements of section 13 of
the BHC Act or this part, shall, upon discovery, promptly terminate the
activity and, as relevant, dispose of the investment.
(b) Whenever the Board finds reasonable cause to believe any
banking entity has engaged in an activity or made an investment in
violation of section 13 of the BHC Act or this part, or engaged in any
activity or made any investment that functions as an evasion of the
requirements of section 13 of the BHC Act or this part, the Board may
take any action permitted by law to enforce compliance with section 13
of the BHC Act and this part, including directing the banking entity to
restrict, limit, or terminate any or all activities under this part and
dispose of any investment.
Appendix A to Part 248--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
248.20(d), this appendix generally applies to a banking entity that,
together with its affiliates and subsidiaries, has significant
trading assets and liabilities. These entities are required to (i)
furnish periodic reports to the Board regarding a variety of
quantitative measurements of their covered trading activities, which
vary depending on the scope and size of covered trading activities,
and (ii) create and maintain records documenting the preparation and
content of these reports. The requirements of this appendix must be
incorporated into the banking entity's internal compliance program
under Sec. 248.20 and Appendix B.
b. The purpose of this appendix is to assist banking entities
and the Board in:
(i) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(ii) Monitoring the banking entity's covered trading activities;
(iii) Identifying covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading activities of
trading desks engaged in market making-related activities subject to
Sec. 248.4(b) are consistent with the requirements governing
permitted market making-related activities;
(v) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. Sec. 248.4, 248.5, or 248.6(a)-(b) (i.e., underwriting and
market making-related related activity, risk-mitigating hedging, or
trading in certain government obligations) are consistent with the
requirement that such activity not result, directly or indirectly,
in a material exposure to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by the Board of such activities; and
(vii) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. The quantitative measurements that must be furnished pursuant
to this appendix are not intended to serve as a dispositive tool for
the identification of permissible or impermissible activities.
d. In order to allow banking entities and the Agencies to
evaluate the effectiveness of these metrics, banking entities must
collect and report these metrics for all trading desks beginning on
the dates established in Sec. 248.20 of the final rule. The
Agencies will review the data collected and revise this collection
requirement as appropriate based on a review of the data collected
prior to September 30, 2015.
e. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 248.20 and Appendix B to this part. The
effectiveness of particular quantitative measurements may differ
based on the profile of the banking entity's businesses in general
and, more specifically, of the particular trading desk, including
types of instruments traded, trading activities and strategies, and
history and experience (e.g., whether the trading desk is an
established, successful market maker or a new entrant to a
competitive market). In all cases, banking entities must ensure that
they have robust measures in place to identify and monitor the risks
taken in their trading activities, to ensure that the activities are
within risk tolerances established by the banking entity, and to
monitor and examine for compliance with the proprietary trading
restrictions in this part.
f. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 248.4 through 248.6(a) and (b), or that
result in a material exposure to high-risk assets or high-risk
trading strategies, must be escalated within the banking entity for
review, further analysis, explanation to the Board, and remediation,
where appropriate. The quantitative measurements discussed in this
appendix should be helpful to banking entities in identifying and
managing the risks related to their covered trading activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 248.2 and 248.3. In addition, for purposes of
this appendix, the following definitions apply:
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of
[[Page 62160]]
a trading desk's holdings, dividend income, and interest income and
expense.
Covered trading activity means trading conducted by a trading
desk under Sec. Sec. 248.4, 248.5, 248.6(a), or 248.6(b). A banking
entity may include trading under Sec. Sec. 248.3(d), 248.6(c),
248.6(d) or 248.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading desk means the smallest discrete unit of organization of
a banking entity that purchases or sells financial instruments for
the trading account of the banking entity or an affiliate thereof.
III. Reporting and Recordkeeping of Quantitative Measurements
a. Scope of Required Reporting
General scope. Each banking entity made subject to this part by
Sec. 248.20 must furnish the following quantitative measurements
for each trading desk of the banking entity, calculated in
accordance with this appendix:
Risk and Position Limits and Usage;
Risk Factor Sensitivities;
Value-at-Risk and Stress VaR;
Comprehensive Profit and Loss Attribution;
Inventory Turnover;
Inventory Aging; and
Customer-Facing Trade Ratio
b. Frequency of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report each
applicable quantitative measurement to the Board on the reporting
schedule established in Sec. 248.20 unless otherwise requested by
the Board. All quantitative measurements for any calendar month must
be reported within the time period required by Sec. 248.20.
c. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the Board pursuant to this appendix and Sec.
248.20(d), create and maintain records documenting the preparation
and content of these reports, as well as such information as is
necessary to permit the Board to verify the accuracy of such
reports, for a period of 5 years from the end of the calendar year
for which the measurement was taken.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Risk and Position Limits and Usage
i. Description: For purposes of this appendix, Risk and Position
Limits are the constraints that define the amount of risk that a
trading desk is permitted to take at a point in time, as defined by
the banking entity for a specific trading desk. Usage represents the
portion of the trading desk's limits that are accounted for by the
current activity of the desk. Risk and position limits and their
usage are key risk management tools used to control and monitor risk
taking and include, but are not limited, to the limits set out in
Sec. 248.4 and Sec. 248.5. A number of the metrics that are
described below, including ``Risk Factor Sensitivities'' and
``Value-at-Risk and Stress Value-at-Risk,'' relate to a trading
desk's risk and position limits and are useful in evaluating and
setting these limits in the broader context of the trading desk's
overall activities, particularly for the market making activities
under Sec. 248.4(b) and hedging activity under Sec. 248.5.
Accordingly, the limits required under Sec. 248.4(b)(2)(iii) and
Sec. 248.5(b)(1)(i) must meet the applicable requirements under
Sec. 248.4(b)(2)(iii) and Sec. 248.5(b)(1)(i) and also must
include appropriate metrics for the trading desk limits including,
at a minimum, the ``Risk Factor Sensitivities'' and ``Value-at-Risk
and Stress Value-at-Risk'' metrics except to the extent any of the
``Risk Factor Sensitivities'' or ``Value-at-Risk and Stress Value-
at-Risk'' metrics are demonstrably ineffective for measuring and
monitoring the risks of a trading desk based on the types of
positions traded by, and risk exposures of, that desk.
ii. General Calculation Guidance: Risk and Position Limits must
be reported in the format used by the banking entity for the
purposes of risk management of each trading desk. Risk and Position
Limits are often expressed in terms of risk measures, such as VaR
and Risk Factor Sensitivities, but may also be expressed in terms of
other observable criteria, such as net open positions. When criteria
other than VaR or Risk Factor Sensitivities are used to define the
Risk and Position Limits, both the value of the Risk and Position
Limits and the value of the variables used to assess whether these
limits have been reached must be reported.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
2. Risk Factor Sensitivities
i. Description: For purposes of this appendix, Risk Factor
Sensitivities are changes in a trading desk's Comprehensive Profit
and Loss that are expected to occur in the event of a change in one
or more underlying variables that are significant sources of the
trading desk's profitability and risk.
ii. General Calculation Guidance: A banking entity must report
the Risk Factor Sensitivities that are monitored and managed as part
of the trading desk's overall risk management policy. The underlying
data and methods used to compute a trading desk's Risk Factor
Sensitivities will depend on the specific function of the trading
desk and the internal risk management models employed. The number
and type of Risk Factor Sensitivities that are monitored and managed
by a trading desk, and furnished to the Board, will depend on the
explicit risks assumed by the trading desk. In general, however,
reported Risk Factor Sensitivities must be sufficiently granular to
account for a preponderance of the expected price variation in the
trading desk's holdings.
A. Trading desks must take into account any relevant factors in
calculating Risk Factor Sensitivities, including, for example, the
following with respect to particular asset classes:
Commodity derivative positions: Risk factors with
respect to the related commodities set out in 17 CFR 20.2, the
maturity of the positions, volatility and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Credit positions: Risk factors with respect to credit
spreads that are sufficiently granular to account for specific
credit sectors and market segments, the maturity profile of the
positions, and risk factors with respect to interest rates of all
relevant maturities;
Credit-related derivative positions: Risk factor
sensitivities, for example credit spreads, shifts (parallel and non-
parallel) in credit spreads--volatility, and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Equity derivative positions: Risk factor sensitivities
such as equity positions, volatility, and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Equity positions: Risk factors for equity prices and
risk factors that differentiate between important equity market
sectors and segments, such as a small capitalization equities and
international equities;
Foreign exchange derivative positions: Risk factors
with respect to major currency pairs and maturities, exposure to
interest rates at relevant maturities, volatility, and/or
correlation sensitivities (expressed in a manner that demonstrates
any significant non-linearities), as well as the maturity profile of
the positions; and
Interest rate positions, including interest rate
derivative positions: Risk factors with respect to major interest
rate categories and maturities and volatility and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and shifts (parallel and non-parallel)
in the interest rate curve, as well as the maturity profile of the
positions.
B. The methods used by a banking entity to calculate
sensitivities to a common factor shared by multiple trading desks,
such as an equity price factor, must be applied consistently across
its trading desks so that the sensitivities can be compared from one
trading desk to another.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Value-at-Risk and Stress Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the commonly used percentile measurement of the risk of
future financial loss in the value of a given set of aggregated
positions over a specified period of time, based on current market
conditions. For purposes of this appendix, Stress Value-at-Risk
(``Stress VaR'') is the percentile measurement of the risk of future
financial loss in the value of a given set of aggregated positions
over a specified period of time, based on market conditions during a
period of significant financial stress.
ii. General Calculation Guidance: Banking entities must compute
and report VaR and Stress VaR by employing generally accepted
standards and methods of calculation. VaR should reflect a loss in a
trading desk that is expected to be exceeded less than one percent
of the time over a one-day period. For those banking entities that
are subject to
[[Page 62161]]
regulatory capital requirements imposed by a Federal banking agency,
VaR and Stress VaR must be computed and reported in a manner that is
consistent with such regulatory capital requirements. In cases where
a trading desk does not have a standalone VaR or Stress VaR
calculation but is part of a larger aggregation of positions for
which a VaR or Stress VaR calculation is performed, a VaR or Stress
VaR calculation that includes only the trading desk's holdings must
be performed consistent with the VaR or Stress VaR model and
methodology used for the larger aggregation of positions.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into three categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); (ii) profit and loss attributable to new
positions resulting from the current day's trading activity (``new
positions''); and (iii) residual profit and loss that cannot be
specifically attributed to existing positions or new positions. The
sum of (i), (ii), and (iii) must equal the trading desk's
comprehensive profit and loss at each point in time. In addition,
profit and loss measurements must calculate volatility of
comprehensive profit and loss (i.e., the standard deviation of the
trading desk's one-day profit and loss, in dollar terms) for the
reporting period for at least a 30-, 60- and 90-day lag period, from
the end of the reporting period, and any other period that the
banking entity deems necessary to meet the requirements of the rule.
A. The comprehensive profit and loss associated with existing
positions must reflect changes in the value of these positions on
the applicable day. The comprehensive profit and loss from existing
positions must be further attributed, as applicable, to changes in
(i) the specific Risk Factors and other factors that are monitored
and managed as part of the trading desk's overall risk management
policies and procedures; and (ii) any other applicable elements,
such as cash flows, carry, changes in reserves, and the correction,
cancellation, or exercise of a trade.
B. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
C. The portion of comprehensive profit and loss that cannot be
specifically attributed to known sources must be allocated to a
residual category identified as an unexplained portion of the
comprehensive profit and loss. Significant unexplained profit and
loss must be escalated for further investigation and analysis.
ii. General Calculation Guidance: The specific categories used
by a trading desk in the attribution analysis and amount of detail
for the analysis should be tailored to the type and amount of
trading activities undertaken by the trading desk. The new position
attribution must be computed by calculating the difference between
the prices at which instruments were bought and/or sold and the
prices at which those instruments are marked to market at the close
of business on that day multiplied by the notional or principal
amount of each purchase or sale. Any fees, commissions, or other
payments received (paid) that are associated with transactions
executed on that day must be added (subtracted) from such
difference. These factors must be measured consistently over time to
facilitate historical comparisons.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
c. Customer-Facing Activity Measurements
1. Inventory Turnover
i. Description: For purposes of this appendix, Inventory
Turnover is a ratio that measures the turnover of a trading desk's
inventory. The numerator of the ratio is the absolute value of all
transactions over the reporting period. The denominator of the ratio
is the value of the trading desk's inventory at the beginning of the
reporting period.
ii. General Calculation Guidance: For purposes of this appendix,
for derivatives, other than options and interest rate derivatives,
value means gross notional value, for options, value means delta
adjusted notional value, and for interest rate derivatives, value
means 10-year bond equivalent value.
iii. Calculation Period: 30 days, 60 days, and 90 days.
iv. Measurement Frequency: Daily.
2. Inventory Aging
i. Description: For purposes of this appendix, Inventory Aging
generally describes a schedule of the trading desk's aggregate
assets and liabilities and the amount of time that those assets and
liabilities have been held. Inventory Aging should measure the age
profile of the trading desk's assets and liabilities.
ii. General Calculation Guidance: In general, Inventory Aging
must be computed using a trading desk's trading activity data and
must identify the value of a trading desk's aggregate assets and
liabilities. Inventory Aging must include two schedules, an asset-
aging schedule and a liability-aging schedule. Each schedule must
record the value of assets or liabilities held over all holding
periods. For derivatives, other than options, and interest rate
derivatives, value means gross notional value, for options, value
means delta adjusted notional value and, for interest rate
derivatives, value means 10-year bond equivalent value.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Customer-Facing Trade Ratio--Trade Count Based and Value Based
i. Description: For purposes of this appendix, the Customer-
Facing Trade Ratio is a ratio comparing (i) the transactions
involving a counterparty that is a customer of the trading desk to
(ii) the transactions involving a counterparty that is not a
customer of the trading desk. A trade count based ratio must be
computed that records the number of transactions involving a
counterparty that is a customer of the trading desk and the number
of transactions involving a counterparty that is not a customer of
the trading desk. A value based ratio must be computed that records
the value of transactions involving a counterparty that is a
customer of the trading desk and the value of transactions involving
a counterparty that is not a customer of the trading desk.
ii. General Calculation Guidance: For purposes of calculating
the Customer-Facing Trade Ratio, a counterparty is considered to be
a customer of the trading desk if the counterparty is a market
participant that makes use of the banking entity's market making-
related services by obtaining such services, responding to
quotations, or entering into a continuing relationship with respect
to such services. However, a trading desk or other organizational
unit of another banking entity would not be a client, customer, or
counterparty of the trading desk if the other entity has trading
assets and liabilities of $50 billion or more as measured in
accordance with Sec. 248.20(d)(1) unless the trading desk documents
how and why a particular trading desk or other organizational unit
of the entity should be treated as a client, customer, or
counterparty of the trading desk. Transactions conducted anonymously
on an exchange or similar trading facility that permits trading on
behalf of a broad range of market participants would be considered
transactions with customers of the trading desk. For derivatives,
other than options, and interest rate derivatives, value means gross
notional value, for options, value means delta adjusted notional
value, and for interest rate derivatives, value means 10-year bond
equivalent value.
iii. Calculation Period: 30 days, 60 days, and 90 days.
iv. Measurement Frequency: Daily.
Appendix B to Part 248--Enhanced Minimum Standards for Compliance
Programs
I. Overview
Section 248.20(c) requires certain banking entities to
establish, maintain, and enforce an enhanced compliance program that
includes the requirements and standards in this Appendix as well as
the minimum written policies and procedures, internal controls,
management framework, independent testing, training, and
recordkeeping provisions outlined in Sec. 248.20. This Appendix
sets forth additional minimum standards with respect to the
establishment, oversight, maintenance, and enforcement by these
banking entities of an enhanced internal compliance program for
ensuring and monitoring compliance with the
[[Page 62162]]
prohibitions and restrictions on proprietary trading and covered
fund activities and investments set forth in section 13 of the BHC
Act and this part.
a. This compliance program must:
1. Be reasonably designed to identify, document, monitor, and
report the permitted trading and covered fund activities and
investments of the banking entity; identify, monitor and promptly
address the risks of these covered activities and investments and
potential areas of noncompliance; and prevent activities or
investments prohibited by, or that do not comply with, section 13 of
the BHC Act and this part;
2. Establish and enforce appropriate limits on the covered
activities and investments of the banking entity, including limits
on the size, scope, complexity, and risks of the individual
activities or investments consistent with the requirements of
section 13 of the BHC Act and this part;
3. Subject the effectiveness of the compliance program to
periodic independent review and testing, and ensure that the
entity's internal audit, corporate compliance and internal control
functions involved in review and testing are effective and
independent;
4. Make senior management, and others as appropriate,
accountable for the effective implementation of the compliance
program, and ensure that the board of directors and chief executive
officer (or equivalent) of the banking entity review the
effectiveness of the compliance program; and
5. Facilitate supervision and examination by the Agencies of the
banking entity's permitted trading and covered fund activities and
investments.
II. Enhanced Compliance Program
a. Proprietary Trading Activities. A banking entity must
establish, maintain and enforce a compliance program that includes
written policies and procedures that are appropriate for the types,
size, and complexity of, and risks associated with, its permitted
trading activities. The compliance program may be tailored to the
types of trading activities conducted by the banking entity, and
must include a detailed description of controls established by the
banking entity to reasonably ensure that its trading activities are
conducted in accordance with the requirements and limitations
applicable to those trading activities under section 13 of the BHC
Act and this part, and provide for appropriate revision of the
compliance program before expansion of the trading activities of the
banking entity. A banking entity must devote adequate resources and
use knowledgeable personnel in conducting, supervising and managing
its trading activities, and promote consistency, independence and
rigor in implementing its risk controls and compliance efforts. The
compliance program must be updated with a frequency sufficient to
account for changes in the activities of the banking entity, results
of independent testing of the program, identification of weaknesses
in the program, and changes in legal, regulatory or other
requirements.
1. Trading Desks: The banking entity must have written policies
and procedures governing each trading desk that include a
description of:
i. The process for identifying, authorizing and documenting
financial instruments each trading desk may purchase or sell, with
separate documentation for market making-related activities
conducted in reliance on Sec. 248.4(b) and for hedging activity
conducted in reliance on Sec. 248.5;
ii. A mapping for each trading desk to the division, business
line, or other organizational structure that is responsible for
managing and overseeing the trading desk's activities;
iii. The mission (i.e., the type of trading activity, such as
market-making, trading in sovereign debt, etc.) and strategy (i.e.,
methods for conducting authorized trading activities) of each
trading desk;
iv. The activities that the trading desk is authorized to
conduct, including (i) authorized instruments and products, and (ii)
authorized hedging strategies, techniques and instruments;
v. The types and amount of risks allocated by the banking entity
to each trading desk to implement the mission and strategy of the
trading desk, including an enumeration of material risks resulting
from the activities in which the trading desk is authorized to
engage (including but not limited to price risks, such as basis,
volatility and correlation risks, as well as counterparty credit
risk). Risk assessments must take into account both the risks
inherent in the trading activity and the strength and effectiveness
of controls designed to mitigate those risks;
vi. How the risks allocated to each trading desk will be
measured;
vii. Why the allocated risks levels are appropriate to the
activities authorized for the trading desk;
viii. The limits on the holding period of, and the risk
associated with, financial instruments under the responsibility of
the trading desk;
ix. The process for setting new or revised limits, as well as
escalation procedures for granting exceptions to any limits or to
any policies or procedures governing the desk, the analysis that
will be required to support revising limits or granting exceptions,
and the process for independently reviewing and documenting those
exceptions and the underlying analysis;
x. The process for identifying, documenting and approving new
products, trading strategies, and hedging strategies;
xi. The types of clients, customers, and counterparties with
whom the trading desk may trade; and
xii. The compensation arrangements, including incentive
arrangements, for employees associated with the trading desk, which
may not be designed to reward or incentivize prohibited proprietary
trading or excessive or imprudent risk-taking.
2. Description of risks and risk management processes: The
compliance program for the banking entity must include a
comprehensive description of the risk management program for the
trading activity of the banking entity. The compliance program must
also include a description of the governance, approval, reporting,
escalation, review and other processes the banking entity will use
to reasonably ensure that trading activity is conducted in
compliance with section 13 of the BHC Act and this part. Trading
activity in similar financial instruments should be subject to
similar governance, limits, testing, controls, and review, unless
the banking entity specifically determines to establish different
limits or processes and documents those differences. Descriptions
must include, at a minimum, the following elements:
i. A description of the supervisory and risk management
structure governing all trading activity, including a description of
processes for initial and senior-level review of new products and
new strategies;
ii. A description of the process for developing, documenting,
testing, approving and reviewing all models used for valuing,
identifying and monitoring the risks of trading activity and related
positions, including the process for periodic independent testing of
the reliability and accuracy of those models;
iii. A description of the process for developing, documenting,
testing, approving and reviewing the limits established for each
trading desk;
iv. A description of the process by which a security may be
purchased or sold pursuant to the liquidity management plan,
including the process for authorizing and monitoring such activity
to ensure compliance with the banking entity's liquidity management
plan and the restrictions on liquidity management activities in this
part;
v. A description of the management review process, including
escalation procedures, for approving any temporary exceptions or
permanent adjustments to limits on the activities, positions,
strategies, or risks associated with each trading desk; and
vi. The role of the audit, compliance, risk management and other
relevant units for conducting independent testing of trading and
hedging activities, techniques and strategies.
3. Authorized risks, instruments, and products. The banking
entity must implement and enforce limits and internal controls for
each trading desk that are reasonably designed to ensure that
trading activity is conducted in conformance with section 13 of the
BHC Act and this part and with the banking entity's written policies
and procedures. The banking entity must establish and enforce risk
limits appropriate for the activity of each trading desk. These
limits should be based on probabilistic and non-probabilistic
measures of potential loss (e.g., Value-at-Risk and notional
exposure, respectively), and measured under normal and stress market
conditions. At a minimum, these internal controls must monitor,
establish and enforce limits on:
i. The financial instruments (including, at a minimum, by type
and exposure) that the trading desk may trade;
ii. The types and levels of risks that may be taken by each
trading desk; and
iii. The types of hedging instruments used, hedging strategies
employed, and the amount of risk effectively hedged.
4. Hedging policies and procedures. The banking entity must
establish, maintain, and enforce written policies and procedures
[[Page 62163]]
regarding the use of risk-mitigating hedging instruments and
strategies that, at a minimum, describe:
i. The positions, techniques and strategies that each trading
desk may use to hedge the risk of its positions;
ii. The manner in which the banking entity will identify the
risks arising in connection with and related to the individual or
aggregated positions, contracts or other holdings of the banking
entity that are to be hedged and determine that those risks have
been properly and effectively hedged;
iii. The level of the organization at which hedging activity and
management will occur;
iv. The manner in which hedging strategies will be monitored and
the personnel responsible for such monitoring;
v. The risk management processes used to control unhedged or
residual risks; and
vi. The process for developing, documenting, testing, approving
and reviewing all hedging positions, techniques and strategies
permitted for each trading desk and for the banking entity in
reliance on Sec. 248.5.
5. Analysis and quantitative measurements. The banking entity
must perform robust analysis and quantitative measurement of its
trading activities that is reasonably designed to ensure that the
trading activity of each trading desk is consistent with the banking
entity's compliance program; monitor and assist in the
identification of potential and actual prohibited proprietary
trading activity; and prevent the occurrence of prohibited
proprietary trading. Analysis and models used to determine, measure
and limit risk must be rigorously tested and be reviewed by
management responsible for trading activity to ensure that trading
activities, limits, strategies, and hedging activities do not
understate the risk and exposure to the banking entity or allow
prohibited proprietary trading. This review should include periodic
and independent back-testing and revision of activities, limits,
strategies and hedging as appropriate to contain risk and ensure
compliance. In addition to the quantitative measurements reported by
any banking entity subject to Appendix A to this part, each banking
entity must develop and implement, to the extent appropriate to
facilitate compliance with this part, additional quantitative
measurements specifically tailored to the particular risks,
practices, and strategies of its trading desks. The banking entity's
analysis and quantitative measurements must incorporate the
quantitative measurements reported by the banking entity pursuant to
Appendix A (if applicable) and include, at a minimum, the following:
i. Internal controls and written policies and procedures
reasonably designed to ensure the accuracy and integrity of
quantitative measurements;
ii. Ongoing, timely monitoring and review of calculated
quantitative measurements;
iii. The establishment of numerical thresholds and appropriate
trading measures for each trading desk and heightened review of
trading activity not consistent with those thresholds to ensure
compliance with section 13 of the BHC Act and this part, including
analysis of the measurement results or other information,
appropriate escalation procedures, and documentation related to the
review; and
iv. Immediate review and compliance investigation of the trading
desk's activities, escalation to senior management with oversight
responsibilities for the applicable trading desk, timely
notification to the Board, appropriate remedial action (e.g.,
divesting of impermissible positions, cessation of impermissible
activity, disciplinary actions), and documentation of the
investigation findings and remedial action taken when quantitative
measurements or other information, considered together with the
facts and circumstances, or findings of internal audit, independent
testing or other review suggest a reasonable likelihood that the
trading desk has violated any part of section 13 of the BHC Act or
this part.
6. Other Compliance Matters. In addition to the requirements
specified above, the banking entity's compliance program must:
i. Identify activities of each trading desk that will be
conducted in reliance on exemptions contained in Sec. Sec. 248.4
through 248.6, including an explanation of:
A. How and where in the organization the activity occurs; and
B. Which exemption is being relied on and how the activity meets
the specific requirements for reliance on the applicable exemption;
ii. Include an explanation of the process for documenting,
approving and reviewing actions taken pursuant to the liquidity
management plan, where in the organization this activity occurs, the
securities permissible for liquidity management, the process for
ensuring that liquidity management activities are not conducted for
the purpose of prohibited proprietary trading, and the process for
ensuring that securities purchased as part of the liquidity
management plan are highly liquid and conform to the requirements of
this part;
iii. Describe how the banking entity monitors for and prohibits
potential or actual material exposure to high-risk assets or high-
risk trading strategies presented by each trading desk that relies
on the exemptions contained in Sec. Sec. 248.3(d)(3), and 248.4
through 248.6, which must take into account potential or actual
exposure to:
A. Assets whose values cannot be externally priced or, where
valuation is reliant on pricing models, whose model inputs cannot be
externally validated;
B. Assets whose changes in value cannot be adequately mitigated
by effective hedging;
C. New products with rapid growth, including those that do not
have a market history;
D. Assets or strategies that include significant embedded
leverage;
E. Assets or strategies that have demonstrated significant
historical volatility;
F. Assets or strategies for which the application of capital and
liquidity standards would not adequately account for the risk; and
G. Assets or strategies that result in large and significant
concentrations to sectors, risk factors, or counterparties;
iv. Establish responsibility for compliance with the reporting
and recordkeeping requirements of subpart B and Sec. 248.20; and
v. Establish policies for monitoring and prohibiting potential
or actual material conflicts of interest between the banking entity
and its clients, customers, or counterparties.
7. Remediation of violations. The banking entity's compliance
program must be reasonably designed and established to effectively
monitor and identify for further analysis any trading activity that
may indicate potential violations of section 13 of the BHC Act and
this part and to prevent actual violations of section 13 of the BHC
Act and this part. The compliance program must describe procedures
for identifying and remedying violations of section 13 of the BHC
Act and this part, and must include, at a minimum, a requirement to
promptly document, address and remedy any violation of section 13 of
the BHC Act or this part, and document all proposed and actual
remediation efforts. The compliance program must include specific
written policies and procedures that are reasonably designed to
assess the extent to which any activity indicates that modification
to the banking entity's compliance program is warranted and to
ensure that appropriate modifications are implemented. The written
policies and procedures must provide for prompt notification to
appropriate management, including senior management and the board of
directors, of any material weakness or significant deficiencies in
the design or implementation of the compliance program of the
banking entity.
b. Covered Fund Activities or Investments. A banking entity must
establish, maintain and enforce a compliance program that includes
written policies and procedures that are appropriate for the types,
size, complexity and risks of the covered fund and related
activities conducted and investments made, by the banking entity.
1. Identification of covered funds. The banking entity's
compliance program must provide a process, which must include
appropriate management review and independent testing, for
identifying and documenting covered funds that each unit within the
banking entity's organization sponsors or organizes and offers, and
covered funds in which each such unit invests. In addition to the
documentation requirements for covered funds, as specified under
Sec. 248.20(e), the documentation must include information that
identifies all pools that the banking entity sponsors or has an
interest in and the type of exemption from the Commodity Exchange
Act (whether or not the pool relies on section 4.7 of the
regulations under the Commodity Exchange Act), and the amount of
ownership interest the banking entity has in those pools.
2. Identification of covered fund activities and investments.
The banking entity's compliance program must identify, document and
map each unit within the organization that is permitted to acquire
or hold an interest in any covered fund or sponsor any covered fund
and map each unit to the division, business line, or other
organizational structure that will be
[[Page 62164]]
responsible for managing and overseeing that unit's activities and
investments.
3. Explanation of compliance. The banking entity's compliance
program must explain how:
i. The banking entity monitors for and prohibits potential or
actual material conflicts of interest between the banking entity and
its clients, customers, or counterparties related to its covered
fund activities and investments;
ii. The banking entity monitors for and prohibits potential or
actual transactions or activities that may threaten the safety and
soundness of the banking entity related to its covered fund
activities and investments; and
iii. The banking entity monitors for and prohibits potential or
actual material exposure to high-risk assets or high-risk trading
strategies presented by its covered fund activities and investments,
taking into account potential or actual exposure to:
A. Assets whose values cannot be externally priced or, where
valuation is reliant on pricing models, whose model inputs cannot be
externally validated;
B. Assets whose changes in values cannot be adequately mitigated
by effective hedging;
C. New products with rapid growth, including those that do not
have a market history;
D. Assets or strategies that include significant embedded
leverage;
E. Assets or strategies that have demonstrated significant
historical volatility;
F. Assets or strategies for which the application of capital and
liquidity standards would not adequately account for the risk; and
G. Assets or strategies that expose the banking entity to large
and significant concentrations with respect to sectors, risk
factors, or counterparties;
4. Description and documentation of covered fund activities and
investments. For each organizational unit engaged in covered fund
activities and investments, the banking entity's compliance program
must document:
i. The covered fund activities and investments that the unit is
authorized to conduct;
ii. The banking entity's plan for actively seeking unaffiliated
investors to ensure that any investment by the banking entity
conforms to the limits contained in Sec. 248.12 or registered in
compliance with the securities laws and thereby exempt from those
limits within the time periods allotted inSec. 248.12; and
iii. How it complies with the requirements of subpart C.
5. Internal Controls. A banking entity must establish, maintain,
and enforce internal controls that are reasonably designed to ensure
that its covered fund activities or investments comply with the
requirements of section 13 of the BHC Act and this part and are
appropriate given the limits on risk established by the banking
entity. These written internal controls must be reasonably designed
and established to effectively monitor and identify for further
analysis any covered fund activity or investment that may indicate
potential violations of section 13 of the BHC Act or this part. The
internal controls must, at a minimum require:
i. Monitoring and limiting the banking entity's individual and
aggregate investments in covered funds;
ii. Monitoring the amount and timing of seed capital investments
for compliance with the limitations under subpart C (including but
not limited to the redemption, sale or disposition requirements) of
Sec. 248.12, and the effectiveness of efforts to seek unaffiliated
investors to ensure compliance with those limits;
iii. Calculating the individual and aggregate levels of
ownership interests in one or more covered fund required by Sec.
248.12;
iv. Attributing the appropriate instruments to the individual
and aggregate ownership interest calculations above;
v. Making disclosures to prospective and actual investors in any
covered fund organized and offered or sponsored by the banking
entity, as provided under Sec. 248.11(a)(8);
vi. Monitoring for and preventing any relationship or
transaction between the banking entity and a covered fund that is
prohibited under Sec. 248.14, including where the banking entity
has been designated as the sponsor, investment manager, investment
adviser, or commodity trading advisor to a covered fund by another
banking entity; and
vii. Appropriate management review and supervision across legal
entities of the banking entity to ensure that services and products
provided by all affiliated entities comply with the limitation on
services and products contained in Sec. 248.14.
6. Remediation of violations. The banking entity's compliance
program must be reasonably designed and established to effectively
monitor and identify for further analysis any covered fund activity
or investment that may indicate potential violations of section 13
of the BHC Act or this part and to prevent actual violations of
section 13 of the BHC Act and this part. The banking entity's
compliance program must describe procedures for identifying and
remedying violations of section 13 of the BHC Act and this part, and
must include, at a minimum, a requirement to promptly document,
address and remedy any violation of section 13 of the BHC Act or
this part, including Sec. 248.21, and document all proposed and
actual remediation efforts. The compliance program must include
specific written policies and procedures that are reasonably
designed to assess the extent to which any activity or investment
indicates that modification to the banking entity's compliance
program is warranted and to ensure that appropriate modifications
are implemented. The written policies and procedures must provide
for prompt notification to appropriate management, including senior
management and the board of directors, of any material weakness or
significant deficiencies in the design or implementation of the
compliance program of the banking entity.
III. Responsibility and Accountability for the Compliance Program
a. A banking entity must establish, maintain, and enforce a
governance and management framework to manage its business and
employees with a view to preventing violations of section 13 of the
BHC Act and this part. A banking entity must have an appropriate
management framework reasonably designed to ensure that: Appropriate
personnel are responsible and accountable for the effective
implementation and enforcement of the compliance program; a clear
reporting line with a chain of responsibility is delineated; and the
compliance program is reviewed periodically by senior management.
The board of directors (or equivalent governance body) and senior
management should have the appropriate authority and access to
personnel and information within the organizations as well as
appropriate resources to conduct their oversight activities
effectively.
1. Corporate governance. The banking entity must adopt a written
compliance program approved by the board of directors, an
appropriate committee of the board, or equivalent governance body,
and senior management.
2. Management procedures. The banking entity must establish,
maintain, and enforce a governance framework that is reasonably
designed to achieve compliance with section 13 of the BHC Act and
this part, which, at a minimum, provides for:
i. The designation of appropriate senior management or committee
of senior management with authority to carry out the management
responsibilities of the banking entity for each trading desk and for
each organizational unit engaged in covered fund activities;
ii. Written procedures addressing the management of the
activities of the banking entity that are reasonably designed to
achieve compliance with section 13 of the BHC Act and this part,
including:
A. A description of the management system, including the titles,
qualifications, and locations of managers and the specific
responsibilities of each person with respect to the banking entity's
activities governed by section 13 of the BHC Act and this part; and
B. Procedures for determining compensation arrangements for
traders engaged in underwriting or market making-related activities
under Sec. 248.4 or risk-mitigating hedging activities under Sec.
248.5 so that such compensation arrangements are designed not to
reward or incentivize prohibited proprietary trading and
appropriately balance risk and financial results in a manner that
does not encourage employees to expose the banking entity to
excessive or imprudent risk.
3. Business line managers. Managers with responsibility for one
or more trading desks of the banking entity are accountable for the
effective implementation and enforcement of the compliance program
with respect to the applicable trading desk(s).
4. The Board of directors, or similar corporate body, and senior
management. The board of directors, or similar corporate body, and
senior management are responsible for setting and communicating an
appropriate culture of compliance with section 13 of the BHC Act and
this part and ensuring that appropriate policies regarding the
management of trading activities and covered fund activities or
investments are adopted to comply with section 13 of the BHC Act and
[[Page 62165]]
this part. The board of directors or similar corporate body (such as
a designated committee of the board or an equivalent governance
body) must ensure that senior management is fully capable,
qualified, and properly motivated to manage compliance with this
part in light of the organization's business activities and the
expectations of the board of directors. The board of directors or
similar corporate body must also ensure that senior management has
established appropriate incentives and adequate resources to support
compliance with this part, including the implementation of a
compliance program meeting the requirements of this appendix into
management goals and compensation structures across the banking
entity.
5. Senior management. Senior management is responsible for
implementing and enforcing the approved compliance program. Senior
management must also ensure that effective corrective action is
taken when failures in compliance with section 13 of the BHC Act and
this part are identified. Senior management and control personnel
charged with overseeing compliance with section 13 of the BHC Act
and this part should review the compliance program for the banking
entity periodically and report to the board, or an appropriate
committee thereof, on the effectiveness of the compliance program
and compliance matters with a frequency appropriate to the size,
scope, and risk profile of the banking entity's trading activities
and covered fund activities or investments, which shall be at least
annually.
6. CEO attestation. Based on a review by the CEO of the banking
entity, the CEO of the banking entity must, annually, attest in
writing to the Board that the banking entity has in place processes
to establish, maintain, enforce, review, test and modify the
compliance program established under this Appendix and Sec. 248.20
of this part in a manner reasonably designed to achieve compliance
with section 13 of the BHC Act and this part. In the case of a U.S.
branch or agency of a foreign banking entity, the attestation may be
provided for the entire U.S. operations of the foreign banking
entity by the senior management officer of the United States
operations of the foreign banking entity who is located in the
United States.
IV. Independent Testing
a. Independent testing must occur with a frequency appropriate
to the size, scope, and risk profile of the banking entity's trading
and covered fund activities or investments, which shall be at least
annually. This independent testing must include an evaluation of:
1. The overall adequacy and effectiveness of the banking
entity's compliance program, including an analysis of the extent to
which the program contains all the required elements of this
appendix;
2. The effectiveness of the banking entity's internal controls,
including an analysis and documentation of instances in which such
internal controls have been breached, and how such breaches were
addressed and resolved; and
3. The effectiveness of the banking entity's management
procedures.
b. A banking entity must ensure that independent testing
regarding the effectiveness of the banking entity's compliance
program is conducted by a qualified independent party, such as the
banking entity's internal audit department, compliance personnel or
risk managers independent of the organizational unit being tested,
outside auditors, consultants, or other qualified independent
parties. A banking entity must promptly take appropriate action to
remedy any significant deficiencies or material weaknesses in its
compliance program and to terminate any violations of section 13 of
the BHC Act or this part.
V. Training
Banking entities must provide adequate training to personnel and
managers of the banking entity engaged in activities or investments
governed by section 13 of the BHC Act or this part, as well as other
appropriate supervisory, risk, independent testing, and audit
personnel, in order to effectively implement and enforce the
compliance program. This training should occur with a frequency
appropriate to the size and the risk profile of the banking entity's
trading activities and covered fund activities or investments.
VI. Recordkeeping
Banking entities must create and retain records sufficient to
demonstrate compliance and support the operations and effectiveness
of the compliance program. A banking entity must retain these
records for a period that is no less than 5 years or such longer
period as required by the Board in a form that allows it to promptly
produce such records to the Board on request.
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Chapter I
Authority and Issuance
For the reasons stated in the Common Preamble, the Federal Deposit
Insurance Corporation amends chapter III of Title 12, Code of Federal
Regulations as follows:
PART 351--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS
0
31. The authority citation for part 351 continues to read as follows:
Authority: 12 U.S.C. 1851; 1811 et seq.; 3101 et seq.; and
5412.
Subpart A--Authority and Definitions
0
32. Section 351.2 is revised to read as follows:
Sec. 351.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(c) Banking entity. (1) Except as provided in paragraph (c)(2) of
this section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an insured depository institution;
(iii) Any company that is treated as a bank holding company for
purposes of section 8 of the International Banking Act of 1978 (12
U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any entity described in
paragraph (c)(1)(i), (ii), or (iii) of this section.
(2) Banking entity does not include:
(vii) A covered fund that is not itself a banking entity under
paragraph (c)(1)(i), (ii), or (iii) of this section;
(viii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraph (c)(1)(i), (ii), or (iii) of
this section; or
(ix) The FDIC acting in its corporate capacity or as conservator or
receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(d) Board means the Board of Governors of the Federal Reserve
System.
(e) CFTC means the Commodity Futures Trading Commission.
(f) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(g) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(h) Derivative. (1) Except as provided in paragraph (h)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as
[[Page 62166]]
that term is defined in section 1a(25) of the Commodity Exchange Act (7
U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the immediate family of the
employee.
(j) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(k) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(l) FDIC means the Federal Deposit Insurance Corporation.
(m) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(n) Foreign banking organization has the same meaning as in Sec.
211.21(o) of the Board's Regulation K (12 CFR 211.21(o)), but does not
include a foreign bank, as defined in section 1(b)(7) of the
International Banking Act of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the Commonwealth of Puerto Rico, Guam,
American Samoa, the United States Virgin Islands, or the Commonwealth
of the Northern Mariana Islands.
(o) Foreign insurance regulator means the insurance commissioner,
or a similar official or agency, of any country other than the United
States that is engaged in the supervision of insurance companies under
foreign insurance law.
(p) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(q) Insurance company means a company that is organized as an
insurance company, primarily and predominantly engaged in writing
insurance or reinsuring risks underwritten by insurance companies,
subject to supervision as such by a state insurance regulator or a
foreign insurance regulator, and not operated for the purpose of
evading the provisions of section 13 of the BHC Act (12 U.S.C. 1851).
(r) Insured depository institution has the same meaning as in
section 3(c) of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)),
but does not include:
(1) An insured depository institution that is described in section
2(c)(2)(D) of the BHC Act (12 U.S.C. 1841(c)(2)(D)); or
(2) An insured depository institution if it has, and if every
company that controls it has, total consolidated assets of $10 billion
or less and total trading assets and trading liabilities, on a
consolidated basis, that are 5 percent or less of total consolidated
assets.
(s) Limited trading assets and liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities (excluding trading assets
and liabilities attributable to trading activities permitted pursuant
to Sec. 351.6(a)(1) and (2) of subpart B) the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, is less
than $1 billion; and
(ii) The FDIC has not determined pursuant to Sec. 351.20(g) or (h)
of this part that the banking entity should not be treated as having
limited trading assets and liabilities.
(2) With respect to a banking entity other than a banking entity
described in paragraph (s)(3) of this section, trading assets and
liabilities for purposes of this paragraph (s) means trading assets and
liabilities (excluding trading assets and liabilities attributable to
trading activities permitted pursuant to Sec. 351.6(a)(1) and (2) of
subpart B) on a worldwide consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (s) means the
trading assets and liabilities (excluding trading assets and
liabilities attributable to trading activities permitted pursuant to
Sec. 351.6(a)(1) and (2) of subpart B) of the combined U.S. operations
of the top-tier foreign banking organization (including all
subsidiaries, affiliates, branches, and agencies of the foreign banking
organization operating, located, or organized in the United States).
(ii) For purposes of paragraph (s)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary. For purposes of paragraph (s)(3)(i) of
this section, all foreign operations of a U.S. agency, branch, or
subsidiary of a foreign banking organization are considered to be
located in the United States, including branches outside the United
States that are managed or controlled by a U.S. branch or agency of the
foreign banking organization, for purposes of calculating the banking
entity's U.S. trading assets and liabilities.
(t) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(u) Moderate trading assets and liabilities means, with respect to
a banking entity, that the banking entity does not have significant
trading assets and liabilities or limited trading assets and
liabilities.
(v) Primary financial regulatory agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 5301(12)).
(w) Purchase includes any contract to buy, purchase, or otherwise
acquire. For security futures products, purchase includes any contract,
agreement, or transaction for future delivery. With respect to a
commodity future, purchase includes any contract, agreement, or
transaction for future delivery. With respect to a derivative, purchase
includes the execution, termination (prior to its scheduled maturity
date), assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a derivative, as the
context may require.
(x) Qualifying foreign banking organization means a foreign banking
organization that qualifies as such under Sec. 211.23(a), (c) or (e)
of the Board's Regulation K (12 CFR 211.23(a), (c), or (e)).
(y) SEC means the Securities and Exchange Commission.
(z) Sale and sell each include any contract to sell or otherwise
dispose of. For security futures products, such terms include any
contract, agreement, or transaction for future delivery. With respect
to a commodity future, such
[[Page 62167]]
terms include any contract, agreement, or transaction for future
delivery. With respect to a derivative, such terms include the
execution, termination (prior to its scheduled maturity date),
assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a derivative, as the
context may require.
(aa) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(bb) Security-based swap dealer has the same meaning as in section
3(a)(71) of the Exchange Act (15 U.S.C. 78c(a)(71)).
(cc) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(dd) Separate account means an account established and maintained
by an insurance company in connection with one or more insurance
contracts to hold assets that are legally segregated from the insurance
company's other assets, under which income, gains, and losses, whether
or not realized, from assets allocated to such account, are, in
accordance with the applicable contract, credited to or charged against
such account without regard to other income, gains, or losses of the
insurance company.
(ee) Significant trading assets and liabilities means with respect
to a banking entity that:
(1)(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, equals or
exceeds $20 billion; or
(ii) The FDIC has determined pursuant to Sec. 351.20(h) of this
part that the banking entity should be treated as having significant
trading assets and liabilities.
(2) With respect to a banking entity, other than a banking entity
described in paragraph (ee)(3) of this section, trading assets and
liabilities for purposes of this paragraph (ee) means trading assets
and liabilities (excluding trading assets and liabilities attributable
to trading activities permitted pursuant to Sec. 351.6(a)(1) and (2)
of subpart B) on a worldwide consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (ee) means the
trading assets and liabilities (excluding trading assets and
liabilities attributable to trading activities permitted pursuant to
Sec. 351.6(a)(1) and (2) of subpart B) of the combined U.S. operations
of the top-tier foreign banking organization (including all
subsidiaries, affiliates, branches, and agencies of the foreign banking
organization operating, located, or organized in the United States as
well as branches outside the United States that are managed or
controlled by a branch or agency of the foreign banking entity
operating, located or organized in the United States).
(ii) For purposes of paragraph (ee)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary. For purposes of paragraph (ee)(3)(i) of
this section, all foreign operations of a U.S. agency, branch, or
subsidiary of a foreign banking organization are considered to be
located in the United States for purposes of calculating the banking
entity's U.S. trading assets and liabilities.
(ff) State means any State, the District of Columbia, the
Commonwealth of Puerto Rico, Guam, American Samoa, the United States
Virgin Islands, and the Commonwealth of the Northern Mariana Islands.
(gg) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(hh) State insurance regulator means the insurance commissioner, or
a similar official or agency, of a State that is engaged in the
supervision of insurance companies under State insurance law.
(ii) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
Subpart B--Proprietary Trading
0
33. Section 351.3 is amended by:
0
a. Revising paragraphs (b) and (d)(3), (8), and (9);
0
b. Adding paragraphs (d)(10) through (13);
0
c. Redesignating paragraphs (e)(5) through (13) as paragraphs (e)(6)
through (14);
0
d. Adding new paragraph (e)(5); and
0
e. Revising redesignated paragraphs (e)(11), (12), and (14).
The revisions and additions read as follows:
Sec. 351.3 Prohibition on proprietary trading.
* * * * *
(b) Definition of trading account. (1) Trading account. Trading
account means:
(i) Any account that is used by a banking entity to purchase or
sell one or more financial instruments principally for the purpose of
short-term resale, benefitting from actual or expected short-term price
movements, realizing short-term arbitrage profits, or hedging one or
more of the positions resulting from the purchases or sales of
financial instruments described in this paragraph;
(ii) Any account that is used by a banking entity to purchase or
sell one or more financial instruments that are both market risk
capital rule covered positions and trading positions (or hedges of
other market risk capital rule covered positions), if the banking
entity, or any affiliate with which the banking entity is consolidated
for regulatory reporting purposes, calculates risk-based capital ratios
under the market risk capital rule; or
(iii) Any account that is used by a banking entity to purchase or
sell one or more financial instruments, if the banking entity:
(A) Is licensed or registered, or is required to be licensed or
registered, to engage in the business of a dealer, swap dealer, or
security-based swap dealer, to the extent the instrument is purchased
or sold in connection with the activities that require the banking
entity to be licensed or registered as such; or
(B) Is engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
the instrument is purchased or sold in connection with the activities
of such business.
(2) Trading account application for certain banking entities. (i) A
banking entity that is subject to paragraph (b)(1)(ii) of this section
in determining the scope of its trading account is not subject to
paragraph (b)(1)(i) of this section.
(ii) A banking entity that does not calculate risk-based capital
ratios under the market risk capital rule and is not a consolidated
affiliate for regulatory reporting purposes of a banking entity that
calculates risk based capital ratios under the market risk capital rule
may elect to apply paragraph (b)(1)(ii) of this section in determining
the scope of its trading account as if it were subject to that
paragraph. A banking entity that elects under this subsection to apply
paragraph (b)(1)(ii) of this section in determining the scope of its
trading account as if it were subject to that paragraph is not required
to apply paragraph (b)(1)(i) of this section.
(3) Consistency of account election for certain banking entities.
(i) Any election
[[Page 62168]]
or change to an election under paragraph (b)(2)(ii) of this section
must apply to the electing banking entity and all of its wholly owned
subsidiaries. The primary financial regulatory agency of a banking
entity that is affiliated with but is not a wholly owned subsidiary of
such electing banking entity may require that the banking entity be
subject to this uniform application requirement if the primary
financial regulatory agency determines that it is necessary to prevent
evasion of the requirements of this part after notice and opportunity
for response as provided in subpart D of this part.
(ii) A banking entity that does not elect under paragraph
(b)(2)(ii) of this section to be subject to the trading account
definition in (b)(1)(ii) of this section may continue to apply the
trading account definition in paragraph (b)(1)(i) of this section for
one year from the date on which it becomes, or becomes a consolidated
affiliate for regulatory reporting purposes with, a banking entity that
calculates risk-based capital ratios under the market risk capital
rule.
(4) Rebuttable presumption for certain purchases and sales. The
purchase (or sale) of a financial instrument by a banking entity shall
be presumed not to be for the trading account of the banking entity
under paragraph (b)(1)(i) of this section if the banking entity holds
the financial instrument for sixty days or longer and does not transfer
substantially all of the risk of the financial instrument within sixty
days of the purchase (or sale).
* * * * *
(d) * * *
(3) Any purchase or sale of a security, foreign exchange forward
(as that term is defined in section 1a(24) of the Commodity Exchange
Act (7 U.S.C. 1a(24)), foreign exchange swap (as that term is defined
in section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)), or
cross-currency swap by a banking entity for the purpose of liquidity
management in accordance with a documented liquidity management plan of
the banking entity that:
(i) Specifically contemplates and authorizes the particular
financial instruments to be used for liquidity management purposes, the
amount, types, and risks of these financial instruments that are
consistent with liquidity management, and the liquidity circumstances
in which the particular financial instruments may or must be used;
(ii) Requires that any purchase or sale of financial instruments
contemplated and authorized by the plan be principally for the purpose
of managing the liquidity of the banking entity, and not for the
purpose of short-term resale, benefitting from actual or expected
short-term price movements, realizing short-term arbitrage profits, or
hedging a position taken for such short-term purposes;
(iii) Requires that any financial instruments purchased or sold for
liquidity management purposes be highly liquid and limited to financial
instruments the market, credit, and other risks of which the banking
entity does not reasonably expect to give rise to appreciable profits
or losses as a result of short-term price movements;
(iv) Limits any financial instruments purchased or sold for
liquidity management purposes, together with any other financial
instruments purchased or sold for such purposes, to an amount that is
consistent with the banking entity's near-term funding needs, including
deviations from normal operations of the banking entity or any
affiliate thereof, as estimated and documented pursuant to methods
specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of financial instruments that are not permitted under Sec. 351.6(a) or
(b) of this subpart are for the purpose of liquidity management and in
accordance with the liquidity management plan described in this
paragraph (d)(3); and
(vi) Is consistent with the FDIC's regulatory requirements
regarding liquidity management;
* * * * *
(8) Any purchase or sale of one or more financial instruments by a
banking entity through a deferred compensation, stock-bonus, profit-
sharing, or pension plan of the banking entity that is established and
administered in accordance with the law of the United States or a
foreign sovereign, if the purchase or sale is made directly or
indirectly by the banking entity as trustee for the benefit of persons
who are or were employees of the banking entity;
(9) Any purchase or sale of one or more financial instruments by a
banking entity in the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
financial instrument as soon as practicable, and in no event may the
banking entity retain such instrument for longer than such period
permitted by the FDIC;
(10) Any purchase or sale of one or more financial instruments that
was made in error by a banking entity in the course of conducting a
permitted or excluded activity or is a subsequent transaction to
correct such an error;
(11) Contemporaneously entering into a customer-driven swap or
customer-driven security-based swap and a matched swap or security-
based swap if:
(i) The banking entity retains no more than minimal price risk; and
(ii) The banking entity is not a registered dealer, swap dealer, or
security-based swap dealer;
(12) Any purchase or sale of one or more financial instruments that
the banking entity uses to hedge mortgage servicing rights or mortgage
servicing assets in accordance with a documented hedging strategy; or
(13) Any purchase or sale of a financial instrument that does not
meet the definition of trading asset or trading liability under the
applicable reporting form for a banking entity as of January 1, 2020.
(e) * * *
(5) Cross-currency swap means a swap in which one party exchanges
with another party principal and interest rate payments in one currency
for principal and interest rate payments in another currency, and the
exchange of principal occurs on the date the swap is entered into, with
a reversal of the exchange of principal at a later date that is agreed
upon when the swap is entered into.
* * * * *
(11) Market risk capital rule covered position and trading position
means a financial instrument that meets the criteria to be a covered
position and a trading position, as those terms are respectively
defined, without regard to whether the financial instrument is reported
as a covered position or trading position on any applicable regulatory
reporting forms:
(i) In the case of a banking entity that is a bank holding company,
savings and loan holding company, or insured depository institution,
under the market risk capital rule that is applicable to the banking
entity; and
(ii) In the case of a banking entity that is affiliated with a bank
holding company or savings and loan holding company, other than a
banking entity to which a market risk capital rule is applicable, under
the market risk capital rule that is applicable to the affiliated bank
holding company or savings and loan holding company.
(12) Market risk capital rule means the market risk capital rule
that is contained in 12 CFR part 3, subpart F, with respect to a
banking entity for which the OCC is the primary financial regulatory
agency, 12 CFR part 217 with
[[Page 62169]]
respect to a banking entity for which the Board is the primary
financial regulatory agency, or 12 CFR part 324 with respect to a
banking entity for which the FDIC is the primary financial regulatory
agency.
* * * * *
(14) Trading desk means a unit of organization of a banking entity
that purchases or sells financial instruments for the trading account
of the banking entity or an affiliate thereof that is:
(i)(A) Structured by the banking entity to implement a well-defined
business strategy;
(B) Organized to ensure appropriate setting, monitoring, and
management review of the desk's trading and hedging limits, current and
potential future loss exposures, and strategies; and
(C) Characterized by a clearly defined unit that:
(1) Engages in coordinated trading activity with a unified approach
to its key elements;
(2) Operates subject to a common and calibrated set of risk
metrics, risk levels, and joint trading limits;
(3) Submits compliance reports and other information as a unit for
monitoring by management; and
(4) Books its trades together; or
(ii) For a banking entity that calculates risk-based capital ratios
under the market risk capital rule, or a consolidated affiliate for
regulatory reporting purposes of a banking entity that calculates risk-
based capital ratios under the market risk capital rule, established by
the banking entity or its affiliate for purposes of market risk capital
calculations under the market risk capital rule.
0
34. Section 351.4 is revised to read as follows:
Sec. 351.4 Permitted underwriting and market making-related
activities.
(a) Underwriting activities--(1) Permitted underwriting activities.
The prohibition contained in Sec. 351.3(a) does not apply to a banking
entity's underwriting activities conducted in accordance with this
paragraph (a).
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii)(A) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
taking into account the liquidity, maturity, and depth of the market
for the relevant types of securities; and
(B) Reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity, maturity, and depth of the market for the relevant types
of securities;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of this
paragraph (a), including reasonably designed written policies and
procedures, internal controls, analysis and independent testing
identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, in accordance with paragraph
(a)(2)(ii)(A) of this section;
(C) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
(D) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
(iv) A banking entity with significant trading assets and
liabilities may satisfy the requirements in paragraphs (a)(2)(iii)(B)
and (C) of this section by complying with the requirements set forth in
paragraph (c) of this section;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
(3) Definition of distribution. For purposes of this paragraph (a),
a distribution of securities means:
(i) An offering of securities, whether or not subject to
registration under the Securities Act of 1933, that is distinguished
from ordinary trading transactions by the presence of special selling
efforts and selling methods; or
(ii) An offering of securities made pursuant to an effective
registration statement under the Securities Act of 1933.
(4) Definition of underwriter. For purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an issuer or selling security
holder to:
(A) Purchase securities from the issuer or selling security holder
for distribution;
(B) Engage in a distribution of securities for or on behalf of the
issuer or selling security holder; or
(C) Manage a distribution of securities for or on behalf of the
issuer or selling security holder; or
(ii) A person who has agreed to participate or is participating in
a distribution of such securities for or on behalf of the issuer or
selling security holder.
(5) Definition of selling security holder. For purposes of this
paragraph (a), selling security holder means any person, other than an
issuer, on whose behalf a distribution is made.
(6) Definition of underwriting position. For purposes of this
section, underwriting position means the long or short positions in one
or more securities held by a banking entity or its affiliate, and
managed by a particular trading desk, in connection with a particular
distribution of securities for which such banking entity or affiliate
is acting as an underwriter.
(7) Definition of client, customer, and counterparty. For purposes
of this paragraph (a), the terms client, customer, and counterparty, on
a collective or individual basis, refer to market participants that may
transact with the banking entity in connection with a particular
distribution for which the banking entity is acting as underwriter.
(b) Market making-related activities--(1) Permitted market making-
related activities. The prohibition contained in Sec. 351.3(a) does
not apply to a banking entity's market making-related activities
conducted in accordance with this paragraph (b).
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure, routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure, and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for
[[Page 62170]]
the liquidity, maturity, and depth of the market for the relevant types
of financial instruments;
(ii) The trading desk's market-making related activities are
designed not to exceed, on an ongoing basis, the reasonably expected
near term demands of clients, customers, or counterparties, taking into
account the liquidity, maturity, and depth of the market for the
relevant types of financial instruments;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (b) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and positions; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, in accordance with paragraph
(b)(2)(ii) of this section;
(D) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
(E) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(iv) A banking entity with significant trading assets and
liabilities may satisfy the requirements in paragraphs (b)(2)(iii)(C)
and (D) of this section by complying with the requirements set forth in
paragraph (c) of this section;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (b) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in
activity described in this paragraph (b) in accordance with applicable
law.
(3) Definition of client, customer, and counterparty. For purposes
of paragraph (b) of this section, the terms client, customer, and
counterparty, on a collective or individual basis refer to market
participants that make use of the banking entity's market making-
related services by obtaining such services, responding to quotations,
or entering into a continuing relationship with respect to such
services, provided that:
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with the methodology described in
Sec. 351.2(ee) of this part, unless:
(A) The trading desk documents how and why a particular trading
desk or other organizational unit of the entity should be treated as a
client, customer, or counterparty of the trading desk for purposes of
paragraph (b)(2) of this section; or
(B) The purchase or sale by the trading desk is conducted
anonymously on an exchange or similar trading facility that permits
trading on behalf of a broad range of market participants.
(ii) [Reserved]
(4) Definition of financial exposure. For purposes of this section,
financial exposure means the aggregate risks of one or more financial
instruments and any associated loans, commodities, or foreign exchange
or currency, held by a banking entity or its affiliate and managed by a
particular trading desk as part of the trading desk's market making-
related activities.
(5) Definition of market-maker positions. For the purposes of this
section, market-maker positions means all of the positions in the
financial instruments for which the trading desk stands ready to make a
market in accordance with paragraph (b)(2)(i) of this section, that are
managed by the trading desk, including the trading desk's open
positions or exposures arising from open transactions.
(c) Rebuttable presumption of compliance--(1) Internal limits. (i)
A banking entity shall be presumed to meet the requirement in paragraph
(a)(2)(ii)(A) or (b)(2)(ii) of this section with respect to the
purchase or sale of a financial instrument if the banking entity has
established and implements, maintains, and enforces the internal limits
for the relevant trading desk as described in paragraph (c)(1)(ii) of
this section.
(ii)(A) With respect to underwriting activities conducted pursuant
to paragraph (a) of this section, the presumption described in
paragraph (c)(1)(i) of this section shall be available to each trading
desk that establishes, implements, maintains, and enforces internal
limits that should take into account the liquidity, maturity, and depth
of the market for the relevant types of securities and are designed not
to exceed the reasonably expected near term demands of clients,
customers, or counterparties, based on the nature and amount of the
trading desk's underwriting activities, on the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.
(B) With respect to market making-related activities conducted
pursuant to paragraph (b) of this section, the presumption described in
paragraph (c)(1)(i) of this section shall be available to each trading
desk that establishes, implements, maintains, and enforces internal
limits that should take into account the liquidity, maturity, and depth
of the market for the relevant types of financial instruments and are
designed not to exceed the reasonably expected near term demands of
clients, customers, or counterparties, based on the nature and amount
of the trading desk's market-making related activities, that address
the:
(1) Amount, types, and risks of its market-maker positions;
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
(4) Period of time a financial instrument may be held.
(2) Supervisory review and oversight. The limits described in
paragraph (c)(1) of this section shall be subject to supervisory review
and oversight by the FDIC on an ongoing basis.
(3) Limit Breaches and Increases. (i) With respect to any limit set
pursuant to paragraph (c)(1)(ii)(A) or (B) of this section, a banking
entity shall maintain and make available to the FDIC upon request
records regarding:
(A) Any limit that is exceeded; and
[[Page 62171]]
(B) Any temporary or permanent increase to any limit(s), in each
case in the form and manner as directed by the FDIC.
(ii) In the event of a breach or increase of any limit set pursuant
to paragraph (c)(1)(ii)(A) or (B) of this section, the presumption
described in paragraph (c)(1)(i) of this section shall continue to be
available only if the banking entity:
(A) Takes action as promptly as possible after a breach to bring
the trading desk into compliance; and
(B) Follows established written authorization procedures, including
escalation procedures that require review and approval of any trade
that exceeds a trading desk's limit(s), demonstrable analysis of the
basis for any temporary or permanent increase to a trading desk's
limit(s), and independent review of such demonstrable analysis and
approval.
(4) Rebutting the presumption. The presumption in paragraph
(c)(1)(i) of this section may be rebutted by the FDIC if the FDIC
determines, taking into account the liquidity, maturity, and depth of
the market for the relevant types of financial instruments and based on
all relevant facts and circumstances, that a trading desk is engaging
in activity that is not based on the reasonably expected near term
demands of clients, customers, or counterparties. The FDIC's rebuttal
of the presumption in paragraph (c)(1)(i) must be made in accordance
with the notice and response procedures in subpart D of this part.
0
35. Section 351.5 is amended by revising paragraphs (b) and (c)(1) and
adding paragraph (c)(4) to read as follows:
Sec. 351.5 Permitted risk-mitigating hedging activities.
* * * * *
(b) * * *
(1) The risk-mitigating hedging activities of a banking entity that
has significant trading assets and liabilities are permitted under
paragraph (a) of this section only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(C) The conduct of analysis and independent testing designed to
ensure that the positions, techniques and strategies that may be used
for hedging may reasonably be expected to reduce or otherwise
significantly mitigate the specific, identifiable risk(s) being hedged;
(ii) The risk-mitigating hedging activity:
(A) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(B) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(D) Is subject to continuing review, monitoring and management by
the banking entity that:
(1) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1)(i) of this section;
(2) Is designed to reduce or otherwise significantly mitigate the
specific, identifiable risks that develop over time from the risk-
mitigating hedging activities undertaken under this section and the
underlying positions, contracts, and other holdings of the banking
entity, based upon the facts and circumstances of the underlying and
hedging positions, contracts and other holdings of the banking entity
and the risks and liquidity thereof; and
(3) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(1)(ii) of this section and is not
prohibited proprietary trading; and
(iii) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(2) The risk-mitigating hedging activities of a banking entity that
does not have significant trading assets and liabilities are permitted
under paragraph (a) of this section only if the risk-mitigating hedging
activity:
(i) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to ongoing recalibration by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading.
(c) * * *
(1) A banking entity that has significant trading assets and
liabilities must comply with the requirements of paragraphs (c)(2) and
(3) of this section, unless the requirements of paragraph (c)(4) of
this section are met, with respect to any purchase or sale of financial
instruments made in reliance on this section for risk-mitigating
hedging purposes that is:
* * * * *
(4) The requirements of paragraphs (c)(2) and (3) of this section
do not apply to the purchase or sale of a financial instrument
described in paragraph (c)(1) of this section if:
(i) The financial instrument purchased or sold is identified on a
written list of pre-approved financial instruments that are commonly
used by the trading desk for the specific type of hedging activity for
which the financial instrument is being purchased or sold; and
(ii) At the time the financial instrument is purchased or sold, the
hedging activity (including the purchase or sale of the financial
instrument) complies with written, pre-approved limits for the trading
desk purchasing or selling the financial instrument for hedging
activities undertaken for one or more other trading desks. The limits
shall be appropriate for the:
[[Page 62172]]
(A) Size, types, and risks of the hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased and sold for hedging activities
by the trading desk; and
(C) Levels and duration of the risk exposures being hedged.
0
36. Section 351.6 is amended by revising paragraph (e)(3); removing
paragraphs (e)(4) and (6); and redesignating paragraph (e)(5) as
paragraph (e)(4).
The revisions reads as follows:
Sec. 351.6 Other permitted proprietary trading activities.
* * * * *
(e) * * *
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
* * * * *
Subpart C--Covered Funds Activities and Investments
0
37. Section 351.10 is amended by revising paragraphs (c)(7)(ii) and
(c)(8)(i)(A) to read as follows:
Sec. 351.10 Prohibition on Acquiring or Retaining an Ownership
Interest in and Having Certain Relationships with a Covered Fund.
* * * * *
(c) * * *
(7) * * *
(ii) Participates in the profits and losses of the separate account
other than in compliance with applicable requirements regarding bank
owned life insurance.
(8) * * *
(i) * * *
(A) Loans as defined in Sec. 351.2(t) of subpart A;
* * * * *
0
38. Section 351.11 is amended by revising paragraph (c) to read as
follows:
Sec. 351.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
* * * * *
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 351.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 351.4(a) or (b) of subpart B, respectively; and
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; or acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in such covered fund in
compliance with section 15G of that Act (15 U.S.C.78o-11) and the
implementing regulations issued thereunder each as permitted by
paragraph (b) of this section, then in each such case any ownership
interests acquired or retained by the banking entity and its affiliates
in connection with underwriting and market making related activities
for that particular covered fund are included in the calculation of
ownership interests permitted to be held by the banking entity and its
affiliates under the limitations of Sec. 351.12(a)(2)(ii) and (iii)
and (d) of this subpart.
Sec. 351.12 [Amended]
0
39. Section 351.12 is amended by redesignating the second instance of
paragraph (e)(2)(vi) as paragraph (e)(2)(vii).
0
40. Section 351.13 is amended by revising paragraphs (a), (b)(3) and
(4), and (c) to read as follows:
Sec. 351.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 351.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to reduce or otherwise
significantly mitigate the specific, identifiable risks to the banking
entity in connection with:
(i) A compensation arrangement with an employee of the banking
entity or an affiliate thereof that directly provides investment
advisory, commodity trading advisory or other services to the covered
fund; or
(ii) A position taken by the banking entity when acting as
intermediary on behalf of a customer that is not itself a banking
entity to facilitate the exposure by the customer to the profits and
losses of the covered fund.
(2) The risk-mitigating hedging activities of a banking entity are
permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program in accordance with subpart
D of this part that is reasonably designed to ensure the banking
entity's compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures,
and internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks arising:
(1) Out of a transaction conducted solely to accommodate a specific
customer request with respect to the covered fund; or
(2) In connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) With respect to risk-mitigating hedging activity conducted
pursuant to paragraph (a)(1)(i) of this section, the compensation
arrangement relates solely to the covered fund in which the banking
entity or any affiliate has acquired an ownership interest pursuant to
paragraph (a)(1)(i) and such compensation arrangement provides that any
losses incurred by the banking
[[Page 62173]]
entity on such ownership interest will be offset by corresponding
decreases in amounts payable under such compensation arrangement.
(b) * * *
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is not sold and has not been
sold pursuant to an offering that targets residents of the United
States in which the banking entity or any affiliate of the banking
entity participates. If the banking entity or an affiliate sponsors or
serves, directly or indirectly, as the investment manager, investment
adviser, commodity pool operator or commodity trading advisor to a
covered fund, then the banking entity or affiliate will be deemed for
purposes of this paragraph (b)(3) to participate in any offer or sale
by the covered fund of ownership interests in the covered fund.
(4) An activity or investment occurs solely outside of the United
States for purposes of paragraph (b)(1)(iv) of this section only if:
(i) The banking entity acting as sponsor, or engaging as principal
in the acquisition or retention of an ownership interest in the covered
fund, is not itself, and is not controlled directly or indirectly by, a
banking entity that is located in the United States or organized under
the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to acquire or retain the ownership interest or act as
sponsor to the covered fund is not located in the United States or
organized under the laws of the United States or of any State; and
(iii) The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State.
* * * * *
(c) Permitted covered fund interests and activities by a regulated
insurance company. The prohibition contained in Sec. 351.10(a) of this
subpart does not apply to the acquisition or retention by an insurance
company, or an affiliate thereof, of any ownership interest in, or the
sponsorship of, a covered fund only if:
(1) The insurance company or its affiliate acquires and retains the
ownership interest solely for the general account of the insurance
company or for one or more separate accounts established by the
insurance company;
(2) The acquisition and retention of the ownership interest is
conducted in compliance with, and subject to, the insurance company
investment laws and regulations of the State or jurisdiction in which
such insurance company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law or regulation described in paragraph (c)(2) of
this section is insufficient to protect the safety and soundness of the
banking entity, or the financial stability of the United States.
0
41. Section 351.14 is amended by revising paragraph (a)(2)(ii)(B) to
read as follows:
Sec. 351.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually no later than March 31 to
the FDIC (with a duty to update the certification if the information in
the certification materially changes) that the banking entity does not,
directly or indirectly, guarantee, assume, or otherwise insure the
obligations or performance of the covered fund or of any covered fund
in which such covered fund invests; and
* * * * *
Subpart D--Compliance Program Requirement; Violations
0
42. Section 351.20 is amended by revising paragraphs (a), (b)
introductory text, (c), (d), (e) introductory text, and (f)(2) and
adding paragraphs (g), (h), and (i) to read as follows:
Sec. 351.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities) shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
(b) Banking entities with significant trading assets and
liabilities. With respect to a banking entity with significant trading
assets and liabilities, the compliance program required by paragraph
(a) of this section, at a minimum, shall include:
* * * * *
(c) CEO attestation. The CEO of a banking entity that has
significant trading assets and liabilities must, based on a review by
the CEO of the banking entity, attest in writing to the FDIC, each year
no later than March 31, that the banking entity has in place processes
to establish, maintain, enforce, review, test and modify the compliance
program required by paragraph (b) of this section in a manner
reasonably designed to achieve compliance with section 13 of the BHC
Act and this part. In the case of a U.S. branch or agency of a foreign
banking entity, the attestation may be provided for the entire U.S.
operations of the foreign banking entity by the senior management
officer of the U.S. operations of the foreign banking entity who is
located in the United States.
(d) Reporting requirements under appendix A to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B shall comply with the reporting requirements described in
appendix A to this part, if:
(i) The banking entity has significant trading assets and
liabilities; or
(ii) The FDIC notifies the banking entity in writing that it must
satisfy the reporting requirements contained in appendix A to this
part.
(2) Frequency of reporting: Unless the FDIC notifies the banking
entity in writing that it must report on a different basis, a banking
entity subject to appendix A to this part shall report the information
required by appendix A for each quarter within 30 days of the end of
the quarter.
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities shall maintain records
that include:
* * * * *
(f) * * *
(2) Banking entities with moderate trading assets and liabilities.
A banking entity with moderate trading assets and liabilities may
satisfy the requirements of this section by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act and this part and adjustments
as appropriate given the activities, size, scope, and complexity of the
banking entity.
[[Page 62174]]
(g) Rebuttable presumption of compliance for banking entities with
limited trading assets and liabilities--(1) Rebuttable presumption.
Except as otherwise provided in this paragraph, a banking entity with
limited trading assets and liabilities shall be presumed to be
compliant with subpart B and subpart C of this part and shall have no
obligation to demonstrate compliance with this part on an ongoing
basis.
(2) Rebuttal of presumption. If upon examination or audit, the FDIC
determines that the banking entity has engaged in proprietary trading
or covered fund activities that are otherwise prohibited under subpart
B or subpart C of this part, the FDIC may require the banking entity to
be treated under this part as if it did not have limited trading assets
and liabilities. The FDIC's rebuttal of the presumption in this
paragraph must be made in accordance with the notice and response
procedures in paragraph (i) of this section.
(h) Reservation of authority. Notwithstanding any other provision
of this part, the FDIC retains its authority to require a banking
entity without significant trading assets and liabilities to apply any
requirements of this part that would otherwise apply if the banking
entity had significant or moderate trading assets and liabilities if
the FDIC determines that the size or complexity of the banking entity's
trading or investment activities, or the risk of evasion of subpart B
or subpart C of this part, does not warrant a presumption of compliance
under paragraph (g) of this section or treatment as a banking entity
with moderate trading assets and liabilities, as applicable. The FDIC's
exercise of this reservation of authority must be made in accordance
with the notice and response procedures in paragraph (i) of this
section.
(i) Notice and response procedures--(1) Notice. The FDIC will
notify the banking entity in writing of any determination requiring
notice under this part and will provide an explanation of the
determination.
(2) Response. The banking entity may respond to any or all items in
the notice described in paragraph (i)(1) of this section. The response
should include any matters that the banking entity would have the FDIC
consider in deciding whether to make the determination. The response
must be in writing and delivered to the designated FDIC official within
30 days after the date on which the banking entity received the notice.
The FDIC may shorten the time period when, in the opinion of the FDIC,
the activities or condition of the banking entity so requires, provided
that the banking entity is informed of the time period at the time of
notice, or with the consent of the banking entity. In its discretion,
the FDIC may extend the time period for good cause.
(3) Waiver. Failure to respond within 30 days or such other time
period as may be specified by the FDIC shall constitute a waiver of any
objections to the FDIC determination.
(4) Decision. The FDIC will notify the banking entity of the
decision in writing. The notice will include an explanation of the
decision.
0
43. Revise appendix A to part 351 to read as follows:
Appendix A to Part 351--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
351.20(d), this appendix applies to a banking entity that, together
with its affiliates and subsidiaries, has significant trading assets
and liabilities. These entities are required to (i) furnish periodic
reports to the FDIC regarding a variety of quantitative measurements
of their covered trading activities, which vary depending on the
scope and size of covered trading activities, and (ii) create and
maintain records documenting the preparation and content of these
reports. The requirements of this appendix must be incorporated into
the banking entity's internal compliance program under Sec. 351.20.
b. The purpose of this appendix is to assist banking entities
and the FDIC in:
(1) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(2) Monitoring the banking entity's covered trading activities;
(3) Identifying covered trading activities that warrant further
review or examination by the banking entity to verify compliance
with the proprietary trading restrictions;
(4) Evaluating whether the covered trading activities of trading
desks engaged in market making-related activities subject to Sec.
351.4(b) are consistent with the requirements governing permitted
market making-related activities;
(5) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. 351.4, Sec. 351.5, or Sec. 351.6(a) and (b) (i.e.,
underwriting and market making-related activity, risk-mitigating
hedging, or trading in certain government obligations) are
consistent with the requirement that such activity not result,
directly or indirectly, in a material exposure to high-risk assets
or high-risk trading strategies;
(6) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by the FDIC of such activities; and
(7) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. Information that must be furnished pursuant to this appendix
is not intended to serve as a dispositive tool for the
identification of permissible or impermissible activities.
d. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 351.20. The effectiveness of particular
quantitative measurements may differ based on the profile of the
banking entity's businesses in general and, more specifically, of
the particular trading desk, including types of instruments traded,
trading activities and strategies, and history and experience (e.g.,
whether the trading desk is an established, successful market maker
or a new entrant to a competitive market). In all cases, banking
entities must ensure that they have robust measures in place to
identify and monitor the risks taken in their trading activities, to
ensure that the activities are within risk tolerances established by
the banking entity, and to monitor and examine for compliance with
the proprietary trading restrictions in this part.
e. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 351.4 through 351.6(a) and (b), or that
result in a material exposure to high-risk assets or high-risk
trading strategies, must be escalated within the banking entity for
review, further analysis, explanation to the FDIC, and remediation,
where appropriate. The quantitative measurements discussed in this
appendix should be helpful to banking entities in identifying and
managing the risks related to their covered trading activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 351.2 and 351.3. In addition, for purposes of
this appendix, the following definitions apply:
Applicability identifies the trading desks for which a banking
entity is required to calculate and report a particular quantitative
measurement based on the type of covered trading activity conducted
by the trading desk.
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material
[[Page 62175]]
sources of trading revenue over a specific period of time,
including, for example, any increase or decrease in the market value
of a trading desk's holdings, dividend income, and interest income
and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. 351.4, Sec. 351.5, Sec. 351.6(a), or Sec.
351.6(b). A banking entity may include in its covered trading
activity trading conducted under Sec. 351.3(d), Sec. 351.6(c),
Sec. 351.6(d) or Sec. 351.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading day means a calendar day on which a trading desk is open
for trading.
III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each banking entity made subject
to this appendix by Sec. 351.20 must furnish the following
quantitative measurements, as applicable, for each trading desk of
the banking entity engaged in covered trading activities and
calculate these quantitative measurements in accordance with this
appendix:
i. Internal Limits and Usage;
ii. Value-at-Risk;
iii. Comprehensive Profit and Loss Attribution;
iv. Positions; and
v. Transaction Volumes.
2. Trading desk information. Each banking entity made subject to
this appendix by Sec. 351.20 must provide certain descriptive
information, as further described in this appendix, regarding each
trading desk engaged in covered trading activities.
3. Quantitative measurements identifying information. Each
banking entity made subject to this appendix by Sec. 351.20 must
provide certain identifying and descriptive information, as further
described in this appendix, regarding its quantitative measurements.
4. Narrative statement. Each banking entity made subject to this
appendix by Sec. 351.20 may provide an optional narrative
statement, as further described in this appendix.
5. File identifying information. Each banking entity made
subject to this appendix by Sec. 351.20 must provide file
identifying information in each submission to the FDIC pursuant to
this appendix, including the name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the Board, and
identification of the reporting period and creation date and time.
b. Trading Desk Information
1. Each banking entity must provide descriptive information
regarding each trading desk engaged in covered trading activities,
including:
i. Name of the trading desk used internally by the banking
entity and a unique identification label for the trading desk;
ii. Identification of each type of covered trading activity in
which the trading desk is engaged;
iii. Brief description of the general strategy of the trading
desk;
v. A list identifying each Agency receiving the submission of
the trading desk;
2. Indication of whether each calendar date is a trading day or
not a trading day for the trading desk; and
3. Currency reported and daily currency conversion rate.
c. Quantitative Measurements Identifying Information
Each banking entity must provide the following information
regarding the quantitative measurements:
1. An Internal Limits Information Schedule that provides
identifying and descriptive information for each limit reported
pursuant to the Internal Limits and Usage quantitative measurement,
including the name of the limit, a unique identification label for
the limit, a description of the limit, the unit of measurement for
the limit, the type of limit, and identification of the
corresponding risk factor attribution in the particular case that
the limit type is a limit on a risk factor sensitivity and profit
and loss attribution to the same risk factor is reported; and
2. A Risk Factor Attribution Information Schedule that provides
identifying and descriptive information for each risk factor
attribution reported pursuant to the Comprehensive Profit and Loss
Attribution quantitative measurement, including the name of the risk
factor or other factor, a unique identification label for the risk
factor or other factor, a description of the risk factor or other
factor, and the risk factor or other factor's change unit.
d. Narrative Statement
Each banking entity made subject to this appendix by Sec.
351.20 may submit in a separate electronic document a Narrative
Statement to the FDIC with any information the banking entity views
as relevant for assessing the information reported. The Narrative
Statement may include further description of or changes to
calculation methods, identification of material events, description
of and reasons for changes in the banking entity's trading desk
structure or trading desk strategies, and when any such changes
occurred.
e. Frequency and Method of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report the
Trading Desk Information, the Quantitative Measurements Identifying
Information, and each applicable quantitative measurement
electronically to the FDIC on the reporting schedule established in
Sec. 351.20 unless otherwise requested by the FDIC. A banking
entity must report the Trading Desk Information, the Quantitative
Measurements Identifying Information, and each applicable
quantitative measurement to the FDIC in accordance with the XML
Schema specified and published on the FDIC's website.
f. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the FDIC pursuant to this appendix and Sec. 351.20(d),
create and maintain records documenting the preparation and content
of these reports, as well as such information as is necessary to
permit the FDIC to verify the accuracy of such reports, for a period
of five years from the end of the calendar year for which the
measurement was taken. A banking entity must retain the Narrative
Statement, the Trading Desk Information, and the Quantitative
Measurements Identifying Information for a period of five years from
the end of the calendar year for which the information was reported
to the FDIC.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Internal Limits and Usage
i. Description: For purposes of this appendix, Internal Limits
are the constraints that define the amount of risk and the positions
that a trading desk is permitted to take at a point in time, as
defined by the banking entity for a specific trading desk. Usage
represents the value of the trading desk's risk or positions that
are accounted for by the current activity of the desk. Internal
limits and their usage are key compliance and risk management tools
used to control and monitor risk taking and include, but are not
limited to, the limits set out in Sec. Sec. 351.4 and 351.5. A
trading desk's risk limits, commonly including a limit on ``Value-
at-Risk,'' are useful in the broader context of the trading desk's
overall activities, particularly for the market making activities
under Sec. 351.4(b) and hedging activity under Sec. 351.5.
Accordingly, the limits required under Sec. Sec.
351.4(b)(2)(iii)(C) and 351.5(b)(1)(i)(A) must meet the applicable
requirements under Sec. Sec. 351.4(b)(2)(iii)(C) and
351.5(b)(1)(i)(A) and also must include appropriate metrics for the
trading desk limits including, at a minimum, ``Value-at-Risk''
except to the extent the ``Value-at-Risk'' metric is demonstrably
ineffective for measuring and monitoring the risks of a trading desk
based on the types of positions traded by, and risk exposures of,
that desk.
A. A banking entity must provide the following information for
each limit reported pursuant to this quantitative measurement: The
unique identification label for the limit reported in the Internal
Limits Information Schedule, the limit size (distinguishing between
an upper and a lower limit), and the value of usage of the limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
2. Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the measurement of the risk of future financial loss in
the value of a trading desk's aggregated positions at the ninety-
nine percent confidence level over a one-day period, based on
current market conditions.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the
[[Page 62176]]
daily fluctuation in the value of a trading desk's positions to
various sources. First, the daily profit and loss of the aggregated
positions is divided into two categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); and (ii) profit and loss attributable to
new positions resulting from the current day's trading activity
(``new positions'').
A. The comprehensive profit and loss associated with existing
positions must reflect changes in the value of these positions on
the applicable day. The comprehensive profit and loss from existing
positions must be further attributed, as applicable, to (i) changes
in the specific risk factors and other factors that are monitored
and managed as part of the trading desk's overall risk management
policies and procedures; and (ii) any other applicable elements,
such as cash flows, carry, changes in reserves, and the correction,
cancellation, or exercise of a trade.
B. For the attribution of comprehensive profit and loss from
existing positions to specific risk factors and other factors, a
banking entity must provide the following information for the
factors that explain the preponderance of the profit or loss changes
due to risk factor changes: The unique identification label for the
risk factor or other factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss due to the risk factor
or other factor change.
C. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and loss from existing
positions that is not attributed to changes in specific risk factors
and other factors must be allocated to a residual category.
Significant unexplained profit and loss must be escalated for
further investigation and analysis.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
c. Positions and Transaction Volumes Measurements
1. Positions
i. Description: For purposes of this appendix, Positions is the
value of securities and derivatives positions managed by the trading
desk. For purposes of the Positions quantitative measurement, do not
include in the Positions calculation for ``securities'' those
securities that are also ``derivatives,'' as those terms are defined
under subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \1225\ A banking entity must
separately report the trading desk's market value of long securities
positions, short securities positions, derivatives receivables, and
derivatives payables.
---------------------------------------------------------------------------
\1225\ See Sec. 351.2(h), (aa). For example, under this part, a
security-based swap is both a ``security'' and a ``derivative.'' For
purposes of the Positions quantitative measurement, security-based
swaps are reported as derivatives rather than securities.
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 351.4(a)
or Sec. 351.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
2. Transaction Volumes
i. Description: For purposes of this appendix, Transaction
Volumes measures three exclusive categories of covered trading
activity conducted by a trading desk. A banking entity is required
to report the value and number of security and derivative
transactions conducted by the trading desk with: (i) Customers,
excluding internal transactions; (ii) non-customers, excluding
internal transactions; and (iii) trading desks and other
organizational units where the transaction is booked into either the
same banking entity or an affiliated banking entity. For securities,
value means gross market value. For derivatives, value means gross
notional value. For purposes of calculating the Transaction Volumes
quantitative measurement, do not include in the Transaction Volumes
calculation for ``securities'' those securities that are also
``derivatives,'' as those terms are defined under subpart A;
instead, report those securities that are also derivatives as
``derivatives.'' \1226\ Further, for purposes of the Transaction
Volumes quantitative measurement, a customer of a trading desk that
relies on Sec. 351.4(a) to conduct underwriting activity is a
market participant identified in Sec. 351.4(a)(7), and a customer
of a trading desk that relies on Sec. 351.4(b) to conduct market
making-related activity is a market participant identified in Sec.
351.4(b)(3).
---------------------------------------------------------------------------
\1226\ See Sec. 351.2(h), (aa).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 351.4(a)
or Sec. 351.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
Appendix B to Part 351 [Removed]
0
44. Appendix B to part 351 is removed.
0
45. Effective January 1, 2020 until December 31, 2020, appendix Z to
part 351 is added to read as follows:
Appendix Z to Part 351--Proprietary Trading and Certain Interests in
and Relationships With Covered Funds (Alternative Compliance)
Note: The content of this appendix reproduces the regulation
implementing Section 13 of the Bank Holding Company Act as of
November 13, 2019.
Subpart A--Authority and Definitions
Sec. 351.1 Authority, purpose, scope, and relationship to other
authorities.
(a) Authority. This part is issued by the FDIC under section 13 of
the Bank Holding Company Act of 1956, as amended (12 U.S.C. 1851).
(b) Purpose. Section 13 of the Bank Holding Company Act establishes
prohibitions and restrictions on proprietary trading and investments in
or relationships with covered funds by certain banking entities,
including any insured depository institution as defined in section
3(c)(2) of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)(2)) and
certain subsidiaries thereof for which the FDIC is the appropriate
Federal banking agency as defined in section 3(q) of the Federal
Deposit Insurance Act (12 U.S.C. 1813(q)). This part implements section
13 of the Bank Holding Company Act by defining terms used in the
statute and related terms, establishing prohibitions and restrictions
on proprietary trading and investments in or relationships with covered
funds, and explaining the statute's requirements.
(c) Scope. This part implements section 13 of the Bank Holding
Company Act with respect to insured depository institutions for which
the FDIC is the appropriate Federal banking agency, as defined in
section 3(q) of the Federal Deposit Insurance Act, and certain
subsidiaries of the foregoing, but does not include such entities to
the extent they are not within the definition of banking entity in
Sec. 351.2(c).
(d) Relationship to other authorities. Except as otherwise provided
in under section 13 of the Bank Holding Company Act, and
notwithstanding any other provision of law, the prohibitions and
restrictions under section 13 of Bank Holding Company Act shall apply
to the activities and investments of a banking entity, even if such
activities and investments are authorized for a banking entity under
other applicable provisions of law.
(e) Preservation of authority. Nothing in this part limits in any
way the authority of the FDIC to impose on a banking entity identified
in paragraph (c) of this section additional requirements or
restrictions with respect to any activity, investment, or relationship
covered under section 13 of the Bank Holding Company Act or this part,
or additional penalties for violation of this part provided under any
other applicable provision of law.
Sec. 351.2 Definitions.
Unless otherwise specified, for purposes of this part:
[[Page 62177]]
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(c) Banking entity. (1) Except as provided in paragraph (c)(2) of
this section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an insured depository institution;
(iii) Any company that is treated as a bank holding company for
purposes of section 8 of the International Banking Act of 1978 (12
U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any entity described in
paragraphs (c)(1)(i), (ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a banking entity under
paragraphs (c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraphs (c)(1)(i), (ii), or (iii) of
this section; or
(iii) The FDIC acting in its corporate capacity or as conservator
or receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(d) Board means the Board of Governors of the Federal Reserve
System.
(e) CFTC means the Commodity Futures Trading Commission.
(f) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(g) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(h) Derivative. (1) Except as provided in paragraph (h)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, guidance, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the immediate family of the
employee.
(j) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(k) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(l) FDIC means the Federal Deposit Insurance Corporation.
(m) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(n) Foreign banking organization has the same meaning as in section
211.21(o) of the Board's Regulation K (12 CFR 211.21(o)), but does not
include a foreign bank, as defined in section 1(b)(7) of the
International Banking Act of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the Commonwealth of Puerto Rico, Guam,
American Samoa, the United States Virgin Islands, or the Commonwealth
of the Northern Mariana Islands.
(o) Foreign insurance regulator means the insurance commissioner,
or a similar official or agency, of any country other than the United
States that is engaged in the supervision of insurance companies under
foreign insurance law.
(p) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(q) Insurance company means a company that is organized as an
insurance company, primarily and predominantly engaged in writing
insurance or reinsuring risks underwritten by insurance companies,
subject to supervision as such by a state insurance regulator or a
foreign insurance regulator, and not operated for the purpose of
evading the provisions of section 13 of the BHC Act (12 U.S.C. 1851).
(r) Insured depository institution, unless otherwise indicated, has
the same meaning as in section 3(c) of the Federal Deposit Insurance
Act (12 U.S.C. 1813(c)), but does not include:
(1) An insured depository institution that is described in section
2(c)(2)(D) of the Bank Holding Company Act of 1956 (12 U.S.C.
1841(c)(2)(D)); or
(2) An insured depository institution if it has, and if every
company that controls it has, total consolidated assets of $10 billion
or less and total trading assets and trading liabilities, on a
consolidated basis, that are 5 percent or less of total consolidated
assets.
(s) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(t) Primary financial regulatory agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 5301(12)).
(u) Purchase includes any contract to buy, purchase, or otherwise
acquire. For security futures products, purchase includes any contract,
agreement, or transaction for future delivery. With respect to a
commodity future, purchase includes any contract, agreement, or
transaction for future delivery. With respect to a derivative, purchase
includes the execution, termination (prior to its scheduled maturity
date), assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a derivative, as the
context may require.
(v) Qualifying foreign banking organization means a foreign banking
organization that qualifies as such under section 211.23(a), (c) or (e)
of the Board's Regulation K (12 CFR 211.23(a), (c), or (e)).
(w) SEC means the Securities and Exchange Commission.
(x) Sale and sell each include any contract to sell or otherwise
dispose of. For security futures products, such terms include any
contract, agreement,
[[Page 62178]]
or transaction for future delivery. With respect to a commodity future,
such terms include any contract, agreement, or transaction for future
delivery. With respect to a derivative, such terms include the
execution, termination (prior to its scheduled maturity date),
assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a derivative, as the
context may require.
(y) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(z) Security-based swap dealer has the same meaning as in section
3(a)(71) of the Exchange Act (15 U.S.C. 78c(a)(71)).
(aa) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(bb) Separate account means an account established and maintained
by an insurance company in connection with one or more insurance
contracts to hold assets that are legally segregated from the insurance
company's other assets, under which income, gains, and losses, whether
or not realized, from assets allocated to such account, are, in
accordance with the applicable contract, credited to or charged against
such account without regard to other income, gains, or losses of the
insurance company.
(cc) State means any State, the District of Columbia, the
Commonwealth of Puerto Rico, Guam, American Samoa, the United States
Virgin Islands, and the Commonwealth of the Northern Mariana Islands.
(dd) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(ee) State insurance regulator means the insurance commissioner, or
a similar official or agency, of a State that is engaged in the
supervision of insurance companies under State insurance law.
(ff) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
Subpart B--Proprietary Trading
Sec. 351.3 Prohibition on proprietary trading.
(a) Prohibition. Except as otherwise provided in this subpart, a
banking entity may not engage in proprietary trading. Proprietary
trading means engaging as principal for the trading account of the
banking entity in any purchase or sale of one or more financial
instruments.
(b) Definition of trading account. (1) Trading account means any
account that is used by a banking entity to:
(i) Purchase or sell one or more financial instruments principally
for the purpose of:
(A) Short-term resale;
(B) Benefitting from actual or expected short-term price movements;
(C) Realizing short-term arbitrage profits; or
(D) Hedging one or more positions resulting from the purchases or
sales of financial instruments described in paragraphs (b)(1)(i)(A),
(B), or (C) of this section;
(ii) Purchase or sell one or more financial instruments that are
both market risk capital rule covered positions and trading positions
(or hedges of other market risk capital rule covered positions), if the
banking entity, or any affiliate of the banking entity, is an insured
depository institution, bank holding company, or savings and loan
holding company, and calculates risk-based capital ratios under the
market risk capital rule; or
(iii) Purchase or sell one or more financial instruments for any
purpose, if the banking entity:
(A) Is licensed or registered, or is required to be licensed or
registered, to engage in the business of a dealer, swap dealer, or
security-based swap dealer, to the extent the instrument is purchased
or sold in connection with the activities that require the banking
entity to be licensed or registered as such; or
(B) Is engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
the instrument is purchased or sold in connection with the activities
of such business.
(2) Rebuttable presumption for certain purchases and sales. The
purchase (or sale) of a financial instrument by a banking entity shall
be presumed to be for the trading account of the banking entity under
paragraph (b)(1)(i) of this section if the banking entity holds the
financial instrument for fewer than sixty days or substantially
transfers the risk of the financial instrument within sixty days of the
purchase (or sale), unless the banking entity can demonstrate, based on
all relevant facts and circumstances, that the banking entity did not
purchase (or sell) the financial instrument principally for any of the
purposes described in paragraph (b)(1)(i) of this section.
(c) Financial instrument. (1) Financial instrument means:
(i) A security, including an option on a security;
(ii) A derivative, including an option on a derivative; or
(iii) A contract of sale of a commodity for future delivery, or
option on a contract of sale of a commodity for future delivery.
(2) A financial instrument does not include:
(i) A loan;
(ii) A commodity that is not:
(A) An excluded commodity (other than foreign exchange or
currency);
(B) A derivative;
(C) A contract of sale of a commodity for future delivery; or
(D) An option on a contract of sale of a commodity for future
delivery; or
(iii) Foreign exchange or currency.
(d) Proprietary trading. Proprietary trading does not include:
(1) Any purchase or sale of one or more financial instruments by a
banking entity that arises under a repurchase or reverse repurchase
agreement pursuant to which the banking entity has simultaneously
agreed, in writing, to both purchase and sell a stated asset, at stated
prices, and on stated dates or on demand with the same counterparty;
(2) Any purchase or sale of one or more financial instruments by a
banking entity that arises under a transaction in which the banking
entity lends or borrows a security temporarily to or from another party
pursuant to a written securities lending agreement under which the
lender retains the economic interests of an owner of such security, and
has the right to terminate the transaction and to recall the loaned
security on terms agreed by the parties;
(3) Any purchase or sale of a security by a banking entity for the
purpose of liquidity management in accordance with a documented
liquidity management plan of the banking entity that:
(i) Specifically contemplates and authorizes the particular
securities to be used for liquidity management purposes, the amount,
types, and risks of these securities that are consistent with liquidity
management, and the liquidity circumstances in which the particular
securities may or must be used;
(ii) Requires that any purchase or sale of securities contemplated
and authorized by the plan be principally for the purpose of managing
the liquidity of the banking entity, and not for the purpose of short-
term resale, benefitting from actual or expected short-term price
movements, realizing short-term arbitrage profits, or hedging a
position taken for such short-term purposes;
(iii) Requires that any securities purchased or sold for liquidity
management purposes be highly liquid and limited to securities the
market, credit, and other risks of which the banking entity does not
reasonably expect to give rise to appreciable profits
[[Page 62179]]
or losses as a result of short-term price movements;
(iv) Limits any securities purchased or sold for liquidity
management purposes, together with any other instruments purchased or
sold for such purposes, to an amount that is consistent with the
banking entity's near-term funding needs, including deviations from
normal operations of the banking entity or any affiliate thereof, as
estimated and documented pursuant to methods specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of securities that are not permitted under Sec. Sec. 351.6(a) or (b)
of this subpart are for the purpose of liquidity management and in
accordance with the liquidity management plan described in paragraph
(d)(3) of this section; and
(vi) Is consistent with the FDIC's supervisory requirements,
guidance, and expectations regarding liquidity management;
(4) Any purchase or sale of one or more financial instruments by a
banking entity that is a derivatives clearing organization or a
clearing agency in connection with clearing financial instruments;
(5) Any excluded clearing activities by a banking entity that is a
member of a clearing agency, a member of a derivatives clearing
organization, or a member of a designated financial market utility;
(6) Any purchase or sale of one or more financial instruments by a
banking entity, so long as:
(i) The purchase (or sale) satisfies an existing delivery
obligation of the banking entity or its customers, including to prevent
or close out a failure to deliver, in connection with delivery,
clearing, or settlement activity; or
(ii) The purchase (or sale) satisfies an obligation of the banking
entity in connection with a judicial, administrative, self-regulatory
organization, or arbitration proceeding;
(7) Any purchase or sale of one or more financial instruments by a
banking entity that is acting solely as agent, broker, or custodian;
(8) Any purchase or sale of one or more financial instruments by a
banking entity through a deferred compensation, stock-bonus, profit-
sharing, or pension plan of the banking entity that is established and
administered in accordance with the law of the United States or a
foreign sovereign, if the purchase or sale is made directly or
indirectly by the banking entity as trustee for the benefit of persons
who are or were employees of the banking entity; or
(9) Any purchase or sale of one or more financial instruments by a
banking entity in the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
financial instrument as soon as practicable, and in no event may the
banking entity retain such instrument for longer than such period
permitted by the FDIC.
(e) Definition of other terms related to proprietary trading. For
purposes of this subpart:
(1) Anonymous means that each party to a purchase or sale is
unaware of the identity of the other party(ies) to the purchase or
sale.
(2) Clearing agency has the same meaning as in section 3(a)(23) of
the Exchange Act (15 U.S.C. 78c(a)(23)).
(3) Commodity has the same meaning as in section 1a(9) of the
Commodity Exchange Act (7 U.S.C. 1a(9)), except that a commodity does
not include any security;
(4) Contract of sale of a commodity for future delivery means a
contract of sale (as that term is defined in section 1a(13) of the
Commodity Exchange Act (7 U.S.C. 1a(13)) for future delivery (as that
term is defined in section 1a(27) of the Commodity Exchange Act (7
U.S.C. 1a(27))).
(5) Derivatives clearing organization means:
(i) A derivatives clearing organization registered under section 5b
of the Commodity Exchange Act (7 U.S.C. 7a-1);
(ii) A derivatives clearing organization that, pursuant to CFTC
regulation, is exempt from the registration requirements under section
5b of the Commodity Exchange Act (7 U.S.C. 7a-1); or
(iii) A foreign derivatives clearing organization that, pursuant to
CFTC regulation, is permitted to clear for a foreign board of trade
that is registered with the CFTC.
(6) Exchange, unless the context otherwise requires, means any
designated contract market, swap execution facility, or foreign board
of trade registered with the CFTC, or, for purposes of securities or
security-based swaps, an exchange, as defined under section 3(a)(1) of
the Exchange Act (15 U.S.C. 78c(a)(1)), or security-based swap
execution facility, as defined under section 3(a)(77) of the Exchange
Act (15 U.S.C. 78c(a)(77)).
(7) Excluded clearing activities means:
(i) With respect to customer transactions cleared on a derivatives
clearing organization, a clearing agency, or a designated financial
market utility, any purchase or sale necessary to correct trading
errors made by or on behalf of a customer provided that such purchase
or sale is conducted in accordance with, for transactions cleared on a
derivatives clearing organization, the Commodity Exchange Act, CFTC
regulations, and the rules or procedures of the derivatives clearing
organization, or, for transactions cleared on a clearing agency, the
rules or procedures of the clearing agency, or, for transactions
cleared on a designated financial market utility that is neither a
derivatives clearing organization nor a clearing agency, the rules or
procedures of the designated financial market utility;
(ii) Any purchase or sale in connection with and related to the
management of a default or threatened imminent default of a customer
provided that such purchase or sale is conducted in accordance with,
for transactions cleared on a derivatives clearing organization, the
Commodity Exchange Act, CFTC regulations, and the rules or procedures
of the derivatives clearing organization, or, for transactions cleared
on a clearing agency, the rules or procedures of the clearing agency,
or, for transactions cleared on a designated financial market utility
that is neither a derivatives clearing organization nor a clearing
agency, the rules or procedures of the designated financial market
utility;
(iii) Any purchase or sale in connection with and related to the
management of a default or threatened imminent default of a member of a
clearing agency, a member of a derivatives clearing organization, or a
member of a designated financial market utility;
(iv) Any purchase or sale in connection with and related to the
management of the default or threatened default of a clearing agency, a
derivatives clearing organization, or a designated financial market
utility; and
(v) Any purchase or sale that is required by the rules or
procedures of a clearing agency, a derivatives clearing organization,
or a designated financial market utility to mitigate the risk to the
clearing agency, derivatives clearing organization, or designated
financial market utility that would result from the clearing by a
member of security-based swaps that reference the member or an
affiliate of the member.
(8) Designated financial market utility has the same meaning as in
section 803(4) of the Dodd-Frank Act (12 U.S.C. 5462(4)).
(9) Issuer has the same meaning as in section 2(a)(4) of the
Securities Act of 1933 (15 U.S.C. 77b(a)(4)).
[[Page 62180]]
(10) Market risk capital rule covered position and trading position
means a financial instrument that is both a covered position and a
trading position, as those terms are respectively defined:
(i) In the case of a banking entity that is a bank holding company,
savings and loan holding company, or insured depository institution,
under the market risk capital rule that is applicable to the banking
entity; and
(ii) In the case of a banking entity that is affiliated with a bank
holding company or savings and loan holding company, other than a
banking entity to which a market risk capital rule is applicable, under
the market risk capital rule that is applicable to the affiliated bank
holding company or savings and loan holding company.
(11) Market risk capital rule means the market risk capital rule
that is contained in subpart F of 12 CFR part 3, 12 CFR parts 208 and
225, or 12 CFR part 324, as applicable.
(12) Municipal security means a security that is a direct
obligation of or issued by, or an obligation guaranteed as to principal
or interest by, a State or any political subdivision thereof, or any
agency or instrumentality of a State or any political subdivision
thereof, or any municipal corporate instrumentality of one or more
States or political subdivisions thereof.
(13) Trading desk means the smallest discrete unit of organization
of a banking entity that purchases or sells financial instruments for
the trading account of the banking entity or an affiliate thereof.
Sec. 351.4 Permitted underwriting and market making-related
activities.
(a) Underwriting activities--(1) Permitted underwriting activities.
The prohibition contained in Sec. 351.3(a) does not apply to a banking
entity's underwriting activities conducted in accordance with this
paragraph (a).
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
and reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity, maturity, and depth of the market for the relevant type
of security;
(iii) The banking entity has established and implements, maintains,
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of paragraph (a) of this section,
including reasonably designed written policies and procedures, internal
controls, analysis and independent testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, based on the nature and amount of
the trading desk's underwriting activities, including the reasonably
expected near term demands of clients, customers, or counterparties, on
the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held;
(C) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(D) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis of the basis for any temporary
or permanent increase to a trading desk's limit(s), and independent
review of such demonstrable analysis and approval;
(iv) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(v) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
(3) Definition of distribution. For purposes of this paragraph (a),
a distribution of securities means:
(i) An offering of securities, whether or not subject to
registration under the Securities Act of 1933, that is distinguished
from ordinary trading transactions by the presence of special selling
efforts and selling methods; or
(ii) An offering of securities made pursuant to an effective
registration statement under the Securities Act of 1933.
(4) Definition of underwriter. For purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an issuer or selling security
holder to:
(A) Purchase securities from the issuer or selling security holder
for distribution;
(B) Engage in a distribution of securities for or on behalf of the
issuer or selling security holder; or
(C) Manage a distribution of securities for or on behalf of the
issuer or selling security holder; or
(ii) A person who has agreed to participate or is participating in
a distribution of such securities for or on behalf of the issuer or
selling security holder.
(5) Definition of selling security holder. For purposes of this
paragraph (a), selling security holder means any person, other than an
issuer, on whose behalf a distribution is made.
(6) Definition of underwriting position. For purposes of this
paragraph (a), underwriting position means the long or short positions
in one or more securities held by a banking entity or its affiliate,
and managed by a particular trading desk, in connection with a
particular distribution of securities for which such banking entity or
affiliate is acting as an underwriter.
(7) Definition of client, customer, and counterparty. For purposes
of this paragraph (a), the terms client, customer, and counterparty, on
a collective or individual basis, refer to market participants that may
transact with the banking entity in connection with a particular
distribution for which the banking entity is acting as underwriter.
(b) Market making-related activities--(1) Permitted market making-
related activities. The prohibition contained in Sec. 351.3(a) does
not apply to a banking entity's market making-related activities
conducted in accordance with this paragraph (b).
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The amount, types, and risks of the financial instruments in
the trading
[[Page 62181]]
desk's market-maker inventory are designed not to exceed, on an ongoing
basis, the reasonably expected near term demands of clients, customers,
or counterparties, based on:
(A) The liquidity, maturity, and depth of the market for the
relevant types of financial instrument(s); and
(B) Demonstrable analysis of historical customer demand, current
inventory of financial instruments, and market and other factors
regarding the amount, types, and risks, of or associated with financial
instruments in which the trading desk makes a market, including through
block trades;
(iii) The banking entity has established and implements, maintains,
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of paragraph (b) of this section,
including reasonably designed written policies and procedures, internal
controls, analysis and independent testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and inventory; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, based on the nature and amount of
the trading desk's market making-related activities, that address the
factors prescribed by paragraph (b)(2)(ii) of this section, on:
(1) The amount, types, and risks of its market-maker inventory;
(2) The amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) The level of exposures to relevant risk factors arising from
its financial exposure; and
(4) The period of time a financial instrument may be held;
(D) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(E) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis that the basis for any temporary
or permanent increase to a trading desk's limit(s) is consistent with
the requirements of this paragraph (b), and independent review of such
demonstrable analysis and approval;
(iv) To the extent that any limit identified pursuant to paragraph
(b)(2)(iii)(C) of this section is exceeded, the trading desk takes
action to bring the trading desk into compliance with the limits as
promptly as possible after the limit is exceeded;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (b) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in
activity described in this paragraph (b) in accordance with applicable
law.
(3) Definition of client, customer, and counterparty. For purposes
of paragraph (b) of this section, the terms client, customer, and
counterparty, on a collective or individual basis refer to market
participants that make use of the banking entity's market making-
related services by obtaining such services, responding to quotations,
or entering into a continuing relationship with respect to such
services, provided that:
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with Sec. 351.20(d)(1) of subpart D,
unless:
(A) The trading desk documents how and why a particular trading
desk or other organizational unit of the entity should be treated as a
client, customer, or counterparty of the trading desk for purposes of
paragraph (b)(2) of this section; or
(B) The purchase or sale by the trading desk is conducted
anonymously on an exchange or similar trading facility that permits
trading on behalf of a broad range of market participants.
(4) Definition of financial exposure. For purposes of this
paragraph (b), financial exposure means the aggregate risks of one or
more financial instruments and any associated loans, commodities, or
foreign exchange or currency, held by a banking entity or its affiliate
and managed by a particular trading desk as part of the trading desk's
market making-related activities.
(5) Definition of market-maker inventory. For the purposes of this
paragraph (b), market-maker inventory means all of the positions in the
financial instruments for which the trading desk stands ready to make a
market in accordance with paragraph (b)(2)(i) of this section, that are
managed by the trading desk, including the trading desk's open
positions or exposures arising from open transactions.
Sec. 351.5 Permitted risk-mitigating hedging activities.
(a) Permitted risk-mitigating hedging activities. The prohibition
contained in Sec. 351.3(a) does not apply to the risk-mitigating
hedging activities of a banking entity in connection with and related
to individual or aggregated positions, contracts, or other holdings of
the banking entity and designed to reduce the specific risks to the
banking entity in connection with and related to such positions,
contracts, or other holdings.
(b) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under paragraph (a) of this section only
if:
(1) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(i) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(ii) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(iii) The conduct of analysis, including correlation analysis, and
independent testing designed to ensure that the positions, techniques
and strategies that may be used for hedging may reasonably be expected
to demonstrably reduce or otherwise significantly mitigate the
specific, identifiable risk(s) being hedged, and such correlation
analysis demonstrates that the hedging activity demonstrably reduces or
otherwise significantly mitigates the specific, identifiable risk(s)
being hedged;
(2) The risk-mitigating hedging activity:
[[Page 62182]]
(i) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(ii) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate and demonstrably reduces or
otherwise significantly mitigates one or more specific, identifiable
risks, including market risk, counterparty or other credit risk,
currency or foreign exchange risk, interest rate risk, commodity price
risk, basis risk, or similar risks, arising in connection with and
related to identified positions, contracts, or other holdings of the
banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(iii) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(iv) Is subject to continuing review, monitoring and management by
the banking entity that:
(A) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1) of this section;
(B) Is designed to reduce or otherwise significantly mitigate and
demonstrably reduces or otherwise significantly mitigates the specific,
identifiable risks that develop over time from the risk-mitigating
hedging activities undertaken under this section and the underlying
positions, contracts, and other holdings of the banking entity, based
upon the facts and circumstances of the underlying and hedging
positions, contracts and other holdings of the banking entity and the
risks and liquidity thereof; and
(C) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading; and
(3) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(c) Documentation requirement--(1) A banking entity must comply
with the requirements of paragraphs (c)(2) and (3) of this section with
respect to any purchase or sale of financial instruments made in
reliance on this section for risk-mitigating hedging purposes that is:
(i) Not established by the specific trading desk establishing or
responsible for the underlying positions, contracts, or other holdings
the risks of which the hedging activity is designed to reduce;
(ii) Established by the specific trading desk establishing or
responsible for the underlying positions, contracts, or other holdings
the risks of which the purchases or sales are designed to reduce, but
that is effected through a financial instrument, exposure, technique,
or strategy that is not specifically identified in the trading desk's
written policies and procedures established under paragraph (b)(1) of
this section or under Sec. 351.4(b)(2)(iii)(B) of this subpart as a
product, instrument, exposure, technique, or strategy such trading desk
may use for hedging; or
(iii) Established to hedge aggregated positions across two or more
trading desks.
(2) In connection with any purchase or sale identified in paragraph
(c)(1) of this section, a banking entity must, at a minimum, and
contemporaneously with the purchase or sale, document:
(i) The specific, identifiable risk(s) of the identified positions,
contracts, or other holdings of the banking entity that the purchase or
sale is designed to reduce;
(ii) The specific risk-mitigating strategy that the purchase or
sale is designed to fulfill; and
(iii) The trading desk or other business unit that is establishing
and responsible for the hedge.
(3) A banking entity must create and retain records sufficient to
demonstrate compliance with the requirements of this paragraph (c) for
a period that is no less than five years in a form that allows the
banking entity to promptly produce such records to the FDIC on request,
or such longer period as required under other law or this part.
Sec. 351.6 Other permitted proprietary trading activities.
(a) Permitted trading in domestic government obligations. The
prohibition contained in Sec. 351.3(a) does not apply to the purchase
or sale by a banking entity of a financial instrument that is:
(1) An obligation of, or issued or guaranteed by, the United
States;
(2) An obligation, participation, or other instrument of, or issued
or guaranteed by, an agency of the United States, the Government
National Mortgage Association, the Federal National Mortgage
Association, the Federal Home Loan Mortgage Corporation, a Federal Home
Loan Bank, the Federal Agricultural Mortgage Corporation or a Farm
Credit System institution chartered under and subject to the provisions
of the Farm Credit Act of 1971 (12 U.S.C. 2001 et seq.);
(3) An obligation of any State or any political subdivision
thereof, including any municipal security; or
(4) An obligation of the FDIC, or any entity formed by or on behalf
of the FDIC for purpose of facilitating the disposal of assets acquired
or held by the FDIC in its corporate capacity or as conservator or
receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(b) Permitted trading in foreign government obligations--(1)
Affiliates of foreign banking entities in the United States. The
prohibition contained in Sec. 351.3(a) does not apply to the purchase
or sale of a financial instrument that is an obligation of, or issued
or guaranteed by, a foreign sovereign (including any multinational
central bank of which the foreign sovereign is a member), or any agency
or political subdivision of such foreign sovereign, by a banking
entity, so long as:
(i) The banking entity is organized under or is directly or
indirectly controlled by a banking entity that is organized under the
laws of a foreign sovereign and is not directly or indirectly
controlled by a top-tier banking entity that is organized under the
laws of the United States;
(ii) The financial instrument is an obligation of, or issued or
guaranteed by, the foreign sovereign under the laws of which the
foreign banking entity referred to in paragraph (b)(1)(i) of this
section is organized (including any multinational central bank of which
the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign; and
(iii) The purchase or sale as principal is not made by an insured
depository institution.
(2) Foreign affiliates of a U.S. banking entity. The prohibition
contained in Sec. 351.3(a) does not apply to the purchase or sale of a
financial instrument that is an obligation of, or issued or guaranteed
by, a foreign sovereign (including any multinational central bank of
which the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign, by a foreign entity that is
owned or controlled by a banking entity organized or established under
the laws of the United States or any State, so long as:
(i) The foreign entity is a foreign bank, as defined in section
211.2(j) of the Board's Regulation K (12 CFR 211.2(j)), or is regulated
by the foreign sovereign as a securities dealer;
[[Page 62183]]
(ii) The financial instrument is an obligation of, or issued or
guaranteed by, the foreign sovereign under the laws of which the
foreign entity is organized (including any multinational central bank
of which the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign; and
(iii) The financial instrument is owned by the foreign entity and
is not financed by an affiliate that is located in the United States or
organized under the laws of the United States or of any State.
(c) Permitted trading on behalf of customers--(1) Fiduciary
transactions. The prohibition contained in Sec. 351.3(a) does not
apply to the purchase or sale of financial instruments by a banking
entity acting as trustee or in a similar fiduciary capacity, so long
as:
(i) The transaction is conducted for the account of, or on behalf
of, a customer; and
(ii) The banking entity does not have or retain beneficial
ownership of the financial instruments.
(2) Riskless principal transactions. The prohibition contained in
Sec. 351.3(a) does not apply to the purchase or sale of financial
instruments by a banking entity acting as riskless principal in a
transaction in which the banking entity, after receiving an order to
purchase (or sell) a financial instrument from a customer, purchases
(or sells) the financial instrument for its own account to offset a
contemporaneous sale to (or purchase from) the customer.
(d) Permitted trading by a regulated insurance company. The
prohibition contained in Sec. 351.3(a) does not apply to the purchase
or sale of financial instruments by a banking entity that is an
insurance company or an affiliate of an insurance company if:
(1) The insurance company or its affiliate purchases or sells the
financial instruments solely for:
(i) The general account of the insurance company; or
(ii) A separate account established by the insurance company;
(2) The purchase or sale is conducted in compliance with, and
subject to, the insurance company investment laws, regulations, and
written guidance of the State or jurisdiction in which such insurance
company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law, regulation, or written guidance described in
paragraph (d)(2) of this section is insufficient to protect the safety
and soundness of the covered banking entity, or the financial stability
of the United States.
(e) Permitted trading activities of foreign banking entities. (1)
The prohibition contained in Sec. 351.3(a) does not apply to the
purchase or sale of financial instruments by a banking entity if:
(i) The banking entity is not organized or directly or indirectly
controlled by a banking entity that is organized under the laws of the
United States or of any State;
(ii) The purchase or sale by the banking entity is made pursuant to
paragraph (9) or (13) of section 4(c) of the BHC Act; and
(iii) The purchase or sale meets the requirements of paragraph
(e)(3) of this section.
(2) A purchase or sale of financial instruments by a banking entity
is made pursuant to paragraph (9) or (13) of section 4(c) of the BHC
Act for purposes of paragraph (e)(1)(ii) of this section only if:
(i) The purchase or sale is conducted in accordance with the
requirements of paragraph (e) of this section; and
(ii)(A) With respect to a banking entity that is a foreign banking
organization, the banking entity meets the qualifying foreign banking
organization requirements of section 211.23(a), (c) or (e) of the
Board's Regulation K (12 CFR 211.23(a), (c) or (e)), as applicable; or
(B) With respect to a banking entity that is not a foreign banking
organization, the banking entity is not organized under the laws of the
United States or of any State and the banking entity, on a fully-
consolidated basis, meets at least two of the following requirements:
(1) Total assets of the banking entity held outside of the United
States exceed total assets of the banking entity held in the United
States;
(2) Total revenues derived from the business of the banking entity
outside of the United States exceed total revenues derived from the
business of the banking entity in the United States; or
(3) Total net income derived from the business of the banking
entity outside of the United States exceeds total net income derived
from the business of the banking entity in the United States.
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including any personnel of the banking entity or its affiliate
that arrange, negotiate or execute such purchase or sale) is not
located in the United States or organized under the laws of the United
States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State;
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State;
(iv) No financing for the banking entity's purchases or sales is
provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State; and
(v) The purchase or sale is not conducted with or through any U.S.
entity, other than:
(A) A purchase or sale with the foreign operations of a U.S. entity
if no personnel of such U.S. entity that are located in the United
States are involved in the arrangement, negotiation, or execution of
such purchase or sale;
(B) A purchase or sale with an unaffiliated market intermediary
acting as principal, provided the purchase or sale is promptly cleared
and settled through a clearing agency or derivatives clearing
organization acting as a central counterparty; or
(C) A purchase or sale through an unaffiliated market intermediary
acting as agent, provided the purchase or sale is conducted anonymously
on an exchange or similar trading facility and is promptly cleared and
settled through a clearing agency or derivatives clearing organization
acting as a central counterparty.
(4) For purposes of this paragraph (e), a U.S. entity is any entity
that is, or is controlled by, or is acting on behalf of, or at the
direction of, any other entity that is, located in the United States or
organized under the laws of the United States or of any State.
(5) For purposes of this paragraph (e), a U.S. branch, agency, or
subsidiary of a foreign banking entity is considered to be located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(6) For purposes of this paragraph (e), unaffiliated market
intermediary means
[[Page 62184]]
an unaffiliated entity, acting as an intermediary, that is:
(i) A broker or dealer registered with the SEC under section 15 of
the Exchange Act or exempt from registration or excluded from
regulation as such;
(ii) A swap dealer registered with the CFTC under section 4s of the
Commodity Exchange Act or exempt from registration or excluded from
regulation as such;
(iii) A security-based swap dealer registered with the SEC under
section 15F of the Exchange Act or exempt from registration or excluded
from regulation as such; or
(iv) A futures commission merchant registered with the CFTC under
section 4f of the Commodity Exchange Act or exempt from registration or
excluded from regulation as such.
Sec. 351.7 Limitations on permitted proprietary trading activities.
(a) No transaction, class of transactions, or activity may be
deemed permissible under Sec. Sec. 351.4 through 351.6 if the
transaction, class of transactions, or activity would:
(1) Involve or result in a material conflict of interest between
the banking entity and its clients, customers, or counterparties;
(2) Result, directly or indirectly, in a material exposure by the
banking entity to a high-risk asset or a high-risk trading strategy; or
(3) Pose a threat to the safety and soundness of the banking entity
or to the financial stability of the United States.
(b) Definition of material conflict of interest. (1) For purposes
of this section, a material conflict of interest between a banking
entity and its clients, customers, or counterparties exists if the
banking entity engages in any transaction, class of transactions, or
activity that would involve or result in the banking entity's interests
being materially adverse to the interests of its client, customer, or
counterparty with respect to such transaction, class of transactions,
or activity, and the banking entity has not taken at least one of the
actions in paragraph (b)(2) of this section.
(2) Prior to effecting the specific transaction or class or type of
transactions, or engaging in the specific activity, the banking entity:
(i) Timely and effective disclosure. (A) Has made clear, timely,
and effective disclosure of the conflict of interest, together with
other necessary information, in reasonable detail and in a manner
sufficient to permit a reasonable client, customer, or counterparty to
meaningfully understand the conflict of interest; and
(B) Such disclosure is made in a manner that provides the client,
customer, or counterparty the opportunity to negate, or substantially
mitigate, any materially adverse effect on the client, customer, or
counterparty created by the conflict of interest; or
(ii) Information barriers. Has established, maintained, and
enforced information barriers that are memorialized in written policies
and procedures, such as physical separation of personnel, or functions,
or limitations on types of activity, that are reasonably designed,
taking into consideration the nature of the banking entity's business,
to prevent the conflict of interest from involving or resulting in a
materially adverse effect on a client, customer, or counterparty. A
banking entity may not rely on such information barriers if, in the
case of any specific transaction, class or type of transactions or
activity, the banking entity knows or should reasonably know that,
notwithstanding the banking entity's establishment of information
barriers, the conflict of interest may involve or result in a
materially adverse effect on a client, customer, or counterparty.
(c) Definition of high-risk asset and high-risk trading strategy.
For purposes of this section:
(1) High-risk asset means an asset or group of related assets that
would, if held by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
(2) High-risk trading strategy means a trading strategy that would,
if engaged in by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
Sec. Sec. 351.8-351.9 [Reserved]
Subpart C--Covered Funds Activities and Investments
Sec. 351.10 Prohibition on acquiring or retaining an ownership
interest in and having certain relationships with a covered fund.
(a) Prohibition. (1) Except as otherwise provided in this subpart,
a banking entity may not, as principal, directly or indirectly, acquire
or retain any ownership interest in or sponsor a covered fund.
(2) Paragraph (a)(1) of this section does not include acquiring or
retaining an ownership interest in a covered fund by a banking entity:
(i) Acting solely as agent, broker, or custodian, so long as;
(A) The activity is conducted for the account of, or on behalf of,
a customer; and
(B) The banking entity and its affiliates do not have or retain
beneficial ownership of such ownership interest;
(ii) Through a deferred compensation, stock-bonus, profit-sharing,
or pension plan of the banking entity (or an affiliate thereof) that is
established and administered in accordance with the law of the United
States or a foreign sovereign, if the ownership interest is held or
controlled directly or indirectly by the banking entity as trustee for
the benefit of persons who are or were employees of the banking entity
(or an affiliate thereof);
(iii) In the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
ownership interest as soon as practicable, and in no event may the
banking entity retain such ownership interest for longer than such
period permitted by the FDIC; or
(iv) On behalf of customers as trustee or in a similar fiduciary
capacity for a customer that is not a covered fund, so long as:
(A) The activity is conducted for the account of, or on behalf of,
the customer; and
(B) The banking entity and its affiliates do not have or retain
beneficial ownership of such ownership interest.
(b) Definition of covered fund. (1) Except as provided in paragraph
(c) of this section, covered fund means:
(i) An issuer that would be an investment company, as defined in
the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.), but for
section 3(c)(1) or 3(c)(7) of that Act (15 U.S.C. 80a-3(c)(1) or (7));
(ii) Any commodity pool under section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10)) for which:
(A) The commodity pool operator has claimed an exemption under 17
CFR 4.7; or
(B)(1) A commodity pool operator is registered with the CFTC as a
commodity pool operator in connection with the operation of the
commodity pool;
(2) Substantially all participation units of the commodity pool are
owned by qualified eligible persons under 17 CFR 4.7(a)(2) and (3); and
(3) Participation units of the commodity pool have not been
publicly offered to persons who are not qualified
[[Page 62185]]
eligible persons under 17 CFR 4.7(a)(2) and (3); or
(iii) For any banking entity that is, or is controlled directly or
indirectly by a banking entity that is, located in or organized under
the laws of the United States or of any State, an entity that:
(A) Is organized or established outside the United States and the
ownership interests of which are offered and sold solely outside the
United States;
(B) Is, or holds itself out as being, an entity or arrangement that
raises money from investors primarily for the purpose of investing in
securities for resale or other disposition or otherwise trading in
securities; and
(C)(1) Has as its sponsor that banking entity (or an affiliate
thereof); or
(2) Has issued an ownership interest that is owned directly or
indirectly by that banking entity (or an affiliate thereof).
(2) An issuer shall not be deemed to be a covered fund under
paragraph (b)(1)(iii) of this section if, were the issuer subject to
U.S. securities laws, the issuer could rely on an exclusion or
exemption from the definition of ``investment company'' under the
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) other than the
exclusions contained in section 3(c)(1) and 3(c)(7) of that Act.
(3) For purposes of paragraph (b)(1)(iii) of this section, a U.S.
branch, agency, or subsidiary of a foreign banking entity is located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(c) Notwithstanding paragraph (b) of this section, unless the
appropriate Federal banking agencies, the SEC, and the CFTC jointly
determine otherwise, a covered fund does not include:
(1) Foreign public funds. (i) Subject to paragraphs (ii) and (iii)
below, an issuer that:
(A) Is organized or established outside of the United States;
(B) Is authorized to offer and sell ownership interests to retail
investors in the issuer's home jurisdiction; and
(C) Sells ownership interests predominantly through one or more
public offerings outside of the United States.
(ii) With respect to a banking entity that is, or is controlled
directly or indirectly by a banking entity that is, located in or
organized under the laws of the United States or of any State and any
issuer for which such banking entity acts as sponsor, the sponsoring
banking entity may not rely on the exemption in paragraph (c)(1)(i) of
this section for such issuer unless ownership interests in the issuer
are sold predominantly to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring banking entity or such issuer;
and
(D) Directors and employees of such entities.
(iii) For purposes of paragraph (c)(1)(i)(C) of this section, the
term ``public offering'' means a distribution (as defined in Sec.
351.4(a)(3) of subpart B) of securities in any jurisdiction outside the
United States to investors, including retail investors, provided that:
(A) The distribution complies with all applicable requirements in
the jurisdiction in which such distribution is being made;
(B) The distribution does not restrict availability to investors
having a minimum level of net worth or net investment assets; and
(C) The issuer has filed or submitted, with the appropriate
regulatory authority in such jurisdiction, offering disclosure
documents that are publicly available.
(2) Wholly-owned subsidiaries. An entity, all of the outstanding
ownership interests of which are owned directly or indirectly by the
banking entity (or an affiliate thereof), except that:
(i) Up to five percent of the entity's outstanding ownership
interests, less any amounts outstanding under paragraph (c)(2)(ii) of
this section, may be held by employees or directors of the banking
entity or such affiliate (including former employees or directors if
their ownership interest was acquired while employed by or in the
service of the banking entity); and
(ii) Up to 0.5 percent of the entity's outstanding ownership
interests may be held by a third party if the ownership interest is
acquired or retained by the third party for the purpose of establishing
corporate separateness or addressing bankruptcy, insolvency, or similar
concerns.
(3) Joint ventures. A joint venture between a banking entity or any
of its affiliates and one or more unaffiliated persons, provided that
the joint venture:
(i) Is comprised of no more than 10 unaffiliated co-venturers;
(ii) Is in the business of engaging in activities that are
permissible for the banking entity or affiliate, other than investing
in securities for resale or other disposition; and
(iii) Is not, and does not hold itself out as being, an entity or
arrangement that raises money from investors primarily for the purpose
of investing in securities for resale or other disposition or otherwise
trading in securities.
(4) Acquisition vehicles. An issuer:
(i) Formed solely for the purpose of engaging in a bona fide merger
or acquisition transaction; and
(ii) That exists only for such period as necessary to effectuate
the transaction.
(5) Foreign pension or retirement funds. A plan, fund, or program
providing pension, retirement, or similar benefits that is:
(i) Organized and administered outside the United States;
(ii) A broad-based plan for employees or citizens that is subject
to regulation as a pension, retirement, or similar plan under the laws
of the jurisdiction in which the plan, fund, or program is organized
and administered; and
(iii) Established for the benefit of citizens or residents of one
or more foreign sovereigns or any political subdivision thereof.
(6) Insurance company separate accounts. A separate account,
provided that no banking entity other than the insurance company
participates in the account's profits and losses.
(7) Bank owned life insurance. A separate account that is used
solely for the purpose of allowing one or more banking entities to
purchase a life insurance policy for which the banking entity or
entities is beneficiary, provided that no banking entity that purchases
the policy:
(i) Controls the investment decisions regarding the underlying
assets or holdings of the separate account; or
(ii) Participates in the profits and losses of the separate account
other than in compliance with applicable supervisory guidance regarding
bank owned life insurance.
(8) Loan securitizations. (i) Scope. An issuing entity for asset-
backed securities that satisfies all the conditions of this paragraph
(c)(8) and the assets or holdings of which are comprised solely of:
(A) Loans as defined in Sec. 351.2(s) of subpart A;
(B) Rights or other assets designed to assure the servicing or
timely distribution of proceeds to holders of such securities and
rights or other assets that are related or incidental to purchasing or
otherwise acquiring and holding the loans, provided that each asset
meets the requirements of paragraph (c)(8)(iii) of this section;
(C) Interest rate or foreign exchange derivatives that meet the
requirements of paragraph (c)(8)(iv) of this section; and
(D) Special units of beneficial interest and collateral
certificates that meet the requirements of paragraph (c)(8)(v) of this
section.
[[Page 62186]]
(ii) Impermissible assets. For purposes of this paragraph (c)(8),
the assets or holdings of the issuing entity shall not include any of
the following:
(A) A security, including an asset-backed security, or an interest
in an equity or debt security other than as permitted in paragraph
(c)(8)(iii) of this section;
(B) A derivative, other than a derivative that meets the
requirements of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities. Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may hold securities if those
securities are:
(A) Cash equivalents for purposes of the rights and assets in
paragraph (c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts previously contracted with
respect to the loans supporting the asset-backed securities.
(iv) Derivatives. The holdings of derivatives by the issuing entity
shall be limited to interest rate or foreign exchange derivatives that
satisfy all of the following conditions:
(A) The written terms of the derivative directly relate to the
loans, the asset-backed securities, or the contractual rights of other
assets described in paragraph (c)(8)(i)(B) of this section; and
(B) The derivatives reduce the interest rate and/or foreign
exchange risks related to the loans, the asset-backed securities, or
the contractual rights or other assets described in paragraph
(c)(8)(i)(B) of this section.
(v) Special units of beneficial interest and collateral
certificates. The assets or holdings of the issuing entity may include
collateral certificates and special units of beneficial interest issued
by a special purpose vehicle, provided that:
(A) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate meets the requirements in
this paragraph (c)(8);
(B) The special unit of beneficial interest or collateral
certificate is used for the sole purpose of transferring to the issuing
entity for the loan securitization the economic risks and benefits of
the assets that are permissible for loan securitizations under this
paragraph (c)(8) and does not directly or indirectly transfer any
interest in any other economic or financial exposure;
(C) The special unit of beneficial interest or collateral
certificate is created solely to satisfy legal requirements or
otherwise facilitate the structuring of the loan securitization; and
(D) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate and the issuing entity
are established under the direction of the same entity that initiated
the loan securitization.
(9) Qualifying asset-backed commercial paper conduits. (i) An
issuing entity for asset-backed commercial paper that satisfies all of
the following requirements:
(A) The asset-backed commercial paper conduit holds only:
(1) Loans and other assets permissible for a loan securitization
under paragraph (c)(8)(i) of this section; and
(2) Asset-backed securities supported solely by assets that are
permissible for loan securitizations under paragraph (c)(8)(i) of this
section and acquired by the asset-backed commercial paper conduit as
part of an initial issuance either directly from the issuing entity of
the asset-backed securities or directly from an underwriter in the
distribution of the asset-backed securities;
(B) The asset-backed commercial paper conduit issues only asset-
backed securities, comprised of a residual interest and securities with
a legal maturity of 397 days or less; and
(C) A regulated liquidity provider has entered into a legally
binding commitment to provide full and unconditional liquidity coverage
with respect to all of the outstanding asset-backed securities issued
by the asset-backed commercial paper conduit (other than any residual
interest) in the event that funds are required to redeem maturing
asset-backed securities.
(ii) For purposes of this paragraph (c)(9), a regulated liquidity
provider means:
(A) A depository institution, as defined in section 3(c) of the
Federal Deposit Insurance Act (12 U.S.C. 1813(c));
(B) A bank holding company, as defined in section 2(a) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(a)), or a subsidiary
thereof;
(C) A savings and loan holding company, as defined in section 10a
of the Home Owners' Loan Act (12 U.S.C. 1467a), provided all or
substantially all of the holding company's activities are permissible
for a financial holding company under section 4(k) of the Bank Holding
Company Act of 1956 (12 U.S.C. 1843(k)), or a subsidiary thereof;
(D) A foreign bank whose home country supervisor, as defined in
Sec. 211.21(q) of the Board's Regulation K (12 CFR 211.21(q)), has
adopted capital standards consistent with the Capital Accord for the
Basel Committee on banking Supervision, as amended, and that is subject
to such standards, or a subsidiary thereof; or
(E) The United States or a foreign sovereign.
(10) Qualifying covered bonds--(i) Scope. An entity owning or
holding a dynamic or fixed pool of loans or other assets as provided in
paragraph (c)(8) of this section for the benefit of the holders of
covered bonds, provided that the assets in the pool are comprised
solely of assets that meet the conditions in paragraph (c)(8)(i) of
this section.
(ii) Covered bond. For purposes of this paragraph (c)(10), a
covered bond means:
(A) A debt obligation issued by an entity that meets the definition
of foreign banking organization, the payment obligations of which are
fully and unconditionally guaranteed by an entity that meets the
conditions set forth in paragraph (c)(10)(i) of this section; or
(B) A debt obligation of an entity that meets the conditions set
forth in paragraph (c)(10)(i) of this section, provided that the
payment obligations are fully and unconditionally guaranteed by an
entity that meets the definition of foreign banking organization and
the entity is a wholly-owned subsidiary, as defined in paragraph (c)(2)
of this section, of such foreign banking organization.
(11) SBICs and public welfare investment funds. An issuer:
(i) That is a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), or that has received from the Small Business Administration
notice to proceed to qualify for a license as a small business
investment company, which notice or license has not been revoked; or
(ii) The business of which is to make investments that are:
(A) Designed primarily to promote the public welfare, of the type
permitted under paragraph (11) of section 5136 of the Revised Statutes
of the United States (12 U.S.C. 24), including the welfare of low- and
moderate-income communities or families (such as providing housing,
services, or jobs); or
(B) Qualified rehabilitation expenditures with respect to a
qualified rehabilitated building or certified historic structure, as
such terms are defined in section 47 of the Internal Revenue Code of
1986 or a similar State historic tax credit program.
(12) Registered investment companies and excluded entities. An
issuer:
(i) That is registered as an investment company under section 8 of
the Investment Company Act of 1940 (15 U.S.C. 80a-8), or that is formed
and
[[Page 62187]]
operated pursuant to a written plan to become a registered investment
company as described in Sec. 351.20(e)(3) of subpart D and that
complies with the requirements of section 18 of the Investment Company
Act of 1940 (15 U.S.C. 80a-18);
(ii) That may rely on an exclusion or exemption from the definition
of ``investment company'' under the Investment Company Act of 1940 (15
U.S.C. 80a-1 et seq.) other than the exclusions contained in section
3(c)(1) and 3(c)(7) of that Act; or
(iii) That has elected to be regulated as a business development
company pursuant to section 54(a) of that Act (15 U.S.C. 80a-53) and
has not withdrawn its election, or that is formed and operated pursuant
to a written plan to become a business development company as described
in Sec. 351.20(e)(3) of subpart D and that complies with the
requirements of section 61 of the Investment Company Act of 1940 (15
U.S.C. 80a-60).
(13) Issuers in conjunction with the FDIC's receivership or
conservatorship operations. An issuer that is an entity formed by or on
behalf of the FDIC for the purpose of facilitating the disposal of
assets acquired in the FDIC's capacity as conservator or receiver under
the Federal Deposit Insurance Act or Title II of the Dodd-Frank Wall
Street Reform and Consumer Protection Act.
(14) Other excluded issuers. (i) Any issuer that the appropriate
Federal banking agencies, the SEC, and the CFTC jointly determine the
exclusion of which is consistent with the purposes of section 13 of the
BHC Act.
(ii) A determination made under paragraph (c)(14)(i) of this
section will be promptly made public.
(d) Definition of other terms related to covered funds. For
purposes of this subpart:
(1) Applicable accounting standards means U.S. generally accepted
accounting principles, or such other accounting standards applicable to
a banking entity that the FDIC determines are appropriate and that the
banking entity uses in the ordinary course of its business in preparing
its consolidated financial statements.
(2) Asset-backed security has the meaning specified in Section
3(a)(79) of the Exchange Act (15 U.S.C. 78c(a)(79)).
(3) Director has the same meaning as provided in section
215.2(d)(1) of the Board's Regulation O (12 CFR 215.2(d)(1)).
(4) Issuer has the same meaning as in section 2(a)(22) of the
Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(22)).
(5) Issuing entity means with respect to asset-backed securities
the special purpose vehicle that owns or holds the pool assets
underlying asset-backed securities and in whose name the asset-backed
securities supported or serviced by the pool assets are issued.
(6) Ownership interest--(i) Ownership interest means any equity,
partnership, or other similar interest. An ``other similar interest''
means an interest that:
(A) Has the right to participate in the selection or removal of a
general partner, managing member, member of the board of directors or
trustees, investment manager, investment adviser, or commodity trading
advisor of the covered fund (excluding the rights of a creditor to
exercise remedies upon the occurrence of an event of default or an
acceleration event);
(B) Has the right under the terms of the interest to receive a
share of the income, gains or profits of the covered fund;
(C) Has the right to receive the underlying assets of the covered
fund after all other interests have been redeemed and/or paid in full
(excluding the rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event);
(D) Has the right to receive all or a portion of excess spread (the
positive difference, if any, between the aggregate interest payments
received from the underlying assets of the covered fund and the
aggregate interest paid to the holders of other outstanding interests);
(E) Provides under the terms of the interest that the amounts
payable by the covered fund with respect to the interest could be
reduced based on losses arising from the underlying assets of the
covered fund, such as allocation of losses, write-downs or charge-offs
of the outstanding principal balance, or reductions in the amount of
interest due and payable on the interest;
(F) Receives income on a pass-through basis from the covered fund,
or has a rate of return that is determined by reference to the
performance of the underlying assets of the covered fund; or
(G) Any synthetic right to have, receive, or be allocated any of
the rights in paragraphs (d)(6)(i)(A) through (F) of this section.
(ii) Ownership interest does not include: Restricted profit
interest. An interest held by an entity (or an employee or former
employee thereof) in a covered fund for which the entity (or employee
thereof) serves as investment manager, investment adviser, commodity
trading advisor, or other service provider so long as:
(A) The sole purpose and effect of the interest is to allow the
entity (or employee or former employee thereof) to share in the profits
of the covered fund as performance compensation for the investment
management, investment advisory, commodity trading advisory, or other
services provided to the covered fund by the entity (or employee or
former employee thereof), provided that the entity (or employee or
former employee thereof) may be obligated under the terms of such
interest to return profits previously received;
(B) All such profit, once allocated, is distributed to the entity
(or employee or former employee thereof) promptly after being earned
or, if not so distributed, is retained by the covered fund for the sole
purpose of establishing a reserve amount to satisfy contractual
obligations with respect to subsequent losses of the covered fund and
such undistributed profit of the entity (or employee or former employee
thereof) does not share in the subsequent investment gains of the
covered fund;
(C) Any amounts invested in the covered fund, including any amounts
paid by the entity (or employee or former employee thereof) in
connection with obtaining the restricted profit interest, are within
the limits of Sec. 351.12 of this subpart; and
(D) The interest is not transferable by the entity (or employee or
former employee thereof) except to an affiliate thereof (or an employee
of the banking entity or affiliate), to immediate family members, or
through the intestacy, of the employee or former employee, or in
connection with a sale of the business that gave rise to the restricted
profit interest by the entity (or employee or former employee thereof)
to an unaffiliated party that provides investment management,
investment advisory, commodity trading advisory, or other services to
the fund.
(7) Prime brokerage transaction means any transaction that would be
a covered transaction, as defined in section 23A(b)(7) of the Federal
Reserve Act (12 U.S.C. 371c(b)(7)), that is provided in connection with
custody, clearance and settlement, securities borrowing or lending
services, trade execution, financing, or data, operational, and
administrative support.
(8) Resident of the United States means a person that is a ``U.S.
person'' as defined in rule 902(k) of the SEC's Regulation S (17 CFR
230.902(k)).
(9) Sponsor means, with respect to a covered fund:
(i) To serve as a general partner, managing member, or trustee of a
covered fund, or to serve as a commodity pool operator with respect
[[Page 62188]]
to a covered fund as defined in (b)(1)(ii) of this section;
(ii) In any manner to select or to control (or to have employees,
officers, or directors, or agents who constitute) a majority of the
directors, trustees, or management of a covered fund; or
(iii) To share with a covered fund, for corporate, marketing,
promotional, or other purposes, the same name or a variation of the
same name, except as permitted under Sec. 351.11(a)(6).
(10) Trustee. (i) For purposes of paragraph (d)(9) of this section
and Sec. 351.11 of subpart C, a trustee does not include:
(A) A trustee that does not exercise investment discretion with
respect to a covered fund, including a trustee that is subject to the
direction of an unaffiliated named fiduciary who is not a trustee
pursuant to section 403(a)(1) of the Employee's Retirement Income
Security Act (29 U.S.C. 1103(a)(1)); or
(B) A trustee that is subject to fiduciary standards imposed under
foreign law that are substantially equivalent to those described in
paragraph (d)(10)(i)(A) of this section;
(ii) Any entity that directs a person described in paragraph
(d)(10)(i) of this section, or that possesses authority and discretion
to manage and control the investment decisions of a covered fund for
which such person serves as trustee, shall be considered to be a
trustee of such covered fund.
Sec. 351.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
(a) Organizing and offering a covered fund in general.
Notwithstanding Sec. 351.10(a) of this subpart, a banking entity is
not prohibited from acquiring or retaining an ownership interest in, or
acting as sponsor to, a covered fund in connection with, directly or
indirectly, organizing and offering a covered fund, including serving
as a general partner, managing member, trustee, or commodity pool
operator of the covered fund and in any manner selecting or controlling
(or having employees, officers, directors, or agents who constitute) a
majority of the directors, trustees, or management of the covered fund,
including any necessary expenses for the foregoing, only if:
(1) The banking entity (or an affiliate thereof) provides bona fide
trust, fiduciary, investment advisory, or commodity trading advisory
services;
(2) The covered fund is organized and offered only in connection
with the provision of bona fide trust, fiduciary, investment advisory,
or commodity trading advisory services and only to persons that are
customers of such services of the banking entity (or an affiliate
thereof), pursuant to a written plan or similar documentation outlining
how the banking entity or such affiliate intends to provide advisory or
similar services to its customers through organizing and offering such
fund;
(3) The banking entity and its affiliates do not acquire or retain
an ownership interest in the covered fund except as permitted under
Sec. 351.12 of this subpart;
(4) The banking entity and its affiliates comply with the
requirements of Sec. 351.14 of this subpart;
(5) The banking entity and its affiliates do not, directly or
indirectly, guarantee, assume, or otherwise insure the obligations or
performance of the covered fund or of any covered fund in which such
covered fund invests;
(6) The covered fund, for corporate, marketing, promotional, or
other purposes:
(i) Does not share the same name or a variation of the same name
with the banking entity (or an affiliate thereof), except that a
covered fund may share the same name or a variation of the same name
with a banking entity that is an investment adviser to the covered fund
if:
(A) The investment adviser is not an insured depository
institution, a company that controls an insured depository institution,
or a company that is treated as a bank holding company for purposes of
section 8 of the International Banking Act of 1978 (12 U.S.C. 3106);
and
(B) The investment adviser does not share the same name or a
variation of the same name as an insured depository institution, a
company that controls an insured depository institution, or a company
that is treated as a bank holding company for purposes of section 8 of
the International Banking Act of 1978 (12 U.S.C. 3106); and
(ii) Does not use the word ``bank'' in its name;
(7) No director or employee of the banking entity (or an affiliate
thereof) takes or retains an ownership interest in the covered fund,
except for any director or employee of the banking entity or such
affiliate who is directly engaged in providing investment advisory,
commodity trading advisory, or other services to the covered fund at
the time the director or employee takes the ownership interest; and
(8) The banking entity:
(i) Clearly and conspicuously discloses, in writing, to any
prospective and actual investor in the covered fund (such as through
disclosure in the covered fund's offering documents):
(A) That ``any losses in [such covered fund] will be borne solely
by investors in [the covered fund] and not by [the banking entity] or
its affiliates; therefore, [the banking entity's] losses in [such
covered fund] will be limited to losses attributable to the ownership
interests in the covered fund held by [the banking entity] and any
affiliate in its capacity as investor in the [covered fund] or as
beneficiary of a restricted profit interest held by [the banking
entity] or any affiliate'';
(B) That such investor should read the fund offering documents
before investing in the covered fund;
(C) That the ``ownership interests in the covered fund are not
insured by the FDIC, and are not deposits, obligations of, or endorsed
or guaranteed in any way, by any banking entity'' (unless that happens
to be the case); and
(D) The role of the banking entity and its affiliates and employees
in sponsoring or providing any services to the covered fund; and
(ii) Complies with any additional rules of the appropriate Federal
banking agencies, the SEC, or the CFTC, as provided in section 13(b)(2)
of the BHC Act, designed to ensure that losses in such covered fund are
borne solely by investors in the covered fund and not by the covered
banking entity and its affiliates.
(b) Organizing and offering an issuing entity of asset-backed
securities. (1) Notwithstanding Sec. 351.10(a) of this subpart, a
banking entity is not prohibited from acquiring or retaining an
ownership interest in, or acting as sponsor to, a covered fund that is
an issuing entity of asset-backed securities in connection with,
directly or indirectly, organizing and offering that issuing entity, so
long as the banking entity and its affiliates comply with all of the
requirements of paragraph (a)(3) through (8) of this section.
(2) For purposes of this paragraph (b), organizing and offering a
covered fund that is an issuing entity of asset-backed securities means
acting as the securitizer, as that term is used in section 15G(a)(3) of
the Exchange Act (15 U.S.C. 78o-11(a)(3)) of the issuing entity, or
acquiring or retaining an ownership interest in the issuing entity as
required by section 15G of that Act (15 U.S.C. 78o-11) and the
implementing regulations issued thereunder.
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 351.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related
[[Page 62189]]
activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 351.4(a) or Sec. 351.4(b) of subpart B,
respectively;
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in such covered fund in
compliance with section 15G of that Act (15 U.S.C. 78o-11) and the
implementing regulations issued thereunder each as permitted by
paragraph (b) of this section; or, directly or indirectly, guarantees,
assumes, or otherwise insures the obligations or performance of the
covered fund or of any covered fund in which such fund invests, then in
each such case any ownership interests acquired or retained by the
banking entity and its affiliates in connection with underwriting and
market making related activities for that particular covered fund are
included in the calculation of ownership interests permitted to be held
by the banking entity and its affiliates under the limitations of Sec.
351.12(a)(2)(ii) and Sec. 351.12(d) of this subpart; and
(3) With respect to any banking entity, the aggregate value of all
ownership interests of the banking entity and its affiliates in all
covered funds acquired and retained under Sec. 351.11 of this subpart,
including all covered funds in which the banking entity holds an
ownership interest in connection with underwriting and market making
related activities permitted under this paragraph (c), are included in
the calculation of all ownership interests under Sec.
351.12(a)(2)(iii) and Sec. 351.12(d) of this subpart.
Sec. 351.12 Permitted investment in a covered fund.
(a) Authority and limitations on permitted investments in covered
funds. (1) Notwithstanding the prohibition contained in Sec. 351.10(a)
of this subpart, a banking entity may acquire and retain an ownership
interest in a covered fund that the banking entity or an affiliate
thereof organizes and offers pursuant to Sec. 351.11, for the purposes
of:
(i) Establishment. Establishing the fund and providing the fund
with sufficient initial equity for investment to permit the fund to
attract unaffiliated investors, subject to the limits contained in
paragraphs (a)(2)(i) and (iii) of this section; or
(ii) De minimis investment. Making and retaining an investment in
the covered fund subject to the limits contained in paragraphs
(a)(2)(ii) and (iii) of this section.
(2) Investment limits--(i) Seeding period. With respect to an
investment in any covered fund made or held pursuant to paragraph
(a)(1)(i) of this section, the banking entity and its affiliates:
(A) Must actively seek unaffiliated investors to reduce, through
redemption, sale, dilution, or other methods, the aggregate amount of
all ownership interests of the banking entity in the covered fund to
the amount permitted in paragraph (a)(2)(i)(B) of this section; and
(B) Must, no later than 1 year after the date of establishment of
the fund (or such longer period as may be provided by the Board
pursuant to paragraph (e) of this section), conform its ownership
interest in the covered fund to the limits in paragraph (a)(2)(ii) of
this section;
(ii) Per-fund limits. (A) Except as provided in paragraph
(a)(2)(ii)(B) of this section, an investment by a banking entity and
its affiliates in any covered fund made or held pursuant to paragraph
(a)(1)(ii) of this section may not exceed 3 percent of the total number
or value of the outstanding ownership interests of the fund.
(B) An investment by a banking entity and its affiliates in a
covered fund that is an issuing entity of asset-backed securities may
not exceed 3 percent of the total fair market value of the ownership
interests of the fund measured in accordance with paragraph (b)(3) of
this section, unless a greater percentage is retained by the banking
entity and its affiliates in compliance with the requirements of
section 15G of the Exchange Act (15 U.S.C. 78o-11) and the implementing
regulations issued thereunder, in which case the investment by the
banking entity and its affiliates in the covered fund may not exceed
the amount, number, or value of ownership interests of the fund
required under section 15G of the Exchange Act and the implementing
regulations issued thereunder.
(iii) Aggregate limit. The aggregate value of all ownership
interests of the banking entity and its affiliates in all covered funds
acquired or retained under this section may not exceed 3 percent of the
tier 1 capital of the banking entity, as provided under paragraph (c)
of this section, and shall be calculated as of the last day of each
calendar quarter.
(iv) Date of establishment. For purposes of this section, the date
of establishment of a covered fund shall be:
(A) In general. The date on which the investment adviser or similar
entity to the covered fund begins making investments pursuant to the
written investment strategy for the fund;
(B) Issuing entities of asset-backed securities. In the case of an
issuing entity of asset-backed securities, the date on which the assets
are initially transferred into the issuing entity of asset-backed
securities.
(b) Rules of construction--(1) Attribution of ownership interests
to a covered banking entity. (i) For purposes of paragraph (a)(2) of
this section, the amount and value of a banking entity's permitted
investment in any single covered fund shall include any ownership
interest held under Sec. 351.12 directly by the banking entity,
including any affiliate of the banking entity.
(ii) Treatment of registered investment companies, SEC-regulated
business development companies and foreign public funds. For purposes
of paragraph (b)(1)(i) of this section, a registered investment
company, SEC-regulated business development companies or foreign public
fund as described in Sec. 351.10(c)(1) of this subpart will not be
considered to be an affiliate of the banking entity so long as the
banking entity:
(A) Does not own, control, or hold with the power to vote 25
percent or more of the voting shares of the company or fund; and
(B) Provides investment advisory, commodity trading advisory,
administrative, and other services to the company or fund in compliance
with the limitations under applicable regulation, order, or other
authority.
(iii) Covered funds. For purposes of paragraph (b)(1)(i) of this
section, a covered fund will not be considered to be an affiliate of a
banking entity so long as the covered fund is held in compliance with
the requirements of this subpart.
(iv) Treatment of employee and director investments financed by the
banking entity. For purposes of paragraph (b)(1)(i) of this section, an
investment by a director or employee of a banking entity who acquires
an ownership interest in his or her personal capacity in a covered fund
sponsored by the banking entity will be attributed to the banking
entity if the banking entity, directly or indirectly, extends financing
for the purpose of enabling the director or employee to
[[Page 62190]]
acquire the ownership interest in the fund and the financing is used to
acquire such ownership interest in the covered fund.
(2) Calculation of permitted ownership interests in a single
covered fund. Except as provided in paragraph (b)(3) or (4), for
purposes of determining whether an investment in a single covered fund
complies with the restrictions on ownership interests under paragraphs
(a)(2)(i)(B) and (a)(2)(ii)(A) of this section:
(i) The aggregate number of the outstanding ownership interests
held by the banking entity shall be the total number of ownership
interests held under this section by the banking entity in a covered
fund divided by the total number of ownership interests held by all
entities in that covered fund, as of the last day of each calendar
quarter (both measured without regard to committed funds not yet called
for investment);
(ii) The aggregate value of the outstanding ownership interests
held by the banking entity shall be the aggregate fair market value of
all investments in and capital contributions made to the covered fund
by the banking entity, divided by the value of all investments in and
capital contributions made to that covered fund by all entities, as of
the last day of each calendar quarter (all measured without regard to
committed funds not yet called for investment). If fair market value
cannot be determined, then the value shall be the historical cost basis
of all investments in and contributions made by the banking entity to
the covered fund;
(iii) For purposes of the calculation under paragraph (b)(2)(ii) of
this section, once a valuation methodology is chosen, the banking
entity must calculate the value of its investment and the investments
of all others in the covered fund in the same manner and according to
the same standards.
(3) Issuing entities of asset-backed securities. In the case of an
ownership interest in an issuing entity of asset-backed securities, for
purposes of determining whether an investment in a single covered fund
complies with the restrictions on ownership interests under paragraphs
(a)(2)(i)(B) and (a)(2)(ii)(B) of this section:
(i) For securitizations subject to the requirements of section 15G
of the Exchange Act (15 U.S.C. 78o-11), the calculations shall be made
as of the date and according to the valuation methodology applicable
pursuant to the requirements of section 15G of the Exchange Act (15
U.S.C. 78o-11) and the implementing regulations issued thereunder; or
(ii) For securitization transactions completed prior to the
compliance date of such implementing regulations (or as to which such
implementing regulations do not apply), the calculations shall be made
as of the date of establishment as defined in paragraph (a)(2)(iv)(B)
of this section or such earlier date on which the transferred assets
have been valued for purposes of transfer to the covered fund, and
thereafter only upon the date on which additional securities of the
issuing entity of asset-backed securities are priced for purposes of
the sales of ownership interests to unaffiliated investors.
(iii) For securitization transactions completed prior to the
compliance date of such implementing regulations (or as to which such
implementing regulations do not apply), the aggregate value of the
outstanding ownership interests in the covered fund shall be the fair
market value of the assets transferred to the issuing entity of the
securitization and any other assets otherwise held by the issuing
entity at such time, determined in a manner that is consistent with its
determination of the fair market value of those assets for financial
statement purposes.
(iv) For purposes of the calculation under paragraph (b)(3)(iii) of
this section, the valuation methodology used to calculate the fair
market value of the ownership interests must be the same for both the
ownership interests held by a banking entity and the ownership
interests held by all others in the covered fund in the same manner and
according to the same standards.
(4) Multi-tier fund investments--(i) Master-feeder fund
investments. If the principal investment strategy of a covered fund
(the ``feeder fund'') is to invest substantially all of its assets in
another single covered fund (the ``master fund''), then for purposes of
the investment limitations in paragraphs (a)(2)(i)(B) and (a)(2)(ii) of
this section, the banking entity's permitted investment in such funds
shall be measured only by reference to the value of the master fund.
The banking entity's permitted investment in the master fund shall
include any investment by the banking entity in the master fund, as
well as the banking entity's pro-rata share of any ownership interest
of the master fund that is held through the feeder fund; and
(ii) Fund-of-funds investments. If a banking entity organizes and
offers a covered fund pursuant to Sec. 351.11 of this subpart for the
purpose of investing in other covered funds (a ``fund of funds'') and
that fund of funds itself invests in another covered fund that the
banking entity is permitted to own, then the banking entity's permitted
investment in that other fund shall include any investment by the
banking entity in that other fund, as well as the banking entity's pro-
rata share of any ownership interest of the fund that is held through
the fund of funds. The investment of the banking entity may not
represent more than 3 percent of the amount or value of any single
covered fund.
(c) Aggregate permitted investments in all covered funds. (1) For
purposes of paragraph (a)(2)(iii) of this section, the aggregate value
of all ownership interests held by a banking entity shall be the sum of
all amounts paid or contributed by the banking entity in connection
with acquiring or retaining an ownership interest in covered funds
(together with any amounts paid by the entity (or employee thereof) in
connection with obtaining a restricted profit interest under Sec.
351.10(d)(6)(ii) of this subpart), on a historical cost basis.
(2) Calculation of tier 1 capital. For purposes of paragraph
(a)(2)(iii) of this section:
(i) Entities that are required to hold and report tier 1 capital.
If a banking entity is required to calculate and report tier 1 capital,
the banking entity's tier 1 capital shall be equal to the amount of
tier 1 capital of the banking entity as of the last day of the most
recent calendar quarter, as reported to its primary financial
regulatory agency; and
(ii) If a banking entity is not required to calculate and report
tier 1 capital, the banking entity's tier 1 capital shall be determined
to be equal to:
(A) In the case of a banking entity that is controlled, directly or
indirectly, by a depository institution that calculates and reports
tier 1 capital, be equal to the amount of tier 1 capital reported by
such controlling depository institution in the manner described in
paragraph (c)(2)(i) of this section;
(B) In the case of a banking entity that is not controlled,
directly or indirectly, by a depository institution that calculates and
reports tier 1 capital:
(1) Bank holding company subsidiaries. If the banking entity is a
subsidiary of a bank holding company or company that is treated as a
bank holding company, be equal to the amount of tier 1 capital reported
by the top-tier affiliate of such covered banking entity that
calculates and reports tier 1 capital in the manner described in
paragraph (c)(2)(i) of this section; and
(2) Other holding companies and any subsidiary or affiliate
thereof. If the banking entity is not a subsidiary of a bank holding
company or a company that is treated as a bank holding company, be
equal to the total amount
[[Page 62191]]
of shareholders' equity of the top-tier affiliate within such
organization as of the last day of the most recent calendar quarter
that has ended, as determined under applicable accounting standards.
(iii) Treatment of foreign banking entities--(A) Foreign banking
entities. Except as provided in paragraph (c)(2)(iii)(B) of this
section, with respect to a banking entity that is not itself, and is
not controlled directly or indirectly by, a banking entity that is
located or organized under the laws of the United States or of any
State, the tier 1 capital of the banking entity shall be the
consolidated tier 1 capital of the entity as calculated under
applicable home country standards.
(B) U.S. affiliates of foreign banking entities. With respect to a
banking entity that is located or organized under the laws of the
United States or of any State and is controlled by a foreign banking
entity identified under paragraph (c)(2)(iii)(A) of this section, the
banking entity's tier 1 capital shall be as calculated under paragraphs
(c)(2)(i) or (ii) of this section.
(d) Capital treatment for a permitted investment in a covered fund.
For purposes of calculating compliance with the applicable regulatory
capital requirements, a banking entity shall deduct from the banking
entity's tier 1 capital (as determined under paragraph (c)(2) of this
section) the greater of:
(1) The sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
(together with any amounts paid by the entity (or employee thereof) in
connection with obtaining a restricted profit interest under Sec.
351.10(d)(6)(ii) of subpart C), on a historical cost basis, plus any
earnings received; and
(2) The fair market value of the banking entity's ownership
interests in the covered fund as determined under paragraph (b)(2)(ii)
or (b)(3) of this section (together with any amounts paid by the entity
(or employee thereof) in connection with obtaining a restricted profit
interest under Sec. 351.10(d)(6)(ii) of subpart C), if the banking
entity accounts for the profits (or losses) of the fund investment in
its financial statements.
(e) Extension of time to divest an ownership interest. (1) Upon
application by a banking entity, the Board may extend the period under
paragraph (a)(2)(i) of this section for up to 2 additional years if the
Board finds that an extension would be consistent with safety and
soundness and not detrimental to the public interest. An application
for extension must:
(i) Be submitted to the Board at least 90 days prior to the
expiration of the applicable time period;
(ii) Provide the reasons for application, including information
that addresses the factors in paragraph (e)(2) of this section; and
(iii) Explain the banking entity's plan for reducing the permitted
investment in a covered fund through redemption, sale, dilution or
other methods as required in paragraph (a)(2) of this section.
(2) Factors governing Board determinations. In reviewing any
application under paragraph (e)(1) of this section, the Board may
consider all the facts and circumstances related to the permitted
investment in a covered fund, including:
(i) Whether the investment would result, directly or indirectly, in
a material exposure by the banking entity to high-risk assets or high-
risk trading strategies;
(ii) The contractual terms governing the banking entity's interest
in the covered fund;
(iii) The date on which the covered fund is expected to have
attracted sufficient investments from investors unaffiliated with the
banking entity to enable the banking entity to comply with the
limitations in paragraph (a)(2)(i) of this section;
(iv) The total exposure of the covered banking entity to the
investment and the risks that disposing of, or maintaining, the
investment in the covered fund may pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of divesting or disposing of the
investment within the applicable period;
(vi) Whether the investment or the divestiture or conformance of
the investment would involve or result in a material conflict of
interest between the banking entity and unaffiliated parties, including
clients, customers or counterparties to which it owes a duty;
(vi) The banking entity's prior efforts to reduce through
redemption, sale, dilution, or other methods its ownership interests in
the covered fund, including activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board believes appropriate.
(3) Authority to impose restrictions on activities or investment
during any extension period. The Board may impose such conditions on
any extension approved under paragraph (e)(1) of this section as the
Board determines are necessary or appropriate to protect the safety and
soundness of the banking entity or the financial stability of the
United States, address material conflicts of interest or other unsound
banking practices, or otherwise further the purposes of section 13 of
the BHC Act and this part.
(4) Consultation. In the case of a banking entity that is primarily
regulated by another Federal banking agency, the SEC, or the CFTC, the
Board will consult with such agency prior to acting on an application
by the banking entity for an extension under paragraph (e)(1) of this
section.
Sec. 351.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 351.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to demonstrably reduce or
otherwise significantly mitigate the specific, identifiable risks to
the banking entity in connection with a compensation arrangement with
an employee of the banking entity or an affiliate thereof that directly
provides investment advisory, commodity trading advisory or other
services to the covered fund.
(2) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures and
internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate and demonstrably reduces or otherwise
significantly mitigates one or more specific, identifiable risks
arising in connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
[[Page 62192]]
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) The compensation arrangement relates solely to the covered
fund in which the banking entity or any affiliate has acquired an
ownership interest pursuant to this paragraph and such compensation
arrangement provides that any losses incurred by the banking entity on
such ownership interest will be offset by corresponding decreases in
amounts payable under such compensation arrangement.
(b) Certain permitted covered fund activities and investments
outside of the United States. (1) The prohibition contained in Sec.
351.10(a) of this subpart does not apply to the acquisition or
retention of any ownership interest in, or the sponsorship of, a
covered fund by a banking entity only if:
(i) The banking entity is not organized or directly or indirectly
controlled by a banking entity that is organized under the laws of the
United States or of one or more States;
(ii) The activity or investment by the banking entity is pursuant
to paragraph (9) or (13) of section 4(c) of the BHC Act;
(iii) No ownership interest in the covered fund is offered for sale
or sold to a resident of the United States; and
(iv) The activity or investment occurs solely outside of the United
States.
(2) An activity or investment by the banking entity is pursuant to
paragraph (9) or (13) of section 4(c) of the BHC Act for purposes of
paragraph (b)(1)(ii) of this section only if:
(i) The activity or investment is conducted in accordance with the
requirements of this section; and
(ii)(A) With respect to a banking entity that is a foreign banking
organization, the banking entity meets the qualifying foreign banking
organization requirements of section 211.23(a), (c) or (e) of the
Board's Regulation K (12 CFR 211.23(a), (c) or (e)), as applicable; or
(B) With respect to a banking entity that is not a foreign banking
organization, the banking entity is not organized under the laws of the
United States or of one or more States and the banking entity, on a
fully-consolidated basis, meets at least two of the following
requirements:
(1) Total assets of the banking entity held outside of the United
States exceed total assets of the banking entity held in the United
States;
(2) Total revenues derived from the business of the banking entity
outside of the United States exceed total revenues derived from the
business of the banking entity in the United States; or
(3) Total net income derived from the business of the banking
entity outside of the United States exceeds total net income derived
from the business of the banking entity in the United States.
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is sold or has been sold
pursuant to an offering that does not target residents of the United
States.
(4) An activity or investment occurs solely outside of the United
States for purposes of paragraph (b)(1)(iv) of this section only if:
(i) The banking entity acting as sponsor, or engaging as principal
in the acquisition or retention of an ownership interest in the covered
fund, is not itself, and is not controlled directly or indirectly by, a
banking entity that is located in the United States or organized under
the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to acquire or retain the ownership interest or act as
sponsor to the covered fund is not located in the United States or
organized under the laws of the United States or of any State;
(iii) The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State; and
(iv) No financing for the banking entity's ownership or sponsorship
is provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State.
(5) For purposes of this section, a U.S. branch, agency, or
subsidiary of a foreign bank, or any subsidiary thereof, is located in
the United States; however, a foreign bank of which that branch,
agency, or subsidiary is a part is not considered to be located in the
United States solely by virtue of operation of the U.S. branch, agency,
or subsidiary.
(c) Permitted covered fund interests and activities by a regulated
insurance company. The prohibition contained in Sec. 351.10(a) of this
subpart does not apply to the acquisition or retention by an insurance
company, or an affiliate thereof, of any ownership interest in, or the
sponsorship of, a covered fund only if:
(1) The insurance company or its affiliate acquires and retains the
ownership interest solely for the general account of the insurance
company or for one or more separate accounts established by the
insurance company;
(2) The acquisition and retention of the ownership interest is
conducted in compliance with, and subject to, the insurance company
investment laws, regulations, and written guidance of the State or
jurisdiction in which such insurance company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law, regulation, or written guidance described in
paragraph (c)(2) of this section is insufficient to protect the safety
and soundness of the banking entity, or the financial stability of the
United States.
Sec. 351.14 Limitations on relationships with a covered fund.
(a) Relationships with a covered fund. (1) Except as provided for
in paragraph (a)(2) of this section, no banking entity that serves,
directly or indirectly, as the investment manager, investment adviser,
commodity trading advisor, or sponsor to a covered fund, that organizes
and offers a covered fund pursuant to Sec. 351.11 of this subpart, or
that continues to hold an ownership interest in accordance with Sec.
351.11(b) of this subpart, and no affiliate of such entity, may enter
into a transaction with the covered fund, or with any other covered
fund that is controlled by such covered fund, that would be a covered
transaction as defined in section 23A of the Federal Reserve Act (12
U.S.C. 371c(b)(7)), as if such banking entity and the affiliate thereof
were a member bank and the covered fund were an affiliate thereof.
(2) Notwithstanding paragraph (a)(1) of this section, a banking
entity may:
(i) Acquire and retain any ownership interest in a covered fund in
accordance with the requirements of Sec. 351.11, Sec. 351.12, or
Sec. 351.13 of this subpart; and
(ii) Enter into any prime brokerage transaction with any covered
fund in which a covered fund managed, sponsored, or advised by such
banking entity (or an affiliate thereof) has taken an ownership
interest, if:
(A) The banking entity is in compliance with each of the
limitations set forth in Sec. 351.11 of this subpart with respect to a
covered fund organized and offered by such banking entity (or an
affiliate thereof);
[[Page 62193]]
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually to the FDIC (with a duty
to update the certification if the information in the certification
materially changes) that the banking entity does not, directly or
indirectly, guarantee, assume, or otherwise insure the obligations or
performance of the covered fund or of any covered fund in which such
covered fund invests; and
(C) The Board has not determined that such transaction is
inconsistent with the safe and sound operation and condition of the
banking entity.
(b) Restrictions on transactions with covered funds. A banking
entity that serves, directly or indirectly, as the investment manager,
investment adviser, commodity trading advisor, or sponsor to a covered
fund, or that organizes and offers a covered fund pursuant to Sec.
351.11 of this subpart, or that continues to hold an ownership interest
in accordance with Sec. 351.11(b) of this subpart, shall be subject to
section 23B of the Federal Reserve Act (12 U.S.C. 371c-1), as if such
banking entity were a member bank and such covered fund were an
affiliate thereof.
(c) Restrictions on prime brokerage transactions. A prime brokerage
transaction permitted under paragraph (a)(2)(ii) of this section shall
be subject to section 23B of the Federal Reserve Act (12 U.S.C. 371c-1)
as if the counterparty were an affiliate of the banking entity.
Sec. 351.15 Other limitations on permitted covered fund activities.
(a) No transaction, class of transactions, or activity may be
deemed permissible under Sec. Sec. 351.11 through 351.13 of this
subpart if the transaction, class of transactions, or activity would:
(1) Involve or result in a material conflict of interest between
the banking entity and its clients, customers, or counterparties;
(2) Result, directly or indirectly, in a material exposure by the
banking entity to a high-risk asset or a high-risk trading strategy; or
(3) Pose a threat to the safety and soundness of the banking entity
or to the financial stability of the United States.
(b) Definition of material conflict of interest. (1) For purposes
of this section, a material conflict of interest between a banking
entity and its clients, customers, or counterparties exists if the
banking entity engages in any transaction, class of transactions, or
activity that would involve or result in the banking entity's interests
being materially adverse to the interests of its client, customer, or
counterparty with respect to such transaction, class of transactions,
or activity, and the banking entity has not taken at least one of the
actions in paragraph (b)(2) of this section.
(2) Prior to effecting the specific transaction or class or type of
transactions, or engaging in the specific activity, the banking entity:
(i) Timely and effective disclosure. (A) Has made clear, timely,
and effective disclosure of the conflict of interest, together with
other necessary information, in reasonable detail and in a manner
sufficient to permit a reasonable client, customer, or counterparty to
meaningfully understand the conflict of interest; and
(B) Such disclosure is made in a manner that provides the client,
customer, or counterparty the opportunity to negate, or substantially
mitigate, any materially adverse effect on the client, customer, or
counterparty created by the conflict of interest; or
(ii) Information barriers. Has established, maintained, and
enforced information barriers that are memorialized in written policies
and procedures, such as physical separation of personnel, or functions,
or limitations on types of activity, that are reasonably designed,
taking into consideration the nature of the banking entity's business,
to prevent the conflict of interest from involving or resulting in a
materially adverse effect on a client, customer, or counterparty. A
banking entity may not rely on such information barriers if, in the
case of any specific transaction, class or type of transactions or
activity, the banking entity knows or should reasonably know that,
notwithstanding the banking entity's establishment of information
barriers, the conflict of interest may involve or result in a
materially adverse effect on a client, customer, or counterparty.
(c) Definition of high-risk asset and high-risk trading strategy.
For purposes of this section:
(1) High-risk asset means an asset or group of related assets that
would, if held by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
(2) High-risk trading strategy means a trading strategy that would,
if engaged in by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
Sec. 351.16 Ownership of Interests in and Sponsorship of Issuers of
Certain Collateralized Debt Obligations Backed by Trust-Preferred
Securities.
(a) The prohibition contained in Sec. 351.10(a)(1) does not apply
to the ownership by a banking entity of an interest in, or sponsorship
of, any issuer if:
(1) The issuer was established, and the interest was issued, before
May 19, 2010;
(2) The banking entity reasonably believes that the offering
proceeds received by the issuer were invested primarily in Qualifying
TruPS Collateral; and
(3) The banking entity acquired such interest on or before December
10, 2013 (or acquired such interest in connection with a merger with or
acquisition of a banking entity that acquired the interest on or before
December 10, 2013).
(b) For purposes of this Sec. 351.16, Qualifying TruPS Collateral
shall mean any trust preferred security or subordinated debt instrument
issued prior to May 19, 2010 by a depository institution holding
company that, as of the end of any reporting period within 12 months
immediately preceding the issuance of such trust preferred security or
subordinated debt instrument, had total consolidated assets of less
than $15,000,000,000 or issued prior to May 19, 2010 by a mutual
holding company.
(c) Notwithstanding paragraph (a)(3) of this section, a banking
entity may act as a market maker with respect to the interests of an
issuer described in paragraph (a) of this section in accordance with
the applicable provisions of Sec. Sec. 351.4 and 351.11.
(d) Without limiting the applicability of paragraph (a) of this
section, the Board, the FDIC and the OCC will make public a non-
exclusive list of issuers that meet the requirements of paragraph (a).
A banking entity may rely on the list published by the Board, the FDIC
and the OCC.
Sec. Sec. 351.17-351.19 [Reserved]
Subpart D--Compliance Program Requirement; Violations
Sec. 351.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope and detail of the
[[Page 62194]]
compliance program shall be appropriate for the types, size, scope and
complexity of activities and business structure of the banking entity.
(b) Contents of compliance program. Except as provided in paragraph
(f) of this section, the compliance program required by paragraph (a)
of this section, at a minimum, shall include:
(1) Written policies and procedures reasonably designed to
document, describe, monitor and limit trading activities subject to
subpart B (including those permitted under Sec. Sec. 351.3 to 351.6 of
subpart B), including setting, monitoring and managing required limits
set out in Sec. 351.4 and Sec. 351.5, and activities and investments
with respect to a covered fund subject to subpart C (including those
permitted under Sec. Sec. 351.11 through 351.14 of subpart C)
conducted by the banking entity to ensure that all activities and
investments conducted by the banking entity that are subject to section
13 of the BHC Act and this part comply with section 13 of the BHC Act
and this part;
(2) A system of internal controls reasonably designed to monitor
compliance with section 13 of the BHC Act and this part and to prevent
the occurrence of activities or investments that are prohibited by
section 13 of the BHC Act and this part;
(3) A management framework that clearly delineates responsibility
and accountability for compliance with section 13 of the BHC Act and
this part and includes appropriate management review of trading limits,
strategies, hedging activities, investments, incentive compensation and
other matters identified in this part or by management as requiring
attention;
(4) Independent testing and audit of the effectiveness of the
compliance program conducted periodically by qualified personnel of the
banking entity or by a qualified outside party;
(5) Training for trading personnel and managers, as well as other
appropriate personnel, to effectively implement and enforce the
compliance program; and
(6) Records sufficient to demonstrate compliance with section 13 of
the BHC Act and this part, which a banking entity must promptly provide
to the FDIC upon request and retain for a period of no less than 5
years or such longer period as required by the FDIC.
(c) Additional standards. In addition to the requirements in
paragraph (b) of this section, the compliance program of a banking
entity must satisfy the requirements and other standards contained in
Appendix B, if:
(1) The banking entity engages in proprietary trading permitted
under subpart B and is required to comply with the reporting
requirements of paragraph (d) of this section;
(2) The banking entity has reported total consolidated assets as of
the previous calendar year end of $50 billion or more or, in the case
of a foreign banking entity, has total U.S. assets as of the previous
calendar year end of $50 billion or more (including all subsidiaries,
affiliates, branches and agencies of the foreign banking entity
operating, located or organized in the United States); or
(3) The FDIC notifies the banking entity in writing that it must
satisfy the requirements and other standards contained in Appendix B to
this part.
(d) Reporting requirements under Appendix A to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B shall comply with the reporting requirements described in
Appendix A, if:
(i) The banking entity (other than a foreign banking entity as
provided in paragraph (d)(1)(ii) of this section) has, together with
its affiliates and subsidiaries, trading assets and liabilities
(excluding trading assets and liabilities involving obligations of or
guaranteed by the United States or any agency of the United States) the
average gross sum of which (on a worldwide consolidated basis) over the
previous consecutive four quarters, as measured as of the last day of
each of the four prior calendar quarters, equals or exceeds the
threshold established in paragraph (d)(2) of this section;
(ii) In the case of a foreign banking entity, the average gross sum
of the trading assets and liabilities of the combined U.S. operations
of the foreign banking entity (including all subsidiaries, affiliates,
branches and agencies of the foreign banking entity operating, located
or organized in the United States and excluding trading assets and
liabilities involving obligations of or guaranteed by the United States
or any agency of the United States) over the previous consecutive four
quarters, as measured as of the last day of each of the four prior
calendar quarters, equals or exceeds the threshold established in
paragraph (d)(2) of this section; or
(iii) The FDIC notifies the banking entity in writing that it must
satisfy the reporting requirements contained in Appendix A.
(2) The threshold for reporting under paragraph (d)(1) of this
section shall be $50 billion beginning on June 30, 2014; $25 billion
beginning on April 30, 2016; and $10 billion beginning on December 31,
2016.
(3) Frequency of reporting: Unless the FDIC notifies the banking
entity in writing that it must report on a different basis, a banking
entity with $50 billion or more in trading assets and liabilities (as
calculated in accordance with paragraph (d)(1) of this section) shall
report the information required by Appendix A for each calendar month
within 30 days of the end of the relevant calendar month; beginning
with information for the month of January 2015, such information shall
be reported within 10 days of the end of each calendar month. Any other
banking entity subject to Appendix A shall report the information
required by Appendix A for each calendar quarter within 30 days of the
end of that calendar quarter unless the FDIC notifies the banking
entity in writing that it must report on a different basis.
(e) Additional documentation for covered funds. Any banking entity
that has more than $10 billion in total consolidated assets as reported
on December 31 of the previous two calendar years shall maintain
records that include:
(1) Documentation of the exclusions or exemptions other than
sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940
relied on by each fund sponsored by the banking entity (including all
subsidiaries and affiliates) in determining that such fund is not a
covered fund;
(2) For each fund sponsored by the banking entity (including all
subsidiaries and affiliates) for which the banking entity relies on one
or more of the exclusions from the definition of covered fund provided
by Sec. Sec. 351.10(c)(1), 351.10(c)(5), 351.10(c)(8), 351.10(c)(9),
or 351.10(c)(10) of subpart C, documentation supporting the banking
entity's determination that the fund is not a covered fund pursuant to
one or more of those exclusions;
(3) For each seeding vehicle described in Sec. 351.10(c)(12)(i) or
(iii) of subpart C that will become a registered investment company or
SEC-regulated business development company, a written plan documenting
the banking entity's determination that the seeding vehicle will become
a registered investment company or SEC-regulated business development
company; the period of time during which the vehicle will operate as a
seeding vehicle; and the banking entity's plan to market the vehicle to
third-party investors and convert it into a registered investment
company or SEC-regulated business development company within the time
period specified in Sec. 351.12(a)(2)(i)(B) of subpart C;
(4) For any banking entity that is, or is controlled directly or
indirectly by a
[[Page 62195]]
banking entity that is, located in or organized under the laws of the
United States or of any State, if the aggregate amount of ownership
interests in foreign public funds that are described in Sec.
351.10(c)(1) of subpart C owned by such banking entity (including
ownership interests owned by any affiliate that is controlled directly
or indirectly by a banking entity that is located in or organized under
the laws of the United States or of any State) exceeds $50 million at
the end of two or more consecutive calendar quarters, beginning with
the next succeeding calendar quarter, documentation of the value of the
ownership interests owned by the banking entity (and such affiliates)
in each foreign public fund and each jurisdiction in which any such
foreign public fund is organized, calculated as of the end of each
calendar quarter, which documentation must continue until the banking
entity's aggregate amount of ownership interests in foreign public
funds is below $50 million for two consecutive calendar quarters; and
(5) For purposes of paragraph (e)(4) of this section, a U.S.
branch, agency, or subsidiary of a foreign banking entity is located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(f) Simplified programs for less active banking entities--(1)
Banking entities with no covered activities. A banking entity that does
not engage in activities or investments pursuant to subpart B or
subpart C (other than trading activities permitted pursuant to Sec.
351.6(a) of subpart B) may satisfy the requirements of this section by
establishing the required compliance program prior to becoming engaged
in such activities or making such investments (other than trading
activities permitted pursuant to Sec. 351.6(a) of subpart B).
(2) Banking entities with modest activities. A banking entity with
total consolidated assets of $10 billion or less as reported on
December 31 of the previous two calendar years that engages in
activities or investments pursuant to subpart B or subpart C (other
than trading activities permitted under Sec. 351.6(a) of subpart B)
may satisfy the requirements of this section by including in its
existing compliance policies and procedures appropriate references to
the requirements of section 13 of the BHC Act and this part and
adjustments as appropriate given the activities, size, scope and
complexity of the banking entity.
Sec. 351.21 Termination of activities or investments; penalties for
violations.
(a) Any banking entity that engages in an activity or makes an
investment in violation of section 13 of the BHC Act or this part, or
acts in a manner that functions as an evasion of the requirements of
section 13 of the BHC Act or this part, including through an abuse of
any activity or investment permitted under subparts B or C, or
otherwise violates the restrictions and requirements of section 13 of
the BHC Act or this part, shall, upon discovery, promptly terminate the
activity and, as relevant, dispose of the investment.
(b) Whenever the FDIC finds reasonable cause to believe any banking
entity has engaged in an activity or made an investment in violation of
section 13 of the BHC Act or this part, or engaged in any activity or
made any investment that functions as an evasion of the requirements of
section 13 of the BHC Act or this part, the FDIC may take any action
permitted by law to enforce compliance with section 13 of the BHC Act
and this part, including directing the banking entity to restrict,
limit, or terminate any or all activities under this part and dispose
of any investment.
Appendix A to Part 351--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
351.20(d), this appendix generally applies to a banking entity that,
together with its affiliates and subsidiaries, has significant
trading assets and liabilities. These entities are required to (i)
furnish periodic reports to the FDIC regarding a variety of
quantitative measurements of their covered trading activities, which
vary depending on the scope and size of covered trading activities,
and (ii) create and maintain records documenting the preparation and
content of these reports. The requirements of this appendix must be
incorporated into the banking entity's internal compliance program
under Sec. 351.20 and Appendix B.
b. The purpose of this appendix is to assist banking entities
and the FDIC in:
(i) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(ii) Monitoring the banking entity's covered trading activities;
(iii) Identifying covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading activities of
trading desks engaged in market making-related activities subject to
Sec. 351.4(b) are consistent with the requirements governing
permitted market making-related activities;
(v) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. Sec. 351.4, 351.5, or 351.6(a)-(b) (i.e., underwriting and
market making-related related activity, risk-mitigating hedging, or
trading in certain government obligations) are consistent with the
requirement that such activity not result, directly or indirectly,
in a material exposure to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by the FDIC of such activities; and
(vii) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. The quantitative measurements that must be furnished pursuant
to this appendix are not intended to serve as a dispositive tool for
the identification of permissible or impermissible activities.
d. In order to allow banking entities and the Agencies to
evaluate the effectiveness of these metrics, banking entities must
collect and report these metrics for all trading desks beginning on
the dates established in Sec. 351.20 of the final rule. The
Agencies will review the data collected and revise this collection
requirement as appropriate based on a review of the data collected
prior to September 30, 2015.
e. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 351.20 and Appendix B to this part. The
effectiveness of particular quantitative measurements may differ
based on the profile of the banking entity's businesses in general
and, more specifically, of the particular trading desk, including
types of instruments traded, trading activities and strategies, and
history and experience (e.g., whether the trading desk is an
established, successful market maker or a new entrant to a
competitive market). In all cases, banking entities must ensure that
they have robust measures in place to identify and monitor the risks
taken in their trading activities, to ensure that the activities are
within risk tolerances established by the banking entity, and to
monitor and examine for compliance with the proprietary trading
restrictions in this part.
f. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 351.4 through 351.6(a) and (b), or that
result in a material
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exposure to high-risk assets or high-risk trading strategies, must
be escalated within the banking entity for review, further analysis,
explanation to the FDIC, and remediation, where appropriate. The
quantitative measurements discussed in this appendix should be
helpful to banking entities in identifying and managing the risks
related to their covered trading activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 351.2 and 351.3. In addition, for purposes of
this appendix, the following definitions apply:
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of a trading desk's holdings, dividend income, and
interest income and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. Sec. 351.4, 351.5, 351.6(a), or 351.6(b). A banking
entity may include trading under Sec. Sec. 351.3(d), 351.6(c),
351.6(d) or 351.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading desk means the smallest discrete unit of organization of
a banking entity that purchases or sells financial instruments for
the trading account of the banking entity or an affiliate thereof.
III. Reporting and Recordkeeping of Quantitative Measurements
a. Scope of Required Reporting
General scope. Each banking entity made subject to this part by
Sec. 351.20 must furnish the following quantitative measurements
for each trading desk of the banking entity, calculated in
accordance with this appendix:
Risk and Position Limits and Usage;
Risk Factor Sensitivities;
Value-at-Risk and Stress VaR;
Comprehensive Profit and Loss Attribution;
Inventory Turnover;
Inventory Aging; and
Customer-Facing Trade Ratio
b. Frequency of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report each
applicable quantitative measurement to the FDIC on the reporting
schedule established in Sec. 351.20 unless otherwise requested by
the FDIC. All quantitative measurements for any calendar month must
be reported within the time period required by Sec. 351.20.
c. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the FDIC pursuant to this appendix and Sec. 351.20(d),
create and maintain records documenting the preparation and content
of these reports, as well as such information as is necessary to
permit the FDIC to verify the accuracy of such reports, for a period
of 5 years from the end of the calendar year for which the
measurement was taken.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Risk and Position Limits and Usage
i. Description: For purposes of this appendix, Risk and Position
Limits are the constraints that define the amount of risk that a
trading desk is permitted to take at a point in time, as defined by
the banking entity for a specific trading desk. Usage represents the
portion of the trading desk's limits that are accounted for by the
current activity of the desk. Risk and position limits and their
usage are key risk management tools used to control and monitor risk
taking and include, but are not limited, to the limits set out in
Sec. 351.4 and Sec. 351.5. A number of the metrics that are
described below, including ``Risk Factor Sensitivities'' and
``Value-at-Risk and Stress Value-at-Risk,'' relate to a trading
desk's risk and position limits and are useful in evaluating and
setting these limits in the broader context of the trading desk's
overall activities, particularly for the market making activities
under Sec. 351.4(b) and hedging activity under Sec. 351.5.
Accordingly, the limits required under Sec. 351.4(b)(2)(iii) and
Sec. 351.5(b)(1)(i) must meet the applicable requirements under
Sec. 351.4(b)(2)(iii) and Sec. 351.5(b)(1)(i) and also must
include appropriate metrics for the trading desk limits including,
at a minimum, the ``Risk Factor Sensitivities'' and ``Value-at-Risk
and Stress Value-at-Risk'' metrics except to the extent any of the
``Risk Factor Sensitivities'' or ``Value-at-Risk and Stress Value-
at-Risk'' metrics are demonstrably ineffective for measuring and
monitoring the risks of a trading desk based on the types of
positions traded by, and risk exposures of, that desk.
ii. General Calculation Guidance: Risk and Position Limits must
be reported in the format used by the banking entity for the
purposes of risk management of each trading desk. Risk and Position
Limits are often expressed in terms of risk measures, such as VaR
and Risk Factor Sensitivities, but may also be expressed in terms of
other observable criteria, such as net open positions. When criteria
other than VaR or Risk Factor Sensitivities are used to define the
Risk and Position Limits, both the value of the Risk and Position
Limits and the value of the variables used to assess whether these
limits have been reached must be reported.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
2. Risk Factor Sensitivities
i. Description: For purposes of this appendix, Risk Factor
Sensitivities are changes in a trading desk's Comprehensive Profit
and Loss that are expected to occur in the event of a change in one
or more underlying variables that are significant sources of the
trading desk's profitability and risk.
ii. General Calculation Guidance: A banking entity must report
the Risk Factor Sensitivities that are monitored and managed as part
of the trading desk's overall risk management policy. The underlying
data and methods used to compute a trading desk's Risk Factor
Sensitivities will depend on the specific function of the trading
desk and the internal risk management models employed. The number
and type of Risk Factor Sensitivities that are monitored and managed
by a trading desk, and furnished to the FDIC, will depend on the
explicit risks assumed by the trading desk. In general, however,
reported Risk Factor Sensitivities must be sufficiently granular to
account for a preponderance of the expected price variation in the
trading desk's holdings.
A. Trading desks must take into account any relevant factors in
calculating Risk Factor Sensitivities, including, for example, the
following with respect to particular asset classes:
Commodity derivative positions: Risk factors with
respect to the related commodities set out in 17 CFR 20.2, the
maturity of the positions, volatility and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Credit positions: Risk factors with respect to credit
spreads that are sufficiently granular to account for specific
credit sectors and market segments, the maturity profile of the
positions, and risk factors with respect to interest rates of all
relevant maturities;
Credit-related derivative positions: Risk factor
sensitivities, for example credit spreads, shifts (parallel and non-
parallel) in credit spreads--volatility, and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Equity derivative positions: Risk factor sensitivities
such as equity positions, volatility, and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Equity positions: Risk factors for equity prices and
risk factors that differentiate between important equity market
sectors and segments, such as a small capitalization equities and
international equities;
Foreign exchange derivative positions: Risk factors
with respect to major currency pairs and maturities, exposure to
interest rates at relevant maturities, volatility, and/or
correlation sensitivities (expressed in a manner that demonstrates
any significant non-linearities), as well as the maturity profile of
the positions; and
Interest rate positions, including interest rate
derivative positions: Risk factors with respect to major interest
rate categories and maturities and volatility and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and shifts (parallel and non-parallel)
in the interest rate curve, as well as the maturity profile of the
positions.
B. The methods used by a banking entity to calculate
sensitivities to a common factor shared by multiple trading desks,
such as an equity price factor, must be applied consistently across
its trading desks so that the sensitivities can be compared from one
trading desk to another.
iii. Calculation Period: One trading day.
[[Page 62197]]
iv. Measurement Frequency: Daily.
3. Value-at-Risk and Stress Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the commonly used percentile measurement of the risk of
future financial loss in the value of a given set of aggregated
positions over a specified period of time, based on current market
conditions. For purposes of this appendix, Stress Value-at-Risk
(``Stress VaR'') is the percentile measurement of the risk of future
financial loss in the value of a given set of aggregated positions
over a specified period of time, based on market conditions during a
period of significant financial stress.
ii. General Calculation Guidance: Banking entities must compute
and report VaR and Stress VaR by employing generally accepted
standards and methods of calculation. VaR should reflect a loss in a
trading desk that is expected to be exceeded less than one percent
of the time over a one-day period. For those banking entities that
are subject to regulatory capital requirements imposed by a Federal
banking agency, VaR and Stress VaR must be computed and reported in
a manner that is consistent with such regulatory capital
requirements. In cases where a trading desk does not have a
standalone VaR or Stress VaR calculation but is part of a larger
aggregation of positions for which a VaR or Stress VaR calculation
is performed, a VaR or Stress VaR calculation that includes only the
trading desk's holdings must be performed consistent with the VaR or
Stress VaR model and methodology used for the larger aggregation of
positions.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into three categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); (ii) profit and loss attributable to new
positions resulting from the current day's trading activity (``new
positions''); and (iii) residual profit and loss that cannot be
specifically attributed to existing positions or new positions. The
sum of (i), (ii), and (iii) must equal the trading desk's
comprehensive profit and loss at each point in time. In addition,
profit and loss measurements must calculate volatility of
comprehensive profit and loss (i.e., the standard deviation of the
trading desk's one-day profit and loss, in dollar terms) for the
reporting period for at least a 30-, 60- and 90-day lag period, from
the end of the reporting period, and any other period that the
banking entity deems necessary to meet the requirements of the rule.
A. The comprehensive profit and loss associated with existing
positions must reflect changes in the value of these positions on
the applicable day. The comprehensive profit and loss from existing
positions must be further attributed, as applicable, to changes in
(i) the specific Risk Factors and other factors that are monitored
and managed as part of the trading desk's overall risk management
policies and procedures; and (ii) any other applicable elements,
such as cash flows, carry, changes in reserves, and the correction,
cancellation, or exercise of a trade.
B. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
C. The portion of comprehensive profit and loss that cannot be
specifically attributed to known sources must be allocated to a
residual category identified as an unexplained portion of the
comprehensive profit and loss. Significant unexplained profit and
loss must be escalated for further investigation and analysis.
ii. General Calculation Guidance: The specific categories used
by a trading desk in the attribution analysis and amount of detail
for the analysis should be tailored to the type and amount of
trading activities undertaken by the trading desk. The new position
attribution must be computed by calculating the difference between
the prices at which instruments were bought and/or sold and the
prices at which those instruments are marked to market at the close
of business on that day multiplied by the notional or principal
amount of each purchase or sale. Any fees, commissions, or other
payments received (paid) that are associated with transactions
executed on that day must be added (subtracted) from such
difference. These factors must be measured consistently over time to
facilitate historical comparisons.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
c. Customer-Facing Activity Measurements
1. Inventory Turnover
i. Description: For purposes of this appendix, Inventory
Turnover is a ratio that measures the turnover of a trading desk's
inventory. The numerator of the ratio is the absolute value of all
transactions over the reporting period. The denominator of the ratio
is the value of the trading desk's inventory at the beginning of the
reporting period.
ii. General Calculation Guidance: For purposes of this appendix,
for derivatives, other than options and interest rate derivatives,
value means gross notional value, for options, value means delta
adjusted notional value, and for interest rate derivatives, value
means 10-year bond equivalent value.
iii. Calculation Period: 30 days, 60 days, and 90 days.
iv. Measurement Frequency: Daily.
2. Inventory Aging
i. Description: For purposes of this appendix, Inventory Aging
generally describes a schedule of the trading desk's aggregate
assets and liabilities and the amount of time that those assets and
liabilities have been held. Inventory Aging should measure the age
profile of the trading desk's assets and liabilities.
ii. General Calculation Guidance: In general, Inventory Aging
must be computed using a trading desk's trading activity data and
must identify the value of a trading desk's aggregate assets and
liabilities. Inventory Aging must include two schedules, an asset-
aging schedule and a liability-aging schedule. Each schedule must
record the value of assets or liabilities held over all holding
periods. For derivatives, other than options, and interest rate
derivatives, value means gross notional value, for options, value
means delta adjusted notional value and, for interest rate
derivatives, value means 10-year bond equivalent value.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Customer-Facing Trade Ratio--Trade Count Based and Value Based
i. Description: For purposes of this appendix, the Customer-
Facing Trade Ratio is a ratio comparing (i) the transactions
involving a counterparty that is a customer of the trading desk to
(ii) the transactions involving a counterparty that is not a
customer of the trading desk. A trade count based ratio must be
computed that records the number of transactions involving a
counterparty that is a customer of the trading desk and the number
of transactions involving a counterparty that is not a customer of
the trading desk. A value based ratio must be computed that records
the value of transactions involving a counterparty that is a
customer of the trading desk and the value of transactions involving
a counterparty that is not a customer of the trading desk.
ii. General Calculation Guidance: For purposes of calculating
the Customer-Facing Trade Ratio, a counterparty is considered to be
a customer of the trading desk if the counterparty is a market
participant that makes use of the banking entity's market making-
related services by obtaining such services, responding to
quotations, or entering into a continuing relationship with respect
to such services. However, a trading desk or other organizational
unit of another banking entity would not be a client, customer, or
counterparty of the trading desk if the other entity has trading
assets and liabilities of $50 billion or more as measured in
accordance with Sec. 351.20(d)(1) unless the trading desk documents
how and why a particular trading desk or other organizational unit
of the entity should be treated as a client, customer, or
counterparty of the trading desk. Transactions conducted anonymously
on an exchange or similar trading facility that permits trading on
behalf of a broad range of market participants would be considered
transactions with customers of the trading desk. For derivatives,
other than options, and interest rate derivatives, value means gross
notional value, for options, value means delta adjusted notional
value, and for interest rate derivatives, value means 10-year bond
equivalent value.
[[Page 62198]]
iii. Calculation Period: 30 days, 60 days, and 90 days.
iv. Measurement Frequency: Daily.
Appendix B to Part 351--Enhanced Minimum Standards for Compliance
Programs
I. Overview
Section 351.20(c) requires certain banking entities to
establish, maintain, and enforce an enhanced compliance program that
includes the requirements and standards in this Appendix as well as
the minimum written policies and procedures, internal controls,
management framework, independent testing, training, and
recordkeeping provisions outlined in Sec. 351.20. This Appendix
sets forth additional minimum standards with respect to the
establishment, oversight, maintenance, and enforcement by these
banking entities of an enhanced internal compliance program for
ensuring and monitoring compliance with the prohibitions and
restrictions on proprietary trading and covered fund activities and
investments set forth in section 13 of the BHC Act and this part.
a. This compliance program must:
1. Be reasonably designed to identify, document, monitor, and
report the permitted trading and covered fund activities and
investments of the banking entity; identify, monitor and promptly
address the risks of these covered activities and investments and
potential areas of noncompliance; and prevent activities or
investments prohibited by, or that do not comply with, section 13 of
the BHC Act and this part;
2. Establish and enforce appropriate limits on the covered
activities and investments of the banking entity, including limits
on the size, scope, complexity, and risks of the individual
activities or investments consistent with the requirements of
section 13 of the BHC Act and this part;
3. Subject the effectiveness of the compliance program to
periodic independent review and testing, and ensure that the
entity's internal audit, corporate compliance and internal control
functions involved in review and testing are effective and
independent;
4. Make senior management, and others as appropriate,
accountable for the effective implementation of the compliance
program, and ensure that the board of directors and chief executive
officer (or equivalent) of the banking entity review the
effectiveness of the compliance program; and
5. Facilitate supervision and examination by the Agencies of the
banking entity's permitted trading and covered fund activities and
investments.
II. Enhanced Compliance Program
a. Proprietary Trading Activities. A banking entity must
establish, maintain and enforce a compliance program that includes
written policies and procedures that are appropriate for the types,
size, and complexity of, and risks associated with, its permitted
trading activities. The compliance program may be tailored to the
types of trading activities conducted by the banking entity, and
must include a detailed description of controls established by the
banking entity to reasonably ensure that its trading activities are
conducted in accordance with the requirements and limitations
applicable to those trading activities under section 13 of the BHC
Act and this part, and provide for appropriate revision of the
compliance program before expansion of the trading activities of the
banking entity. A banking entity must devote adequate resources and
use knowledgeable personnel in conducting, supervising and managing
its trading activities, and promote consistency, independence and
rigor in implementing its risk controls and compliance efforts. The
compliance program must be updated with a frequency sufficient to
account for changes in the activities of the banking entity, results
of independent testing of the program, identification of weaknesses
in the program, and changes in legal, regulatory or other
requirements.
1. Trading Desks: The banking entity must have written policies
and procedures governing each trading desk that include a
description of:
i. The process for identifying, authorizing and documenting
financial instruments each trading desk may purchase or sell, with
separate documentation for market making-related activities
conducted in reliance on Sec. 351.4(b) and for hedging activity
conducted in reliance on Sec. 351.5;
ii. A mapping for each trading desk to the division, business
line, or other organizational structure that is responsible for
managing and overseeing the trading desk's activities;
iii. The mission (i.e., the type of trading activity, such as
market-making, trading in sovereign debt, etc.) and strategy (i.e.,
methods for conducting authorized trading activities) of each
trading desk;
iv. The activities that the trading desk is authorized to
conduct, including (i) authorized instruments and products, and (ii)
authorized hedging strategies, techniques and instruments;
v. The types and amount of risks allocated by the banking entity
to each trading desk to implement the mission and strategy of the
trading desk, including an enumeration of material risks resulting
from the activities in which the trading desk is authorized to
engage (including but not limited to price risks, such as basis,
volatility and correlation risks, as well as counterparty credit
risk). Risk assessments must take into account both the risks
inherent in the trading activity and the strength and effectiveness
of controls designed to mitigate those risks;
vi. How the risks allocated to each trading desk will be
measured;
vii. Why the allocated risks levels are appropriate to the
activities authorized for the trading desk;
viii. The limits on the holding period of, and the risk
associated with, financial instruments under the responsibility of
the trading desk;
ix. The process for setting new or revised limits, as well as
escalation procedures for granting exceptions to any limits or to
any policies or procedures governing the desk, the analysis that
will be required to support revising limits or granting exceptions,
and the process for independently reviewing and documenting those
exceptions and the underlying analysis;
x. The process for identifying, documenting and approving new
products, trading strategies, and hedging strategies;
xi. The types of clients, customers, and counterparties with
whom the trading desk may trade; and
xii. The compensation arrangements, including incentive
arrangements, for employees associated with the trading desk, which
may not be designed to reward or incentivize prohibited proprietary
trading or excessive or imprudent risk-taking.
2. Description of risks and risk management processes: The
compliance program for the banking entity must include a
comprehensive description of the risk management program for the
trading activity of the banking entity. The compliance program must
also include a description of the governance, approval, reporting,
escalation, review and other processes the banking entity will use
to reasonably ensure that trading activity is conducted in
compliance with section 13 of the BHC Act and this part. Trading
activity in similar financial instruments should be subject to
similar governance, limits, testing, controls, and review, unless
the banking entity specifically determines to establish different
limits or processes and documents those differences. Descriptions
must include, at a minimum, the following elements:
i. A description of the supervisory and risk management
structure governing all trading activity, including a description of
processes for initial and senior-level review of new products and
new strategies;
ii. A description of the process for developing, documenting,
testing, approving and reviewing all models used for valuing,
identifying and monitoring the risks of trading activity and related
positions, including the process for periodic independent testing of
the reliability and accuracy of those models;
iii. A description of the process for developing, documenting,
testing, approving and reviewing the limits established for each
trading desk;
iv. A description of the process by which a security may be
purchased or sold pursuant to the liquidity management plan,
including the process for authorizing and monitoring such activity
to ensure compliance with the banking entity's liquidity management
plan and the restrictions on liquidity management activities in this
part;
v. A description of the management review process, including
escalation procedures, for approving any temporary exceptions or
permanent adjustments to limits on the activities, positions,
strategies, or risks associated with each trading desk; and
vi. The role of the audit, compliance, risk management and other
relevant units for conducting independent testing of trading and
hedging activities, techniques and strategies.
3. Authorized risks, instruments, and products. The banking
entity must implement and enforce limits and internal controls for
each trading desk that are reasonably designed to ensure that
trading activity is conducted in conformance with
[[Page 62199]]
section 13 of the BHC Act and this part and with the banking
entity's written policies and procedures. The banking entity must
establish and enforce risk limits appropriate for the activity of
each trading desk. These limits should be based on probabilistic and
non-probabilistic measures of potential loss (e.g., Value-at-Risk
and notional exposure, respectively), and measured under normal and
stress market conditions. At a minimum, these internal controls must
monitor, establish and enforce limits on:
i. The financial instruments (including, at a minimum, by type
and exposure) that the trading desk may trade;
ii. The types and levels of risks that may be taken by each
trading desk; and
iii. The types of hedging instruments used, hedging strategies
employed, and the amount of risk effectively hedged.
4. Hedging policies and procedures. The banking entity must
establish, maintain, and enforce written policies and procedures
regarding the use of risk-mitigating hedging instruments and
strategies that, at a minimum, describe:
i. The positions, techniques and strategies that each trading
desk may use to hedge the risk of its positions;
ii. The manner in which the banking entity will identify the
risks arising in connection with and related to the individual or
aggregated positions, contracts or other holdings of the banking
entity that are to be hedged and determine that those risks have
been properly and effectively hedged;
iii. The level of the organization at which hedging activity and
management will occur;
iv. The manner in which hedging strategies will be monitored and
the personnel responsible for such monitoring;
v. The risk management processes used to control unhedged or
residual risks; and
vi. The process for developing, documenting, testing, approving
and reviewing all hedging positions, techniques and strategies
permitted for each trading desk and for the banking entity in
reliance on Sec. 351.5.
5. Analysis and quantitative measurements. The banking entity
must perform robust analysis and quantitative measurement of its
trading activities that is reasonably designed to ensure that the
trading activity of each trading desk is consistent with the banking
entity's compliance program; monitor and assist in the
identification of potential and actual prohibited proprietary
trading activity; and prevent the occurrence of prohibited
proprietary trading. Analysis and models used to determine, measure
and limit risk must be rigorously tested and be reviewed by
management responsible for trading activity to ensure that trading
activities, limits, strategies, and hedging activities do not
understate the risk and exposure to the banking entity or allow
prohibited proprietary trading. This review should include periodic
and independent back-testing and revision of activities, limits,
strategies and hedging as appropriate to contain risk and ensure
compliance. In addition to the quantitative measurements reported by
any banking entity subject to Appendix A to this part, each banking
entity must develop and implement, to the extent appropriate to
facilitate compliance with this part, additional quantitative
measurements specifically tailored to the particular risks,
practices, and strategies of its trading desks. The banking entity's
analysis and quantitative measurements must incorporate the
quantitative measurements reported by the banking entity pursuant to
Appendix A (if applicable) and include, at a minimum, the following:
i. Internal controls and written policies and procedures
reasonably designed to ensure the accuracy and integrity of
quantitative measurements;
ii. Ongoing, timely monitoring and review of calculated
quantitative measurements;
iii. The establishment of numerical thresholds and appropriate
trading measures for each trading desk and heightened review of
trading activity not consistent with those thresholds to ensure
compliance with section 13 of the BHC Act and this part, including
analysis of the measurement results or other information,
appropriate escalation procedures, and documentation related to the
review; and
iv. Immediate review and compliance investigation of the trading
desk's activities, escalation to senior management with oversight
responsibilities for the applicable trading desk, timely
notification to the FDIC, appropriate remedial action (e.g.,
divesting of impermissible positions, cessation of impermissible
activity, disciplinary actions), and documentation of the
investigation findings and remedial action taken when quantitative
measurements or other information, considered together with the
facts and circumstances, or findings of internal audit, independent
testing or other review suggest a reasonable likelihood that the
trading desk has violated any part of section 13 of the BHC Act or
this part.
6. Other Compliance Matters. In addition to the requirements
specified above, the banking entity's compliance program must:
i. Identify activities of each trading desk that will be
conducted in reliance on exemptions contained in Sec. Sec. 351.4
through 351.6, including an explanation of:
A. How and where in the organization the activity occurs; and
B. Which exemption is being relied on and how the activity meets
the specific requirements for reliance on the applicable exemption;
ii. Include an explanation of the process for documenting,
approving and reviewing actions taken pursuant to the liquidity
management plan, where in the organization this activity occurs, the
securities permissible for liquidity management, the process for
ensuring that liquidity management activities are not conducted for
the purpose of prohibited proprietary trading, and the process for
ensuring that securities purchased as part of the liquidity
management plan are highly liquid and conform to the requirements of
this part;
iii. Describe how the banking entity monitors for and prohibits
potential or actual material exposure to high-risk assets or high-
risk trading strategies presented by each trading desk that relies
on the exemptions contained in Sec. Sec. 351.3(d)(3), and 351.4
through 351.6, which must take into account potential or actual
exposure to:
A. Assets whose values cannot be externally priced or, where
valuation is reliant on pricing models, whose model inputs cannot be
externally validated;
B. Assets whose changes in value cannot be adequately mitigated
by effective hedging;
C. New products with rapid growth, including those that do not
have a market history;
D. Assets or strategies that include significant embedded
leverage;
E. Assets or strategies that have demonstrated significant
historical volatility;
F. Assets or strategies for which the application of capital and
liquidity standards would not adequately account for the risk; and
G. Assets or strategies that result in large and significant
concentrations to sectors, risk factors, or counterparties;
iv. Establish responsibility for compliance with the reporting
and recordkeeping requirements of subpart B and Sec. 351.20; and
v. Establish policies for monitoring and prohibiting potential
or actual material conflicts of interest between the banking entity
and its clients, customers, or counterparties.
7. Remediation of violations. The banking entity's compliance
program must be reasonably designed and established to effectively
monitor and identify for further analysis any trading activity that
may indicate potential violations of section 13 of the BHC Act and
this part and to prevent actual violations of section 13 of the BHC
Act and this part. The compliance program must describe procedures
for identifying and remedying violations of section 13 of the BHC
Act and this part, and must include, at a minimum, a requirement to
promptly document, address and remedy any violation of section 13 of
the BHC Act or this part, and document all proposed and actual
remediation efforts. The compliance program must include specific
written policies and procedures that are reasonably designed to
assess the extent to which any activity indicates that modification
to the banking entity's compliance program is warranted and to
ensure that appropriate modifications are implemented. The written
policies and procedures must provide for prompt notification to
appropriate management, including senior management and the board of
directors, of any material weakness or significant deficiencies in
the design or implementation of the compliance program of the
banking entity.
b. Covered Fund Activities or Investments. A banking entity must
establish, maintain and enforce a compliance program that includes
written policies and procedures that are appropriate for the types,
size, complexity and risks of the covered fund and related
activities conducted and investments made, by the banking entity.
1. Identification of covered funds. The banking entity's
compliance program must provide a process, which must include
appropriate management review and independent testing, for
identifying and documenting covered funds that each unit within the
banking entity's organization
[[Page 62200]]
sponsors or organizes and offers, and covered funds in which each
such unit invests. In addition to the documentation requirements for
covered funds, as specified under Sec. 351.20(e), the documentation
must include information that identifies all pools that the banking
entity sponsors or has an interest in and the type of exemption from
the Commodity Exchange Act (whether or not the pool relies on
section 4.7 of the regulations under the Commodity Exchange Act),
and the amount of ownership interest the banking entity has in those
pools.
2. Identification of covered fund activities and investments.
The banking entity's compliance program must identify, document and
map each unit within the organization that is permitted to acquire
or hold an interest in any covered fund or sponsor any covered fund
and map each unit to the division, business line, or other
organizational structure that will be responsible for managing and
overseeing that unit's activities and investments.
3. Explanation of compliance. The banking entity's compliance
program must explain how:
i. The banking entity monitors for and prohibits potential or
actual material conflicts of interest between the banking entity and
its clients, customers, or counterparties related to its covered
fund activities and investments;
ii. The banking entity monitors for and prohibits potential or
actual transactions or activities that may threaten the safety and
soundness of the banking entity related to its covered fund
activities and investments; and
iii. The banking entity monitors for and prohibits potential or
actual material exposure to high-risk assets or high-risk trading
strategies presented by its covered fund activities and investments,
taking into account potential or actual exposure to:
A. Assets whose values cannot be externally priced or, where
valuation is reliant on pricing models, whose model inputs cannot be
externally validated;
B. Assets whose changes in values cannot be adequately mitigated
by effective hedging;
C. New products with rapid growth, including those that do not
have a market history;
D. Assets or strategies that include significant embedded
leverage;
E. Assets or strategies that have demonstrated significant
historical volatility;
F. Assets or strategies for which the application of capital and
liquidity standards would not adequately account for the risk; and
G. Assets or strategies that expose the banking entity to large
and significant concentrations with respect to sectors, risk
factors, or counterparties;
4. Description and documentation of covered fund activities and
investments. For each organizational unit engaged in covered fund
activities and investments, the banking entity's compliance program
must document:
i. The covered fund activities and investments that the unit is
authorized to conduct;
ii. The banking entity's plan for actively seeking unaffiliated
investors to ensure that any investment by the banking entity
conforms to the limits contained in Sec. 351.12 or registered in
compliance with the securities laws and thereby exempt from those
limits within the time periods allotted in Sec. 351.12; and
iii. How it complies with the requirements of subpart C.
5. Internal Controls. A banking entity must establish, maintain,
and enforce internal controls that are reasonably designed to ensure
that its covered fund activities or investments comply with the
requirements of section 13 of the BHC Act and this part and are
appropriate given the limits on risk established by the banking
entity. These written internal controls must be reasonably designed
and established to effectively monitor and identify for further
analysis any covered fund activity or investment that may indicate
potential violations of section 13 of the BHC Act or this part. The
internal controls must, at a minimum require:
i. Monitoring and limiting the banking entity's individual and
aggregate investments in covered funds;
ii. Monitoring the amount and timing of seed capital investments
for compliance with the limitations under subpart C (including but
not limited to the redemption, sale or disposition requirements) of
Sec. 351.12, and the effectiveness of efforts to seek unaffiliated
investors to ensure compliance with those limits;
iii. Calculating the individual and aggregate levels of
ownership interests in one or more covered fund required by Sec.
351.12;
iv. Attributing the appropriate instruments to the individual
and aggregate ownership interest calculations above;
v. Making disclosures to prospective and actual investors in any
covered fund organized and offered or sponsored by the banking
entity, as provided under Sec. 351.11(a)(8);
vi. Monitoring for and preventing any relationship or
transaction between the banking entity and a covered fund that is
prohibited under Sec. 351.14, including where the banking entity
has been designated as the sponsor, investment manager, investment
adviser, or commodity trading advisor to a covered fund by another
banking entity; and
vii. Appropriate management review and supervision across legal
entities of the banking entity to ensure that services and products
provided by all affiliated entities comply with the limitation on
services and products contained in Sec. 351.14.
6. Remediation of violations. The banking entity's compliance
program must be reasonably designed and established to effectively
monitor and identify for further analysis any covered fund activity
or investment that may indicate potential violations of section 13
of the BHC Act or this part and to prevent actual violations of
section 13 of the BHC Act and this part. The banking entity's
compliance program must describe procedures for identifying and
remedying violations of section 13 of the BHC Act and this part, and
must include, at a minimum, a requirement to promptly document,
address and remedy any violation of section 13 of the BHC Act or
this part, including Sec. 351.21, and document all proposed and
actual remediation efforts. The compliance program must include
specific written policies and procedures that are reasonably
designed to assess the extent to which any activity or investment
indicates that modification to the banking entity's compliance
program is warranted and to ensure that appropriate modifications
are implemented. The written policies and procedures must provide
for prompt notification to appropriate management, including senior
management and the board of directors, of any material weakness or
significant deficiencies in the design or implementation of the
compliance program of the banking entity.
III. Responsibility and Accountability for the Compliance Program
a. A banking entity must establish, maintain, and enforce a
governance and management framework to manage its business and
employees with a view to preventing violations of section 13 of the
BHC Act and this part. A banking entity must have an appropriate
management framework reasonably designed to ensure that: Appropriate
personnel are responsible and accountable for the effective
implementation and enforcement of the compliance program; a clear
reporting line with a chain of responsibility is delineated; and the
compliance program is reviewed periodically by senior management.
The board of directors (or equivalent governance body) and senior
management should have the appropriate authority and access to
personnel and information within the organizations as well as
appropriate resources to conduct their oversight activities
effectively.
1. Corporate governance. The banking entity must adopt a written
compliance program approved by the board of directors, an
appropriate committee of the board, or equivalent governance body,
and senior management.
2. Management procedures. The banking entity must establish,
maintain, and enforce a governance framework that is reasonably
designed to achieve compliance with section 13 of the BHC Act and
this part, which, at a minimum, provides for:
i. The designation of appropriate senior management or committee
of senior management with authority to carry out the management
responsibilities of the banking entity for each trading desk and for
each organizational unit engaged in covered fund activities;
ii. Written procedures addressing the management of the
activities of the banking entity that are reasonably designed to
achieve compliance with section 13 of the BHC Act and this part,
including:
A. A description of the management system, including the titles,
qualifications, and locations of managers and the specific
responsibilities of each person with respect to the banking entity's
activities governed by section 13 of the BHC Act and this part; and
B. Procedures for determining compensation arrangements for
traders engaged in underwriting or market making-related activities
under Sec. 351.4 or risk-mitigating hedging activities under Sec.
351.5 so that such compensation arrangements are designed not to
reward or incentivize
[[Page 62201]]
prohibited proprietary trading and appropriately balance risk and
financial results in a manner that does not encourage employees to
expose the banking entity to excessive or imprudent risk.
3. Business line managers. Managers with responsibility for one
or more trading desks of the banking entity are accountable for the
effective implementation and enforcement of the compliance program
with respect to the applicable trading desk(s).
4. Board of directors, or similar corporate body, and senior
management. The board of directors, or similar corporate body, and
senior management are responsible for setting and communicating an
appropriate culture of compliance with section 13 of the BHC Act and
this part and ensuring that appropriate policies regarding the
management of trading activities and covered fund activities or
investments are adopted to comply with section 13 of the BHC Act and
this part. The board of directors or similar corporate body (such as
a designated committee of the board or an equivalent governance
body) must ensure that senior management is fully capable,
qualified, and properly motivated to manage compliance with this
part in light of the organization's business activities and the
expectations of the board of directors. The board of directors or
similar corporate body must also ensure that senior management has
established appropriate incentives and adequate resources to support
compliance with this part, including the implementation of a
compliance program meeting the requirements of this appendix into
management goals and compensation structures across the banking
entity.
5. Senior management. Senior management is responsible for
implementing and enforcing the approved compliance program. Senior
management must also ensure that effective corrective action is
taken when failures in compliance with section 13 of the BHC Act and
this part are identified. Senior management and control personnel
charged with overseeing compliance with section 13 of the BHC Act
and this part should review the compliance program for the banking
entity periodically and report to the board, or an appropriate
committee thereof, on the effectiveness of the compliance program
and compliance matters with a frequency appropriate to the size,
scope, and risk profile of the banking entity's trading activities
and covered fund activities or investments, which shall be at least
annually.
6. CEO attestation. Based on a review by the CEO of the banking
entity, the CEO of the banking entity must, annually, attest in
writing to the FDIC that the banking entity has in place processes
to establish, maintain, enforce, review, test and modify the
compliance program established under this Appendix and Sec. 351.20
of this part in a manner reasonably designed to achieve compliance
with section 13 of the BHC Act and this part. In the case of a U.S.
branch or agency of a foreign banking entity, the attestation may be
provided for the entire U.S. operations of the foreign banking
entity by the senior management officer of the United States
operations of the foreign banking entity who is located in the
United States.
IV. Independent Testing
a. Independent testing must occur with a frequency appropriate
to the size, scope, and risk profile of the banking entity's trading
and covered fund activities or investments, which shall be at least
annually. This independent testing must include an evaluation of:
1. The overall adequacy and effectiveness of the banking
entity's compliance program, including an analysis of the extent to
which the program contains all the required elements of this
appendix;
2. The effectiveness of the banking entity's internal controls,
including an analysis and documentation of instances in which such
internal controls have been breached, and how such breaches were
addressed and resolved; and
3. The effectiveness of the banking entity's management
procedures.
b. A banking entity must ensure that independent testing
regarding the effectiveness of the banking entity's compliance
program is conducted by a qualified independent party, such as the
banking entity's internal audit department, compliance personnel or
risk managers independent of the organizational unit being tested,
outside auditors, consultants, or other qualified independent
parties. A banking entity must promptly take appropriate action to
remedy any significant deficiencies or material weaknesses in its
compliance program and to terminate any violations of section 13 of
the BHC Act or this part.
V. Training
Banking entities must provide adequate training to personnel and
managers of the banking entity engaged in activities or investments
governed by section 13 of the BHC Act or this part, as well as other
appropriate supervisory, risk, independent testing, and audit
personnel, in order to effectively implement and enforce the
compliance program. This training should occur with a frequency
appropriate to the size and the risk profile of the banking entity's
trading activities and covered fund activities or investments.
VI. Recordkeeping
Banking entities must create and retain records sufficient to
demonstrate compliance and support the operations and effectiveness
of the compliance program. A banking entity must retain these
records for a period that is no less than 5 years or such longer
period as required by the FDIC in a form that allows it to promptly
produce such records to the FDIC on request.
COMMODITY FUTURES TRADING COMMISSION
17 CFR Chapter I
Authority and Issuance
For the reasons stated in the Common Preamble, the Commodity
Futures Trading Commission amends part 75 to chapter I of Title 17 Code
of Federal Regulations as follows:
PART 75--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS
0
46. The authority citation for part 75 continues to read as follows:
Authority: 12 U.S.C. 1851.
Subpart A--Authority and Definitions
0
47. Section 75.2 is revised to read as follows:
Sec. 75.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(c) Banking entity. (1) Except as provided in paragraph (c)(2) of
this section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an insured depository institution;
(iii) Any company that is treated as a bank holding company for
purposes of section 8 of the International Banking Act of 1978 (12
U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any entity described in
paragraph (c)(1)(i), (ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a banking entity under
paragraph (c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraph (c)(1)(i), (ii), or (iii) of
this section; or
(iii) The FDIC acting in its corporate capacity or as conservator
or receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(d) Board means the Board of Governors of the Federal Reserve
System.
(e) CFTC means the Commodity Futures Trading Commission.
(f) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(g) Depository institution has the same meaning as in section 3(c)
of the Federal
[[Page 62202]]
Deposit Insurance Act (12 U.S.C. 1813(c)).
(h) Derivative. (1) Except as provided in paragraph (h)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the immediate family of the
employee.
(j) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(k) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(l) FDIC means the Federal Deposit Insurance Corporation.
(m) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(n) Foreign banking organization has the same meaning as in Sec.
211.21(o) of the Board's Regulation K (12 CFR 211.21(o)), but does not
include a foreign bank, as defined in section 1(b)(7) of the
International Banking Act of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the Commonwealth of Puerto Rico, Guam,
American Samoa, the United States Virgin Islands, or the Commonwealth
of the Northern Mariana Islands.
(o) Foreign insurance regulator means the insurance commissioner,
or a similar official or agency, of any country other than the United
States that is engaged in the supervision of insurance companies under
foreign insurance law.
(p) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(q) Insurance company means a company that is organized as an
insurance company, primarily and predominantly engaged in writing
insurance or reinsuring risks underwritten by insurance companies,
subject to supervision as such by a state insurance regulator or a
foreign insurance regulator, and not operated for the purpose of
evading the provisions of section 13 of the BHC Act (12 U.S.C. 1851).
(r) Insured depository institution has the same meaning as in
section 3(c) of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)),
but does not include: (1) An insured depository institution that is
described in section 2(c)(2)(D) of the BHC Act (12 U.S.C.
1841(c)(2)(D)); or (2) An insured depository institution if it has, and
if every company that controls it has, total consolidated assets of $10
billion or less and total trading assets and trading liabilities, on a
consolidated basis, that are 5 percent or less of total consolidated
assets.
(s) Limited trading assets and liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities (excluding trading assets
and liabilities attributable to trading activities permitted pursuant
to Sec. 75.6(a)(1) and (2) of subpart B) the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, is less
than $1 billion; and
(ii) The CFTC has not determined pursuant to Sec. 75.20(g) or (h)
of this part that the banking entity should not be treated as having
limited trading assets and liabilities.
(2) With respect to a banking entity other than a banking entity
described in paragraph (s)(3) of this section, trading assets and
liabilities for purposes of this paragraph (s) means trading assets and
liabilities (excluding trading assets and liabilities attributable to
trading activities permitted pursuant to Sec. 75.6(a)(1) and (2) of
subpart B) on a worldwide consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (s) means the
trading assets and liabilities (excluding trading assets and
liabilities attributable to trading activities permitted pursuant to
Sec. 75.6(a)(1) and (2) of subpart B) of the combined U.S. operations
of the top-tier foreign banking organization (including all
subsidiaries, affiliates, branches, and agencies of the foreign banking
organization operating, located, or organized in the United States).
(ii) For purposes of paragraph (s)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary. For purposes of paragraph (s)(3)(i) of
this section, all foreign operations of a U.S. agency, branch, or
subsidiary of a foreign banking organization are considered to be
located in the United States, including branches outside the United
States that are managed or controlled by a U.S. branch or agency of the
foreign banking organization, for purposes of calculating the banking
entity's U.S. trading assets and liabilities.
(t) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(u) Moderate trading assets and liabilities means, with respect to
a banking entity, that the banking entity does not have significant
trading assets and liabilities or limited trading assets and
liabilities.
(v) Primary financial regulatory agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 5301(12)).
(w) Purchase includes any contract to buy, purchase, or otherwise
acquire. For security futures products, purchase includes any contract,
agreement, or transaction for future delivery. With respect to a
commodity future, purchase includes any contract, agreement, or
transaction for future delivery. With respect to a derivative, purchase
includes the execution, termination (prior to its scheduled maturity
date),
[[Page 62203]]
assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a derivative, as the
context may require.
(x) Qualifying foreign banking organization means a foreign banking
organization that qualifies as such under Sec. 211.23(a), (c) or (e)
of the Board's Regulation K (12 CFR 211.23(a), (c), or (e)).
(y) SEC means the Securities and Exchange Commission.
(z) Sale and sell each include any contract to sell or otherwise
dispose of. For security futures products, such terms include any
contract, agreement, or transaction for future delivery. With respect
to a commodity future, such terms include any contract, agreement, or
transaction for future delivery. With respect to a derivative, such
terms include the execution, termination (prior to its scheduled
maturity date), assignment, exchange, or similar transfer or conveyance
of, or extinguishing of rights or obligations under, a derivative, as
the context may require.
(aa) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(bb) Security-based swap dealer has the same meaning as in section
3(a)(71) of the Exchange Act (15 U.S.C. 78c(a)(71)).
(cc) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(dd) Separate account means an account established and maintained
by an insurance company in connection with one or more insurance
contracts to hold assets that are legally segregated from the insurance
company's other assets, under which income, gains, and losses, whether
or not realized, from assets allocated to such account, are, in
accordance with the applicable contract, credited to or charged against
such account without regard to other income, gains, or losses of the
insurance company.
(ee) Significant trading assets and liabilities means with respect
to a banking entity that:
(1)(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, equals or
exceeds $20 billion; or
(ii) The CFTC has determined pursuant to Sec. 75.20(h) of this
part that the banking entity should be treated as having significant
trading assets and liabilities.
(2) With respect to a banking entity, other than a banking entity
described in paragraph (ee)(3) of this section, trading assets and
liabilities for purposes of this paragraph (ee) means trading assets
and liabilities (excluding trading assets and liabilities attributable
to trading activities permitted pursuant to Sec. 75.6(a)(1) and (2) of
subpart B) on a worldwide consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (ee) means the
trading assets and liabilities (excluding trading assets and
liabilities attributable to trading activities permitted pursuant to
Sec. 75.6(a)(1) and (2) of subpart B) of the combined U.S. operations
of the top-tier foreign banking organization (including all
subsidiaries, affiliates, branches, and agencies of the foreign banking
organization operating, located, or organized in the United States as
well as branches outside the United States that are managed or
controlled by a branch or agency of the foreign banking entity
operating, located or organized in the United States).
(ii) For purposes of paragraph (ee)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary. For purposes of paragraph (ee)(3)(i) of
this section, all foreign operations of a U.S. agency, branch, or
subsidiary of a foreign banking organization are considered to be
located in the United States for purposes of calculating the banking
entity's U.S. trading assets and liabilities.
(ff) State means any State, the District of Columbia, the
Commonwealth of Puerto Rico, Guam, American Samoa, the United States
Virgin Islands, and the Commonwealth of the Northern Mariana Islands.
(gg) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(hh) State insurance regulator means the insurance commissioner, or
a similar official or agency, of a State that is engaged in the
supervision of insurance companies under State insurance law.
(ii) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
Subpart B--Proprietary Trading
0
48. Section 75.3 is amended by:
0
a. Revising paragraphs (b), and (d)(3), (8), and (9);
0
b. Adding paragraphs (d)(10) through (13);
0
c. Redesignating paragraphs (e)(5) through (13) as paragraphs (e)(6)
through (14);
0
d. Adding new paragraph (e)(5); and
0
e. Revising paragraph (e)(11), (12), and (14).
The revisions and additions read as follows:
Sec. 75.3 Prohibition on proprietary trading.
* * * * *
(b) Definition of trading account. (1) Trading account. Trading
account means:
(i) Any account that is used by a banking entity to purchase or
sell one or more financial instruments principally for the purpose of
short-term resale, benefitting from actual or expected short-term price
movements, realizing short-term arbitrage profits, or hedging one or
more of the positions resulting from the purchases or sales of
financial instruments described in this paragraph;
(ii) Any account that is used by a banking entity to purchase or
sell one or more financial instruments that are both market risk
capital rule covered positions and trading positions (or hedges of
other market risk capital rule covered positions), if the banking
entity, or any affiliate with which the banking entity is consolidated
for regulatory reporting purposes, calculates risk-based capital ratios
under the market risk capital rule; or
(iii) Any account that is used by a banking entity to purchase or
sell one or more financial instruments, if the banking entity:
(A) Is licensed or registered, or is required to be licensed or
registered, to engage in the business of a dealer, swap dealer, or
security-based swap dealer, to the extent the instrument is purchased
or sold in connection with the activities that require the banking
entity to be licensed or registered as such; or
(B) Is engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
the instrument is purchased or sold in connection with the activities
of such business.
(2) Trading account application for certain banking entities. (i) A
banking entity that is subject to paragraph (b)(1)(ii) of this section
in determining the scope of its trading account is not subject to
paragraph (b)(1)(i) of this section.
(ii) A banking entity that does not calculate risk-based capital
ratios under
[[Page 62204]]
the market risk capital rule and is not a consolidated affiliate for
regulatory reporting purposes of a banking entity that calculates risk
based capital ratios under the market risk capital rule may elect to
apply paragraph (b)(1)(ii) of this section in determining the scope of
its trading account as if it were subject to that paragraph. A banking
entity that elects under this subsection to apply paragraph (b)(1)(ii)
of this section in determining the scope of its trading account as if
it were subject to that paragraph is not required to apply paragraph
(b)(1)(i) of this section.
(3) Consistency of account election for certain banking entities.
(i) Any election or change to an election under paragraph (b)(2)(ii) of
this section must apply to the electing banking entity and all of its
wholly owned subsidiaries. The primary financial regulatory agency of a
banking entity that is affiliated with but is not a wholly owned
subsidiary of such electing banking entity may require that the banking
entity be subject to this uniform application requirement if the
primary financial regulatory agency determines that it is necessary to
prevent evasion of the requirements of this part after notice and
opportunity for response as provided in subpart D of this part.
(ii) A banking entity that does not elect under paragraph
(b)(2)(ii) of this section to be subject to the trading account
definition in (b)(1)(ii) may continue to apply the trading account
definition in paragraph (b)(1)(i) of this section for one year from the
date on which it becomes, or becomes a consolidated affiliate for
regulatory reporting purposes with, a banking entity that calculates
risk-based capital ratios under the market risk capital rule.
(4) Rebuttable presumption for certain purchases and sales. The
purchase (or sale) of a financial instrument by a banking entity shall
be presumed not to be for the trading account of the banking entity
under paragraph (b)(1)(i) of this section if the banking entity holds
the financial instrument for sixty days or longer and does not transfer
substantially all of the risk of the financial instrument within sixty
days of the purchase (or sale).
* * * * *
(d) * * *
(3) Any purchase or sale of a security, foreign exchange forward
(as that term is defined in section 1a(24) of the Commodity Exchange
Act (7 U.S.C. 1a(24)), foreign exchange swap (as that term is defined
in section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)), or
cross-currency swap by a banking entity for the purpose of liquidity
management in accordance with a documented liquidity management plan of
the banking entity that:
(i) Specifically contemplates and authorizes the particular
financial instruments to be used for liquidity management purposes, the
amount, types, and risks of these financial instruments that are
consistent with liquidity management, and the liquidity circumstances
in which the particular financial instruments may or must be used;
(ii) Requires that any purchase or sale of financial instruments
contemplated and authorized by the plan be principally for the purpose
of managing the liquidity of the banking entity, and not for the
purpose of short-term resale, benefitting from actual or expected
short-term price movements, realizing short-term arbitrage profits, or
hedging a position taken for such short-term purposes;
(iii) Requires that any financial instruments purchased or sold for
liquidity management purposes be highly liquid and limited to financial
instruments the market, credit, and other risks of which the banking
entity does not reasonably expect to give rise to appreciable profits
or losses as a result of short-term price movements;
(iv) Limits any financial instruments purchased or sold for
liquidity management purposes, together with any other financial
instruments purchased or sold for such purposes, to an amount that is
consistent with the banking entity's near-term funding needs, including
deviations from normal operations of the banking entity or any
affiliate thereof, as estimated and documented pursuant to methods
specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of financial instruments that are not permitted under Sec. 75.6(a) or
(b) of this subpart are for the purpose of liquidity management and in
accordance with the liquidity management plan described in this
paragraph (d)(3); and
(vi) Is consistent with the CFTC's regulatory requirements
regarding liquidity management;
* * * * *
(8) Any purchase or sale of one or more financial instruments by a
banking entity through a deferred compensation, stock-bonus, profit-
sharing, or pension plan of the banking entity that is established and
administered in accordance with the law of the United States or a
foreign sovereign, if the purchase or sale is made directly or
indirectly by the banking entity as trustee for the benefit of persons
who are or were employees of the banking entity;
(9) Any purchase or sale of one or more financial instruments by a
banking entity in the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
financial instrument as soon as practicable, and in no event may the
banking entity retain such instrument for longer than such period
permitted by the OCC;
(10) Any purchase or sale of one or more financial instruments that
was made in error by a banking entity in the course of conducting a
permitted or excluded activity or is a subsequent transaction to
correct such an error;
(11) Contemporaneously entering into a customer-driven swap or
customer-driven security-based swap and a matched swap or security-
based swap if:
(i) The banking entity retains no more than minimal price risk; and
(ii) The banking entity is not a registered dealer, swap dealer, or
security-based swap dealer;
(12) Any purchase or sale of one or more financial instruments that
the banking entity uses to hedge mortgage servicing rights or mortgage
servicing assets in accordance with a documented hedging strategy; or
(13) Any purchase or sale of a financial instrument that does not
meet the definition of trading asset or trading liability under the
applicable reporting form for a banking entity as of January 1, 2020.
(e) * * *
(5) Cross-currency swap means a swap in which one party exchanges
with another party principal and interest rate payments in one currency
for principal and interest rate payments in another currency, and the
exchange of principal occurs on the date the swap is entered into, with
a reversal of the exchange of principal at a later date that is agreed
upon when the swap is entered into.
* * * * *
(11) Market risk capital rule covered position and trading position
means a financial instrument that meets the criteria to be a covered
position and a trading position, as those terms are respectively
defined, without regard to whether the financial instrument is reported
as a covered position or trading position on any applicable regulatory
reporting forms:
(i) In the case of a banking entity that is a bank holding company,
savings and loan holding company, or insured depository institution,
under the market
[[Page 62205]]
risk capital rule that is applicable to the banking entity; and
(ii) In the case of a banking entity that is affiliated with a bank
holding company or savings and loan holding company, other than a
banking entity to which a market risk capital rule is applicable, under
the market risk capital rule that is applicable to the affiliated bank
holding company or savings and loan holding company.
(12) Market risk capital rule means the market risk capital rule
that is contained in 12 CFR part 3, subpart F, with respect to a
banking entity for which the OCC is the primary financial regulatory
agency, 12 CFR part 217 with respect to a banking entity for which the
Board is the primary financial regulatory agency, or 12 CFR part 324
with respect to a banking entity for which the FDIC is the primary
financial regulatory agency.
* * * * *
(14) Trading desk means a unit of organization of a banking entity
that purchases or sells financial instruments for the trading account
of the banking entity or an affiliate thereof that is:
(i)(A) Structured by the banking entity to implement a well-defined
business strategy;
(B) Organized to ensure appropriate setting, monitoring, and
management review of the desk's trading and hedging limits, current and
potential future loss exposures, and strategies; and
(C) Characterized by a clearly defined unit that:
(1) Engages in coordinated trading activity with a unified approach
to its key elements;
(2) Operates subject to a common and calibrated set of risk
metrics, risk levels, and joint trading limits;
(3) Submits compliance reports and other information as a unit for
monitoring by management; and
(4) Books its trades together; or
(ii) For a banking entity that calculates risk-based capital ratios
under the market risk capital rule, or a consolidated affiliate for
regulatory reporting purposes of a banking entity that calculates risk-
based capital ratios under the market risk capital rule, established by
the banking entity or its affiliate for purposes of market risk capital
calculations under the market risk capital rule.
0
49. Section 75.4 is revised to read as follows:
Sec. 75.4 Permitted underwriting and market making-related
activities.
(a) Underwriting activities--(1) Permitted underwriting activities.
The prohibition contained in Sec. 75.3(a) does not apply to a banking
entity's underwriting activities conducted in accordance with this
paragraph (a).
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii)(A) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
taking into account the liquidity, maturity, and depth of the market
for the relevant types of securities; and
(B) Reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity, maturity, and depth of the market for the relevant types
of securities;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (a) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, in accordance with paragraph
(a)(2)(ii)(A) of this section;
(C) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
(D) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
(iv) A banking entity with significant trading assets and
liabilities may satisfy the requirements in paragraphs (a)(2))iii)(B)
and (C) of this section by complying with the requirements set forth
below in paragraph (c) of this section;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
(3) Definition of distribution. For purposes of this paragraph (a),
a distribution of securities means:
(i) An offering of securities, whether or not subject to
registration under the Securities Act of 1933, that is distinguished
from ordinary trading transactions by the presence of special selling
efforts and selling methods; or
(ii) An offering of securities made pursuant to an effective
registration statement under the Securities Act of 1933.
(4) Definition of underwriter. For purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an issuer or selling security
holder to:
(A) Purchase securities from the issuer or selling security holder
for distribution;
(B) Engage in a distribution of securities for or on behalf of the
issuer or selling security holder; or
(C) Manage a distribution of securities for or on behalf of the
issuer or selling security holder; or
(ii) A person who has agreed to participate or is participating in
a distribution of such securities for or on behalf of the issuer or
selling security holder.
(5) Definition of selling security holder. For purposes of this
paragraph (a), selling security holder means any person, other than an
issuer, on whose behalf a distribution is made.
(6) Definition of underwriting position. For purposes of this
section, underwriting position means the long or short positions in one
or more securities held by a banking entity or its affiliate, and
managed by a particular trading desk, in connection with a particular
distribution of securities for which such banking entity or affiliate
is acting as an underwriter.
(7) Definition of client, customer, and counterparty. For purposes
of this paragraph (a), the terms client, customer, and counterparty, on
a collective or individual basis, refer to market participants that may
transact with the banking entity in connection with a particular
distribution for which the banking entity is acting as underwriter.
(b) Market making-related activities--(1) Permitted market making-
related activities. The prohibition contained in Sec. 75.3(a) does not
apply to a banking entity's market making-related activities
[[Page 62206]]
conducted in accordance with this paragraph (b).
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure, routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure, and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The trading desk's market-making related activities are
designed not to exceed, on an ongoing basis, the reasonably expected
near term demands of clients, customers, or counterparties, taking into
account the liquidity, maturity, and depth of the market for the
relevant types of financial instruments;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (b) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and positions; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, in accordance with paragraph
(b)(2)(ii) of this section;
(D) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
(E) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
(iv) A banking entity with significant trading assets and
liabilities may satisfy the requirements in paragraphs (b)(2)(iii)(C)
and (D) of this section by complying with the requirements set forth
below in paragraph (c) of this section;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (b) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in
activity described in this paragraph (b) in accordance with applicable
law.
(3) Definition of client, customer, and counterparty. For purposes
of paragraph (b) of this section, the terms client, customer, and
counterparty, on a collective or individual basis refer to market
participants that make use of the banking entity's market making-
related services by obtaining such services, responding to quotations,
or entering into a continuing relationship with respect to such
services, provided that:
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with the methodology described in
Sec. 75.2(ee) of this part, unless:
(A) The trading desk documents how and why a particular trading
desk or other organizational unit of the entity should be treated as a
client, customer, or counterparty of the trading desk for purposes of
paragraph (b)(2) of this section; or
(B) The purchase or sale by the trading desk is conducted
anonymously on an exchange or similar trading facility that permits
trading on behalf of a broad range of market participants.
(ii) [Reserved]
(4) Definition of financial exposure. For purposes of this section,
financial exposure means the aggregate risks of one or more financial
instruments and any associated loans, commodities, or foreign exchange
or currency, held by a banking entity or its affiliate and managed by a
particular trading desk as part of the trading desk's market making-
related activities.
(5) Definition of market-maker positions. For the purposes of this
section, market-maker positions means all of the positions in the
financial instruments for which the trading desk stands ready to make a
market in accordance with paragraph (b)(2)(i) of this section, that are
managed by the trading desk, including the trading desk's open
positions or exposures arising from open transactions.
(c) Rebuttable presumption of compliance--(1) Internal limits. (i)
A banking entity shall be presumed to meet the requirement in paragraph
(a)(2)(ii)(A) or (b)(2)(ii) of this section with respect to the
purchase or sale of a financial instrument if the banking entity has
established and implements, maintains, and enforces the internal limits
for the relevant trading desk as described in paragraph (c)(1)(ii) of
this section.
(ii)(A) With respect to underwriting activities conducted pursuant
to paragraph (a) of this section, the presumption described in
paragraph (c)(1)(i) of this section shall be available to each trading
desk that establishes, implements, maintains, and enforces internal
limits that should take into account the liquidity, maturity, and depth
of the market for the relevant types of securities and are designed not
to exceed the reasonably expected near term demands of clients,
customers, or counterparties, based on the nature and amount of the
trading desk's underwriting activities, on the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.
(B) With respect to market making-related activities conducted
pursuant to paragraph (b) of this section, the presumption described in
paragraph (c)(1)(i) of this section shall be available to each trading
desk that establishes, implements, maintains, and enforces internal
limits that should take into account the liquidity, maturity, and depth
of the market for the relevant types of financial instruments and are
designed not to exceed the reasonably expected near term demands of
clients, customers, or counterparties, based on the nature and amount
of the trading desk's market-making related activities, that address
the:
(1) Amount, types, and risks of its market-maker positions;
[[Page 62207]]
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
(4) Period of time a financial instrument may be held.
(2) Supervisory review and oversight. The limits described in
paragraph (c)(1) of this section shall be subject to supervisory review
and oversight by the CFTC on an ongoing basis.
(3) Limit Breaches and Increases. (i) With respect to any limit set
pursuant to paragraph (c)(1)(ii)(A) or (B) of this section, a banking
entity shall maintain and make available to the CFTC upon request
records regarding:
(A) Any limit that is exceeded; and
(B) Any temporary or permanent increase to any limit(s), in each
case in the form and manner as directed by the CFTC.
(ii) In the event of a breach or increase of any limit set pursuant
to paragraph (c)(1)(ii)(A) or (B) of this section, the presumption
described in paragraph (c)(1)(i) of this section shall continue to be
available only if the banking entity:
(A) Takes action as promptly as possible after a breach to bring
the trading desk into compliance; and
(B) Follows established written authorization procedures, including
escalation procedures that require review and approval of any trade
that exceeds a trading desk's limit(s), demonstrable analysis of the
basis for any temporary or permanent increase to a trading desk's
limit(s), and independent review of such demonstrable analysis and
approval.
(4) Rebutting the presumption. The presumption in paragraph
(c)(1)(i) of this section may be rebutted by the CFTC if the CFTC
determines, taking into account the liquidity, maturity, and depth of
the market for the relevant types of financial instruments and based on
all relevant facts and circumstances, that a trading desk is engaging
in activity that is not based on the reasonably expected near term
demands of clients, customers, or counterparties. The CFTC's rebuttal
of the presumption in paragraph (c)(1)(i) of this section must be made
in accordance with the notice and response procedures in subpart D of
this part.
0
50. Section 75.5 is amended by revising paragraphs (b) and (c)(1)
introductory text and adding paragraph (c)(4) to read as follows:
Sec. 75.5 Permitted risk-mitigating hedging activities.
* * * * *
(b) Requirements. (1) The risk-mitigating hedging activities of a
banking entity that has significant trading assets and liabilities are
permitted under paragraph (a) of this section only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(C) The conduct of analysis and independent testing designed to
ensure that the positions, techniques and strategies that may be used
for hedging may reasonably be expected to reduce or otherwise
significantly mitigate the specific, identifiable risk(s) being hedged;
(ii) The risk-mitigating hedging activity:
(A) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(B) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(D) Is subject to continuing review, monitoring and management by
the banking entity that:
(1) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1)(i) of this section;
(2) Is designed to reduce or otherwise significantly mitigate the
specific, identifiable risks that develop over time from the risk-
mitigating hedging activities undertaken under this section and the
underlying positions, contracts, and other holdings of the banking
entity, based upon the facts and circumstances of the underlying and
hedging positions, contracts and other holdings of the banking entity
and the risks and liquidity thereof; and
(3) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(1)(ii) of this section and is not
prohibited proprietary trading; and
(iii) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(2) The risk-mitigating hedging activities of a banking entity that
does not have significant trading assets and liabilities are permitted
under paragraph (a) of this section only if the risk-mitigating hedging
activity:
(i) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to ongoing recalibration by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading.
(c) * * *
(1) A banking entity that has significant trading assets and
liabilities must comply with the requirements of paragraphs (c)(2) and
(3) of this section, unless the requirements of paragraph (c)(4) of
this section are met, with respect to any purchase or sale of financial
instruments made in reliance on this section for risk-mitigating
hedging purposes that is:
* * * * *
(4) The requirements of paragraphs (c)(2) and (3) of this section
do not
[[Page 62208]]
apply to the purchase or sale of a financial instrument described in
paragraph (c)(1) of this section if:
(i) The financial instrument purchased or sold is identified on a
written list of pre-approved financial instruments that are commonly
used by the trading desk for the specific type of hedging activity for
which the financial instrument is being purchased or sold; and
(ii) At the time the financial instrument is purchased or sold, the
hedging activity (including the purchase or sale of the financial
instrument) complies with written, pre-approved limits for the trading
desk purchasing or selling the financial instrument for hedging
activities undertaken for one or more other trading desks. The limits
shall be appropriate for the:
(A) Size, types, and risks of the hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased and sold for hedging activities
by the trading desk; and
(C) Levels and duration of the risk exposures being hedged.
0
51. Section 75.6 is amended by revising paragraph (e)(3); removing
paragraphs (e)(4) and (6); and redesignating paragraph (e)(5) as
paragraph (e)(4).
The revision reads as follows:
Sec. 75.6 Other permitted proprietary trading activities.
* * * * *
(e) * * *
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
* * * * *
Subpart C--Covered Funds Activities and Investments
0
52. Section 75.10 is amended by revising paragraphs (c)(7)(ii) and
(c)(8)(i)(A) to read as follows:
Sec. 75.10 Prohibition on Acquiring or Retaining an Ownership
Interest in and Having Certain Relationships with a Covered Fund
* * * * *
(c) * * *
(7) * * *
(ii) Participates in the profits and losses of the separate account
other than in compliance with applicable requirements regarding bank
owned life insurance.
(8) * * *
(i) * * *
(A) Loans as defined in Sec. 75.2(t) of subpart A;
* * * * *
0
53. Section 75.11 is amended by revising paragraph (c) to read as
follows:
Sec. 75.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
* * * * *
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 75.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 75.4(a) or (b) of subpart B, respectively; and
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; or acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in such covered fund in
compliance with section 15G of that Act (15 U.S.C. 78o-11) and the
implementing regulations issued thereunder each as permitted by
paragraph (b) of this section, then in each such case any ownership
interests acquired or retained by the banking entity and its affiliates
in connection with underwriting and market making related activities
for that particular covered fund are included in the calculation of
ownership interests permitted to be held by the banking entity and its
affiliates under the limitations of Sec. 75.12(a)(2)(ii); Sec.
75.12(a)(2)(iii), and Sec. 75.12(d) of this subpart.
0
54. Section 75.13 is amended by revising paragraphs (a), (b)(3) and
(4), and (c) to read as follows:
Sec. 75.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 75.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to reduce or otherwise
significantly mitigate the specific, identifiable risks to the banking
entity in connection with:
(i) A compensation arrangement with an employee of the banking
entity or an affiliate thereof that directly provides investment
advisory, commodity trading advisory or other services to the covered
fund; or
(ii) A position taken by the banking entity when acting as
intermediary on behalf of a customer that is not itself a banking
entity to facilitate the exposure by the customer to the profits and
losses of the covered fund.
(2) The risk-mitigating hedging activities of a banking entity are
permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program in accordance with subpart
D of this part that is reasonably designed to ensure the banking
entity's compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures,
and internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks arising:
(1) Out of a transaction conducted solely to accommodate a specific
customer request with respect to the covered fund; or
(2) In connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
[[Page 62209]]
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) With respect to risk-mitigating hedging activity conducted
pursuant to paragraph (a)(1)(i) of this section, the compensation
arrangement relates solely to the covered fund in which the banking
entity or any affiliate has acquired an ownership interest pursuant to
paragraph (a)(1)(i) and such compensation arrangement provides that any
losses incurred by the banking entity on such ownership interest will
be offset by corresponding decreases in amounts payable under such
compensation arrangement.
(b) * * *
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is not sold and has not been
sold pursuant to an offering that targets residents of the United
States in which the banking entity or any affiliate of the banking
entity participates. If the banking entity or an affiliate sponsors or
serves, directly or indirectly, as the investment manager, investment
adviser, commodity pool operator or commodity trading advisor to a
covered fund, then the banking entity or affiliate will be deemed for
purposes of this paragraph (b)(3) to participate in any offer or sale
by the covered fund of ownership interests in the covered fund.
(4) An activity or investment occurs solely outside of the United
States for purposes of paragraph (b)(1)(iv) of this section only if:
(i) The banking entity acting as sponsor, or engaging as principal
in the acquisition or retention of an ownership interest in the covered
fund, is not itself, and is not controlled directly or indirectly by, a
banking entity that is located in the United States or organized under
the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to acquire or retain the ownership interest or act as
sponsor to the covered fund is not located in the United States or
organized under the laws of the United States or of any State; and
(iii) The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State.
* * * * *
(c) Permitted covered fund interests and activities by a regulated
insurance company. The prohibition contained in Sec. 75.10(a) of this
subpart does not apply to the acquisition or retention by an insurance
company, or an affiliate thereof, of any ownership interest in, or the
sponsorship of, a covered fund only if:
(1) The insurance company or its affiliate acquires and retains the
ownership interest solely for the general account of the insurance
company or for one or more separate accounts established by the
insurance company;
(2) The acquisition and retention of the ownership interest is
conducted in compliance with, and subject to, the insurance company
investment laws and regulations of the State or jurisdiction in which
such insurance company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law or regulation described in paragraph (c)(2) of
this section is insufficient to protect the safety and soundness of the
banking entity, or the financial stability of the United States.
0
55. Section 75.14 is amended by revising paragraph (a)(2)(ii)(B) to
read as follows:
Sec. 75.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually no later than March 31 to
the CFTC (with a duty to update the certification if the information in
the certification materially changes) that the banking entity does not,
directly or indirectly, guarantee, assume, or otherwise insure the
obligations or performance of the covered fund or of any covered fund
in which such covered fund invests; and
* * * * *
Subpart D--Compliance Program Requirement; Violations
0
56. Section 75.20 is amended by revising paragraphs (a), (b)
introductory text, (c), (d), (e) introductory text, and (f)(2) and
adding paragraphs (g), (h), and (i) to read as follows:
Sec. 75.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities) shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
(b) Banking entities with significant trading assets and
liabilities. With respect to a banking entity with significant trading
assets and liabilities, the compliance program required by paragraph
(a) of this section, at a minimum, shall include:
* * * * *
(c) CEO attestation. The CEO of a banking entity that has
significant trading assets and liabilities must, based on a review by
the CEO of the banking entity, attest in writing to the CFTC, each year
no later than March 31, that the banking entity has in place processes
to establish, maintain, enforce, review, test and modify the compliance
program required by paragraph (b) of this section in a manner
reasonably designed to achieve compliance with section 13 of the BHC
Act and this part. In the case of a U.S. branch or agency of a foreign
banking entity, the attestation may be provided for the entire U.S.
operations of the foreign banking entity by the senior management
officer of the U.S. operations of the foreign banking entity who is
located in the United States.
(d) Reporting requirements under appendix A to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B of this part shall comply with the reporting requirements
described in appendix A to this part, if:
(i) The banking entity has significant trading assets and
liabilities; or
(ii) The CFTC notifies the banking entity in writing that it must
satisfy the reporting requirements contained in appendix A to this
part.
(2) Frequency of reporting: Unless the CFTC notifies the banking
entity in writing that it must report on a different basis, a banking
entity subject to appendix A to this part shall report the information
required by appendix A for
[[Page 62210]]
each quarter within 30 days of the end of the quarter.
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities shall maintain records
that include:
* * * * *
(f) * * *
(2) Banking entities with moderate trading assets and liabilities.
A banking entity with moderate trading assets and liabilities may
satisfy the requirements of this section by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act and this part and adjustments
as appropriate given the activities, size, scope, and complexity of the
banking entity.
(g) Rebuttable presumption of compliance for banking entities with
limited trading assets and liabilities--(1) Rebuttable presumption.
Except as otherwise provided in this paragraph, a banking entity with
limited trading assets and liabilities shall be presumed to be
compliant with subpart B and subpart C of this part and shall have no
obligation to demonstrate compliance with this part on an ongoing
basis.
(2) Rebuttal of presumption. If upon examination or audit, the CFTC
determines that the banking entity has engaged in proprietary trading
or covered fund activities that are otherwise prohibited under subpart
B or subpart C of this part, the CFTC may require the banking entity to
be treated under this part as if it did not have limited trading assets
and liabilities. The CFTC's rebuttal of the presumption in this
paragraph must be made in accordance with the notice and response
procedures in paragraph (i) of this section.
(h) Reservation of authority. Notwithstanding any other provision
of this part, the CFTC retains its authority to require a banking
entity without significant trading assets and liabilities to apply any
requirements of this part that would otherwise apply if the banking
entity had significant or moderate trading assets and liabilities if
the CFTC determines that the size or complexity of the banking entity's
trading or investment activities, or the risk of evasion of subpart B
or subpart C, of this part does not warrant a presumption of compliance
under paragraph (g) of this section or treatment as a banking entity
with moderate trading assets and liabilities, as applicable. The CFTC's
exercise of this reservation of authority must be made in accordance
with the notice and response procedures in paragraph (i) of this
section.
(i) Notice and response procedures--(1) Notice. The CFTC will
notify the banking entity in writing of any determination requiring
notice under this part and will provide an explanation of the
determination.
(2) Response. The banking entity may respond to any or all items in
the notice described in paragraph (i)(1) of this section. The response
should include any matters that the banking entity would have the CFTC
consider in deciding whether to make the determination. The response
must be in writing and delivered to the designated CFTC official within
30 days after the date on which the banking entity received the notice.
The CFTC may shorten the time period when, in the opinion of the CFTC,
the activities or condition of the banking entity so requires, provided
that the banking entity is informed of the time period at the time of
notice, or with the consent of the banking entity. In its discretion,
the CFTC may extend the time period for good cause.
(3) Waiver. Failure to respond within 30 days or such other time
period as may be specified by the CFTC shall constitute a waiver of any
objections to the CFTC's determination.
(4) Decision. The CFTC will notify the banking entity of the
decision in writing. The notice will include an explanation of the
decision.
0
57. Revise appendix A to part 75 to read as follows:
Appendix A to Part 75--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
75.20(d), this appendix applies to a banking entity that, together
with its affiliates and subsidiaries, has significant trading assets
and liabilities. These entities are required to (i) furnish periodic
reports to the CFTC regarding a variety of quantitative measurements
of their covered trading activities, which vary depending on the
scope and size of covered trading activities, and (ii) create and
maintain records documenting the preparation and content of these
reports. The requirements of this appendix must be incorporated into
the banking entity's internal compliance program under Sec. 75.20.
b. The purpose of this appendix is to assist banking entities
and the CFTC in:
(1) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(2) Monitoring the banking entity's covered trading activities;
(3) Identifying covered trading activities that warrant further
review or examination by the banking entity to verify compliance
with the proprietary trading restrictions;
(4) Evaluating whether the covered trading activities of trading
desks engaged in market making-related activities subject to Sec.
75.4(b) are consistent with the requirements governing permitted
market making-related activities;
(5) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. 75.4, 75.5, or 75.6(a) and (b) (i.e., underwriting and market
making-related activity, risk-mitigating hedging, or trading in
certain government obligations) are consistent with the requirement
that such activity not result, directly or indirectly, in a material
exposure to high-risk assets or high-risk trading strategies;
(6) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by CFTC of such activities; and
(7) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. Information that must be furnished pursuant to this appendix
is not intended to serve as a dispositive tool for the
identification of permissible or impermissible activities.
d. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 75.20. The effectiveness of particular
quantitative measurements may differ based on the profile of the
banking entity's businesses in general and, more specifically, of
the particular trading desk, including types of instruments traded,
trading activities and strategies, and history and experience (e.g.,
whether the trading desk is an established, successful market maker
or a new entrant to a competitive market). In all cases, banking
entities must ensure that they have robust measures in place to
identify and monitor the risks taken in their trading activities, to
ensure that the activities are within risk tolerances established by
the banking entity, and to monitor and examine for compliance with
the proprietary trading restrictions in this part.
e. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 75.4 through 75.6(a) and (b), or that
result in a material exposure to high-risk assets or high-risk
trading strategies, must be escalated within the banking entity for
review, further analysis, explanation to CFTC, and
[[Page 62211]]
remediation, where appropriate. The quantitative measurements
discussed in this appendix should be helpful to banking entities in
identifying and managing the risks related to their covered trading
activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 75.2 and 75.3. In addition, for purposes of this
appendix, the following definitions apply:
Applicability identifies the trading desks for which a banking
entity is required to calculate and report a particular quantitative
measurement based on the type of covered trading activity conducted
by the trading desk.
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of a trading desk's holdings, dividend income, and
interest income and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. 75.4, Sec. 75.5, Sec. 75.6(a), or Sec. 75.6(b).
A banking entity may include in its covered trading activity trading
conducted under Sec. 75.3(d), Sec. 75.6(c), Sec. 75.6(d) or Sec.
75.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading day means a calendar day on which a trading desk is open
for trading.
III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each banking entity made subject
to this appendix by Sec. 75.20 must furnish the following
quantitative measurements, as applicable, for each trading desk of
the banking entity engaged in covered trading activities and
calculate these quantitative measurements in accordance with this
appendix:
i. Internal Limits and Usage;
ii. Value-at-Risk;
iii. Comprehensive Profit and Loss Attribution;
iv. Positions; and
v. Transaction Volumes.
2. Trading desk information. Each banking entity made subject to
this appendix by Sec. 75.20 must provide certain descriptive
information, as further described in this appendix, regarding each
trading desk engaged in covered trading activities.
3. Quantitative measurements identifying information. Each
banking entity made subject to this appendix by Sec. 75.20 must
provide certain identifying and descriptive information, as further
described in this appendix, regarding its quantitative measurements.
4. Narrative statement. Each banking entity made subject to this
appendix by Sec. 75.20 may provide an optional narrative statement,
as further described in this appendix.
5. File identifying information. Each banking entity made
subject to this appendix by Sec. 75.20 must provide file
identifying information in each submission to the CFTC pursuant to
this appendix, including the name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the Board, and
identification of the reporting period and creation date and time.
b. Trading Desk Information
1. Each banking entity must provide descriptive information
regarding each trading desk engaged in covered trading activities,
including:
i. Name of the trading desk used internally by the banking
entity and a unique identification label for the trading desk;
ii. Identification of each type of covered trading activity in
which the trading desk is engaged;
iii. Brief description of the general strategy of the trading
desk;
v. A list identifying each Agency receiving the submission of
the trading desk;
2. Indication of whether each calendar date is a trading day or
not a trading day for the trading desk; and
3. Currency reported and daily currency conversion rate.
c. Quantitative Measurements Identifying Information
Each banking entity must provide the following information
regarding the quantitative measurements:
1. An Internal Limits Information Schedule that provides
identifying and descriptive information for each limit reported
pursuant to the Internal Limits and Usage quantitative measurement,
including the name of the limit, a unique identification label for
the limit, a description of the limit, the unit of measurement for
the limit, the type of limit, and identification of the
corresponding risk factor attribution in the particular case that
the limit type is a limit on a risk factor sensitivity and profit
and loss attribution to the same risk factor is reported; and
2. A Risk Factor Attribution Information Schedule that provides
identifying and descriptive information for each risk factor
attribution reported pursuant to the Comprehensive Profit and Loss
Attribution quantitative measurement, including the name of the risk
factor or other factor, a unique identification label for the risk
factor or other factor, a description of the risk factor or other
factor, and the risk factor or other factor's change unit.
d. Narrative Statement
Each banking entity made subject to this appendix by Sec. 75.20
may submit in a separate electronic document a Narrative Statement
to the CFTC with any information the banking entity views as
relevant for assessing the information reported. The Narrative
Statement may include further description of or changes to
calculation methods, identification of material events, description
of and reasons for changes in the banking entity's trading desk
structure or trading desk strategies, and when any such changes
occurred.
e. Frequency and Method of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report the
Trading Desk Information, the Quantitative Measurements Identifying
Information, and each applicable quantitative measurement
electronically to the CFTC on the reporting schedule established in
Sec. 75.20 unless otherwise requested by the CFTC. A banking entity
must report the Trading Desk Information, the Quantitative
Measurements Identifying Information, and each applicable
quantitative measurement to the CFTC in accordance with the XML
Schema specified and published on the CFTC's website.
f. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the CFTC pursuant to this appendix and Sec. 75.20(d),
create and maintain records documenting the preparation and content
of these reports, as well as such information as is necessary to
permit the CFTC to verify the accuracy of such reports, for a period
of five years from the end of the calendar year for which the
measurement was taken. A banking entity must retain the Narrative
Statement, the Trading Desk Information, and the Quantitative
Measurements Identifying Information for a period of five years from
the end of the calendar year for which the information was reported
to the CFTC.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Internal Limits and Usage
i. Description: For purposes of this appendix, Internal Limits
are the constraints that define the amount of risk and the positions
that a trading desk is permitted to take at a point in time, as
defined by the banking entity for a specific trading desk. Usage
represents the value of the trading desk's risk or positions that
are accounted for by the current activity of the desk. Internal
limits and their usage are key compliance and risk management tools
used to control and monitor risk taking and include, but are not
limited to, the limits set out in Sec. Sec. 75.4 and 75.5. A
trading desk's risk limits, commonly including a limit on ``Value-
at-Risk,'' are useful in the broader context of the trading desk's
overall activities, particularly for the market making activities
under Sec. 75.4(b) and hedging activity under Sec. 75.5.
Accordingly, the limits required under Sec. Sec. 75.4(b)(2)(iii)(C)
and 75.5(b)(1)(i)(A) must meet the applicable requirements under
Sec. Sec. 75.4(b)(2)(iii)(C) and 75.5(b)(1)(i)(A) and also must
include appropriate metrics for the trading desk limits including,
at a minimum, ``Value-at-Risk'' except to the extent the ``Value-at-
Risk'' metric is demonstrably ineffective for measuring and
monitoring the risks of a trading desk based on the types of
positions traded by, and risk exposures of, that desk.
A. A banking entity must provide the following information for
each limit reported pursuant to this quantitative measurement: The
unique identification label for the limit reported in the Internal
Limits Information Schedule, the limit size (distinguishing between
an upper and a lower limit), and the value of usage of the limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
[[Page 62212]]
iv. Applicability: All trading desks engaged in covered trading
activities.
2. Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the measurement of the risk of future financial loss in
the value of a trading desk's aggregated positions at the ninety-
nine percent confidence level over a one-day period, based on
current market conditions.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into two categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); and (ii) profit and loss attributable to
new positions resulting from the current day's trading activity
(``new positions'').
A. The comprehensive profit and loss associated with existing
positions must reflect changes in the value of these positions on
the applicable day. The comprehensive profit and loss from existing
positions must be further attributed, as applicable, to (i) changes
in the specific risk factors and other factors that are monitored
and managed as part of the trading desk's overall risk management
policies and procedures; and (ii) any other applicable elements,
such as cash flows, carry, changes in reserves, and the correction,
cancellation, or exercise of a trade.
B. For the attribution of comprehensive profit and loss from
existing positions to specific risk factors and other factors, a
banking entity must provide the following information for the
factors that explain the preponderance of the profit or loss changes
due to risk factor changes: The unique identification label for the
risk factor or other factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss due to the risk factor
or other factor change.
C. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and loss from existing
positions that is not attributed to changes in specific risk factors
and other factors must be allocated to a residual category.
Significant unexplained profit and loss must be escalated for
further investigation and analysis.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
c. Positions and Transaction Volumes Measurements
1. Positions
i. Description: For purposes of this appendix, Positions is the
value of securities and derivatives positions managed by the trading
desk. For purposes of the Positions quantitative measurement, do not
include in the Positions calculation for ``securities'' those
securities that are also ``derivatives,'' as those terms are defined
under subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \1227\ A banking entity must
separately report the trading desk's market value of long securities
positions, short securities positions, derivatives receivables, and
derivatives payables.
---------------------------------------------------------------------------
\1227\ See Sec. 75.2(h), (aa). For example, under this part, a
security-based swap is both a ``security'' and a ``derivative.'' For
purposes of the Positions quantitative measurement, security-based
swaps are reported as derivatives rather than securities.
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 75.4(a)
or (b) to conduct underwriting activity or market-making-related
activity, respectively.
2. Transaction Volumes
i. Description: For purposes of this appendix, Transaction
Volumes measures three exclusive categories of covered trading
activity conducted by a trading desk. A banking entity is required
to report the value and number of security and derivative
transactions conducted by the trading desk with: (i) Customers,
excluding internal transactions; (ii) non-customers, excluding
internal transactions; and (iii) trading desks and other
organizational units where the transaction is booked into either the
same banking entity or an affiliated banking entity. For securities,
value means gross market value. For derivatives, value means gross
notional value. For purposes of calculating the Transaction Volumes
quantitative measurement, do not include in the Transaction Volumes
calculation for ``securities'' those securities that are also
``derivatives,'' as those terms are defined under subpart A;
instead, report those securities that are also derivatives as
``derivatives.'' \1228\ Further, for purposes of the Transaction
Volumes quantitative measurement, a customer of a trading desk that
relies on Sec. 75.4(a) to conduct underwriting activity is a market
participant identified in Sec. 75.4(a)(7), and a customer of a
trading desk that relies on Sec. 75.4(b) to conduct market making-
related activity is a market participant identified in Sec.
75.4(b)(3).
---------------------------------------------------------------------------
\1228\ See Sec. 75.2(h), (aa).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 75.4(a)
or (b) to conduct underwriting activity or market-making-related
activity, respectively.
Appendix B to Part 75 [Removed]
0
58. Appendix B to part 75 is removed.
0
59. Effective January 1, 2020, until December 31, 2020, appendix Z to
part 75 is added to read as follows:
Appendix Z to Part 75--Proprietary Trading and Certain Interests in and
Relationships with Covered Funds (Alternative Compliance)
Note: The content of this appendix reproduces the regulation
implementing Section 13 of the Bank Holding Company Act as of
November 13, 2019.
Subpart A--Authority and Definitions
Sec. 75.1 Authority, purpose, scope, and relationship to other
authorities.
(a) Authority. This part is issued by the Commission under section
13 of the Bank Holding Company Act of 1956, as amended (12 U.S.C.
1851).
(b) Purpose. Section 13 of the Bank Holding Company Act establishes
prohibitions and restrictions on proprietary trading by, and
investments in or relationships with covered funds by, certain banking
entities. This part implements section 13 of the Bank Holding Company
Act by defining terms used in the statute and related terms,
establishing prohibitions and restrictions on proprietary trading and
investments in or relationships with covered funds, and further
explaining the statute's requirements.
(c) Scope. This part implements section 13 of the Bank Holding
Company Act with respect to banking entities for which the CFTC is the
primary financial regulatory agency, as defined in section 2(12) of the
Dodd-Frank Act, but does not include such entities to the extent they
are not within the definition of banking entity in Sec. 75.2(c).
(d) Relationship to other authorities. Except as otherwise provided
under section 13 of the BHC Act, and notwithstanding any other
provision of law, the prohibitions and restrictions under section 13 of
the BHC Act shall apply to the activities of an applicable banking
entity, even if such activities are authorized for the applicable
banking entity under other applicable provisions of law.
Sec. 75.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Bank holding company has the same meaning as in section 2 of
the
[[Page 62213]]
Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(c) Banking entity. (1) Except as provided in paragraph (c)(2) of
this section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an insured depository institution;
(iii) Any company that is treated as a bank holding company for
purposes of section 8 of the International Banking Act of 1978 (12
U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any entity described in
paragraphs (c)(1)(i), (ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a banking entity under
paragraphs (c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraphs (c)(1)(i), (ii), or (iii) of
this section; or
(iii) The FDIC acting in its corporate capacity or as conservator
or receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(d) Board means the Board of Governors of the Federal Reserve
System.
(e) CFTC or Commission means the Commodity Futures Trading
Commission.
(f) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(g) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(h) Derivative. (1) Except as provided in paragraph (h)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, guidance, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the immediate family of the
employee.
(j) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(k) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(l) FDIC means the Federal Deposit Insurance Corporation.
(m) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(n) Foreign banking organization has the same meaning as in section
211.21(o) of the Board's Regulation K (12 CFR 211.21(o)), but does not
include a foreign bank, as defined in section 1(b)(7) of the
International Banking Act of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the Commonwealth of Puerto Rico, Guam,
American Samoa, the United States Virgin Islands, or the Commonwealth
of the Northern Mariana Islands.
(o) Foreign insurance regulator means the insurance commissioner,
or a similar official or agency, of any country other than the United
States that is engaged in the supervision of insurance companies under
foreign insurance law.
(p) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(q) Insurance company means a company that is organized as an
insurance company, primarily and predominantly engaged in writing
insurance or reinsuring risks underwritten by insurance companies,
subject to supervision as such by a state insurance regulator or a
foreign insurance regulator, and not operated for the purpose of
evading the provisions of section 13 of the BHC Act (12 U.S.C. 1851).
(r) Insured depository institution, unless otherwise indicated, has
the same meaning as in section 3(c) of the Federal Deposit Insurance
Act (12 U.S.C. 1813(c)), but does not include:
(1) An insured depository institution that is described in section
2(c)(2)(D) of the Bank Holding Company Act of 1956 (12 U.S.C.
1841(c)(2)(D)); or
(2) An insured depository institution if it has, and if every
company that controls it has, total consolidated assets of $10 billion
or less and total trading assets and trading liabilities, on a
consolidated basis, that are 5 percent or less of total consolidated
assets.
(s) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(t) Primary financial regulatory agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 5301(12)).
(u) Purchase includes any contract to buy, purchase, or otherwise
acquire. For security futures products, purchase includes any contract,
agreement, or transaction for future delivery. With respect to a
commodity future, purchase includes any contract, agreement, or
transaction for future delivery. With respect to a derivative, purchase
includes the execution, termination (prior to its scheduled maturity
date), assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a derivative, as the
context may require.
(v) Qualifying foreign banking organization means a foreign banking
organization that qualifies as such under Sec. 211.23(a), (c) or (e)
of the Board's Regulation K (12 CFR 211.23(a), (c), or (e)).
(w) SEC means the Securities and Exchange Commission.
(x) Sale and sell each include any contract to sell or otherwise
dispose of. For security futures products, such terms include any
contract, agreement, or transaction for future delivery. With respect
to a commodity future, such terms include any contract, agreement, or
transaction for future delivery. With
[[Page 62214]]
respect to a derivative, such terms include the execution, termination
(prior to its scheduled maturity date), assignment, exchange, or
similar transfer or conveyance of, or extinguishing of rights or
obligations under, a derivative, as the context may require.
(y) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(z) Security-based swap dealer has the same meaning as in section
3(a)(71) of the Exchange Act (15 U.S.C. 78c(a)(71)).
(aa) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(bb) Separate account means an account established and maintained
by an insurance company in connection with one or more insurance
contracts to hold assets that are legally segregated from the insurance
company's other assets, under which income, gains, and losses, whether
or not realized, from assets allocated to such account, are, in
accordance with the applicable contract, credited to or charged against
such account without regard to other income, gains, or losses of the
insurance company.
(cc) State means any State, the District of Columbia, the
Commonwealth of Puerto Rico, Guam, American Samoa, the United States
Virgin Islands, and the Commonwealth of the Northern Mariana Islands.
(dd) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(ee) State insurance regulator means the insurance commissioner, or
a similar official or agency, of a State that is engaged in the
supervision of insurance companies under State insurance law.
(ff) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
Subpart B--Proprietary Trading
Sec. 75.3 Prohibition on proprietary trading.
(a) Prohibition. Except as otherwise provided in this subpart, a
banking entity may not engage in proprietary trading. Proprietary
trading means engaging as principal for the trading account of the
banking entity in any purchase or sale of one or more financial
instruments.
(b) Definition of trading account. (1) Trading account means any
account that is used by a banking entity to:
(i) Purchase or sell one or more financial instruments principally
for the purpose of:
(A) Short-term resale;
(B) Benefitting from actual or expected short-term price movements;
(C) Realizing short-term arbitrage profits; or
(D) Hedging one or more positions resulting from the purchases or
sales of financial instruments described in paragraphs (b)(1)(i)(A),
(B), or (C) of this section;
(ii) Purchase or sell one or more financial instruments that are
both market risk capital rule covered positions and trading positions
(or hedges of other market risk capital rule covered positions), if the
banking entity, or any affiliate of the banking entity, is an insured
depository institution, bank holding company, or savings and loan
holding company, and calculates risk-based capital ratios under the
market risk capital rule; or
(iii) Purchase or sell one or more financial instruments for any
purpose, if the banking entity:
(A) Is licensed or registered, or is required to be licensed or
registered, to engage in the business of a dealer, swap dealer, or
security-based swap dealer, to the extent the instrument is purchased
or sold in connection with the activities that require the banking
entity to be licensed or registered as such; or
(B) Is engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
the instrument is purchased or sold in connection with the activities
of such business.
(2) Rebuttable presumption for certain purchases and sales. The
purchase (or sale) of a financial instrument by a banking entity shall
be presumed to be for the trading account of the banking entity under
paragraph (b)(1)(i) of this section if the banking entity holds the
financial instrument for fewer than sixty days or substantially
transfers the risk of the financial instrument within sixty days of the
purchase (or sale), unless the banking entity can demonstrate, based on
all relevant facts and circumstances, that the banking entity did not
purchase (or sell) the financial instrument principally for any of the
purposes described in paragraph (b)(1)(i) of this section.
(c) Financial instrument--(1) Financial instrument means:
(i) A security, including an option on a security;
(ii) A derivative, including an option on a derivative; or
(iii) A contract of sale of a commodity for future delivery, or
option on a contract of sale of a commodity for future delivery.
(2) A financial instrument does not include:
(i) A loan;
(ii) A commodity that is not:
(A) An excluded commodity (other than foreign exchange or
currency);
(B) A derivative;
(C) A contract of sale of a commodity for future delivery; or
(D) An option on a contract of sale of a commodity for future
delivery; or
(iii) Foreign exchange or currency.
(d) Proprietary trading does not include:--(1) Any purchase or sale
of one or more financial instruments by a banking entity that arises
under a repurchase or reverse repurchase agreement pursuant to which
the banking entity has simultaneously agreed, in writing, to both
purchase and sell a stated asset, at stated prices, and on stated dates
or on demand with the same counterparty;
(2) Any purchase or sale of one or more financial instruments by a
banking entity that arises under a transaction in which the banking
entity lends or borrows a security temporarily to or from another party
pursuant to a written securities lending agreement under which the
lender retains the economic interests of an owner of such security, and
has the right to terminate the transaction and to recall the loaned
security on terms agreed by the parties;
(3) Any purchase or sale of a security by a banking entity for the
purpose of liquidity management in accordance with a documented
liquidity management plan of the banking entity that:
(i) Specifically contemplates and authorizes the particular
securities to be used for liquidity management purposes, the amount,
types, and risks of these securities that are consistent with liquidity
management, and the liquidity circumstances in which the particular
securities may or must be used;
(ii) Requires that any purchase or sale of securities contemplated
and authorized by the plan be principally for the purpose of managing
the liquidity of the banking entity, and not for the purpose of short-
term resale, benefitting from actual or expected short-term price
movements, realizing short-term arbitrage profits, or hedging a
position taken for such short-term purposes;
(iii) Requires that any securities purchased or sold for liquidity
management purposes be highly liquid and limited to securities the
market, credit, and other risks of which the banking entity does not
reasonably expect to give rise to appreciable profits or losses as a
result of short-term price movements;
(iv) Limits any securities purchased or sold for liquidity
management purposes, together with any other instruments
[[Page 62215]]
purchased or sold for such purposes, to an amount that is consistent
with the banking entity's near-term funding needs, including deviations
from normal operations of the banking entity or any affiliate thereof,
as estimated and documented pursuant to methods specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of securities that are not permitted under Sec. 75.6(a) or (b) are for
the purpose of liquidity management and in accordance with the
liquidity management plan described in paragraph (d)(3) of this
section; and
(vi) Is consistent with the Commission's supervisory requirements,
guidance, and expectations regarding liquidity management;
(4) Any purchase or sale of one or more financial instruments by a
banking entity that is a derivatives clearing organization or a
clearing agency in connection with clearing financial instruments;
(5) Any excluded clearing activities by a banking entity that is a
member of a clearing agency, a member of a derivatives clearing
organization, or a member of a designated financial market utility;
(6) Any purchase or sale of one or more financial instruments by a
banking entity, so long as:
(i) The purchase (or sale) satisfies an existing delivery
obligation of the banking entity or its customers, including to prevent
or close out a failure to deliver, in connection with delivery,
clearing, or settlement activity; or
(ii) The purchase (or sale) satisfies an obligation of the banking
entity in connection with a judicial, administrative, self-regulatory
organization, or arbitration proceeding;
(7) Any purchase or sale of one or more financial instruments by a
banking entity that is acting solely as agent, broker, or custodian;
(8) Any purchase or sale of one or more financial instruments by a
banking entity through a deferred compensation, stock-bonus, profit-
sharing, or pension plan of the banking entity that is established and
administered in accordance with the law of the United States or a
foreign sovereign, if the purchase or sale is made directly or
indirectly by the banking entity as trustee for the benefit of persons
who are or were employees of the banking entity; or
(9) Any purchase or sale of one or more financial instruments by a
banking entity in the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
financial instrument as soon as practicable, and in no event may the
banking entity retain such instrument for longer than such period
permitted by the Commission.
(e) Definition of other terms related to proprietary trading. For
purposes of this subpart:
(1) Anonymous means that each party to a purchase or sale is
unaware of the identity of the other party(ies) to the purchase or
sale.
(2) Clearing agency has the same meaning as in section 3(a)(23) of
the Exchange Act (15 U.S.C. 78c(a)(23)).
(3) Commodity has the same meaning as in section 1a(9) of the
Commodity Exchange Act (7 U.S.C. 1a(9)), except that a commodity does
not include any security;
(4) Contract of sale of a commodity for future delivery means a
contract of sale (as that term is defined in section 1a(13) of the
Commodity Exchange Act (7 U.S.C. 1a(13)) for future delivery (as that
term is defined in section 1a(27) of the Commodity Exchange Act (7
U.S.C. 1a(27))).
(5) Derivatives clearing organization means:
(i) A derivatives clearing organization registered under section 5b
of the Commodity Exchange Act (7 U.S.C. 7a-1);
(ii) A derivatives clearing organization that, pursuant to CFTC
regulation, is exempt from the registration requirements under section
5b of the Commodity Exchange Act (7 U.S.C. 7a-1); or
(iii) A foreign derivatives clearing organization that, pursuant to
CFTC regulation, is permitted to clear for a foreign board of trade
that is registered with the CFTC.
(6) Exchange, unless the context otherwise requires, means any
designated contract market, swap execution facility, or foreign board
of trade registered with the CFTC, or, for purposes of securities or
security-based swaps, an exchange, as defined under section 3(a)(1) of
the Exchange Act (15 U.S.C. 78c(a)(1)), or security-based swap
execution facility, as defined under section 3(a)(77) of the Exchange
Act (15 U.S.C. 78c(a)(77)).
(7) Excluded clearing activities means:
(i) With respect to customer transactions cleared on a derivatives
clearing organization, a clearing agency, or a designated financial
market utility, any purchase or sale necessary to correct trading
errors made by or on behalf of a customer provided that such purchase
or sale is conducted in accordance with, for transactions cleared on a
derivatives clearing organization, the Commodity Exchange Act, CFTC
regulations, and the rules or procedures of the derivatives clearing
organization, or, for transactions cleared on a clearing agency, the
rules or procedures of the clearing agency, or, for transactions
cleared on a designated financial market utility that is neither a
derivatives clearing organization nor a clearing agency, the rules or
procedures of the designated financial market utility;
(ii) Any purchase or sale in connection with and related to the
management of a default or threatened imminent default of a customer
provided that such purchase or sale is conducted in accordance with,
for transactions cleared on a derivatives clearing organization, the
Commodity Exchange Act, CFTC regulations, and the rules or procedures
of the derivatives clearing organization, or, for transactions cleared
on a clearing agency, the rules or procedures of the clearing agency,
or, for transactions cleared on a designated financial market utility
that is neither a derivatives clearing organization nor a clearing
agency, the rules or procedures of the designated financial market
utility;
(iii) Any purchase or sale in connection with and related to the
management of a default or threatened imminent default of a member of a
clearing agency, a member of a derivatives clearing organization, or a
member of a designated financial market utility;
(iv) Any purchase or sale in connection with and related to the
management of the default or threatened default of a clearing agency, a
derivatives clearing organization, or a designated financial market
utility; and
(v) Any purchase or sale that is required by the rules or
procedures of a clearing agency, a derivatives clearing organization,
or a designated financial market utility to mitigate the risk to the
clearing agency, derivatives clearing organization, or designated
financial market utility that would result from the clearing by a
member of security-based swaps that reference the member or an
affiliate of the member.
(8) Designated financial market utility has the same meaning as in
section 803(4) of the Dodd-Frank Act (12 U.S.C. 5462(4)).
(9) Issuer has the same meaning as in section 2(a)(4) of the
Securities Act of 1933 (15 U.S.C. 77b(a)(4)).
(10) Market risk capital rule covered position and trading position
means a financial instrument that is both a covered position and a
trading position, as those terms are respectively defined:
[[Page 62216]]
(i) In the case of a banking entity that is a bank holding company,
savings and loan holding company, or insured depository institution,
under the market risk capital rule that is applicable to the banking
entity; and
(ii) In the case of a banking entity that is affiliated with a bank
holding company or savings and loan holding company, other than a
banking entity to which a market risk capital rule is applicable, under
the market risk capital rule that is applicable to the affiliated bank
holding company or savings and loan holding company.
(11) Market risk capital rule means the market risk capital rule
that is contained in subpart F of 12 CFR part 3, 12 CFR parts 208 and
225, or 12 CFR part 324, as applicable.
(12) Municipal security means a security that is a direct
obligation of or issued by, or an obligation guaranteed as to principal
or interest by, a State or any political subdivision thereof, or any
agency or instrumentality of a State or any political subdivision
thereof, or any municipal corporate instrumentality of one or more
States or political subdivisions thereof.
(13) Trading desk means the smallest discrete unit of organization
of a banking entity that purchases or sells financial instruments for
the trading account of the banking entity or an affiliate thereof.
Sec. 75.4 Permitted underwriting and market making-related
activities.
(a) Underwriting activities--(1) Permitted underwriting activities.
The prohibition contained in Sec. 75.3(a) does not apply to a banking
entity's underwriting activities conducted in accordance with paragraph
(a) of this section.
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
and reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity, maturity, and depth of the market for the relevant type
of security;
(iii) The banking entity has established and implements, maintains,
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of paragraph (a) of this section,
including reasonably designed written policies and procedures, internal
controls, analysis and independent testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, based on the nature and amount of
the trading desk's underwriting activities, including the reasonably
expected near term demands of clients, customers, or counterparties, on
the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held;
(C) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(D) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis of the basis for any temporary
or permanent increase to a trading desk's limit(s), and independent
review of such demonstrable analysis and approval;
(iv) The compensation arrangements of persons performing the
activities described in paragraph (a) of this section are designed not
to reward or incentivize prohibited proprietary trading; and
(v) The banking entity is licensed or registered to engage in the
activity described in paragraph (a) of this section in accordance with
applicable law.
(3) Definition of distribution. For purposes of paragraph (a) of
this section, a distribution of securities means:
(i) An offering of securities, whether or not subject to
registration under the Securities Act of 1933, that is distinguished
from ordinary trading transactions by the presence of special selling
efforts and selling methods; or
(ii) An offering of securities made pursuant to an effective
registration statement under the Securities Act of 1933.
(4) Definition of underwriter. For purposes of paragraph (a) of
this section, underwriter means:
(i) A person who has agreed with an issuer or selling security
holder to:
(A) Purchase securities from the issuer or selling security holder
for distribution;
(B) Engage in a distribution of securities for or on behalf of the
issuer or selling security holder; or
(C) Manage a distribution of securities for or on behalf of the
issuer or selling security holder; or
(ii) A person who has agreed to participate or is participating in
a distribution of such securities for or on behalf of the issuer or
selling security holder.
(5) Definition of selling security holder. For purposes of
paragraph (a) of this section, selling security holder means any
person, other than an issuer, on whose behalf a distribution is made.
(6) Definition of underwriting position. For purposes of paragraph
(a) of this section, underwriting position means the long or short
positions in one or more securities held by a banking entity or its
affiliate, and managed by a particular trading desk, in connection with
a particular distribution of securities for which such banking entity
or affiliate is acting as an underwriter.
(7) Definition of client, customer, and counterparty. For purposes
of paragraph (a) of this section, the terms client, customer, and
counterparty, on a collective or individual basis, refer to market
participants that may transact with the banking entity in connection
with a particular distribution for which the banking entity is acting
as underwriter.
(b) Market making-related activities--(1) Permitted market making-
related activities. The prohibition contained in Sec. 75.3(a) does not
apply to a banking entity's market making-related activities conducted
in accordance with paragraph (b) of this section.
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The amount, types, and risks of the financial instruments in
the trading desk's market-maker inventory are designed not to exceed,
on an ongoing
[[Page 62217]]
basis, the reasonably expected near term demands of clients, customers,
or counterparties, based on:
(A) The liquidity, maturity, and depth of the market for the
relevant types of financial instrument(s); and
(B) Demonstrable analysis of historical customer demand, current
inventory of financial instruments, and market and other factors
regarding the amount, types, and risks, of or associated with financial
instruments in which the trading desk makes a market, including through
block trades;
(iii) The banking entity has established and implements, maintains,
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of paragraph (b) of this section,
including reasonably designed written policies and procedures, internal
controls, analysis and independent testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and inventory; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, based on the nature and amount of
the trading desk's market making-related activities, that address the
factors prescribed by paragraph (b)(2)(ii) of this section, on:
(1) The amount, types, and risks of its market-maker inventory;
(2) The amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) The level of exposures to relevant risk factors arising from
its financial exposure; and
(4) The period of time a financial instrument may be held;
(D) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(E) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis that the basis for any temporary
or permanent increase to a trading desk's limit(s) is consistent with
the requirements of paragraph (b) of this section, and independent
review of such demonstrable analysis and approval;
(iv) To the extent that any limit identified pursuant to paragraph
(b)(2)(iii)(C) of this section is exceeded, the trading desk takes
action to bring the trading desk into compliance with the limits as
promptly as possible after the limit is exceeded;
(v) The compensation arrangements of persons performing the
activities described in paragraph (b) of this section are designed not
to reward or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in
activity described in paragraph (b) of this section in accordance with
applicable law.
(3) Definition of client, customer, and counterparty. For purposes
of paragraph (b) of this section, the terms client, customer, and
counterparty, on a collective or individual basis refer to market
participants that make use of the banking entity's market making-
related services by obtaining such services, responding to quotations,
or entering into a continuing relationship with respect to such
services, provided that:
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with Sec. 75.20(d)(1), unless:
(A) The trading desk documents how and why a particular trading
desk or other organizational unit of the entity should be treated as a
client, customer, or counterparty of the trading desk for purposes of
paragraph (b)(2) of this section; or
(B) The purchase or sale by the trading desk is conducted
anonymously on an exchange or similar trading facility that permits
trading on behalf of a broad range of market participants.
(ii) [Reserved]
(4) Definition of financial exposure. For purposes of paragraph (b)
of this section, financial exposure means the aggregate risks of one or
more financial instruments and any associated loans, commodities, or
foreign exchange or currency, held by a banking entity or its affiliate
and managed by a particular trading desk as part of the trading desk's
market making-related activities.
(5) Definition of market-maker inventory. For the purposes of
paragraph (b) of this section, market-maker inventory means all of the
positions in the financial instruments for which the trading desk
stands ready to make a market in accordance with paragraph (b)(2)(i) of
this section that are managed by the trading desk, including the
trading desk's open positions or exposures arising from open
transactions.
Sec. 75.5 Permitted risk-mitigating hedging activities.
(a) Permitted risk-mitigating hedging activities. The prohibition
contained in Sec. 75.3(a) does not apply to the risk-mitigating
hedging activities of a banking entity in connection with and related
to individual or aggregated positions, contracts, or other holdings of
the banking entity and designed to reduce the specific risks to the
banking entity in connection with and related to such positions,
contracts, or other holdings.
(b) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under paragraph (a) of this section only
if:
(1) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(i) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(ii) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(iii) The conduct of analysis, including correlation analysis, and
independent testing designed to ensure that the positions, techniques
and strategies that may be used for hedging may reasonably be expected
to demonstrably reduce or otherwise significantly mitigate the
specific, identifiable risk(s) being hedged, and such correlation
analysis demonstrates that the hedging activity demonstrably reduces or
otherwise significantly mitigates the specific, identifiable risk(s)
being hedged;
(2) The risk-mitigating hedging activity:
[[Page 62218]]
(i) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(ii) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate and demonstrably reduces or
otherwise significantly mitigates one or more specific, identifiable
risks, including market risk, counterparty or other credit risk,
currency or foreign exchange risk, interest rate risk, commodity price
risk, basis risk, or similar risks, arising in connection with and
related to identified positions, contracts, or other holdings of the
banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(iii) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(iv) Is subject to continuing review, monitoring and management by
the banking entity that:
(A) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1) of this section;
(B) Is designed to reduce or otherwise significantly mitigate and
demonstrably reduces or otherwise significantly mitigates the specific,
identifiable risks that develop over time from the risk-mitigating
hedging activities undertaken under this section and the underlying
positions, contracts, and other holdings of the banking entity, based
upon the facts and circumstances of the underlying and hedging
positions, contracts and other holdings of the banking entity and the
risks and liquidity thereof; and
(C) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading; and
(3) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(c) Documentation requirement. (1) A banking entity must comply
with the requirements of paragraphs (c)(2) and (c)(3) of this section
with respect to any purchase or sale of financial instruments made in
reliance on this section for risk-mitigating hedging purposes that is:
(i) Not established by the specific trading desk establishing or
responsible for the underlying positions, contracts, or other holdings
the risks of which the hedging activity is designed to reduce;
(ii) Established by the specific trading desk establishing or
responsible for the underlying positions, contracts, or other holdings
the risks of which the purchases or sales are designed to reduce, but
that is effected through a financial instrument, exposure, technique,
or strategy that is not specifically identified in the trading desk's
written policies and procedures established under paragraph (b)(1) of
this section or under Sec. 75.4(b)(2)(iii)(B) as a product,
instrument, exposure, technique, or strategy such trading desk may use
for hedging; or
(iii) Established to hedge aggregated positions across two or more
trading desks.
(2) In connection with any purchase or sale identified in paragraph
(c)(1) of this section, a banking entity must, at a minimum, and
contemporaneously with the purchase or sale, document:
(i) The specific, identifiable risk(s) of the identified positions,
contracts, or other holdings of the banking entity that the purchase or
sale is designed to reduce;
(ii) The specific risk-mitigating strategy that the purchase or
sale is designed to fulfill; and
(iii) The trading desk or other business unit that is establishing
and responsible for the hedge.
(3) A banking entity must create and retain records sufficient to
demonstrate compliance with the requirements of paragraph (c) of this
section for a period that is no less than five years in a form that
allows the banking entity to promptly produce such records to the
Commission on request, or such longer period as required under other
law or this part.
Sec. 75.6 Other permitted proprietary trading activities.
(a) Permitted trading in domestic government obligations. The
prohibition contained in Sec. 75.3(a) does not apply to the purchase
or sale by a banking entity of a financial instrument that is:
(1) An obligation of, or issued or guaranteed by, the United
States;
(2) An obligation, participation, or other instrument of, or issued
or guaranteed by, an agency of the United States, the Government
National Mortgage Association, the Federal National Mortgage
Association, the Federal Home Loan Mortgage Corporation, a Federal Home
Loan Bank, the Federal Agricultural Mortgage Corporation or a Farm
Credit System institution chartered under and subject to the provisions
of the Farm Credit Act of 1971 (12 U.S.C. 2001 et seq.);
(3) An obligation of any State or any political subdivision
thereof, including any municipal security; or
(4) An obligation of the FDIC, or any entity formed by or on behalf
of the FDIC for purpose of facilitating the disposal of assets acquired
or held by the FDIC in its corporate capacity or as conservator or
receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(b) Permitted trading in foreign government obligations--(1)
Affiliates of foreign banking entities in the United States. The
prohibition contained in Sec. 75.3(a) does not apply to the purchase
or sale of a financial instrument that is an obligation of, or issued
or guaranteed by, a foreign sovereign (including any multinational
central bank of which the foreign sovereign is a member), or any agency
or political subdivision of such foreign sovereign, by a banking
entity, so long as:
(i) The banking entity is organized under or is directly or
indirectly controlled by a banking entity that is organized under the
laws of a foreign sovereign and is not directly or indirectly
controlled by a top-tier banking entity that is organized under the
laws of the United States;
(ii) The financial instrument is an obligation of, or issued or
guaranteed by, the foreign sovereign under the laws of which the
foreign banking entity referred to in paragraph (b)(1)(i) of this
section is organized (including any multinational central bank of which
the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign; and
(iii) The purchase or sale as principal is not made by an insured
depository institution.
(2) Foreign affiliates of a U.S. banking entity. The prohibition
contained in Sec. 75.3(a) does not apply to the purchase or sale of a
financial instrument that is an obligation of, or issued or guaranteed
by, a foreign sovereign (including any multinational central bank of
which the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign, by a foreign entity that is
owned or controlled by a banking entity organized or established under
the laws of the United States or any State, so long as:
(i) The foreign entity is a foreign bank, as defined in Sec.
211.2(j) of the Board's Regulation K (12 CFR 211.2(j)), or is regulated
by the foreign sovereign as a securities dealer;
[[Page 62219]]
(ii) The financial instrument is an obligation of, or issued or
guaranteed by, the foreign sovereign under the laws of which the
foreign entity is organized (including any multinational central bank
of which the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign; and
(iii) The financial instrument is owned by the foreign entity and
is not financed by an affiliate that is located in the United States or
organized under the laws of the United States or of any State.
(c) Permitted trading on behalf of customers--(1) Fiduciary
transactions. The prohibition contained in Sec. 75.3(a) does not apply
to the purchase or sale of financial instruments by a banking entity
acting as trustee or in a similar fiduciary capacity, so long as:
(i) The transaction is conducted for the account of, or on behalf
of, a customer; and
(ii) The banking entity does not have or retain beneficial
ownership of the financial instruments.
(2) Riskless principal transactions. The prohibition contained in
Sec. 75.3(a) does not apply to the purchase or sale of financial
instruments by a banking entity acting as riskless principal in a
transaction in which the banking entity, after receiving an order to
purchase (or sell) a financial instrument from a customer, purchases
(or sells) the financial instrument for its own account to offset a
contemporaneous sale to (or purchase from) the customer.
(d) Permitted trading by a regulated insurance company. The
prohibition contained in Sec. 75.3(a) does not apply to the purchase
or sale of financial instruments by a banking entity that is an
insurance company or an affiliate of an insurance company if:
(1) The insurance company or its affiliate purchases or sells the
financial instruments solely for:
(i) The general account of the insurance company; or
(ii) A separate account established by the insurance company;
(2) The purchase or sale is conducted in compliance with, and
subject to, the insurance company investment laws, regulations, and
written guidance of the State or jurisdiction in which such insurance
company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law, regulation, or written guidance described in
paragraph (d)(2) of this section is insufficient to protect the safety
and soundness of the covered banking entity, or the financial stability
of the United States.
(e) Permitted trading activities of foreign banking entities. (1)
The prohibition contained in Sec. 75.3(a) does not apply to the
purchase or sale of financial instruments by a banking entity if:
(i) The banking entity is not organized or directly or indirectly
controlled by a banking entity that is organized under the laws of the
United States or of any State;
(ii) The purchase or sale by the banking entity is made pursuant to
paragraph (9) or (13) of section 4(c) of the BHC Act; and
(iii) The purchase or sale meets the requirements of paragraph
(e)(3) of this section.
(2) A purchase or sale of financial instruments by a banking entity
is made pursuant to paragraph (9) or (13) of section 4(c) of the BHC
Act for purposes of paragraph (e)(1)(ii) of this section only if:
(i) The purchase or sale is conducted in accordance with the
requirements of paragraph (e) of this section; and
(ii)(A) With respect to a banking entity that is a foreign banking
organization, the banking entity meets the qualifying foreign banking
organization requirements of Sec. 211.23(a), (c) or (e) of the Board's
Regulation K (12 CFR 211.23(a), (c) or (e)), as applicable; or
(B) With respect to a banking entity that is not a foreign banking
organization, the banking entity is not organized under the laws of the
United States or of any State and the banking entity, on a fully-
consolidated basis, meets at least two of the following requirements:
(1) Total assets of the banking entity held outside of the United
States exceed total assets of the banking entity held in the United
States;
(2) Total revenues derived from the business of the banking entity
outside of the United States exceed total revenues derived from the
business of the banking entity in the United States; or
(3) Total net income derived from the business of the banking
entity outside of the United States exceeds total net income derived
from the business of the banking entity in the United States.
(3) A purchase or sale by a banking entity is permitted for
purposes of paragraph (e) of this section only if:
(i) The banking entity engaging as principal in the purchase or
sale (including any personnel of the banking entity or its affiliate
that arrange, negotiate or execute such purchase or sale) is not
located in the United States or organized under the laws of the United
States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State;
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State;
(iv) No financing for the banking entity's purchases or sales is
provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State; and
(v) The purchase or sale is not conducted with or through any U.S.
entity, other than:
(A) A purchase or sale with the foreign operations of a U.S. entity
if no personnel of such U.S. entity that are located in the United
States are involved in the arrangement, negotiation, or execution of
such purchase or sale;
(B) A purchase or sale with an unaffiliated market intermediary
acting as principal, provided the purchase or sale is promptly cleared
and settled through a clearing agency or derivatives clearing
organization acting as a central counterparty; or
(C) A purchase or sale through an unaffiliated market intermediary
acting as agent, provided the purchase or sale is conducted anonymously
on an exchange or similar trading facility and is promptly cleared and
settled through a clearing agency or derivatives clearing organization
acting as a central counterparty,
(4) For purposes of paragraph (e) of this section, a U.S. entity is
any entity that is, or is controlled by, or is acting on behalf of, or
at the direction of, any other entity that is, located in the United
States or organized under the laws of the United States or of any
State.
(5) For purposes of paragraph (e) of this section, a U.S. branch,
agency, or subsidiary of a foreign banking entity is considered to be
located in the United States; however, the foreign bank that operates
or controls that branch, agency, or subsidiary is not considered to be
located in the United States solely by virtue of operating or
controlling the U.S. branch, agency, or subsidiary.
(6) For purposes of paragraph (e) of this section, unaffiliated
market
[[Page 62220]]
intermediary means an unaffiliated entity, acting as an intermediary,
that is:
(i) A broker or dealer registered with the SEC under section 15 of
the Exchange Act or exempt from registration or excluded from
regulation as such;
(ii) A swap dealer registered with the CFTC under section 4s of the
Commodity Exchange Act or exempt from registration or excluded from
regulation as such;
(iii) A security-based swap dealer registered with the SEC under
section 15F of the Exchange Act or exempt from registration or excluded
from regulation as such; or
(iv) A futures commission merchant registered with the CFTC under
section 4f of the Commodity Exchange Act or exempt from registration or
excluded from regulation as such.
Sec. 75.7 Limitations on permitted proprietary trading activities.
(a) No transaction, class of transactions, or activity may be
deemed permissible under Sec. Sec. 75.4 through 75.6 if the
transaction, class of transactions, or activity would:
(1) Involve or result in a material conflict of interest between
the banking entity and its clients, customers, or counterparties;
(2) Result, directly or indirectly, in a material exposure by the
banking entity to a high-risk asset or a high-risk trading strategy; or
(3) Pose a threat to the safety and soundness of the banking entity
or to the financial stability of the United States.
(b) Definition of material conflict of interest. (1) For purposes
of this section, a material conflict of interest between a banking
entity and its clients, customers, or counterparties exists if the
banking entity engages in any transaction, class of transactions, or
activity that would involve or result in the banking entity's interests
being materially adverse to the interests of its client, customer, or
counterparty with respect to such transaction, class of transactions,
or activity, and the banking entity has not taken at least one of the
actions in paragraph (b)(2) of this section.
(2) Prior to effecting the specific transaction or class or type of
transactions, or engaging in the specific activity, the banking entity:
(i) Timely and effective disclosure. (A) Has made clear, timely,
and effective disclosure of the conflict of interest, together with
other necessary information, in reasonable detail and in a manner
sufficient to permit a reasonable client, customer, or counterparty to
meaningfully understand the conflict of interest; and
(B) Such disclosure is made in a manner that provides the client,
customer, or counterparty the opportunity to negate, or substantially
mitigate, any materially adverse effect on the client, customer, or
counterparty created by the conflict of interest; or
(ii) Information barriers. Has established, maintained, and
enforced information barriers that are memorialized in written policies
and procedures, such as physical separation of personnel, or functions,
or limitations on types of activity, that are reasonably designed,
taking into consideration the nature of the banking entity's business,
to prevent the conflict of interest from involving or resulting in a
materially adverse effect on a client, customer, or counterparty. A
banking entity may not rely on such information barriers if, in the
case of any specific transaction, class or type of transactions or
activity, the banking entity knows or should reasonably know that,
notwithstanding the banking entity's establishment of information
barriers, the conflict of interest may involve or result in a
materially adverse effect on a client, customer, or counterparty.
(c) Definition of high-risk asset and high-risk trading strategy.
For purposes of this section:
(1) High-risk asset means an asset or group of related assets that
would, if held by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
(2) High-risk trading strategy means a trading strategy that would,
if engaged in by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
Sec. Sec. 75.8-75.9 [Reserved]
Subpart C--Covered Fund Activities and Investments
Sec. 75.10 Prohibition on acquiring or retaining an ownership
interest in and having certain relationships with a covered fund.
(a) Prohibition. (1) Except as otherwise provided in this subpart,
a banking entity may not, as principal, directly or indirectly, acquire
or retain any ownership interest in or sponsor a covered fund.
(2) Paragraph (a)(1) of this section does not include acquiring or
retaining an ownership interest in a covered fund by a banking entity:
(i) Acting solely as agent, broker, or custodian, so long as;
(A) The activity is conducted for the account of, or on behalf of,
a customer; and
(B) The banking entity and its affiliates do not have or retain
beneficial ownership of such ownership interest;
(ii) Through a deferred compensation, stock-bonus, profit-sharing,
or pension plan of the banking entity (or an affiliate thereof) that is
established and administered in accordance with the law of the United
States or a foreign sovereign, if the ownership interest is held or
controlled directly or indirectly by the banking entity as trustee for
the benefit of persons who are or were employees of the banking entity
(or an affiliate thereof);
(iii) In the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
ownership interest as soon as practicable, and in no event may the
banking entity retain such ownership interest for longer than such
period permitted by the Commission; or
(iv) On behalf of customers as trustee or in a similar fiduciary
capacity for a customer that is not a covered fund, so long as:
(A) The activity is conducted for the account of, or on behalf of,
the customer; and
(B) The banking entity and its affiliates do not have or retain
beneficial ownership of such ownership interest.
(b) Definition of covered fund. (1) Except as provided in paragraph
(c) of this section, covered fund means:
(i) An issuer that would be an investment company, as defined in
the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.), but for
section 3(c)(1) or 3(c)(7) of that Act (15 U.S.C. 80a-3(c)(1) or (7));
(ii) Any commodity pool under section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10)) for which:
(A) The commodity pool operator has claimed an exemption under
Sec. 4.7 of this chapter; or
(B)(1) A commodity pool operator is registered with the CFTC as a
commodity pool operator in connection with the operation of the
commodity pool;
(2) Substantially all participation units of the commodity pool are
owned by qualified eligible persons under Sec. 4.7(a)(2) and (3) of
this chapter; and
(3) Participation units of the commodity pool have not been
publicly offered to persons who are not qualified
[[Page 62221]]
eligible persons under Sec. 4.7(a)(2) and (3) of this chapter; or
(iii) For any banking entity that is, or is controlled directly or
indirectly by a banking entity that is, located in or organized under
the laws of the United States or of any State, an entity that:
(A) Is organized or established outside the United States and the
ownership interests of which are offered and sold solely outside the
United States;
(B) Is, or holds itself out as being, an entity or arrangement that
raises money from investors primarily for the purpose of investing in
securities for resale or other disposition or otherwise trading in
securities; and
(C)(1) Has as its sponsor that banking entity (or an affiliate
thereof); or
(2) Has issued an ownership interest that is owned directly or
indirectly by that banking entity (or an affiliate thereof).
(2) An issuer shall not be deemed to be a covered fund under
paragraph (b)(1)(iii) of this section if, were the issuer subject to
U.S. securities laws, the issuer could rely on an exclusion or
exemption from the definition of ``investment company'' under the
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) other than the
exclusions contained in section 3(c)(1) and 3(c)(7) of that Act.
(3) For purposes of paragraph (b)(1)(iii) of this section, a U.S.
branch, agency, or subsidiary of a foreign banking entity is located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(c) Notwithstanding paragraph (b) of this section, unless the
appropriate Federal banking agencies, the SEC, and the CFTC jointly
determine otherwise, a covered fund does not include:
(1) Foreign public funds. (i) Subject to paragraphs (c)(1)(ii) and
(iii) of this section, an issuer that:
(A) Is organized or established outside of the United States;
(B) Is authorized to offer and sell ownership interests to retail
investors in the issuer's home jurisdiction; and
(C) Sells ownership interests predominantly through one or more
public offerings outside of the United States.
(ii) With respect to a banking entity that is, or is controlled
directly or indirectly by a banking entity that is, located in or
organized under the laws of the United States or of any State and any
issuer for which such banking entity acts as sponsor, the sponsoring
banking entity may not rely on the exemption in paragraph (c)(1)(i) of
this section for such issuer unless ownership interests in the issuer
are sold predominantly to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring banking entity or such issuer;
and
(D) Directors and employees of such entities.
(iii) For purposes of paragraph (c)(1)(i)(C) of this section, the
term public offering means a distribution (as defined in Sec.
75.4(a)(3)) of securities in any jurisdiction outside the United States
to investors, including retail investors, provided that:
(A) The distribution complies with all applicable requirements in
the jurisdiction in which such distribution is being made;
(B) The distribution does not restrict availability to investors
having a minimum level of net worth or net investment assets; and
(C) The issuer has filed or submitted, with the appropriate
regulatory authority in such jurisdiction, offering disclosure
documents that are publicly available.
(2) Wholly-owned subsidiaries. An entity, all of the outstanding
ownership interests of which are owned directly or indirectly by the
banking entity (or an affiliate thereof), except that:
(i) Up to five percent of the entity's outstanding ownership
interests, less any amounts outstanding under paragraph (c)(2)(ii) of
this section, may be held by employees or directors of the banking
entity or such affiliate (including former employees or directors if
their ownership interest was acquired while employed by or in the
service of the banking entity); and
(ii) Up to 0.5 percent of the entity's outstanding ownership
interests may be held by a third party if the ownership interest is
acquired or retained by the third party for the purpose of establishing
corporate separateness or addressing bankruptcy, insolvency, or similar
concerns.
(3) Joint ventures. A joint venture between a banking entity or any
of its affiliates and one or more unaffiliated persons, provided that
the joint venture:
(i) Is comprised of no more than 10 unaffiliated co-venturers;
(ii) Is in the business of engaging in activities that are
permissible for the banking entity or affiliate, other than investing
in securities for resale or other disposition; and
(iii) Is not, and does not hold itself out as being, an entity or
arrangement that raises money from investors primarily for the purpose
of investing in securities for resale or other disposition or otherwise
trading in securities.
(4) Acquisition vehicles. An issuer:
(i) Formed solely for the purpose of engaging in a bona fide merger
or acquisition transaction; and
(ii) That exists only for such period as necessary to effectuate
the transaction.
(5) Foreign pension or retirement funds. A plan, fund, or program
providing pension, retirement, or similar benefits that is:
(i) Organized and administered outside the United States;
(ii) A broad-based plan for employees or citizens that is subject
to regulation as a pension, retirement, or similar plan under the laws
of the jurisdiction in which the plan, fund, or program is organized
and administered; and
(iii) Established for the benefit of citizens or residents of one
or more foreign sovereigns or any political subdivision thereof.
(6) Insurance company separate accounts. A separate account,
provided that no banking entity other than the insurance company
participates in the account's profits and losses.
(7) Bank owned life insurance. A separate account that is used
solely for the purpose of allowing one or more banking entities to
purchase a life insurance policy for which the banking entity or
entities is beneficiary, provided that no banking entity that purchases
the policy:
(i) Controls the investment decisions regarding the underlying
assets or holdings of the separate account; or
(ii) Participates in the profits and losses of the separate account
other than in compliance with applicable supervisory guidance regarding
bank owned life insurance.
(8) Loan securitizations--(i) Scope. An issuing entity for asset-
backed securities that satisfies all the conditions of paragraph (c)(8)
of this section and the assets or holdings of which are comprised
solely of:
(A) Loans as defined in Sec. 75.2(s);
(B) Rights or other assets designed to assure the servicing or
timely distribution of proceeds to holders of such securities and
rights or other assets that are related or incidental to purchasing or
otherwise acquiring and holding the loans, provided that each asset
meets the requirements of paragraph (c)(8)(iii) of this section;
(C) Interest rate or foreign exchange derivatives that meet the
requirements of paragraph (c)(8)(iv) of this section; and
(D) Special units of beneficial interest and collateral
certificates that meet the requirements of paragraph (c)(8)(v) of this
section.
[[Page 62222]]
(ii) Impermissible assets. For purposes of paragraph (c)(8) of this
section, the assets or holdings of the issuing entity shall not include
any of the following:
(A) A security, including an asset-backed security, or an interest
in an equity or debt security other than as permitted in paragraph
(c)(8)(iii) of this section;
(B) A derivative, other than a derivative that meets the
requirements of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities. Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may hold securities if those
securities are:
(A) Cash equivalents for purposes of the rights and assets in
paragraph (c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts previously contracted with
respect to the loans supporting the asset-backed securities.
(iv) Derivatives. The holdings of derivatives by the issuing entity
shall be limited to interest rate or foreign exchange derivatives that
satisfy all of the following conditions:
(A) The written terms of the derivative directly relate to the
loans, the asset-backed securities, or the contractual rights of other
assets described in paragraph (c)(8)(i)(B) of this section; and
(B) The derivatives reduce the interest rate and/or foreign
exchange risks related to the loans, the asset-backed securities, or
the contractual rights or other assets described in paragraph
(c)(8)(i)(B) of this section.
(v) Special units of beneficial interest and collateral
certificates. The assets or holdings of the issuing entity may include
collateral certificates and special units of beneficial interest issued
by a special purpose vehicle, provided that:
(A) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate meets the requirements in
paragraph (c)(8) of this section;
(B) The special unit of beneficial interest or collateral
certificate is used for the sole purpose of transferring to the issuing
entity for the loan securitization the economic risks and benefits of
the assets that are permissible for loan securitizations under
paragraph (c)(8) of this section and does not directly or indirectly
transfer any interest in any other economic or financial exposure;
(C) The special unit of beneficial interest or collateral
certificate is created solely to satisfy legal requirements or
otherwise facilitate the structuring of the loan securitization; and
(D) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate and the issuing entity
are established under the direction of the same entity that initiated
the loan securitization.
(9) Qualifying asset-backed commercial paper conduits. (i) An
issuing entity for asset-backed commercial paper that satisfies all of
the following requirements:
(A) The asset-backed commercial paper conduit holds only:
(1) Loans and other assets permissible for a loan securitization
under paragraph (c)(8)(i) of this section; and
(2) Asset-backed securities supported solely by assets that are
permissible for loan securitizations under paragraph (c)(8)(i) of this
section and acquired by the asset-backed commercial paper conduit as
part of an initial issuance either directly from the issuing entity of
the asset-backed securities or directly from an underwriter in the
distribution of the asset-backed securities;
(B) The asset-backed commercial paper conduit issues only asset-
backed securities, comprised of a residual interest and securities with
a legal maturity of 397 days or less; and
(C) A regulated liquidity provider has entered into a legally
binding commitment to provide full and unconditional liquidity coverage
with respect to all of the outstanding asset-backed securities issued
by the asset-backed commercial paper conduit (other than any residual
interest) in the event that funds are required to redeem maturing
asset-backed securities.
(ii) For purposes of this paragraph (c)(9) of this section, a
regulated liquidity provider means:
(A) A depository institution, as defined in section 3(c) of the
Federal Deposit Insurance Act (12 U.S.C. 1813(c));
(B) A bank holding company, as defined in section 2(a) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(a)), or a subsidiary
thereof;
(C) A savings and loan holding company, as defined in section 10a
of the Home Owners' Loan Act (12 U.S.C. 1467a), provided all or
substantially all of the holding company's activities are permissible
for a financial holding company under section 4(k) of the Bank Holding
Company Act of 1956 (12 U.S.C. 1843(k)), or a subsidiary thereof;
(D) A foreign bank whose home country supervisor, as defined in
Sec. 211.21(q) of the Board's Regulation K (12 CFR 211.21(q)), has
adopted capital standards consistent with the Capital Accord for the
Basel Committee on Banking Supervision, as amended, and that is subject
to such standards, or a subsidiary thereof; or
(E) The United States or a foreign sovereign.
(10) Qualifying covered bonds--(i) Scope. An entity owning or
holding a dynamic or fixed pool of loans or other assets as provided in
paragraph (c)(8) of this section for the benefit of the holders of
covered bonds, provided that the assets in the pool are comprised
solely of assets that meet the conditions in paragraph (c)(8)(i) of
this section.
(ii) Covered bond. For purposes of paragraph (c)(10) of this
section, a covered bond means:
(A) A debt obligation issued by an entity that meets the definition
of foreign banking organization, the payment obligations of which are
fully and unconditionally guaranteed by an entity that meets the
conditions set forth in paragraph (c)(10)(i) of this section; or
(B) A debt obligation of an entity that meets the conditions set
forth in paragraph (c)(10)(i) of this section, provided that the
payment obligations are fully and unconditionally guaranteed by an
entity that meets the definition of foreign banking organization and
the entity is a wholly-owned subsidiary, as defined in paragraph (c)(2)
of this section, of such foreign banking organization.
(11) SBICs and public welfare investment funds. An issuer:
(i) That is a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), or that has received from the Small Business Administration
notice to proceed to qualify for a license as a small business
investment company, which notice or license has not been revoked; or
(ii) The business of which is to make investments that are:
(A) Designed primarily to promote the public welfare, of the type
permitted under paragraph (11) of section 5136 of the Revised Statutes
of the United States (12 U.S.C. 24), including the welfare of low- and
moderate-income communities or families (such as providing housing,
services, or jobs); or
(B) Qualified rehabilitation expenditures with respect to a
qualified rehabilitated building or certified historic structure, as
such terms are defined in section 47 of the Internal Revenue Code of
1986 or a similar State historic tax credit program.
(12) Registered investment companies and excluded entities. An
issuer:
(i) That is registered as an investment company under section 8 of
the Investment Company Act of 1940 (15 U.S.C. 80a-8), or that is formed
and
[[Page 62223]]
operated pursuant to a written plan to become a registered investment
company as described in Sec. 75.20(e)(3) and that complies with the
requirements of section 18 of the Investment Company Act of 1940 (15
U.S.C. 80a-18);
(ii) That may rely on an exclusion or exemption from the definition
of ``investment company'' under the Investment Company Act of 1940 (15
U.S.C. 80a-1 et seq.) other than the exclusions contained in section
3(c)(1) and 3(c)(7) of that Act; or
(iii) That has elected to be regulated as a business development
company pursuant to section 54(a) of that Act (15 U.S.C. 80a-53) and
has not withdrawn its election, or that is formed and operated pursuant
to a written plan to become a business development company as described
in Sec. 75.20(e)(3) and that complies with the requirements of section
61 of the Investment Company Act of 1940 (15 U.S.C. 80a-60).
(13) Issuers in conjunction with the FDIC's receivership or
conservatorship operations. An issuer that is an entity formed by or on
behalf of the FDIC for the purpose of facilitating the disposal of
assets acquired in the FDIC's capacity as conservator or receiver under
the Federal Deposit Insurance Act or Title II of the Dodd-Frank Wall
Street Reform and Consumer Protection Act.
(14) Other excluded issuers. (i) Any issuer that the appropriate
Federal banking agencies, the SEC, and the CFTC jointly determine the
exclusion of which is consistent with the purposes of section 13 of the
BHC Act.
(ii) A determination made under paragraph (c)(14)(i) of this
section will be promptly made public.
(d) Definition of other terms related to covered funds. For
purposes of this subpart:
(1) Applicable accounting standards means U.S. generally accepted
accounting principles, or such other accounting standards applicable to
a banking entity that the Commission determines are appropriate and
that the banking entity uses in the ordinary course of its business in
preparing its consolidated financial statements.
(2) Asset-backed security has the meaning specified in section
3(a)(79) of the Exchange Act (15 U.S.C. 78c(a)(79)).
(3) Director has the same meaning as provided in Sec. 215.2(d)(1)
of the Board's Regulation O (12 CFR 215.2(d)(1)).
(4) Issuer has the same meaning as in section 2(a)(22) of the
Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(22)).
(5) Issuing entity means with respect to asset-backed securities
the special purpose vehicle that owns or holds the pool assets
underlying asset-backed securities and in whose name the asset-backed
securities supported or serviced by the pool assets are issued.
(6) Ownership interest--(i) Ownership interest means any equity,
partnership, or other similar interest. An ``other similar interest''
means an interest that:
(A) Has the right to participate in the selection or removal of a
general partner, managing member, member of the board of directors or
trustees, investment manager, investment adviser, or commodity trading
advisor of the covered fund (excluding the rights of a creditor to
exercise remedies upon the occurrence of an event of default or an
acceleration event);
(B) Has the right under the terms of the interest to receive a
share of the income, gains or profits of the covered fund;
(C) Has the right to receive the underlying assets of the covered
fund after all other interests have been redeemed and/or paid in full
(excluding the rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event);
(D) Has the right to receive all or a portion of excess spread (the
positive difference, if any, between the aggregate interest payments
received from the underlying assets of the covered fund and the
aggregate interest paid to the holders of other outstanding interests);
(E) Provides under the terms of the interest that the amounts
payable by the covered fund with respect to the interest could be
reduced based on losses arising from the underlying assets of the
covered fund, such as allocation of losses, write-downs or charge-offs
of the outstanding principal balance, or reductions in the amount of
interest due and payable on the interest;
(F) Receives income on a pass-through basis from the covered fund,
or has a rate of return that is determined by reference to the
performance of the underlying assets of the covered fund; or
(G) Any synthetic right to have, receive, or be allocated any of
the rights in paragraphs (d)(6)(i)(A) through (d)(6)(i)(F) of this
section.
(ii) Ownership interest does not include restricted profit
interest, which is an interest held by an entity (or an employee or
former employee thereof) in a covered fund for which the entity (or
employee thereof) serves as investment manager, investment adviser,
commodity trading advisor, or other service provider so long as:
(A) The sole purpose and effect of the interest is to allow the
entity (or employee or former employee thereof) to share in the profits
of the covered fund as performance compensation for the investment
management, investment advisory, commodity trading advisory, or other
services provided to the covered fund by the entity (or employee or
former employee thereof), provided that the entity (or employee or
former employee thereof) may be obligated under the terms of such
interest to return profits previously received;
(B) All such profit, once allocated, is distributed to the entity
(or employee or former employee thereof) promptly after being earned
or, if not so distributed, is retained by the covered fund for the sole
purpose of establishing a reserve amount to satisfy contractual
obligations with respect to subsequent losses of the covered fund and
such undistributed profit of the entity (or employee or former employee
thereof) does not share in the subsequent investment gains of the
covered fund;
(C) Any amounts invested in the covered fund, including any amounts
paid by the entity (or employee or former employee thereof) in
connection with obtaining the restricted profit interest, are within
the limits of Sec. 75.12; and
(D) The interest is not transferable by the entity (or employee or
former employee thereof) except to an affiliate thereof (or an employee
of the banking entity or affiliate), to immediate family members, or
through the intestacy, of the employee or former employee, or in
connection with a sale of the business that gave rise to the restricted
profit interest by the entity (or employee or former employee thereof)
to an unaffiliated party that provides investment management,
investment advisory, commodity trading advisory, or other services to
the fund.
(7) Prime brokerage transaction means any transaction that would be
a covered transaction, as defined in section 23A(b)(7) of the Federal
Reserve Act (12 U.S.C. 371c(b)(7)), that is provided in connection with
custody, clearance and settlement, securities borrowing or lending
services, trade execution, financing, or data, operational, and
administrative support.
(8) Resident of the United States means a person that is a ``U.S.
person'' as defined in rule 902(k) of the SEC's Regulation S (17 CFR
230.902(k)).
(9) Sponsor means, with respect to a covered fund:
(i) To serve as a general partner, managing member, or trustee of a
covered fund, or to serve as a commodity pool operator with respect to
a covered fund as defined in (b)(1)(ii) of this section;
[[Page 62224]]
(ii) In any manner to select or to control (or to have employees,
officers, or directors, or agents who constitute) a majority of the
directors, trustees, or management of a covered fund; or
(iii) To share with a covered fund, for corporate, marketing,
promotional, or other purposes, the same name or a variation of the
same name, except as permitted under Sec. 75.11(a)(6).
(10) Trustee. (i) For purposes of paragraph (d)(9) of this section
and Sec. 75.11, a trustee does not include:
(A) A trustee that does not exercise investment discretion with
respect to a covered fund, including a trustee that is subject to the
direction of an unaffiliated named fiduciary who is not a trustee
pursuant to section 403(a)(1) of the Employee's Retirement Income
Security Act (29 U.S.C. 1103(a)(1)); or
(B) A trustee that is subject to fiduciary standards imposed under
foreign law that are substantially equivalent to those described in
paragraph (d)(10)(i)(A) of this section;
(ii) Any entity that directs a person described in paragraph
(d)(10)(i) of this section, or that possesses authority and discretion
to manage and control the investment decisions of a covered fund for
which such person serves as trustee, shall be considered to be a
trustee of such covered fund.
Sec. 75.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
(a) Organizing and offering a covered fund in general.
Notwithstanding Sec. 75.10(a), a banking entity is not prohibited from
acquiring or retaining an ownership interest in, or acting as sponsor
to, a covered fund in connection with, directly or indirectly,
organizing and offering a covered fund, including serving as a general
partner, managing member, trustee, or commodity pool operator of the
covered fund and in any manner selecting or controlling (or having
employees, officers, directors, or agents who constitute) a majority of
the directors, trustees, or management of the covered fund, including
any necessary expenses for the foregoing, only if:
(1) The banking entity (or an affiliate thereof) provides bona fide
trust, fiduciary, investment advisory, or commodity trading advisory
services;
(2) The covered fund is organized and offered only in connection
with the provision of bona fide trust, fiduciary, investment advisory,
or commodity trading advisory services and only to persons that are
customers of such services of the banking entity (or an affiliate
thereof), pursuant to a written plan or similar documentation outlining
how the banking entity or such affiliate intends to provide advisory or
similar services to its customers through organizing and offering such
fund;
(3) The banking entity and its affiliates do not acquire or retain
an ownership interest in the covered fund except as permitted under
Sec. 75.12;
(4) The banking entity and its affiliates comply with the
requirements of Sec. 75.14;
(5) The banking entity and its affiliates do not, directly or
indirectly, guarantee, assume, or otherwise insure the obligations or
performance of the covered fund or of any covered fund in which such
covered fund invests;
(6) The covered fund, for corporate, marketing, promotional, or
other purposes:
(i) Does not share the same name or a variation of the same name
with the banking entity (or an affiliate thereof), except that a
covered fund may share the same name or a variation of the same name
with a banking entity that is an investment adviser to the covered fund
if:
(A) The investment adviser is not an insured depository
institution, a company that controls an insured depository institution,
or a company that is treated as a bank holding company for purposes of
section 8 of the International Banking Act of 1978 (12 U.S.C. 3106);
and
(B) The investment adviser does not share the same name or a
variation of the same name as an insured depository institution, a
company that controls an insured depository institution, or a company
that is treated as a bank holding company for purposes of section 8 of
the International Banking Act of 1978 (12 U.S.C. 3106); and
(ii) Does not use the word ``bank'' in its name;
(7) No director or employee of the banking entity (or an affiliate
thereof) takes or retains an ownership interest in the covered fund,
except for any director or employee of the banking entity or such
affiliate who is directly engaged in providing investment advisory,
commodity trading advisory, or other services to the covered fund at
the time the director or employee takes the ownership interest; and
(8) The banking entity:
(i) Clearly and conspicuously discloses, in writing, to any
prospective and actual investor in the covered fund (such as through
disclosure in the covered fund's offering documents):
(A) That ``any losses in [such covered fund] will be borne solely
by investors in [the covered fund] and not by [the banking entity] or
its affiliates; therefore, [the banking entity's] losses in [such
covered fund] will be limited to losses attributable to the ownership
interests in the covered fund held by [the banking entity] and any
affiliate in its capacity as investor in the [covered fund] or as
beneficiary of a restricted profit interest held by [the banking
entity] or any affiliate'';
(B) That such investor should read the fund offering documents
before investing in the covered fund;
(C) That the ``ownership interests in the covered fund are not
insured by the FDIC, and are not deposits, obligations of, or endorsed
or guaranteed in any way, by any banking entity'' (unless that happens
to be the case); and
(D) The role of the banking entity and its affiliates and employees
in sponsoring or providing any services to the covered fund; and
(ii) Complies with any additional rules of the appropriate Federal
banking agencies, the SEC, or the CFTC, as provided in section 13(b)(2)
of the BHC Act, designed to ensure that losses in such covered fund are
borne solely by investors in the covered fund and not by the covered
banking entity and its affiliates.
(b) Organizing and offering an issuing entity of asset-backed
securities. (1) Notwithstanding Sec. 75.10(a), a banking entity is not
prohibited from acquiring or retaining an ownership interest in, or
acting as sponsor to, a covered fund that is an issuing entity of
asset-backed securities in connection with, directly or indirectly,
organizing and offering that issuing entity, so long as the banking
entity and its affiliates comply with all of the requirements of
paragraphs (a)(3) through (a)(8) of this section.
(2) For purposes of paragraph (b) of this section, organizing and
offering a covered fund that is an issuing entity of asset-backed
securities means acting as the securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)) of the
issuing entity, or acquiring or retaining an ownership interest in the
issuing entity as required by section 15G of that Act (15 U.S.C. 78o-
11) and the implementing regulations issued thereunder.
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 75.10(a) does not
apply to a banking entity's underwriting activities or market making-
related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 75.4(a) or (b), respectively;
(2) With respect to any banking entity (or any affiliate thereof)
that acts as a
[[Page 62225]]
sponsor, investment adviser or commodity trading advisor to a
particular covered fund or otherwise acquires and retains an ownership
interest in such covered fund in reliance on paragraph (a) of this
section; acquires and retains an ownership interest in such covered
fund and is either a securitizer, as that term is used in section
15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is acquiring
and retaining an ownership interest in such covered fund in compliance
with section 15G of that Act (15 U.S.C. 78o-11) and the implementing
regulations issued thereunder each as permitted by paragraph (b) of
this section; or, directly or indirectly, guarantees, assumes, or
otherwise insures the obligations or performance of the covered fund or
of any covered fund in which such fund invests, then in each such case
any ownership interests acquired or retained by the banking entity and
its affiliates in connection with underwriting and market making
related activities for that particular covered fund are included in the
calculation of ownership interests permitted to be held by the banking
entity and its affiliates under the limitations of Sec.
75.12(a)(2)(ii) and (d); and
(3) With respect to any banking entity, the aggregate value of all
ownership interests of the banking entity and its affiliates in all
covered funds acquired and retained under Sec. 75.11, including all
covered funds in which the banking entity holds an ownership interest
in connection with underwriting and market making related activities
permitted under paragraph (c) of this section, are included in the
calculation of all ownership interests under Sec. 75.12(a)(2)(iii) and
(d).
Sec. 75.12 Permitted investment in a covered fund.
(a) Authority and limitations on permitted investments in covered
funds. (1) Notwithstanding the prohibition contained in Sec. 75.10(a),
a banking entity may acquire and retain an ownership interest in a
covered fund that the banking entity or an affiliate thereof organizes
and offers pursuant to Sec. 75.11, for the purposes of:
(i) Establishment. Establishing the fund and providing the fund
with sufficient initial equity for investment to permit the fund to
attract unaffiliated investors, subject to the limits contained in
paragraphs (a)(2)(i) and (a)(2)(iii) of this section; or
(ii) De minimis investment. Making and retaining an investment in
the covered fund subject to the limits contained in paragraphs
(a)(2)(ii) and (a)(2)(iii) of this section.
(2) Investment limits--(i) Seeding period. With respect to an
investment in any covered fund made or held pursuant to paragraph
(a)(1)(i) of this section, the banking entity and its affiliates:
(A) Must actively seek unaffiliated investors to reduce, through
redemption, sale, dilution, or other methods, the aggregate amount of
all ownership interests of the banking entity in the covered fund to
the amount permitted in paragraph (a)(2)(i)(B) of this section; and
(B) Must, no later than 1 year after the date of establishment of
the fund (or such longer period as may be provided by the Board
pursuant to paragraph (e) of this section), conform its ownership
interest in the covered fund to the limits in paragraph (a)(2)(ii) of
this section;
(ii) Per-fund limits. (A) Except as provided in paragraph
(a)(2)(ii)(B) of this section, an investment by a banking entity and
its affiliates in any covered fund made or held pursuant to paragraph
(a)(1)(ii) of this section may not exceed 3 percent of the total number
or value of the outstanding ownership interests of the fund.
(B) An investment by a banking entity and its affiliates in a
covered fund that is an issuing entity of asset-backed securities may
not exceed 3 percent of the total fair market value of the ownership
interests of the fund measured in accordance with paragraph (b)(3) of
this section, unless a greater percentage is retained by the banking
entity and its affiliates in compliance with the requirements of
section 15G of the Exchange Act (15 U.S.C. 78o-11) and the implementing
regulations issued thereunder, in which case the investment by the
banking entity and its affiliates in the covered fund may not exceed
the amount, number, or value of ownership interests of the fund
required under section 15G of the Exchange Act and the implementing
regulations issued thereunder.
(iii) Aggregate limit. The aggregate value of all ownership
interests of the banking entity and its affiliates in all covered funds
acquired or retained under this section may not exceed 3 percent of the
tier 1 capital of the banking entity, as provided under paragraph (c)
of this section, and shall be calculated as of the last day of each
calendar quarter.
(iv) Date of establishment. For purposes of this section, the date
of establishment of a covered fund shall be:
(A) In general. The date on which the investment adviser or similar
entity to the covered fund begins making investments pursuant to the
written investment strategy for the fund;
(B) Issuing entities of asset-backed securities. In the case of an
issuing entity of asset-backed securities, the date on which the assets
are initially transferred into the issuing entity of asset-backed
securities.
(b) Rules of construction--(1) Attribution of ownership interests
to a covered banking entity. (i) For purposes of paragraph (a)(2) of
this section, the amount and value of a banking entity's permitted
investment in any single covered fund shall include any ownership
interest held under Sec. 75.12 directly by the banking entity,
including any affiliate of the banking entity.
(ii) Treatment of registered investment companies, SEC-regulated
business development companies and foreign public funds. For purposes
of paragraph (b)(1)(i) of this section, a registered investment
company, SEC-regulated business development companies or foreign public
fund as described in Sec. 75.10(c)(1) will not be considered to be an
affiliate of the banking entity so long as the banking entity:
(A) Does not own, control, or hold with the power to vote 25
percent or more of the voting shares of the company or fund; and
(B) Provides investment advisory, commodity trading advisory,
administrative, and other services to the company or fund in compliance
with the limitations under applicable regulation, order, or other
authority.
(iii) Covered funds. For purposes of paragraph (b)(1)(i) of this
section, a covered fund will not be considered to be an affiliate of a
banking entity so long as the covered fund is held in compliance with
the requirements of this subpart.
(iv) Treatment of employee and director investments financed by the
banking entity. For purposes of paragraph (b)(1)(i) of this section, an
investment by a director or employee of a banking entity who acquires
an ownership interest in his or her personal capacity in a covered fund
sponsored by the banking entity will be attributed to the banking
entity if the banking entity, directly or indirectly, extends financing
for the purpose of enabling the director or employee to acquire the
ownership interest in the fund and the financing is used to acquire
such ownership interest in the covered fund.
(2) Calculation of permitted ownership interests in a single
covered fund. Except as provided in paragraphs (b)(3) or (4) of this
section, for purposes of determining whether an investment in a single
covered fund complies with
[[Page 62226]]
the restrictions on ownership interests under paragraphs (a)(2)(i)(B)
and (ii)(A) of this section:
(i) The aggregate number of the outstanding ownership interests
held by the banking entity shall be the total number of ownership
interests held under this section by the banking entity in a covered
fund divided by the total number of ownership interests held by all
entities in that covered fund, as of the last day of each calendar
quarter (both measured without regard to committed funds not yet called
for investment);
(ii) The aggregate value of the outstanding ownership interests
held by the banking entity shall be the aggregate fair market value of
all investments in and capital contributions made to the covered fund
by the banking entity, divided by the value of all investments in and
capital contributions made to that covered fund by all entities, as of
the last day of each calendar quarter (all measured without regard to
committed funds not yet called for investment). If fair market value
cannot be determined, then the value shall be the historical cost basis
of all investments in and contributions made by the banking entity to
the covered fund;
(iii) For purposes of the calculation under paragraph (b)(2)(ii) of
this section, once a valuation methodology is chosen, the banking
entity must calculate the value of its investment and the investments
of all others in the covered fund in the same manner and according to
the same standards.
(3) Issuing entities of asset-backed securities. In the case of an
ownership interest in an issuing entity of asset-backed securities, for
purposes of determining whether an investment in a single covered fund
complies with the restrictions on ownership interests under paragraphs
(a)(2)(i)(B) and (a)(2)(ii)(B) of this section:
(i) For securitizations subject to the requirements of section 15G
of the Exchange Act (15 U.S.C. 78o-11), the calculations shall be made
as of the date and according to the valuation methodology applicable
pursuant to the requirements of section 15G of the Exchange Act (15
U.S.C. 78o-11) and the implementing regulations issued thereunder; or
(ii) For securitization transactions completed prior to the
compliance date of such implementing regulations (or as to which such
implementing regulations do not apply), the calculations shall be made
as of the date of establishment as defined in paragraph (a)(2)(iv)(B)
of this section or such earlier date on which the transferred assets
have been valued for purposes of transfer to the covered fund, and
thereafter only upon the date on which additional securities of the
issuing entity of asset-backed securities are priced for purposes of
the sales of ownership interests to unaffiliated investors.
(iii) For securitization transactions completed prior to the
compliance date of such implementing regulations (or as to which such
implementing regulations do not apply), the aggregate value of the
outstanding ownership interests in the covered fund shall be the fair
market value of the assets transferred to the issuing entity of the
securitization and any other assets otherwise held by the issuing
entity at such time, determined in a manner that is consistent with its
determination of the fair market value of those assets for financial
statement purposes.
(iv) For purposes of the calculation under paragraph (b)(3)(iii) of
this section, the valuation methodology used to calculate the fair
market value of the ownership interests must be the same for both the
ownership interests held by a banking entity and the ownership
interests held by all others in the covered fund in the same manner and
according to the same standards.
(4) Multi-tier fund investments--(i) Master-feeder fund
investments. If the principal investment strategy of a covered fund
(the ``feeder fund'') is to invest substantially all of its assets in
another single covered fund (the ``master fund''), then for purposes of
the investment limitations in paragraphs (a)(2)(i)(B) and (a)(2)(ii) of
this section, the banking entity's permitted investment in such funds
shall be measured only by reference to the value of the master fund.
The banking entity's permitted investment in the master fund shall
include any investment by the banking entity in the master fund, as
well as the banking entity's pro-rata share of any ownership interest
of the master fund that is held through the feeder fund; and
(ii) Fund-of-funds investments. If a banking entity organizes and
offers a covered fund pursuant to Sec. 75.11 for the purpose of
investing in other covered funds (a ``fund of funds'') and that fund of
funds itself invests in another covered fund that the banking entity is
permitted to own, then the banking entity's permitted investment in
that other fund shall include any investment by the banking entity in
that other fund, as well as the banking entity's pro-rata share of any
ownership interest of the fund that is held through the fund of funds.
The investment of the banking entity may not represent more than 3
percent of the amount or value of any single covered fund.
(c) Aggregate permitted investments in all covered funds. (1) For
purposes of paragraph (a)(2)(iii) of this section, the aggregate value
of all ownership interests held by a banking entity shall be the sum of
all amounts paid or contributed by the banking entity in connection
with acquiring or retaining an ownership interest in covered funds
(together with any amounts paid by the entity (or employee thereof) in
connection with obtaining a restricted profit interest under Sec.
75.10(d)(6)(ii)), on a historical cost basis.
(2) Calculation of tier 1 capital. For purposes of paragraph
(a)(2)(iii) of this section:
(i) Entities that are required to hold and report tier 1 capital.
If a banking entity is required to calculate and report tier 1 capital,
the banking entity's tier 1 capital shall be equal to the amount of
tier 1 capital of the banking entity as of the last day of the most
recent calendar quarter, as reported to its primary financial
regulatory agency; and
(ii) If a banking entity is not required to calculate and report
tier 1 capital, the banking entity's tier 1 capital shall be determined
to be equal to:
(A) In the case of a banking entity that is controlled, directly or
indirectly, by a depository institution that calculates and reports
tier 1 capital, be equal to the amount of tier 1 capital reported by
such controlling depository institution in the manner described in
paragraph (c)(2)(i) of this section;
(B) In the case of a banking entity that is not controlled,
directly or indirectly, by a depository institution that calculates and
reports tier 1 capital:
(1) Bank holding company subsidiaries. If the banking entity is a
subsidiary of a bank holding company or company that is treated as a
bank holding company, be equal to the amount of tier 1 capital reported
by the top-tier affiliate of such covered banking entity that
calculates and reports tier 1 capital in the manner described in
paragraph (c)(2)(i) of this section; and
(2) Other holding companies and any subsidiary or affiliate
thereof. If the banking entity is not a subsidiary of a bank holding
company or a company that is treated as a bank holding company, be
equal to the total amount of shareholders' equity of the top-tier
affiliate within such organization as of the last day of the most
recent calendar quarter that has ended, as determined under applicable
accounting standards.
(iii) Treatment of foreign banking entities--(A) Foreign banking
entities. Except as provided in paragraph (c)(2)(iii)(B) of this
section, with respect to a banking entity that is not itself, and is
not controlled directly or indirectly
[[Page 62227]]
by, a banking entity that is located or organized under the laws of the
United States or of any State, the tier 1 capital of the banking entity
shall be the consolidated tier 1 capital of the entity as calculated
under applicable home country standards.
(B) U.S. affiliates of foreign banking entities. With respect to a
banking entity that is located or organized under the laws of the
United States or of any State and is controlled by a foreign banking
entity identified under paragraph (c)(2)(iii)(A) of this section, the
banking entity's tier 1 capital shall be as calculated under paragraphs
(c)(2)(i) or (ii) of this section.
(d) Capital treatment for a permitted investment in a covered fund.
For purposes of calculating compliance with the applicable regulatory
capital requirements, a banking entity shall deduct from the banking
entity's tier 1 capital (as determined under paragraph (c)(2) of this
section) the greater of:
(1) The sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
(together with any amounts paid by the entity (or employee thereof) in
connection with obtaining a restricted profit interest under Sec.
75.10(d)(6)(ii)), on a historical cost basis, plus any earnings
received; and
(2) The fair market value of the banking entity's ownership
interests in the covered fund as determined under paragraph (b)(2)(ii)
or (3) of this section (together with any amounts paid by the entity
(or employee thereof) in connection with obtaining a restricted profit
interest under Sec. 75.10(d)(6)(ii)), if the banking entity accounts
for the profits (or losses) of the fund investment in its financial
statements.
(e) Extension of time to divest an ownership interest. (1) Upon
application by a banking entity, the Board may extend the period under
paragraph (a)(2)(i) of this section for up to 2 additional years if the
Board finds that an extension would be consistent with safety and
soundness and not detrimental to the public interest. An application
for extension must:
(i) Be submitted to the Board at least 90 days prior to the
expiration of the applicable time period;
(ii) Provide the reasons for application, including information
that addresses the factors in paragraph (e)(2) of this section; and
(iii) Explain the banking entity's plan for reducing the permitted
investment in a covered fund through redemption, sale, dilution or
other methods as required in paragraph (a)(2) of this section.
(2) Factors governing Board determinations. In reviewing any
application under paragraph (e)(1) of this section, the Board may
consider all the facts and circumstances related to the permitted
investment in a covered fund, including:
(i) Whether the investment would result, directly or indirectly, in
a material exposure by the banking entity to high-risk assets or high-
risk trading strategies;
(ii) The contractual terms governing the banking entity's interest
in the covered fund;
(iii) The date on which the covered fund is expected to have
attracted sufficient investments from investors unaffiliated with the
banking entity to enable the banking entity to comply with the
limitations in paragraph (a)(2)(i) of this section;
(iv) The total exposure of the covered banking entity to the
investment and the risks that disposing of, or maintaining, the
investment in the covered fund may pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of divesting or disposing of the
investment within the applicable period;
(vi) Whether the investment or the divestiture or conformance of
the investment would involve or result in a material conflict of
interest between the banking entity and unaffiliated parties, including
clients, customers or counterparties to which it owes a duty;
(vii) The banking entity's prior efforts to reduce through
redemption, sale, dilution, or other methods its ownership interests in
the covered fund, including activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board believes appropriate.
(3) Authority to impose restrictions on activities or investment
during any extension period. The Board may impose such conditions on
any extension approved under paragraph (e)(1) of this section as the
Board determines are necessary or appropriate to protect the safety and
soundness of the banking entity or the financial stability of the
United States, address material conflicts of interest or other unsound
banking practices, or otherwise further the purposes of section 13 of
the BHC Act and this part.
(4) Consultation. In the case of a banking entity that is primarily
regulated by another Federal banking agency, the SEC, or the CFTC, the
Board will consult with such agency prior to acting on an application
by the banking entity for an extension under paragraph (e)(1) of this
section.
Sec. 75.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 75.10(a) does not apply with respect to
an ownership interest in a covered fund acquired or retained by a
banking entity that is designed to demonstrably reduce or otherwise
significantly mitigate the specific, identifiable risks to the banking
entity in connection with a compensation arrangement with an employee
of the banking entity or an affiliate thereof that directly provides
investment advisory, commodity trading advisory or other services to
the covered fund.
(2) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under paragraph (a) of this section only
if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures and
internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate and demonstrably reduces or otherwise
significantly mitigates one or more specific, identifiable risks
arising in connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) The compensation arrangement relates solely to the covered
fund in which the banking entity or any affiliate has acquired an
ownership interest pursuant to this paragraph and such compensation
arrangement provides that any losses incurred by the banking entity on
such ownership interest will be offset by corresponding decreases in
[[Page 62228]]
amounts payable under such compensation arrangement.
(b) Certain permitted covered fund activities and investments
outside of the United States. (1) The prohibition contained in Sec.
75.10(a) does not apply to the acquisition or retention of any
ownership interest in, or the sponsorship of, a covered fund by a
banking entity only if:
(i) The banking entity is not organized or directly or indirectly
controlled by a banking entity that is organized under the laws of the
United States or of one or more States;
(ii) The activity or investment by the banking entity is pursuant
to paragraph (9) or (13) of section 4(c) of the BHC Act;
(iii) No ownership interest in the covered fund is offered for sale
or sold to a resident of the United States; and
(iv) The activity or investment occurs solely outside of the United
States.
(2) An activity or investment by the banking entity is pursuant to
paragraph (9) or (13) of section 4(c) of the BHC Act for purposes of
paragraph (b)(1)(ii) of this section only if:
(i) The activity or investment is conducted in accordance with the
requirements of this section; and
(ii)(A) With respect to a banking entity that is a foreign banking
organization, the banking entity meets the qualifying foreign banking
organization requirements of Sec. 211.23(a), (c) or (e) of the Board's
Regulation K (12 CFR 211.23(a), (c) or (e)), as applicable; or
(B) With respect to a banking entity that is not a foreign banking
organization, the banking entity is not organized under the laws of the
United States or of one or more States and the banking entity, on a
fully-consolidated basis, meets at least two of the following
requirements:
(1) Total assets of the banking entity held outside of the United
States exceed total assets of the banking entity held in the United
States;
(2) Total revenues derived from the business of the banking entity
outside of the United States exceed total revenues derived from the
business of the banking entity in the United States; or
(3) Total net income derived from the business of the banking
entity outside of the United States exceeds total net income derived
from the business of the banking entity in the United States.
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is sold or has been sold
pursuant to an offering that does not target residents of the United
States.
(4) An activity or investment occurs solely outside of the United
States for purposes of paragraph (b)(1)(iv) of this section only if:
(i) The banking entity acting as sponsor, or engaging as principal
in the acquisition or retention of an ownership interest in the covered
fund, is not itself, and is not controlled directly or indirectly by, a
banking entity that is located in the United States or organized under
the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to acquire or retain the ownership interest or act as
sponsor to the covered fund is not located in the United States or
organized under the laws of the United States or of any State;
(iii) The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State; and
(iv) No financing for the banking entity's ownership or sponsorship
is provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State.
(5) For purposes of this section, a U.S. branch, agency, or
subsidiary of a foreign bank, or any subsidiary thereof, is located in
the United States; however, a foreign bank of which that branch,
agency, or subsidiary is a part is not considered to be located in the
United States solely by virtue of operation of the U.S. branch, agency,
or subsidiary.
(c) Permitted covered fund interests and activities by a regulated
insurance company. The prohibition contained in Sec. 75.10(a) does not
apply to the acquisition or retention by an insurance company, or an
affiliate thereof, of any ownership interest in, or the sponsorship of,
a covered fund only if:
(1) The insurance company or its affiliate acquires and retains the
ownership interest solely for the general account of the insurance
company or for one or more separate accounts established by the
insurance company;
(2) The acquisition and retention of the ownership interest is
conducted in compliance with, and subject to, the insurance company
investment laws, regulations, and written guidance of the State or
jurisdiction in which such insurance company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law, regulation, or written guidance described in
paragraph (c)(2) of this section is insufficient to protect the safety
and soundness of the banking entity, or the financial stability of the
United States.
Sec. 75.14 Limitations on relationships with a covered fund.
(a) Relationships with a covered fund. (1) Except as provided for
in paragraph (a)(2) of this section, no banking entity that serves,
directly or indirectly, as the investment manager, investment adviser,
commodity trading advisor, or sponsor to a covered fund, that organizes
and offers a covered fund pursuant to Sec. 75.11, or that continues to
hold an ownership interest in accordance with Sec. 75.11(b), and no
affiliate of such entity, may enter into a transaction with the covered
fund, or with any other covered fund that is controlled by such covered
fund, that would be a covered transaction as defined in section 23A of
the Federal Reserve Act (12 U.S.C. 371c(b)(7)), as if such banking
entity and the affiliate thereof were a member bank and the covered
fund were an affiliate thereof.
(2) Notwithstanding paragraph (a)(1) of this section, a banking
entity may:
(i) Acquire and retain any ownership interest in a covered fund in
accordance with the requirements of Sec. 75.11, Sec. 75.12, or Sec.
75.13; and
(ii) Enter into any prime brokerage transaction with any covered
fund in which a covered fund managed, sponsored, or advised by such
banking entity (or an affiliate thereof) has taken an ownership
interest, if:
(A) The banking entity is in compliance with each of the
limitations set forth in Sec. 75.11 with respect to a covered fund
organized and offered by such banking entity (or an affiliate thereof);
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually to the Commission (with a
duty to update the certification if the information in the
certification materially changes) that the banking entity does not,
directly or indirectly, guarantee, assume, or otherwise insure the
obligations or performance of the covered fund or of any covered fund
in which such covered fund invests; and
(C) The Board has not determined that such transaction is
inconsistent with the safe and sound operation and condition of the
banking entity.
[[Page 62229]]
(b) Restrictions on transactions with covered funds. A banking
entity that serves, directly or indirectly, as the investment manager,
investment adviser, commodity trading advisor, or sponsor to a covered
fund, or that organizes and offers a covered fund pursuant to Sec.
75.11, or that continues to hold an ownership interest in accordance
with Sec. 75.11(b), shall be subject to section 23B of the Federal
Reserve Act (12 U.S.C. 371c-1), as if such banking entity were a member
bank and such covered fund were an affiliate thereof.
(c) Restrictions on prime brokerage transactions. A prime brokerage
transaction permitted under paragraph (a)(2)(ii) of this section shall
be subject to section 23B of the Federal Reserve Act (12 U.S.C. 371c-1)
as if the counterparty were an affiliate of the banking entity.
Sec. 75.15 Other limitations on permitted covered fund activities.
(a) No transaction, class of transactions, or activity may be
deemed permissible under Sec. Sec. 75.11 through 75.13 if the
transaction, class of transactions, or activity would:
(1) Involve or result in a material conflict of interest between
the banking entity and its clients, customers, or counterparties;
(2) Result, directly or indirectly, in a material exposure by the
banking entity to a high-risk asset or a high-risk trading strategy; or
(3) Pose a threat to the safety and soundness of the banking entity
or to the financial stability of the United States.
(b) Definition of material conflict of interest. (1) For purposes
of this section, a material conflict of interest between a banking
entity and its clients, customers, or counterparties exists if the
banking entity engages in any transaction, class of transactions, or
activity that would involve or result in the banking entity's interests
being materially adverse to the interests of its client, customer, or
counterparty with respect to such transaction, class of transactions,
or activity, and the banking entity has not taken at least one of the
actions in paragraph (b)(2) of this section.
(2) Prior to effecting the specific transaction or class or type of
transactions, or engaging in the specific activity, the banking entity:
(i) Timely and effective disclosure. (A) Has made clear, timely,
and effective disclosure of the conflict of interest, together with
other necessary information, in reasonable detail and in a manner
sufficient to permit a reasonable client, customer, or counterparty to
meaningfully understand the conflict of interest; and
(B) Such disclosure is made in a manner that provides the client,
customer, or counterparty the opportunity to negate, or substantially
mitigate, any materially adverse effect on the client, customer, or
counterparty created by the conflict of interest; or
(ii) Information barriers. Has established, maintained, and
enforced information barriers that are memorialized in written policies
and procedures, such as physical separation of personnel, or functions,
or limitations on types of activity, that are reasonably designed,
taking into consideration the nature of the banking entity's business,
to prevent the conflict of interest from involving or resulting in a
materially adverse effect on a client, customer, or counterparty. A
banking entity may not rely on such information barriers if, in the
case of any specific transaction, class or type of transactions or
activity, the banking entity knows or should reasonably know that,
notwithstanding the banking entity's establishment of information
barriers, the conflict of interest may involve or result in a
materially adverse effect on a client, customer, or counterparty.
(c) Definition of high-risk asset and high-risk trading strategy.
For purposes of this section:
(1) High-risk asset means an asset or group of related assets that
would, if held by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
(2) High-risk trading strategy means a trading strategy that would,
if engaged in by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
Sec. 75.16 Ownership of interests in and sponsorship of issuers of
certain collateralized debt obligations backed by trust-preferred
securities.
(a) The prohibition contained in Sec. 75.10(a)(1) does not apply
to the ownership by a banking entity of an interest in, or sponsorship
of, any issuer if:
(1) The issuer was established, and the interest was issued, before
May 19, 2010;
(2) The banking entity reasonably believes that the offering
proceeds received by the issuer were invested primarily in Qualifying
TruPS Collateral; and
(3) The banking entity acquired such interest on or before December
10, 2013 (or acquired such interest in connection with a merger with or
acquisition of a banking entity that acquired the interest on or before
December 10, 2013).
(b) For purposes of this Sec. 75.16, Qualifying TruPS Collateral
shall mean any trust preferred security or subordinated debt instrument
issued prior to May 19, 2010 by a depository institution holding
company that, as of the end of any reporting period within 12 months
immediately preceding the issuance of such trust preferred security or
subordinated debt instrument, had total consolidated assets of less
than $15,000,000,000 or issued prior to May 19, 2010 by a mutual
holding company.
(c) Notwithstanding paragraph (a)(3) of this section, a banking
entity may act as a market maker with respect to the interests of an
issuer described in paragraph (a) of this section in accordance with
the applicable provisions of Sec. Sec. 75.4 and 75.11.
(d) Without limiting the applicability of paragraph (a) of this
section, the Board, the FDIC and the OCC will make public a non-
exclusive list of issuers that meet the requirements of paragraph (a).
A banking entity may rely on the list published by the Board, the FDIC
and the OCC.
Sec. Sec. 75.17-75.19 [Reserved]
Subpart D--Compliance Program Requirement; Violations
Sec. 75.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope and detail of the compliance program shall
be appropriate for the types, size, scope and complexity of activities
and business structure of the banking entity.
(b) Contents of compliance program. Except as provided in paragraph
(f) of this section, the compliance program required by paragraph (a)
of this section, at a minimum, shall include:
(1) Written policies and procedures reasonably designed to
document, describe, monitor and limit trading activities subject to
subpart B of this part (including those permitted under Sec. Sec. 75.3
to 75.6), including setting,
[[Page 62230]]
monitoring and managing required limits set out in Sec. Sec. 75.4 and
75.5, and activities and investments with respect to a covered fund
subject to subpart C of this part (including those permitted under
Sec. Sec. 75.11 through 75.14) conducted by the banking entity to
ensure that all activities and investments conducted by the banking
entity that are subject to section 13 of the BHC Act and this part
comply with section 13 of the BHC Act and this part;
(2) A system of internal controls reasonably designed to monitor
compliance with section 13 of the BHC Act and this part and to prevent
the occurrence of activities or investments that are prohibited by
section 13 of the BHC Act and this part;
(3) A management framework that clearly delineates responsibility
and accountability for compliance with section 13 of the BHC Act and
this part and includes appropriate management review of trading limits,
strategies, hedging activities, investments, incentive compensation and
other matters identified in this part or by management as requiring
attention;
(4) Independent testing and audit of the effectiveness of the
compliance program conducted periodically by qualified personnel of the
banking entity or by a qualified outside party;
(5) Training for trading personnel and managers, as well as other
appropriate personnel, to effectively implement and enforce the
compliance program; and
(6) Records sufficient to demonstrate compliance with section 13 of
the BHC Act and this part, which a banking entity must promptly provide
to the Commission upon request and retain for a period of no less than
5 years or such longer period as required by the Commission.
(c) Additional standards. In addition to the requirements in
paragraph (b) of this section, the compliance program of a banking
entity must satisfy the requirements and other standards contained in
appendix B of this part, if:
(1) The banking entity engages in proprietary trading permitted
under subpart B of this part and is required to comply with the
reporting requirements of paragraph (d) of this section;
(2) The banking entity has reported total consolidated assets as of
the previous calendar year end of $50 billion or more or, in the case
of a foreign banking entity, has total U.S. assets as of the previous
calendar year end of $50 billion or more (including all subsidiaries,
affiliates, branches and agencies of the foreign banking entity
operating, located or organized in the United States); or
(3) The Commission notifies the banking entity in writing that it
must satisfy the requirements and other standards contained in appendix
B of this part.
(d) Reporting requirements under appendix A of this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B of this part shall comply with the reporting requirements
described in appendix A of this part, if:
(i) The banking entity (other than a foreign banking entity as
provided in paragraph (d)(1)(ii) of this section) has, together with
its affiliates and subsidiaries, trading assets and liabilities
(excluding trading assets and liabilities involving obligations of or
guaranteed by the United States or any agency of the United States) the
average gross sum of which (on a worldwide consolidated basis) over the
previous consecutive four quarters, as measured as of the last day of
each of the four prior calendar quarters, equals or exceeds the
threshold established in paragraph (d)(2) of this section;
(ii) In the case of a foreign banking entity, the average gross sum
of the trading assets and liabilities of the combined U.S. operations
of the foreign banking entity (including all subsidiaries, affiliates,
branches and agencies of the foreign banking entity operating, located
or organized in the United States and excluding trading assets and
liabilities involving obligations of or guaranteed by the United States
or any agency of the United States) over the previous consecutive four
quarters, as measured as of the last day of each of the four prior
calendar quarters, equals or exceeds the threshold established in
paragraph (d)(2) of this section; or
(iii) The Commission notifies the banking entity in writing that it
must satisfy the reporting requirements contained in appendix A of this
part.
(2) The threshold for reporting under paragraph (d)(1) of this
section shall be $50 billion beginning on June 30, 2014; $25 billion
beginning on April 30, 2016; and $10 billion beginning on December 31,
2016.
(3) Frequency of reporting. Unless the Commission notifies the
banking entity in writing that it must report on a different basis, a
banking entity with $50 billion or more in trading assets and
liabilities (as calculated in accordance with paragraph (d)(1) of this
section) shall report the information required by appendix A of this
part for each calendar month within 30 days of the end of the relevant
calendar month; beginning with information for the month of January
2015, such information shall be reported within 10 days of the end of
each calendar month. Any other banking entity subject to appendix A of
this part shall report the information required by appendix A of this
part for each calendar quarter within 30 days of the end of that
calendar quarter unless the Commission notifies the banking entity in
writing that it must report on a different basis.
(e) Additional documentation for covered funds. Any banking entity
that has more than $10 billion in total consolidated assets as reported
on December 31 of the previous two calendar years shall maintain
records that include:
(1) Documentation of the exclusions or exemptions other than
sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940
relied on by each fund sponsored by the banking entity (including all
subsidiaries and affiliates) in determining that such fund is not a
covered fund;
(2) For each fund sponsored by the banking entity (including all
subsidiaries and affiliates) for which the banking entity relies on one
or more of the exclusions from the definition of covered fund provided
by Sec. 75.10(c)(1), (5), (8), (9), or (10), documentation supporting
the banking entity's determination that the fund is not a covered fund
pursuant to one or more of those exclusions;
(3) For each seeding vehicle described in Sec. 75.10(c)(12)(i) or
(iii) that will become a registered investment company or SEC-regulated
business development company, a written plan documenting the banking
entity's determination that the seeding vehicle will become a
registered investment company or SEC-regulated business development
company; the period of time during which the vehicle will operate as a
seeding vehicle; and the banking entity's plan to market the vehicle to
third-party investors and convert it into a registered investment
company or SEC-regulated business development company within the time
period specified in Sec. 75.12(a)(2)(i)(B);
(4) For any banking entity that is, or is controlled directly or
indirectly by a banking entity that is, located in or organized under
the laws of the United States or of any State, if the aggregate amount
of ownership interests in foreign public funds that are described in
Sec. 75.10(c)(1) owned by such banking entity (including ownership
interests owned by any affiliate that is controlled directly or
indirectly by a banking entity that is located in or organized under
the laws of the United States or of any State) exceeds $50 million at
the end of two or more consecutive calendar quarters,
[[Page 62231]]
beginning with the next succeeding calendar quarter, documentation of
the value of the ownership interests owned by the banking entity (and
such affiliates) in each foreign public fund and each jurisdiction in
which any such foreign public fund is organized, calculated as of the
end of each calendar quarter, which documentation must continue until
the banking entity's aggregate amount of ownership interests in foreign
public funds is below $50 million for two consecutive calendar
quarters; and
(5) For purposes of paragraph (e)(4) of this section, a U.S.
branch, agency, or subsidiary of a foreign banking entity is located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(f) Simplified programs for less active banking entities--(1)
Banking entities with no covered activities. A banking entity that does
not engage in activities or investments pursuant to subpart B or
subpart C of this part (other than trading activities permitted
pursuant to Sec. 75.6(a)) may satisfy the requirements of this section
by establishing the required compliance program prior to becoming
engaged in such activities or making such investments (other than
trading activities permitted pursuant to Sec. 75.6(a)).
(2) Banking entities with modest activities. A banking entity with
total consolidated assets of $10 billion or less as reported on
December 31 of the previous two calendar years that engages in
activities or investments pursuant to subpart B or subpart C of this
part (other than trading activities permitted under Sec. 75.6(a)) may
satisfy the requirements of this section by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act and this part and adjustments
as appropriate given the activities, size, scope and complexity of the
banking entity.
Sec. 75.21 Termination of activities or investments; penalties for
violations.
(a) Any banking entity that engages in an activity or makes an
investment in violation of section 13 of the BHC Act or this part, or
acts in a manner that functions as an evasion of the requirements of
section 13 of the BHC Act or this part, including through an abuse of
any activity or investment permitted under subparts B or C of this
part, or otherwise violates the restrictions and requirements of
section 13 of the BHC Act or this part, shall, upon discovery, promptly
terminate the activity and, as relevant, dispose of the investment.
(b) Whenever the Commission finds reasonable cause to believe any
banking entity has engaged in an activity or made an investment in
violation of section 13 of the BHC Act or this part, or engaged in any
activity or made any investment that functions as an evasion of the
requirements of section 13 of the BHC Act or this part, the Commission
may take any action permitted by law to enforce compliance with section
13 of the BHC Act and this part, including directing the banking entity
to restrict, limit, or terminate any or all activities under this part
and dispose of any investment.
Appendix A to Part 75--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B of this part (``proprietary trading restrictions'').
Pursuant to Sec. 75.20(d), this appendix generally applies to a
banking entity that, together with its affiliates and subsidiaries,
has significant trading assets and liabilities. These entities are
required to (i) furnish periodic reports to the Commission regarding
a variety of quantitative measurements of their covered trading
activities, which vary depending on the scope and size of covered
trading activities, and (ii) create and maintain records documenting
the preparation and content of these reports. The requirements of
this appendix must be incorporated into the banking entity's
internal compliance program under Sec. 75.20 and Appendix B of this
part.
b. The purpose of this appendix is to assist banking entities
and the Commission in:
(i) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(ii) Monitoring the banking entity's covered trading activities;
(iii) Identifying covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading activities of
trading desks engaged in market making-related activities subject to
Sec. 75.4(b) are consistent with the requirements governing
permitted market making-related activities;
(v) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. 75.4, 75.5, or 75.6(a) and (b) (i.e., underwriting and market
making-related related activity, risk-mitigating hedging, or trading
in certain government obligations) are consistent with the
requirement that such activity not result, directly or indirectly,
in a material exposure to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by the Commission of such activities; and
(vii) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. The quantitative measurements that must be furnished pursuant
to this appendix are not intended to serve as a dispositive tool for
the identification of permissible or impermissible activities.
d. In order to allow banking entities and the Agencies to
evaluate the effectiveness of these metrics, banking entities must
collect and report these metrics for all trading desks beginning on
the dates established in Sec. 75.20. The Agencies will review the
data collected and revise this collection requirement as appropriate
based on a review of the data collected prior to September 30, 2015.
e. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 75.20 and Appendix B of this part. The
effectiveness of particular quantitative measurements may differ
based on the profile of the banking entity's businesses in general
and, more specifically, of the particular trading desk, including
types of instruments traded, trading activities and strategies, and
history and experience (e.g., whether the trading desk is an
established, successful market maker or a new entrant to a
competitive market). In all cases, banking entities must ensure that
they have robust measures in place to identify and monitor the risks
taken in their trading activities, to ensure that the activities are
within risk tolerances established by the banking entity, and to
monitor and examine for compliance with the proprietary trading
restrictions in this part.
f. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 75.4 through 75.6(a) and (b), or that
result in a material exposure to high-risk assets or high-risk
trading strategies, must be escalated within the banking entity for
review, further analysis, explanation to the Commission, and
remediation, where appropriate. The quantitative measurements
discussed in this appendix should be helpful to banking entities in
identifying and managing the risks related to their covered trading
activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 75.2 and 75.3. In addition, for purposes of this
appendix, the following definitions apply:
[[Page 62232]]
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of a trading desk's holdings, dividend income, and
interest income and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. 75.4, 75.5, or 75.6(a) or (b). A banking entity may
include trading under Sec. 75.3(d) or 75.6(c), (d) or (e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading desk means the smallest discrete unit of organization of
a banking entity that purchases or sells financial instruments for
the trading account of the banking entity or an affiliate thereof.
III. Reporting and Recordkeeping of Quantitative Measurements
a. Scope of Required Reporting
General scope. Each banking entity made subject to this part by
Sec. 75.20 must furnish the following quantitative measurements for
each trading desk of the banking entity, calculated in accordance
with this appendix:
Risk and Position Limits and Usage;
Risk Factor Sensitivities;
Value-at-Risk and Stress VaR;
Comprehensive Profit and Loss Attribution;
Inventory Turnover;
Inventory Aging; and
Customer Facing Trade Ratio
b. Frequency of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report each
applicable quantitative measurement to the Commission on the
reporting schedule established in Sec. 75.20 unless otherwise
requested by the Commission. All quantitative measurements for any
calendar month must be reported within the time period required by
Sec. 75.20.
c. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the Commission pursuant to this appendix and Sec.
75.20(d), create and maintain records documenting the preparation
and content of these reports, as well as such information as is
necessary to permit the Commission to verify the accuracy of such
reports, for a period of 5 years from the end of the calendar year
for which the measurement was taken.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Risk and Position Limits and Usage
i. Description: For purposes of this appendix, Risk and Position
Limits are the constraints that define the amount of risk that a
trading desk is permitted to take at a point in time, as defined by
the banking entity for a specific trading desk. Usage represents the
portion of the trading desk's limits that are accounted for by the
current activity of the desk. Risk and position limits and their
usage are key risk management tools used to control and monitor risk
taking and include, but are not limited, to the limits set out in
Sec. Sec. 75.4 and 75.5. A number of the metrics that are described
below, including ``Risk Factor Sensitivities'' and ``Value-at-Risk
and Stress Value-at-Risk,'' relate to a trading desk's risk and
position limits and are useful in evaluating and setting these
limits in the broader context of the trading desk's overall
activities, particularly for the market making activities under
Sec. 75.4(b) and hedging activity under Sec. 75.5. Accordingly,
the limits required under Sec. Sec. 75.4(b)(2)(iii) and
75.5(b)(1)(i) must meet the applicable requirements under Sec. Sec.
75.4(b)(2)(iii) and 75.5(b)(1)(i) and also must include appropriate
metrics for the trading desk limits including, at a minimum, the
``Risk Factor Sensitivities'' and ``Value-at-Risk and Stress Value-
at-Risk'' metrics except to the extent any of the ``Risk Factor
Sensitivities'' or ``Value-at-Risk and Stress Value-at-Risk''
metrics are demonstrably ineffective for measuring and monitoring
the risks of a trading desk based on the types of positions traded
by, and risk exposures of, that desk.
ii. General Calculation Guidance: Risk and Position Limits must
be reported in the format used by the banking entity for the
purposes of risk management of each trading desk. Risk and Position
Limits are often expressed in terms of risk measures, such as VaR
and Risk Factor Sensitivities, but may also be expressed in terms of
other observable criteria, such as net open positions. When criteria
other than VaR or Risk Factor Sensitivities are used to define the
Risk and Position Limits, both the value of the Risk and Position
Limits and the value of the variables used to assess whether these
limits have been reached must be reported.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
2. Risk Factor Sensitivities
i. Description: For purposes of this appendix, Risk Factor
Sensitivities are changes in a trading desk's Comprehensive Profit
and Loss that are expected to occur in the event of a change in one
or more underlying variables that are significant sources of the
trading desk's profitability and risk.
ii. General Calculation Guidance: A banking entity must report
the Risk Factor Sensitivities that are monitored and managed as part
of the trading desk's overall risk management policy. The underlying
data and methods used to compute a trading desk's Risk Factor
Sensitivities will depend on the specific function of the trading
desk and the internal risk management models employed. The number
and type of Risk Factor Sensitivities that are monitored and managed
by a trading desk, and furnished to the Commission, will depend on
the explicit risks assumed by the trading desk. In general, however,
reported Risk Factor Sensitivities must be sufficiently granular to
account for a preponderance of the expected price variation in the
trading desk's holdings.
A. Trading desks must take into account any relevant factors in
calculating Risk Factor Sensitivities, including, for example, the
following with respect to particular asset classes:
Commodity derivative positions: Risk factors with
respect to the related commodities set out in Sec. 20.2 of this
chapter, the maturity of the positions, volatility and/or
correlation sensitivities (expressed in a manner that demonstrates
any significant non-linearities), and the maturity profile of the
positions;
Credit positions: Risk factors with respect to credit
spreads that are sufficiently granular to account for specific
credit sectors and market segments, the maturity profile of the
positions, and risk factors with respect to interest rates of all
relevant maturities;
Credit-related derivative positions: Risk factor
sensitivities, for example credit spreads, shifts (parallel and non-
parallel) in credit spreads--volatility, and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Equity derivative positions: Risk factor sensitivities
such as equity positions, volatility, and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Equity positions: Risk factors for equity prices and
risk factors that differentiate between important equity market
sectors and segments, such as a small capitalization equities and
international equities;
Foreign exchange derivative positions: Risk factors
with respect to major currency pairs and maturities, exposure to
interest rates at relevant maturities, volatility, and/or
correlation sensitivities (expressed in a manner that demonstrates
any significant non-linearities), as well as the maturity profile of
the positions; and
Interest rate positions, including interest rate
derivative positions: Risk factors with respect to major interest
rate categories and maturities and volatility and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and shifts (parallel and non-parallel)
in the interest rate curve, as well as the maturity profile of the
positions.
B. The methods used by a banking entity to calculate
sensitivities to a common factor shared by multiple trading desks,
such as an equity price factor, must be applied consistently across
its trading desks so that the sensitivities can be compared from one
trading desk to another.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Value-at-Risk and Stress Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the commonly used percentile measurement of the risk of
future financial loss in the value of a given set of aggregated
positions over a specified period of time, based on current market
conditions. For purposes of this appendix, Stress Value-at-Risk
(``Stress VaR'') is the percentile measurement of the risk of future
financial loss in the value of a given set of aggregated positions
over a specified
[[Page 62233]]
period of time, based on market conditions during a period of
significant financial stress.
ii. General Calculation Guidance: Banking entities must compute
and report VaR and Stress VaR by employing generally accepted
standards and methods of calculation. VaR should reflect a loss in a
trading desk that is expected to be exceeded less than one percent
of the time over a one-day period. For those banking entities that
are subject to regulatory capital requirements imposed by a Federal
banking agency, VaR and Stress VaR must be computed and reported in
a manner that is consistent with such regulatory capital
requirements. In cases where a trading desk does not have a
standalone VaR or Stress VaR calculation but is part of a larger
aggregation of positions for which a VaR or Stress VaR calculation
is performed, a VaR or Stress VaR calculation that includes only the
trading desk's holdings must be performed consistent with the VaR or
Stress VaR model and methodology used for the larger aggregation of
positions.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into three categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); (ii) profit and loss attributable to new
positions resulting from the current day's trading activity (``new
positions''); and (iii) residual profit and loss that cannot be
specifically attributed to existing positions or new positions. The
sum of (i), (ii), and (iii) must equal the trading desk's
comprehensive profit and loss at each point in time. In addition,
profit and loss measurements must calculate volatility of
comprehensive profit and loss (i.e., the standard deviation of the
trading desk's one-day profit and loss, in dollar terms) for the
reporting period for at least a 30-, 60- and 90-day lag period, from
the end of the reporting period, and any other period that the
banking entity deems necessary to meet the requirements of the rule.
A. The comprehensive profit and loss associated with existing
positions must reflect changes in the value of these positions on
the applicable day. The comprehensive profit and loss from existing
positions must be further attributed, as applicable, to changes in
(i) the specific Risk Factors and other factors that are monitored
and managed as part of the trading desk's overall risk management
policies and procedures; and (ii) any other applicable elements,
such as cash flows, carry, changes in reserves, and the correction,
cancellation, or exercise of a trade.
B. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
C. The portion of comprehensive profit and loss that cannot be
specifically attributed to known sources must be allocated to a
residual category identified as an unexplained portion of the
comprehensive profit and loss. Significant unexplained profit and
loss must be escalated for further investigation and analysis.
ii. General Calculation Guidance: The specific categories used
by a trading desk in the attribution analysis and amount of detail
for the analysis should be tailored to the type and amount of
trading activities undertaken by the trading desk. The new position
attribution must be computed by calculating the difference between
the prices at which instruments were bought and/or sold and the
prices at which those instruments are marked to market at the close
of business on that day multiplied by the notional or principal
amount of each purchase or sale. Any fees, commissions, or other
payments received (paid) that are associated with transactions
executed on that day must be added (subtracted) from such
difference. These factors must be measured consistently over time to
facilitate historical comparisons.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
c. Customer-Facing Activity Measurements
1. Inventory Turnover
i. Description: For purposes of this appendix, Inventory
Turnover is a ratio that measures the turnover of a trading desk's
inventory. The numerator of the ratio is the absolute value of all
transactions over the reporting period. The denominator of the ratio
is the value of the trading desk's inventory at the beginning of the
reporting period.
ii. General Calculation Guidance: For purposes of this appendix,
for derivatives, other than options and interest rate derivatives,
value means gross notional value, for options, value means delta
adjusted notional value, and for interest rate derivatives, value
means 10-year bond equivalent value.
iii. Calculation Period: 30 days, 60 days, and 90 days.
iv. Measurement Frequency: Daily.
2. Inventory Aging
i. Description: For purposes of this appendix, Inventory Aging
generally describes a schedule of the trading desk's aggregate
assets and liabilities and the amount of time that those assets and
liabilities have been held. Inventory Aging should measure the age
profile of the trading desk's assets and liabilities.
ii. General Calculation Guidance: In general, Inventory Aging
must be computed using a trading desk's trading activity data and
must identify the value of a trading desk's aggregate assets and
liabilities. Inventory Aging must include two schedules, an asset-
aging schedule and a liability-aging schedule. Each schedule must
record the value of assets or liabilities held over all holding
periods. For derivatives, other than options, and interest rate
derivatives, value means gross notional value, for options, value
means delta adjusted notional value and, for interest rate
derivatives, value means 10-year bond equivalent value.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Customer-Facing Trade Ratio--Trade Count Based and Value Based
i. Description: For purposes of this appendix, the Customer-
Facing Trade Ratio is a ratio comparing (i) the transactions
involving a counterparty that is a customer of the trading desk to
(ii) the transactions involving a counterparty that is not a
customer of the trading desk. A trade count based ratio must be
computed that records the number of transactions involving a
counterparty that is a customer of the trading desk and the number
of transactions involving a counterparty that is not a customer of
the trading desk. A value based ratio must be computed that records
the value of transactions involving a counterparty that is a
customer of the trading desk and the value of transactions involving
a counterparty that is not a customer of the trading desk.
ii. General Calculation Guidance: For purposes of calculating
the Customer-Facing Trade Ratio, a counterparty is considered to be
a customer of the trading desk if the counterparty is a market
participant that makes use of the banking entity's market making-
related services by obtaining such services, responding to
quotations, or entering into a continuing relationship with respect
to such services. However, a trading desk or other organizational
unit of another banking entity would not be a client, customer, or
counterparty of the trading desk if the other entity has trading
assets and liabilities of $50 billion or more as measured in
accordance with Sec. 75.20(d)(1) unless the trading desk documents
how and why a particular trading desk or other organizational unit
of the entity should be treated as a client, customer, or
counterparty of the trading desk. Transactions conducted anonymously
on an exchange or similar trading facility that permits trading on
behalf of a broad range of market participants would be considered
transactions with customers of the trading desk. For derivatives,
other than options, and interest rate derivatives, value means gross
notional value, for options, value means delta adjusted notional
value, and for interest rate derivatives, value means 10-year bond
equivalent value.
iii. Calculation Period: 30 days, 60 days, and 90 days.
iv. Measurement Frequency: Daily.
Appendix B to Part 75--Enhanced Minimum Standards for Compliance
Programs
I. Overview
Section 75.20(c) requires certain banking entities to establish,
maintain, and enforce an enhanced compliance program that includes
the requirements and standards in this Appendix as well as the
minimum written
[[Page 62234]]
policies and procedures, internal controls, management framework,
independent testing, training, and recordkeeping provisions outlined
in Sec. 75.20. This Appendix sets forth additional minimum
standards with respect to the establishment, oversight, maintenance,
and enforcement by these banking entities of an enhanced internal
compliance program for ensuring and monitoring compliance with the
prohibitions and restrictions on proprietary trading and covered
fund activities and investments set forth in section 13 of the BHC
Act and this part.
a. This compliance program must:
1. Be reasonably designed to identify, document, monitor, and
report the permitted trading and covered fund activities and
investments of the banking entity; identify, monitor and promptly
address the risks of these covered activities and investments and
potential areas of noncompliance; and prevent activities or
investments prohibited by, or that do not comply with, section 13 of
the BHC Act and this part;
2. Establish and enforce appropriate limits on the covered
activities and investments of the banking entity, including limits
on the size, scope, complexity, and risks of the individual
activities or investments consistent with the requirements of
section 13 of the BHC Act and this part;
3. Subject the effectiveness of the compliance program to
periodic independent review and testing, and ensure that the
entity's internal audit, corporate compliance and internal control
functions involved in review and testing are effective and
independent;
4. Make senior management, and others as appropriate,
accountable for the effective implementation of the compliance
program, and ensure that the board of directors and chief executive
officer (or equivalent) of the banking entity review the
effectiveness of the compliance program; and
5. Facilitate supervision and examination by the Agencies of the
banking entity's permitted trading and covered fund activities and
investments.
II. Enhanced Compliance Program
a. Proprietary Trading Activities
A banking entity must establish, maintain and enforce a
compliance program that includes written policies and procedures
that are appropriate for the types, size, and complexity of, and
risks associated with, its permitted trading activities. The
compliance program may be tailored to the types of trading
activities conducted by the banking entity, and must include a
detailed description of controls established by the banking entity
to reasonably ensure that its trading activities are conducted in
accordance with the requirements and limitations applicable to those
trading activities under section 13 of the BHC Act and this part,
and provide for appropriate revision of the compliance program
before expansion of the trading activities of the banking entity. A
banking entity must devote adequate resources and use knowledgeable
personnel in conducting, supervising and managing its trading
activities, and promote consistency, independence and rigor in
implementing its risk controls and compliance efforts. The
compliance program must be updated with a frequency sufficient to
account for changes in the activities of the banking entity, results
of independent testing of the program, identification of weaknesses
in the program, and changes in legal, regulatory or other
requirements.
1. Trading Desks: The banking entity must have written policies
and procedures governing each trading desk that include a
description of:
i. The process for identifying, authorizing and documenting
financial instruments each trading desk may purchase or sell, with
separate documentation for market making-related activities
conducted in reliance on Sec. 75.4(b) and for hedging activity
conducted in reliance on Sec. 75.5;
ii. A mapping for each trading desk to the division, business
line, or other organizational structure that is responsible for
managing and overseeing the trading desk's activities;
iii. The mission (i.e., the type of trading activity, such as
market-making, trading in sovereign debt, etc.) and strategy (i.e.,
methods for conducting authorized trading activities) of each
trading desk;
iv. The activities that the trading desk is authorized to
conduct, including (i) authorized instruments and products, and (ii)
authorized hedging strategies, techniques and instruments;
v. The types and amount of risks allocated by the banking entity
to each trading desk to implement the mission and strategy of the
trading desk, including an enumeration of material risks resulting
from the activities in which the trading desk is authorized to
engage (including but not limited to price risks, such as basis,
volatility and correlation risks, as well as counterparty credit
risk). Risk assessments must take into account both the risks
inherent in the trading activity and the strength and effectiveness
of controls designed to mitigate those risks;
vi. How the risks allocated to each trading desk will be
measured;
vii. Why the allocated risks levels are appropriate to the
activities authorized for the trading desk;
viii. The limits on the holding period of, and the risk
associated with, financial instruments under the responsibility of
the trading desk;
ix. The process for setting new or revised limits, as well as
escalation procedures for granting exceptions to any limits or to
any policies or procedures governing the desk, the analysis that
will be required to support revising limits or granting exceptions,
and the process for independently reviewing and documenting those
exceptions and the underlying analysis;
x. The process for identifying, documenting and approving new
products, trading strategies, and hedging strategies;
xi. The types of clients, customers, and counterparties with
whom the trading desk may trade; and
xii. The compensation arrangements, including incentive
arrangements, for employees associated with the trading desk, which
may not be designed to reward or incentivize prohibited proprietary
trading or excessive or imprudent risk-taking.
2. Description of risks and risk management processes: The
compliance program for the banking entity must include a
comprehensive description of the risk management program for the
trading activity of the banking entity. The compliance program must
also include a description of the governance, approval, reporting,
escalation, review and other processes the banking entity will use
to reasonably ensure that trading activity is conducted in
compliance with section 13 of the BHC Act and this part. Trading
activity in similar financial instruments should be subject to
similar governance, limits, testing, controls, and review, unless
the banking entity specifically determines to establish different
limits or processes and documents those differences. Descriptions
must include, at a minimum, the following elements:
i. A description of the supervisory and risk management
structure governing all trading activity, including a description of
processes for initial and senior-level review of new products and
new strategies;
ii. A description of the process for developing, documenting,
testing, approving and reviewing all models used for valuing,
identifying and monitoring the risks of trading activity and related
positions, including the process for periodic independent testing of
the reliability and accuracy of those models;
iii. A description of the process for developing, documenting,
testing, approving and reviewing the limits established for each
trading desk;
iv. A description of the process by which a security may be
purchased or sold pursuant to the liquidity management plan,
including the process for authorizing and monitoring such activity
to ensure compliance with the banking entity's liquidity management
plan and the restrictions on liquidity management activities in this
part;
v. A description of the management review process, including
escalation procedures, for approving any temporary exceptions or
permanent adjustments to limits on the activities, positions,
strategies, or risks associated with each trading desk; and
vi. The role of the audit, compliance, risk management and other
relevant units for conducting independent testing of trading and
hedging activities, techniques and strategies.
3. Authorized risks, instruments, and products. The banking
entity must implement and enforce limits and internal controls for
each trading desk that are reasonably designed to ensure that
trading activity is conducted in conformance with section 13 of the
BHC Act and this part and with the banking entity's written policies
and procedures. The banking entity must establish and enforce risk
limits appropriate for the activity of each trading desk. These
limits should be based on probabilistic and non-probabilistic
measures of potential loss (e.g., Value-at-Risk and notional
exposure, respectively), and measured under normal and stress market
conditions. At a minimum, these internal controls must monitor,
establish and enforce limits on:
i. The financial instruments (including, at a minimum, by type
and exposure) that the trading desk may trade;
[[Page 62235]]
ii. The types and levels of risks that may be taken by each
trading desk; and
iii. The types of hedging instruments used, hedging strategies
employed, and the amount of risk effectively hedged.
4. Hedging policies and procedures. The banking entity must
establish, maintain, and enforce written policies and procedures
regarding the use of risk-mitigating hedging instruments and
strategies that, at a minimum, describe:
i. The positions, techniques and strategies that each trading
desk may use to hedge the risk of its positions;
ii. The manner in which the banking entity will identify the
risks arising in connection with and related to the individual or
aggregated positions, contracts or other holdings of the banking
entity that are to be hedged and determine that those risks have
been properly and effectively hedged;
iii. The level of the organization at which hedging activity and
management will occur;
iv. The manner in which hedging strategies will be monitored and
the personnel responsible for such monitoring;
v. The risk management processes used to control unhedged or
residual risks; and
vi. The process for developing, documenting, testing, approving
and reviewing all hedging positions, techniques and strategies
permitted for each trading desk and for the banking entity in
reliance on Sec. 75.5.
5. Analysis and quantitative measurements. The banking entity
must perform robust analysis and quantitative measurement of its
trading activities that is reasonably designed to ensure that the
trading activity of each trading desk is consistent with the banking
entity's compliance program; monitor and assist in the
identification of potential and actual prohibited proprietary
trading activity; and prevent the occurrence of prohibited
proprietary trading. Analysis and models used to determine, measure
and limit risk must be rigorously tested and be reviewed by
management responsible for trading activity to ensure that trading
activities, limits, strategies, and hedging activities do not
understate the risk and exposure to the banking entity or allow
prohibited proprietary trading. This review should include periodic
and independent back-testing and revision of activities, limits,
strategies and hedging as appropriate to contain risk and ensure
compliance. In addition to the quantitative measurements reported by
any banking entity subject to Appendix A of this part, each banking
entity must develop and implement, to the extent appropriate to
facilitate compliance with this part, additional quantitative
measurements specifically tailored to the particular risks,
practices, and strategies of its trading desks. The banking entity's
analysis and quantitative measurements must incorporate the
quantitative measurements reported by the banking entity pursuant to
Appendix A of this part (if applicable) and include, at a minimum,
the following:
i. Internal controls and written policies and procedures
reasonably designed to ensure the accuracy and integrity of
quantitative measurements;
ii. Ongoing, timely monitoring and review of calculated
quantitative measurements;
iii. The establishment of numerical thresholds and appropriate
trading measures for each trading desk and heightened review of
trading activity not consistent with those thresholds to ensure
compliance with section 13 of the BHC Act and this part, including
analysis of the measurement results or other information,
appropriate escalation procedures, and documentation related to the
review; and
iv. Immediate review and compliance investigation of the trading
desk's activities, escalation to senior management with oversight
responsibilities for the applicable trading desk, timely
notification to the Commission, appropriate remedial action (e.g.,
divesting of impermissible positions, cessation of impermissible
activity, disciplinary actions), and documentation of the
investigation findings and remedial action taken when quantitative
measurements or other information, considered together with the
facts and circumstances, or findings of internal audit, independent
testing or other review suggest a reasonable likelihood that the
trading desk has violated any part of section 13 of the BHC Act or
this part.
6. Other Compliance Matters. In addition to the requirements
specified above, the banking entity's compliance program must:
i. Identify activities of each trading desk that will be
conducted in reliance on exemptions contained in Sec. Sec. 75.4
through 75.6, including an explanation of:
A. How and where in the organization the activity occurs; and
B. Which exemption is being relied on and how the activity meets
the specific requirements for reliance on the applicable exemption;
ii. Include an explanation of the process for documenting,
approving and reviewing actions taken pursuant to the liquidity
management plan, where in the organization this activity occurs, the
securities permissible for liquidity management, the process for
ensuring that liquidity management activities are not conducted for
the purpose of prohibited proprietary trading, and the process for
ensuring that securities purchased as part of the liquidity
management plan are highly liquid and conform to the requirements of
this part;
iii. Describe how the banking entity monitors for and prohibits
potential or actual material exposure to high-risk assets or high-
risk trading strategies presented by each trading desk that relies
on the exemptions contained in Sec. Sec. 75.3(d)(3) and 75.4
through 75.6, which must take into account potential or actual
exposure to:
A. Assets whose values cannot be externally priced or, where
valuation is reliant on pricing models, whose model inputs cannot be
externally validated;
B. Assets whose changes in value cannot be adequately mitigated
by effective hedging;
C. New products with rapid growth, including those that do not
have a market history;
D. Assets or strategies that include significant embedded
leverage;
E. Assets or strategies that have demonstrated significant
historical volatility;
F. Assets or strategies for which the application of capital and
liquidity standards would not adequately account for the risk; and
G. Assets or strategies that result in large and significant
concentrations to sectors, risk factors, or counterparties;
iv. Establish responsibility for compliance with the reporting
and recordkeeping requirements of subpart B of this part and Sec.
75.20; and
v. Establish policies for monitoring and prohibiting potential
or actual material conflicts of interest between the banking entity
and its clients, customers, or counterparties.
7. Remediation of violations. The banking entity's compliance
program must be reasonably designed and established to effectively
monitor and identify for further analysis any trading activity that
may indicate potential violations of section 13 of the BHC Act and
this part and to prevent actual violations of section 13 of the BHC
Act and this part. The compliance program must describe procedures
for identifying and remedying violations of section 13 of the BHC
Act and this part, and must include, at a minimum, a requirement to
promptly document, address and remedy any violation of section 13 of
the BHC Act or this part, and document all proposed and actual
remediation efforts. The compliance program must include specific
written policies and procedures that are reasonably designed to
assess the extent to which any activity indicates that modification
to the banking entity's compliance program is warranted and to
ensure that appropriate modifications are implemented. The written
policies and procedures must provide for prompt notification to
appropriate management, including senior management and the board of
directors, of any material weakness or significant deficiencies in
the design or implementation of the compliance program of the
banking entity.
b. Covered Fund Activities or Investments
A banking entity must establish, maintain and enforce a
compliance program that includes written policies and procedures
that are appropriate for the types, size, complexity and risks of
the covered fund and related activities conducted and investments
made, by the banking entity.
1. Identification of covered funds. The banking entity's
compliance program must provide a process, which must include
appropriate management review and independent testing, for
identifying and documenting covered funds that each unit within the
banking entity's organization sponsors or organizes and offers, and
covered funds in which each such unit invests. In addition to the
documentation requirements for covered funds, as specified under
Sec. 75.20(e), the documentation must include information that
identifies all pools that the banking entity sponsors or has an
interest in and the type of exemption from the Commodity Exchange
Act (whether or not the pool relies on Sec. 4.7 of the regulations
under the Commodity Exchange Act (Sec. 4.7 of this chapter)), and
the amount of ownership interest the banking entity has in those
pools.
[[Page 62236]]
2. Identification of covered fund activities and investments.
The banking entity's compliance program must identify, document and
map each unit within the organization that is permitted to acquire
or hold an interest in any covered fund or sponsor any covered fund
and map each unit to the division, business line, or other
organizational structure that will be responsible for managing and
overseeing that unit's activities and investments.
3. Explanation of compliance. The banking entity's compliance
program must explain how:
i. The banking entity monitors for and prohibits potential or
actual material conflicts of interest between the banking entity and
its clients, customers, or counterparties related to its covered
fund activities and investments;
ii. The banking entity monitors for and prohibits potential or
actual transactions or activities that may threaten the safety and
soundness of the banking entity related to its covered fund
activities and investments; and
iii. The banking entity monitors for and prohibits potential or
actual material exposure to high-risk assets or high-risk trading
strategies presented by its covered fund activities and investments,
taking into account potential or actual exposure to:
A. Assets whose values cannot be externally priced or, where
valuation is reliant on pricing models, whose model inputs cannot be
externally validated;
B. Assets whose changes in values cannot be adequately mitigated
by effective hedging;
C. New products with rapid growth, including those that do not
have a market history;
D. Assets or strategies that include significant embedded
leverage;
E. Assets or strategies that have demonstrated significant
historical volatility;
F. Assets or strategies for which the application of capital and
liquidity standards would not adequately account for the risk; and
G. Assets or strategies that expose the banking entity to large
and significant concentrations with respect to sectors, risk
factors, or counterparties;
4. Description and documentation of covered fund activities and
investments. For each organizational unit engaged in covered fund
activities and investments, the banking entity's compliance program
must document:
i. The covered fund activities and investments that the unit is
authorized to conduct;
ii. The banking entity's plan for actively seeking unaffiliated
investors to ensure that any investment by the banking entity
conforms to the limits contained in Sec. 75.12 or registered in
compliance with the securities laws and thereby exempt from those
limits within the time periods allotted in Sec. 75.12; and
iii. How it complies with the requirements of subpart C of this
part.
5. Internal Controls. A banking entity must establish, maintain,
and enforce internal controls that are reasonably designed to ensure
that its covered fund activities or investments comply with the
requirements of section 13 of the BHC Act and this part and are
appropriate given the limits on risk established by the banking
entity. These written internal controls must be reasonably designed
and established to effectively monitor and identify for further
analysis any covered fund activity or investment that may indicate
potential violations of section 13 of the BHC Act or this part. The
internal controls must, at a minimum require:
i. Monitoring and limiting the banking entity's individual and
aggregate investments in covered funds;
ii. Monitoring the amount and timing of seed capital investments
for compliance with the limitations under subpart C of this part
(including but not limited to the redemption, sale or disposition
requirements of Sec. 75.12), and the effectiveness of efforts to
seek unaffiliated investors to ensure compliance with those limits;
iii. Calculating the individual and aggregate levels of
ownership interests in one or more covered fund required by Sec.
75.12;
iv. Attributing the appropriate instruments to the individual
and aggregate ownership interest calculations above;
v. Making disclosures to prospective and actual investors in any
covered fund organized and offered or sponsored by the banking
entity, as provided under Sec. 75.11(a)(8);
vi. Monitoring for and preventing any relationship or
transaction between the banking entity and a covered fund that is
prohibited under Sec. 75.14, including where the banking entity has
been designated as the sponsor, investment manager, investment
adviser, or commodity trading advisor to a covered fund by another
banking entity; and
vii. Appropriate management review and supervision across legal
entities of the banking entity to ensure that services and products
provided by all affiliated entities comply with the limitation on
services and products contained in Sec. 75.14.
6. Remediation of violations. The banking entity's compliance
program must be reasonably designed and established to effectively
monitor and identify for further analysis any covered fund activity
or investment that may indicate potential violations of section 13
of the BHC Act or this part and to prevent actual violations of
section 13 of the BHC Act and this part. The banking entity's
compliance program must describe procedures for identifying and
remedying violations of section 13 of the BHC Act and this part, and
must include, at a minimum, a requirement to promptly document,
address and remedy any violation of section 13 of the BHC Act or
this part, including Sec. 75.21, and document all proposed and
actual remediation efforts. The compliance program must include
specific written policies and procedures that are reasonably
designed to assess the extent to which any activity or investment
indicates that modification to the banking entity's compliance
program is warranted and to ensure that appropriate modifications
are implemented. The written policies and procedures must provide
for prompt notification to appropriate management, including senior
management and the board of directors, of any material weakness or
significant deficiencies in the design or implementation of the
compliance program of the banking entity.
III. Responsibility and Accountability for the Compliance Program
a. A banking entity must establish, maintain, and enforce a
governance and management framework to manage its business and
employees with a view to preventing violations of section 13 of the
BHC Act and this part. A banking entity must have an appropriate
management framework reasonably designed to ensure that: Appropriate
personnel are responsible and accountable for the effective
implementation and enforcement of the compliance program; a clear
reporting line with a chain of responsibility is delineated; and the
compliance program is reviewed periodically by senior management.
The board of directors (or equivalent governance body) and senior
management should have the appropriate authority and access to
personnel and information within the organizations as well as
appropriate resources to conduct their oversight activities
effectively.
1. Corporate governance. The banking entity must adopt a written
compliance program approved by the board of directors, an
appropriate committee of the board, or equivalent governance body,
and senior management.
2. Management procedures. The banking entity must establish,
maintain, and enforce a governance framework that is reasonably
designed to achieve compliance with section 13 of the BHC Act and
this part, which, at a minimum, provides for:
i. The designation of appropriate senior management or committee
of senior management with authority to carry out the management
responsibilities of the banking entity for each trading desk and for
each organizational unit engaged in covered fund activities;
ii. Written procedures addressing the management of the
activities of the banking entity that are reasonably designed to
achieve compliance with section 13 of the BHC Act and this part,
including:
A. A description of the management system, including the titles,
qualifications, and locations of managers and the specific
responsibilities of each person with respect to the banking entity's
activities governed by section 13 of the BHC Act and this part; and
B. Procedures for determining compensation arrangements for
traders engaged in underwriting or market making-related activities
under Sec. 75.4 or risk-mitigating hedging activities under Sec.
75.5 so that such compensation arrangements are designed not to
reward or incentivize prohibited proprietary trading and
appropriately balance risk and financial results in a manner that
does not encourage employees to expose the banking entity to
excessive or imprudent risk.
3. Business line managers. Managers with responsibility for one
or more trading desks of the banking entity are accountable for the
effective implementation and enforcement of the compliance program
with respect to the applicable trading desk(s).
4. Board of directors, or similar corporate body, and senior
management. The board of
[[Page 62237]]
directors, or similar corporate body, and senior management are
responsible for setting and communicating an appropriate culture of
compliance with section 13 of the BHC Act and this part and ensuring
that appropriate policies regarding the management of trading
activities and covered fund activities or investments are adopted to
comply with section 13 of the BHC Act and this part. The board of
directors or similar corporate body (such as a designated committee
of the board or an equivalent governance body) must ensure that
senior management is fully capable, qualified, and properly
motivated to manage compliance with this part in light of the
organization's business activities and the expectations of the board
of directors. The board of directors or similar corporate body must
also ensure that senior management has established appropriate
incentives and adequate resources to support compliance with this
part, including the implementation of a compliance program meeting
the requirements of this appendix into management goals and
compensation structures across the banking entity.
5. Senior management. Senior management is responsible for
implementing and enforcing the approved compliance program. Senior
management must also ensure that effective corrective action is
taken when failures in compliance with section 13 of the BHC Act and
this part are identified. Senior management and control personnel
charged with overseeing compliance with section 13 of the BHC Act
and this part should review the compliance program for the banking
entity periodically and report to the board, or an appropriate
committee thereof, on the effectiveness of the compliance program
and compliance matters with a frequency appropriate to the size,
scope, and risk profile of the banking entity's trading activities
and covered fund activities or investments, which shall be at least
annually.
6. CEO attestation. Based on a review by the CEO of the banking
entity, the CEO of the banking entity must, annually, attest in
writing to the Commission that the banking entity has in place
processes to establish, maintain, enforce, review, test and modify
the compliance program established under this appendix and Sec.
75.20 in a manner reasonably designed to achieve compliance with
section 13 of the BHC Act and this part. In the case of a U.S.
branch or agency of a foreign banking entity, the attestation may be
provided for the entire U.S. operations of the foreign banking
entity by the senior management officer of the United States
operations of the foreign banking entity who is located in the
United States.
IV. Independent Testing
a. Independent testing must occur with a frequency appropriate
to the size, scope, and risk profile of the banking entity's trading
and covered fund activities or investments, which shall be at least
annually. This independent testing must include an evaluation of:
1. The overall adequacy and effectiveness of the banking
entity's compliance program, including an analysis of the extent to
which the program contains all the required elements of this
appendix;
2. The effectiveness of the banking entity's internal controls,
including an analysis and documentation of instances in which such
internal controls have been breached, and how such breaches were
addressed and resolved; and
3. The effectiveness of the banking entity's management
procedures.
b. A banking entity must ensure that independent testing
regarding the effectiveness of the banking entity's compliance
program is conducted by a qualified independent party, such as the
banking entity's internal audit department, compliance personnel or
risk managers independent of the organizational unit being tested,
outside auditors, consultants, or other qualified independent
parties. A banking entity must promptly take appropriate action to
remedy any significant deficiencies or material weaknesses in its
compliance program and to terminate any violations of section 13 of
the BHC Act or this part.
V. Training
Banking entities must provide adequate training to personnel and
managers of the banking entity engaged in activities or investments
governed by section 13 of the BHC Act or this part, as well as other
appropriate supervisory, risk, independent testing, and audit
personnel, in order to effectively implement and enforce the
compliance program. This training should occur with a frequency
appropriate to the size and the risk profile of the banking entity's
trading activities and covered fund activities or investments.
VI. Recordkeeping
Banking entities must create and retain records sufficient to
demonstrate compliance and support the operations and effectiveness
of the compliance program. A banking entity must retain these
records for a period that is no less than 5 years or such longer
period as required by the Commission in a form that allows it to
promptly produce such records to the Commission on request.
SECURITIES AND EXCHANGE COMMISSION
17 CFR Chapter II
Authority and Issuance
For the reasons set forth in the Common Preamble, the Securities
and Exchange Commission amends part 255 to chapter II of Title 17 of
the Code of Federal Regulations as follows:
PART 255--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS
0
60. The authority citation for part 255 continues to read as follows:
Authority: 12 U.S.C. 1851.
Subpart A--Authority and Definitions
0
61. Section 255.2 is revised to read as follows:
Sec. 255.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(c) Banking entity. (1) Except as provided in paragraph (c)(2) of
this section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an insured depository institution;
(iii) Any company that is treated as a bank holding company for
purposes of section 8 of the International Banking Act of 1978 (12
U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any entity described in
paragraph (c)(1)(i), (ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a banking entity under
paragraph (c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraph (c)(1)(i), (ii), or (iii) of
this section; or
(iii) The FDIC acting in its corporate capacity or as conservator
or receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(d) Board means the Board of Governors of the Federal Reserve
System.
(e) CFTC means the Commodity Futures Trading Commission.
(f) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(g) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(h) Derivative. (1) Except as provided in paragraph (h)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
[[Page 62238]]
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the immediate family of the
employee.
(j) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(k) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(l) FDIC means the Federal Deposit Insurance Corporation.
(m) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(n) Foreign banking organization has the same meaning as in Sec.
211.21(o) of the Board's Regulation K (12 CFR 211.21(o)), but does not
include a foreign bank, as defined in section 1(b)(7) of the
International Banking Act of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the Commonwealth of Puerto Rico, Guam,
American Samoa, the United States Virgin Islands, or the Commonwealth
of the Northern Mariana Islands.
(o) Foreign insurance regulator means the insurance commissioner,
or a similar official or agency, of any country other than the United
States that is engaged in the supervision of insurance companies under
foreign insurance law.
(p) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(q) Insurance company means a company that is organized as an
insurance company, primarily and predominantly engaged in writing
insurance or reinsuring risks underwritten by insurance companies,
subject to supervision as such by a state insurance regulator or a
foreign insurance regulator, and not operated for the purpose of
evading the provisions of section 13 of the BHC Act (12 U.S.C. 1851).
(r) Insured depository institution has the same meaning as in
section 3(c) of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)),
but does not include:
(1) An insured depository institution that is described in section
2(c)(2)(D) of the BHC Act (12 U.S.C. 1841(c)(2)(D)); or
(2) An insured depository institution if it has, and if every
company that controls it has, total consolidated assets of $10 billion
or less and total trading assets and trading liabilities, on a
consolidated basis, that are 5 percent or less of total consolidated
assets.
(s) Limited trading assets and liabilities means with respect to a
banking entity that:
(1)(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities (excluding trading assets
and liabilities attributable to trading activities permitted pursuant
to Sec. 255.6(a)(1) and (2) of subpart B) the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, is less
than $1 billion; and
(ii) The SEC has not determined pursuant to Sec. 255.20(g) or (h)
of this part that the banking entity should not be treated as having
limited trading assets and liabilities.
(2) With respect to a banking entity other than a banking entity
described in paragraph (s)(3) of this section, trading assets and
liabilities for purposes of this paragraph (s) means trading assets and
liabilities (excluding trading assets and liabilities attributable to
trading activities permitted pursuant to Sec. 255.6(a)(1) and (2) of
subpart B) on a worldwide consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (s) means the
trading assets and liabilities (excluding trading assets and
liabilities attributable to trading activities permitted pursuant to
Sec. 255.6(a)(1) and (2) of subpart B) of the combined U.S. operations
of the top-tier foreign banking organization (including all
subsidiaries, affiliates, branches, and agencies of the foreign banking
organization operating, located, or organized in the United States).
(ii) For purposes of paragraph (s)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary. For purposes of paragraph (s)(3)(i) of
this section, all foreign operations of a U.S. agency, branch, or
subsidiary of a foreign banking organization are considered to be
located in the United States, including branches outside the United
States that are managed or controlled by a U.S. branch or agency of the
foreign banking organization, for purposes of calculating the banking
entity's U.S. trading assets and liabilities.
(t) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(u) Moderate trading assets and liabilities means, with respect to
a banking entity, that the banking entity does not have significant
trading assets and liabilities or limited trading assets and
liabilities.
(v) Primary financial regulatory agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 5301(12)).
(w) Purchase includes any contract to buy, purchase, or otherwise
acquire. For security futures products, purchase includes any contract,
agreement, or transaction for future delivery. With respect to a
commodity future, purchase includes any contract, agreement, or
transaction for future delivery. With respect to a derivative, purchase
includes the execution, termination (prior to its scheduled maturity
date), assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a derivative, as the
context may require.
(x) Qualifying foreign banking organization means a foreign banking
organization that qualifies as such under Sec. 211.23(a), (c) or (e)
of the Board's Regulation K (12 CFR 211.23(a), (c), or (e)).
[[Page 62239]]
(y) SEC means the Securities and Exchange Commission.
(z) Sale and sell each include any contract to sell or otherwise
dispose of. For security futures products, such terms include any
contract, agreement, or transaction for future delivery. With respect
to a commodity future, such terms include any contract, agreement, or
transaction for future delivery. With respect to a derivative, such
terms include the execution, termination (prior to its scheduled
maturity date), assignment, exchange, or similar transfer or conveyance
of, or extinguishing of rights or obligations under, a derivative, as
the context may require.
(aa) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(bb) Security-based swap dealer has the same meaning as in section
3(a)(71) of the Exchange Act (15 U.S.C. 78c(a)(71)).
(cc) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(dd) Separate account means an account established and maintained
by an insurance company in connection with one or more insurance
contracts to hold assets that are legally segregated from the insurance
company's other assets, under which income, gains, and losses, whether
or not realized, from assets allocated to such account, are, in
accordance with the applicable contract, credited to or charged against
such account without regard to other income, gains, or losses of the
insurance company.
(ee) Significant trading assets and liabilities means with respect
to a banking entity that: (1)(i) The banking entity has, together with
its affiliates and subsidiaries, trading assets and liabilities the
average gross sum of which over the previous consecutive four quarters,
as measured as of the last day of each of the four previous calendar
quarters, equals or exceeds $20 billion; or
(ii) The SEC has determined pursuant to Sec. 255.20(h) of this
part that the banking entity should be treated as having significant
trading assets and liabilities.
(2) With respect to a banking entity, other than a banking entity
described in paragraph (ee)(3) of this section, trading assets and
liabilities for purposes of this paragraph (ee) means trading assets
and liabilities (excluding trading assets and liabilities attributable
to trading activities permitted pursuant to Sec. 255.6(a)(1) and (2)
of subpart B) on a worldwide consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (ee) means the
trading assets and liabilities (excluding trading assets and
liabilities attributable to trading activities permitted pursuant to
Sec. 255.6(a)(1) and (2) of subpart B) of the combined U.S. operations
of the top-tier foreign banking organization (including all
subsidiaries, affiliates, branches, and agencies of the foreign banking
organization operating, located, or organized in the United States as
well as branches outside the United States that are managed or
controlled by a branch or agency of the foreign banking entity
operating, located or organized in the United States).
(ii) For purposes of paragraph (ee)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary. For purposes of paragraph (ee)(3)(i) of
this section, all foreign operations of a U.S. agency, branch, or
subsidiary of a foreign banking organization are considered to be
located in the United States for purposes of calculating the banking
entity's U.S. trading assets and liabilities.
(ff) State means any State, the District of Columbia, the
Commonwealth of Puerto Rico, Guam, American Samoa, the United States
Virgin Islands, and the Commonwealth of the Northern Mariana Islands.
(gg) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(hh) State insurance regulator means the insurance commissioner, or
a similar official or agency, of a State that is engaged in the
supervision of insurance companies under State insurance law.
(ii) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
Subpart B--Proprietary Trading
0
62. Section 255.3 is amended by:
0
a. Revising paragraphs (b) and (d)(3), (8), and (9);
0
b. Adding paragraphs (d)(10) through (13);
0
c. Redesignating paragraphs (e)(5) through (13) as paragraphs (e)(6)
through (14);
0
d. Adding new paragraph (e)(5); and
0
e. Revising paragraph (e)(11), (12), and (14).
The revisions and additions read as follows:
Sec. 255.3 Prohibition on proprietary trading.
* * * * *
(b) Definition of trading account. (1) Trading account. Trading
account means:
(i) Any account that is used by a banking entity to purchase or
sell one or more financial instruments principally for the purpose of
short-term resale, benefitting from actual or expected short-term price
movements, realizing short-term arbitrage profits, or hedging one or
more of the positions resulting from the purchases or sales of
financial instruments described in this paragraph;
(ii) Any account that is used by a banking entity to purchase or
sell one or more financial instruments that are both market risk
capital rule covered positions and trading positions (or hedges of
other market risk capital rule covered positions), if the banking
entity, or any affiliate with which the banking entity is consolidated
for regulatory reporting purposes, calculates risk-based capital ratios
under the market risk capital rule; or
(iii) Any account that is used by a banking entity to purchase or
sell one or more financial instruments, if the banking entity:
(A) Is licensed or registered, or is required to be licensed or
registered, to engage in the business of a dealer, swap dealer, or
security-based swap dealer, to the extent the instrument is purchased
or sold in connection with the activities that require the banking
entity to be licensed or registered as such; or
(B) Is engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
the instrument is purchased or sold in connection with the activities
of such business.
(2) Trading account application for certain banking entities. (i) A
banking entity that is subject to paragraph (b)(1)(ii) of this section
in determining the scope of its trading account is not subject to
paragraph (b)(1)(i) of this section.
(ii) A banking entity that does not calculate risk-based capital
ratios under the market risk capital rule and is not a consolidated
affiliate for regulatory reporting purposes of a banking entity that
calculates risk based capital ratios under the market risk capital rule
may elect to apply paragraph (b)(1)(ii) of this section in determining
the scope of its trading account as if it were subject to that
paragraph. A banking entity that
[[Page 62240]]
elects under this section to apply paragraph (b)(1)(ii) of this section
in determining the scope of its trading account as if it were subject
to that paragraph is not required to apply paragraph (b)(1)(i) of this
section.
(3) Consistency of account election for certain banking entities.
(i) Any election or change to an election under paragraph (b)(2)(ii) of
this section must apply to the electing banking entity and all of its
wholly owned subsidiaries. The primary financial regulatory agency of a
banking entity that is affiliated with but is not a wholly owned
subsidiary of such electing banking entity may require that the banking
entity be subject to this uniform application requirement if the
primary financial regulatory agency determines that it is necessary to
prevent evasion of the requirements of this part after notice and
opportunity for response as provided in subpart D.
(ii) A banking entity that does not elect under paragraph
(b)(2)(ii) of this section to be subject to the trading account
definition in (b)(1)(ii) may continue to apply the trading account
definition in paragraph (b)(1)(i) of this section for one year from the
date on which it becomes, or becomes a consolidated affiliate for
regulatory reporting purposes with, a banking entity that calculates
risk-based capital ratios under the market risk capital rule.
(4) Rebuttable presumption for certain purchases and sales. The
purchase (or sale) of a financial instrument by a banking entity shall
be presumed not to be for the trading account of the banking entity
under paragraph (b)(1)(i) of this section if the banking entity holds
the financial instrument for sixty days or longer and does not transfer
substantially all of the risk of the financial instrument within sixty
days of the purchase (or sale).
* * * * *
(d) * * *
(3) Any purchase or sale of a security, foreign exchange forward
(as that term is defined in section 1a(24) of the Commodity Exchange
Act (7 U.S.C. 1a(24)), foreign exchange swap (as that term is defined
in section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)), or
cross-currency swap by a banking entity for the purpose of liquidity
management in accordance with a documented liquidity management plan of
the banking entity that:
(i) Specifically contemplates and authorizes the particular
financial instruments to be used for liquidity management purposes, the
amount, types, and risks of these financial instruments that are
consistent with liquidity management, and the liquidity circumstances
in which the particular financial instruments may or must be used;
(ii) Requires that any purchase or sale of financial instruments
contemplated and authorized by the plan be principally for the purpose
of managing the liquidity of the banking entity, and not for the
purpose of short-term resale, benefitting from actual or expected
short-term price movements, realizing short-term arbitrage profits, or
hedging a position taken for such short-term purposes;
(iii) Requires that any financial instruments purchased or sold for
liquidity management purposes be highly liquid and limited to financial
instruments the market, credit, and other risks of which the banking
entity does not reasonably expect to give rise to appreciable profits
or losses as a result of short-term price movements;
(iv) Limits any financial instruments purchased or sold for
liquidity management purposes, together with any other financial
instruments purchased or sold for such purposes, to an amount that is
consistent with the banking entity's near-term funding needs, including
deviations from normal operations of the banking entity or any
affiliate thereof, as estimated and documented pursuant to methods
specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of financial instruments that are not permitted under Sec. 255.6(a) or
(b) of this subpart are for the purpose of liquidity management and in
accordance with the liquidity management plan described in this
paragraph (d)(3); and
(vi) Is consistent with the SEC's regulatory requirements regarding
liquidity management;
* * * * *
(8) Any purchase or sale of one or more financial instruments by a
banking entity through a deferred compensation, stock-bonus, profit-
sharing, or pension plan of the banking entity that is established and
administered in accordance with the law of the United States or a
foreign sovereign, if the purchase or sale is made directly or
indirectly by the banking entity as trustee for the benefit of persons
who are or were employees of the banking entity;
(9) Any purchase or sale of one or more financial instruments by a
banking entity in the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
financial instrument as soon as practicable, and in no event may the
banking entity retain such instrument for longer than such period
permitted by the SEC;
(10) Any purchase or sale of one or more financial instruments that
was made in error by a banking entity in the course of conducting a
permitted or excluded activity or is a subsequent transaction to
correct such an error;
(11) Contemporaneously entering into a customer-driven swap or
customer-driven security-based swap and a matched swap or security-
based swap if:
(i) The banking entity retains no more than minimal price risk; and
(ii) The banking entity is not a registered dealer, swap dealer, or
security-based swap dealer;
(12) Any purchase or sale of one or more financial instruments that
the banking entity uses to hedge mortgage servicing rights or mortgage
servicing assets in accordance with a documented hedging strategy; or
(13) Any purchase or sale of a financial instrument that does not
meet the definition of trading asset or trading liability under the
applicable reporting form for a banking entity as of January 1, 2020.
(e) * * *
(5) Cross-currency swap means a swap in which one party exchanges
with another party principal and interest rate payments in one currency
for principal and interest rate payments in another currency, and the
exchange of principal occurs on the date the swap is entered into, with
a reversal of the exchange of principal at a later date that is agreed
upon when the swap is entered into.
* * * * *
(11) Market risk capital rule covered position and trading position
means a financial instrument that meets the criteria to be a covered
position and a trading position, as those terms are respectively
defined, without regard to whether the financial instrument is reported
as a covered position or trading position on any applicable regulatory
reporting forms:
(i) In the case of a banking entity that is a bank holding company,
savings and loan holding company, or insured depository institution,
under the market risk capital rule that is applicable to the banking
entity; and
(ii) In the case of a banking entity that is affiliated with a bank
holding company or savings and loan holding company, other than a
banking entity to which a market risk capital rule is applicable, under
the market risk capital rule that is applicable to the affiliated
[[Page 62241]]
bank holding company or savings and loan holding company.
(12) Market risk capital rule means the market risk capital rule
that is contained in 12 CFR part 3, subpart F, with respect to a
banking entity for which the OCC is the primary financial regulatory
agency, 12 CFR part 217 with respect to a banking entity for which the
Board is the primary financial regulatory agency, or 12 CFR part 324
with respect to a banking entity for which the FDIC is the primary
financial regulatory agency.
* * * * *
(14) Trading desk means a unit of organization of a banking entity
that purchases or sells financial instruments for the trading account
of the banking entity or an affiliate thereof that is:
(i)(A) Structured by the banking entity to implement a well-defined
business strategy;
(B) Organized to ensure appropriate setting, monitoring, and
management review of the desk's trading and hedging limits, current and
potential future loss exposures, and strategies; and
(C) Characterized by a clearly defined unit that:
(1) Engages in coordinated trading activity with a unified approach
to its key elements;
(2) Operates subject to a common and calibrated set of risk
metrics, risk levels, and joint trading limits;
(3) Submits compliance reports and other information as a unit for
monitoring by management; and
(4) Books its trades together; or
(ii) For a banking entity that calculates risk-based capital ratios
under the market risk capital rule, or a consolidated affiliate for
regulatory reporting purposes of a banking entity that calculates risk-
based capital ratios under the market risk capital rule, established by
the banking entity or its affiliate for purposes of market risk capital
calculations under the market risk capital rule.
0
63. Section 255.4 is revised to read as follows:
Sec. 255.4 Permitted underwriting and market making-related
activities.
(a) Underwriting activities--(1) Permitted underwriting activities.
The prohibition contained in Sec. 255.3(a) does not apply to a banking
entity's underwriting activities conducted in accordance with this
paragraph (a).
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii)(A) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
taking into account the liquidity, maturity, and depth of the market
for the relevant types of securities; and
(B) Reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity, maturity, and depth of the market for the relevant types
of securities;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (a) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, in accordance with paragraph
(a)(2)(ii)(A) of this section;
(C) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
(D) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
(iv) A banking entity with significant trading assets and
liabilities may satisfy the requirements in paragraphs (a)(2)(iii)(B)
and (C) of this section by complying with the requirements set forth
below in paragraph (c) of this section;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
(3) Definition of distribution. For purposes of this paragraph (a),
a distribution of securities means:
(i) An offering of securities, whether or not subject to
registration under the Securities Act of 1933, that is distinguished
from ordinary trading transactions by the presence of special selling
efforts and selling methods; or
(ii) An offering of securities made pursuant to an effective
registration statement under the Securities Act of 1933.
(4) Definition of underwriter. For purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an issuer or selling security
holder to:
(A) Purchase securities from the issuer or selling security holder
for distribution;
(B) Engage in a distribution of securities for or on behalf of the
issuer or selling security holder; or
(C) Manage a distribution of securities for or on behalf of the
issuer or selling security holder; or
(ii) A person who has agreed to participate or is participating in
a distribution of such securities for or on behalf of the issuer or
selling security holder.
(5) Definition of selling security holder. For purposes of this
paragraph (a), selling security holder means any person, other than an
issuer, on whose behalf a distribution is made.
(6) Definition of underwriting position. For purposes of this
section, underwriting position means the long or short positions in one
or more securities held by a banking entity or its affiliate, and
managed by a particular trading desk, in connection with a particular
distribution of securities for which such banking entity or affiliate
is acting as an underwriter.
(7) Definition of client, customer, and counterparty. For purposes
of this paragraph (a), the terms client, customer, and counterparty, on
a collective or individual basis, refer to market participants that may
transact with the banking entity in connection with a particular
distribution for which the banking entity is acting as underwriter.
(b) Market making-related activities--(1) Permitted market making-
related activities. The prohibition contained in Sec. 255.3(a) does
not apply to a banking entity's market making-related activities
conducted in accordance with this paragraph (b).
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
[[Page 62242]]
(i) The trading desk that establishes and manages the financial
exposure, routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure, and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The trading desk's market-making related activities are
designed not to exceed, on an ongoing basis, the reasonably expected
near term demands of clients, customers, or counterparties, taking into
account the liquidity, maturity, and depth of the market for the
relevant types of financial instruments;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (b) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and positions; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, in accordance with paragraph
(b)(2)(ii) of this section;
(D) Written authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed a trading desk's limit(s), demonstrable analysis of the basis
for any temporary or permanent increase to a trading desk's limit(s),
and independent review of such demonstrable analysis and approval; and
(E) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits.
(iv) A banking entity with significant trading assets and
liabilities may satisfy the requirements in paragraphs (b)(2)(iii)(C)
and (D) of this section by complying with the requirements set forth
below in paragraph (c) of this section;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (b) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in
activity described in this paragraph (b) in accordance with applicable
law.
(3) Definition of client, customer, and counterparty. For purposes
of paragraph (b) of this section, the terms client, customer, and
counterparty, on a collective or individual basis refer to market
participants that make use of the banking entity's market making-
related services by obtaining such services, responding to quotations,
or entering into a continuing relationship with respect to such
services, provided that:
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with the methodology described in
Sec. 255.2(ee) of this part, unless:
(A) The trading desk documents how and why a particular trading
desk or other organizational unit of the entity should be treated as a
client, customer, or counterparty of the trading desk for purposes of
paragraph (b)(2) of this section; or
(B) The purchase or sale by the trading desk is conducted
anonymously on an exchange or similar trading facility that permits
trading on behalf of a broad range of market participants.
(ii) [Reserved]
(4) Definition of financial exposure. For purposes of this section,
financial exposure means the aggregate risks of one or more financial
instruments and any associated loans, commodities, or foreign exchange
or currency, held by a banking entity or its affiliate and managed by a
particular trading desk as part of the trading desk's market making-
related activities.
(5) Definition of market-maker positions. For the purposes of this
section, market-maker positions means all of the positions in the
financial instruments for which the trading desk stands ready to make a
market in accordance with paragraph (b)(2)(i) of this section, that are
managed by the trading desk, including the trading desk's open
positions or exposures arising from open transactions.
(c) Rebuttable presumption of compliance--(1) Internal limits. (i)
A banking entity shall be presumed to meet the requirement in paragraph
(a)(2)(ii)(A) or (b)(2)(ii) of this section with respect to the
purchase or sale of a financial instrument if the banking entity has
established and implements, maintains, and enforces the internal limits
for the relevant trading desk as described in paragraph (c)(1)(ii) of
this section.
(ii)(A) With respect to underwriting activities conducted pursuant
to paragraph (a) of this section, the presumption described in
paragraph (c)(1)(i) of this section shall be available to each trading
desk that establishes, implements, maintains, and enforces internal
limits that should take into account the liquidity, maturity, and depth
of the market for the relevant types of securities and are designed not
to exceed the reasonably expected near term demands of clients,
customers, or counterparties, based on the nature and amount of the
trading desk's underwriting activities, on the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.
(B) With respect to market making-related activities conducted
pursuant to paragraph (b) of this section, the presumption described in
paragraph (c)(1)(i) of this section shall be available to each trading
desk that establishes, implements, maintains, and enforces internal
limits that should take into account the liquidity, maturity, and depth
of the market for the relevant types of financial instruments and are
designed not to exceed the reasonably expected near term demands of
clients, customers, or counterparties, based on the nature and amount
of the trading desk's market-making related activities, that address
the:
(1) Amount, types, and risks of its market-maker positions;
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
[[Page 62243]]
(4) Period of time a financial instrument may be held.
(2) Supervisory review and oversight. The limits described in
paragraph (c)(1) of this section shall be subject to supervisory review
and oversight by the SEC on an ongoing basis.
(3) Limit breaches and increases. (i) With respect to any limit set
pursuant to paragraphs (c)(1)(ii)(A) or (c)(1)(ii)(B) of this section,
a banking entity shall maintain and make available to the SEC upon
request records regarding any limit that is exceeded and any temporary
or permanent increase to any limit(s), in each case in the form and
manner as directed by the SEC.
(ii) In the event of a breach or increase of any limit set pursuant
to paragraph (c)(1)(ii)(A) or (B) of this section, the presumption
described in paragraph (c)(1)(i) of this section shall continue to be
available only if the banking entity:
(A) Takes action as promptly as possible after a breach to bring
the trading desk into compliance; and
(B) Follows established written authorization procedures, including
escalation procedures that require review and approval of any trade
that exceeds a trading desk's limit(s), demonstrable analysis of the
basis for any temporary or permanent increase to a trading desk's
limit(s), and independent review of such demonstrable analysis and
approval.
(4) Rebutting the presumption. The presumption in paragraph
(c)(1)(i) of this section may be rebutted by the SEC if the SEC
determines, taking into account the liquidity, maturity, and depth of
the market for the relevant types of financial instruments and based on
all relevant facts and circumstances, that a trading desk is engaging
in activity that is not based on the reasonably expected near term
demands of clients, customers, or counterparties. The SEC's rebuttal of
the presumption in paragraph (c)(1)(i) must be made in accordance with
the notice and response procedures in subpart D of this part.
0
64. Section 255.5 is amended by revising paragraphs (b) and (c)(1)
introductory text and adding paragraph (c)(4) to read as follows:
Sec. 255.5 Permitted risk-mitigating hedging activities.
* * * * *
(b) Requirements. (1) The risk-mitigating hedging activities of a
banking entity that has significant trading assets and liabilities are
permitted under paragraph (a) of this section only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(C) The conduct of analysis and independent testing designed to
ensure that the positions, techniques and strategies that may be used
for hedging may reasonably be expected to reduce or otherwise
significantly mitigate the specific, identifiable risk(s) being hedged;
(ii) The risk-mitigating hedging activity:
(A) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(B) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(D) Is subject to continuing review, monitoring and management by
the banking entity that:
(1) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1)(i) of this section;
(2) Is designed to reduce or otherwise significantly mitigate the
specific, identifiable risks that develop over time from the risk-
mitigating hedging activities undertaken under this section and the
underlying positions, contracts, and other holdings of the banking
entity, based upon the facts and circumstances of the underlying and
hedging positions, contracts and other holdings of the banking entity
and the risks and liquidity thereof; and
(3) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(1)(ii) of this section and is not
prohibited proprietary trading; and
(iii) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(2) The risk-mitigating hedging activities of a banking entity that
does not have significant trading assets and liabilities are permitted
under paragraph (a) of this section only if the risk-mitigating hedging
activity:
(i) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to ongoing recalibration by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading.
(c) * * *
(1) A banking entity that has significant trading assets and
liabilities must comply with the requirements of paragraphs (c)(2) and
(3) of this section, unless the requirements of paragraph (c)(4) of
this section are met, with respect to any purchase or sale of financial
instruments made in reliance on this section for risk-mitigating
hedging purposes that is:
* * * * *
(4) The requirements of paragraphs (c)(2) and (3) of this section
do not apply to the purchase or sale of a financial instrument
described in paragraph (c)(1) of this section if:
(i) The financial instrument purchased or sold is identified on a
written list of pre-approved financial instruments that are commonly
used by the trading desk for the specific type of
[[Page 62244]]
hedging activity for which the financial instrument is being purchased
or sold; and
(ii) At the time the financial instrument is purchased or sold, the
hedging activity (including the purchase or sale of the financial
instrument) complies with written, pre-approved limits for the trading
desk purchasing or selling the financial instrument for hedging
activities undertaken for one or more other trading desks. The limits
shall be appropriate for the:
(A) Size, types, and risks of the hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased and sold for hedging activities
by the trading desk; and
(C) Levels and duration of the risk exposures being hedged.
0
65. Section 255.6 is amended by revising paragraph (e)(3); removing
paragraphs (e)(4) and (6); and redesignating paragraph (e)(5) as
paragraph (e)(4).
The revision reads as follows:
Sec. 255.6 Other permitted proprietary trading activities.
* * * * *
(e) * * *
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
* * * * *
Subpart C--Covered Funds Activities and Investments
0
66. Section 255.10 is amended by revising paragraphs (c)(7)(ii) and
(c)(8)(i)(A) to read as follows:
Sec. 255.10 Prohibition on Acquiring or Retaining an Ownership
Interest in and Having Certain Relationships with a Covered Fund.
* * * * *
(c) * * *
(7) * * *
(ii) Participates in the profits and losses of the separate account
other than in compliance with applicable requirements regarding bank
owned life insurance.
(8) * * *
(i) * * *
(A) Loans as defined in Sec. 255.2(t) of subpart A;
* * * * *
0
67. Section 255.11 is amended by revising paragraph (c) to read as
follows:
Sec. 255.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
* * * * *
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 255.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 255.4(a) or Sec. 255.4(b) of subpart B,
respectively; and
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; or acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in such covered fund in
compliance with section 15G of that Act (15 U.S.C.78o-11) and the
implementing regulations issued thereunder each as permitted by
paragraph (b) of this section, then in each such case any ownership
interests acquired or retained by the banking entity and its affiliates
in connection with underwriting and market making related activities
for that particular covered fund are included in the calculation of
ownership interests permitted to be held by the banking entity and its
affiliates under the limitations of Sec. 255.12(a)(2)(ii); Sec.
255.12(a)(2)(iii), and Sec. 255.12(d) of this subpart.
Sec. 255.12 [Amended]
0
68. Section 255.12 is amended by redesignating the second instance of
paragraph (e)(2)(vi) as paragraph (e)(2)(vii).
0
69. Section 255.13 is amended by revising paragraphs (a), (b)(3) and
(4), and (c) to read as follows:
Sec. 255.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 255.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to reduce or otherwise
significantly mitigate the specific, identifiable risks to the banking
entity in connection with:
(i) A compensation arrangement with an employee of the banking
entity or an affiliate thereof that directly provides investment
advisory, commodity trading advisory or other services to the covered
fund; or
(ii) A position taken by the banking entity when acting as
intermediary on behalf of a customer that is not itself a banking
entity to facilitate the exposure by the customer to the profits and
losses of the covered fund.
(2) The risk-mitigating hedging activities of a banking entity are
permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program in accordance with subpart
D of this part that is reasonably designed to ensure the banking
entity's compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures,
and internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks arising:
(1) Out of a transaction conducted solely to accommodate a specific
customer request with respect to the covered fund; or
(2) In connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
[[Page 62245]]
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) With respect to risk-mitigating hedging activity conducted
pursuant to paragraph (a)(1)(i) of this section, the compensation
arrangement relates solely to the covered fund in which the banking
entity or any affiliate has acquired an ownership interest pursuant to
paragraph (a)(1)(i) and such compensation arrangement provides that any
losses incurred by the banking entity on such ownership interest will
be offset by corresponding decreases in amounts payable under such
compensation arrangement.
(b) * * *
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is not sold and has not been
sold pursuant to an offering that targets residents of the United
States in which the banking entity or any affiliate of the banking
entity participates. If the banking entity or an affiliate sponsors or
serves, directly or indirectly, as the investment manager, investment
adviser, commodity pool operator or commodity trading advisor to a
covered fund, then the banking entity or affiliate will be deemed for
purposes of this paragraph (b)(3) to participate in any offer or sale
by the covered fund of ownership interests in the covered fund.
(4) An activity or investment occurs solely outside of the United
States for purposes of paragraph (b)(1)(iv) of this section only if:
(i) The banking entity acting as sponsor, or engaging as principal
in the acquisition or retention of an ownership interest in the covered
fund, is not itself, and is not controlled directly or indirectly by, a
banking entity that is located in the United States or organized under
the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to acquire or retain the ownership interest or act as
sponsor to the covered fund is not located in the United States or
organized under the laws of the United States or of any State; and
(iii) The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State.
* * * * *
(c) Permitted covered fund interests and activities by a regulated
insurance company. The prohibition contained in Sec. 255.10(a) of this
subpart does not apply to the acquisition or retention by an insurance
company, or an affiliate thereof, of any ownership interest in, or the
sponsorship of, a covered fund only if:
(1) The insurance company or its affiliate acquires and retains the
ownership interest solely for the general account of the insurance
company or for one or more separate accounts established by the
insurance company;
(2) The acquisition and retention of the ownership interest is
conducted in compliance with, and subject to, the insurance company
investment laws and regulations of the State or jurisdiction in which
such insurance company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law or regulation described in paragraph (c)(2) of
this section is insufficient to protect the safety and soundness of the
banking entity, or the financial stability of the United States.
0
70. Section 255.14 is amended by revising paragraph (a)(2)(ii)(B) to
read as follows:
Sec. 255.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually no later than March 31 to
the SEC (with a duty to update the certification if the information in
the certification materially changes) that the banking entity does not,
directly or indirectly, guarantee, assume, or otherwise insure the
obligations or performance of the covered fund or of any covered fund
in which such covered fund invests; and
* * * * *
Subpart D--Compliance Program Requirement; Violations
0
71. Section 255.20 is amended by eevising paragraphs (a), (b)
introductory text, (c), (d), (e) introductory text, and (f)(2) and
adding paragraphs (g), (h) and (i) to read as follows:
Sec. 255.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities) shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
(b) Banking entities with significant trading assets and
liabilities. With respect to a banking entity with significant trading
assets and liabilities, the compliance program required by paragraph
(a) of this section, at a minimum, shall include:
* * * * *
(c) CEO attestation. The CEO of a banking entity that has
significant trading assets and liabilities must, based on a review by
the CEO of the banking entity, attest in writing to the SEC, each year
no later than March 31, that the banking entity has in place processes
to establish, maintain, enforce, review, test and modify the compliance
program required by paragraph (b) of this section in a manner
reasonably designed to achieve compliance with section 13 of the BHC
Act and this part. In the case of a U.S. branch or agency of a foreign
banking entity, the attestation may be provided for the entire U.S.
operations of the foreign banking entity by the senior management
officer of the U.S. operations of the foreign banking entity who is
located in the United States.
(d) Reporting requirements under appendix A to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B of this part shall comply with the reporting requirements
described in appendix A to this part, if:
(i) The banking entity has significant trading assets and
liabilities; or
(ii) The SEC notifies the banking entity in writing that it must
satisfy the reporting requirements contained in appendix A to this
part.
(2) Frequency of reporting: Unless the SEC notifies the banking
entity in writing that it must report on a different basis, a banking
entity subject to appendix A to this part shall report the information
required by appendix A for each quarter within 30 days of the end of
the quarter.
(e) Additional documentation for covered funds. A banking entity
with
[[Page 62246]]
significant trading assets and liabilities shall maintain records that
include:
* * * * *
(f) * * *
(2) Banking entities with moderate trading assets and liabilities.
A banking entity with moderate trading assets and liabilities may
satisfy the requirements of this section by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act and this part and adjustments
as appropriate given the activities, size, scope, and complexity of the
banking entity.
(g) Rebuttable presumption of compliance for banking entities with
limited trading assets and liabilities--(1) Rebuttable presumption.
Except as otherwise provided in this paragraph, a banking entity with
limited trading assets and liabilities shall be presumed to be
compliant with subpart B and subpart C of this part and shall have no
obligation to demonstrate compliance with this part on an ongoing
basis.
(2) Rebuttal of presumption. If upon examination or audit, the SEC
determines that the banking entity has engaged in proprietary trading
or covered fund activities that are otherwise prohibited under subpart
B or subpart C of this part, the SEC may require the banking entity to
be treated under this part as if it did not have limited trading assets
and liabilities. The SEC's rebuttal of the presumption in this
paragraph must be made in accordance with the notice and response
procedures in paragraph (i) of this section.
(h) Reservation of authority. Notwithstanding any other provision
of this part, the SEC retains its authority to require a banking entity
without significant trading assets and liabilities to apply any
requirements of this part that would otherwise apply if the banking
entity had significant or moderate trading assets and liabilities if
the SEC determines that the size or complexity of the banking entity's
trading or investment activities, or the risk of evasion of subpart B
or subpart C of this part, does not warrant a presumption of compliance
under paragraph (g) of this section or treatment as a banking entity
with moderate trading assets and liabilities, as applicable. The SEC's
exercise of this reservation of authority must be made in accordance
with the notice and response procedures in paragraph (i) of this
section.
(i) Notice and response procedures--(1) Notice. The SEC will notify
the banking entity in writing of any determination requiring notice
under this part and will provide an explanation of the determination.
(2) Response. The banking entity may respond to any or all items in
the notice described in paragraph (i)(1) of this section. The response
should include any matters that the banking entity would have the SEC
consider in deciding whether to make the determination. The response
must be in writing and delivered to the designated SEC official within
30 days after the date on which the banking entity received the notice.
The SEC may shorten the time period when, in the opinion of the SEC,
the activities or condition of the banking entity so requires, provided
that the banking entity is informed of the time period at the time of
notice, or with the consent of the banking entity. In its discretion,
the SEC may extend the time period for good cause.
(3) Waiver. Failure to respond within 30 days or such other time
period as may be specified by the SEC shall constitute a waiver of any
objections to the SEC's determination.
(4) Decision. The SEC will notify the banking entity of the
decision in writing. The notice will include an explanation of the
decision.
0
72. Revise appendix A to part 255 to read as follows:
Appendix A to Part 255--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
255.20(d), this appendix applies to a banking entity that, together
with its affiliates and subsidiaries, has significant trading assets
and liabilities. These entities are required to (i) furnish periodic
reports to the SEC regarding a variety of quantitative measurements
of their covered trading activities, which vary depending on the
scope and size of covered trading activities, and (ii) create and
maintain records documenting the preparation and content of these
reports. The requirements of this appendix must be incorporated into
the banking entity's internal compliance program under Sec. 255.20.
b. The purpose of this appendix is to assist banking entities
and the SEC in:
(1) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(2) Monitoring the banking entity's covered trading activities;
(3) Identifying covered trading activities that warrant further
review or examination by the banking entity to verify compliance
with the proprietary trading restrictions;
(4) Evaluating whether the covered trading activities of trading
desks engaged in market making-related activities subject to Sec.
255.4(b) are consistent with the requirements governing permitted
market making-related activities;
(5) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. 255.4, Sec. 255.5, or Sec. 255.6(a) and (b) (i.e.,
underwriting and market making-related activity, risk-mitigating
hedging, or trading in certain government obligations) are
consistent with the requirement that such activity not result,
directly or indirectly, in a material exposure to high-risk assets
or high-risk trading strategies;
(6) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by SEC of such activities; and
(7) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. Information that must be furnished pursuant to this appendix
is not intended to serve as a dispositive tool for the
identification of permissible or impermissible activities.
d. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 255.20. The effectiveness of particular
quantitative measurements may differ based on the profile of the
banking entity's businesses in general and, more specifically, of
the particular trading desk, including types of instruments traded,
trading activities and strategies, and history and experience (e.g.,
whether the trading desk is an established, successful market maker
or a new entrant to a competitive market). In all cases, banking
entities must ensure that they have robust measures in place to
identify and monitor the risks taken in their trading activities, to
ensure that the activities are within risk tolerances established by
the banking entity, and to monitor and examine for compliance with
the proprietary trading restrictions in this part.
e. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 255.4 through 255.6(a) and (b), or that
result in a material exposure to high-risk assets or high-risk
trading strategies, must be escalated within the banking entity for
review, further analysis, explanation to SEC, and remediation, where
appropriate. The quantitative measurements discussed in this
appendix should be helpful to banking entities in identifying and
managing the risks related to their covered trading activities.
[[Page 62247]]
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 255.2 and 255.3. In addition, for purposes of
this appendix, the following definitions apply:
Applicability identifies the trading desks for which a banking
entity is required to calculate and report a particular quantitative
measurement based on the type of covered trading activity conducted
by the trading desk.
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of a trading desk's holdings, dividend income, and
interest income and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. 255.4, Sec. 255.5, Sec. 255.6(a), or Sec.
255.6(b). A banking entity may include in its covered trading
activity trading conducted under Sec. 255.3(d), Sec. 255.6(c),
Sec. 255.6(d), or Sec. 255.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading day means a calendar day on which a trading desk is open
for trading.
III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each banking entity made subject
to this appendix by Sec. 255.20 must furnish the following
quantitative measurements, as applicable, for each trading desk of
the banking entity engaged in covered trading activities and
calculate these quantitative measurements in accordance with this
appendix:
i. Internal Limits and Usage;
ii. Value-at-Risk;
iii. Comprehensive Profit and Loss Attribution;
iv. Positions; and
v. Transaction Volumes.
2. Trading desk information. Each banking entity made subject to
this appendix by Sec. 255.20 must provide certain descriptive
information, as further described in this appendix, regarding each
trading desk engaged in covered trading activities.
3. Quantitative measurements identifying information. Each
banking entity made subject to this appendix by Sec. 255.20 must
provide certain identifying and descriptive information, as further
described in this appendix, regarding its quantitative measurements.
4. Narrative statement. Each banking entity made subject to this
appendix by Sec. 255.20 may provide an optional narrative
statement, as further described in this appendix.
5. File identifying information. Each banking entity made
subject to this appendix by Sec. 255.20 must provide file
identifying information in each submission to the SEC pursuant to
this appendix, including the name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the Board, and
identification of the reporting period and creation date and time.
b. Trading Desk Information
1. Each banking entity must provide descriptive information
regarding each trading desk engaged in covered trading activities,
including:
i. Name of the trading desk used internally by the banking
entity and a unique identification label for the trading desk;
ii. Identification of each type of covered trading activity in
which the trading desk is engaged;
iii. Brief description of the general strategy of the trading
desk;
v. A list identifying each Agency receiving the submission of
the trading desk;
2. Indication of whether each calendar date is a trading day or
not a trading day for the trading desk; and
3. Currency reported and daily currency conversion rate.
c. Quantitative Measurements Identifying Information
Each banking entity must provide the following information
regarding the quantitative measurements:
1. An Internal Limits Information Schedule that provides
identifying and descriptive information for each limit reported
pursuant to the Internal Limits and Usage quantitative measurement,
including the name of the limit, a unique identification label for
the limit, a description of the limit, the unit of measurement for
the limit, the type of limit, and identification of the
corresponding risk factor attribution in the particular case that
the limit type is a limit on a risk factor sensitivity and profit
and loss attribution to the same risk factor is reported; and
2. A Risk Factor Attribution Information Schedule that provides
identifying and descriptive information for each risk factor
attribution reported pursuant to the Comprehensive Profit and Loss
Attribution quantitative measurement, including the name of the risk
factor or other factor, a unique identification label for the risk
factor or other factor, a description of the risk factor or other
factor, and the risk factor or other factor's change unit.
d. Narrative Statement
Each banking entity made subject to this appendix by Sec.
255.20 may submit in a separate electronic document a Narrative
Statement to the SEC with any information the banking entity views
as relevant for assessing the information reported. The Narrative
Statement may include further description of or changes to
calculation methods, identification of material events, description
of and reasons for changes in the banking entity's trading desk
structure or trading desk strategies, and when any such changes
occurred.
e. Frequency and Method of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report the
Trading Desk Information, the Quantitative Measurements Identifying
Information, and each applicable quantitative measurement
electronically to the SEC on the reporting schedule established in
Sec. 255.20 unless otherwise requested by the SEC. A banking entity
must report the Trading Desk Information, the Quantitative
Measurements Identifying Information, and each applicable
quantitative measurement to the SEC in accordance with the XML
Schema specified and published on the SEC's website.
f. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the SEC pursuant to this appendix and Sec. 255.20(d),
create and maintain records documenting the preparation and content
of these reports, as well as such information as is necessary to
permit the SEC to verify the accuracy of such reports, for a period
of five years from the end of the calendar year for which the
measurement was taken. A banking entity must retain the Narrative
Statement, the Trading Desk Information, and the Quantitative
Measurements Identifying Information for a period of five years from
the end of the calendar year for which the information was reported
to the SEC.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Internal Limits and Usage
i. Description: For purposes of this appendix, Internal Limits
are the constraints that define the amount of risk and the positions
that a trading desk is permitted to take at a point in time, as
defined by the banking entity for a specific trading desk. Usage
represents the value of the trading desk's risk or positions that
are accounted for by the current activity of the desk. Internal
limits and their usage are key compliance and risk management tools
used to control and monitor risk taking and include, but are not
limited to, the limits set out in Sec. Sec. 255.4 and 255.5. A
trading desk's risk limits, commonly including a limit on ``Value-
at-Risk,'' are useful in the broader context of the trading desk's
overall activities, particularly for the market making activities
under Sec. 255.4(b) and hedging activity under Sec. 255.5.
Accordingly, the limits required under Sec. Sec.
255.4(b)(2)(iii)(C) and 255.5(b)(1)(i)(A) must meet the applicable
requirements under Sec. Sec. 255.4(b)(2)(iii)(C) and
255.5(b)(1)(i)(A) and also must include appropriate metrics for the
trading desk limits including, at a minimum, ``Value-at-Risk''
except to the extent the ``Value-at-Risk'' metric is demonstrably
ineffective for measuring and monitoring the risks of a trading desk
based on the types of positions traded by, and risk exposures of,
that desk.
A. A banking entity must provide the following information for
each limit reported pursuant to this quantitative measurement: The
unique identification label for the limit reported in the Internal
Limits Information Schedule, the limit size (distinguishing between
an upper and a lower limit), and the value of usage of the limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
2. Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the
[[Page 62248]]
measurement of the risk of future financial loss in the value of a
trading desk's aggregated positions at the ninety-nine percent
confidence level over a one-day period, based on current market
conditions.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into two categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); and (ii) profit and loss attributable to
new positions resulting from the current day's trading activity
(``new positions'').
A. The comprehensive profit and loss associated with existing
positions must reflect changes in the value of these positions on
the applicable day. The comprehensive profit and loss from existing
positions must be further attributed, as applicable, to (i) changes
in the specific risk factors and other factors that are monitored
and managed as part of the trading desk's overall risk management
policies and procedures; and (ii) any other applicable elements,
such as cash flows, carry, changes in reserves, and the correction,
cancellation, or exercise of a trade.
B. For the attribution of comprehensive profit and loss from
existing positions to specific risk factors and other factors, a
banking entity must provide the following information for the
factors that explain the preponderance of the profit or loss changes
due to risk factor changes: The unique identification label for the
risk factor or other factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss due to the risk factor
or other factor change.
C. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and loss from existing
positions that is not attributed to changes in specific risk factors
and other factors must be allocated to a residual category.
Significant unexplained profit and loss must be escalated for
further investigation and analysis.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
c. Positions and Transaction Volumes Measurements
1. Positions
i. Description: For purposes of this appendix, Positions is the
value of securities and derivatives positions managed by the trading
desk. For purposes of the Positions quantitative measurement, do not
include in the Positions calculation for ``securities'' those
securities that are also ``derivatives,'' as those terms are defined
under subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \1\ A banking entity must separately
report the trading desk's market value of long securities positions,
short securities positions, derivatives receivables, and derivatives
payables.
---------------------------------------------------------------------------
\1\ See Sec. 255.2(h), (aa). For example, under this part, a
security-based swap is both a ``security'' and a ``derivative.'' For
purposes of the Positions quantitative measurement, security-based
swaps are reported as derivatives rather than securities.
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 255.4(a)
or (b) to conduct underwriting activity or market-making-related
activity, respectively.
2. Transaction Volumes
i. Description: For purposes of this appendix, Transaction
Volumes measures three exclusive categories of covered trading
activity conducted by a trading desk. A banking entity is required
to report the value and number of security and derivative
transactions conducted by the trading desk with: (i) Customers,
excluding internal transactions; (ii) non-customers, excluding
internal transactions; and (iii) trading desks and other
organizational units where the transaction is booked into either the
same banking entity or an affiliated banking entity. For securities,
value means gross market value. For derivatives, value means gross
notional value. For purposes of calculating the Transaction Volumes
quantitative measurement, do not include in the Transaction Volumes
calculation for ``securities'' those securities that are also
``derivatives,'' as those terms are defined under subpart A;
instead, report those securities that are also derivatives as
``derivatives.'' \2\ Further, for purposes of the Transaction
Volumes quantitative measurement, a customer of a trading desk that
relies on Sec. 255.4(a) to conduct underwriting activity is a
market participant identified in Sec. 255.4(a)(7), and a customer
of a trading desk that relies on Sec. 255.4(b) to conduct market
making-related activity is a market participant identified in Sec.
255.4(b)(3).
---------------------------------------------------------------------------
\2\ See Sec. 255.2(h), (aa).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 255.4(a)
or (b) to conduct underwriting activity or market-making-related
activity, respectively.
Appendix B to Part 255 [Removed]
0
73. Appendix B to part 255 is removed.
0
74. Effective January 1, 2020, until December 31, 2020, appendix Z to
part 255 is added to read as follows:
Appendix Z to Part 255--Proprietary Trading and Certain Interests in
and Relationships With Covered Funds (Alternative Compliance)
Note: The content of this appendix reproduces the regulation
implementing Section 13 of the Bank Holding Company Act as of
November 13, 2019.
Subpart A--Authority and Definitions
Sec. 255.1 Authority, purpose, scope, and relationship to other
authorities.
(a) Authority. This part is issued by the SEC under section 13 of
the Bank Holding Company Act of 1956, as amended (12 U.S.C. 1851).
(b) Purpose. Section 13 of the Bank Holding Company Act establishes
prohibitions and restrictions on proprietary trading and investments in
or relationships with covered funds by certain banking entities,
including registered broker-dealers, registered investment advisers,
and registered security-based swap dealers, among others identified in
section 2(12)(B) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (12 U.S.C. 5301(12)(B)). This part implements
section 13 of the Bank Holding Company Act by defining terms used in
the statute and related terms, establishing prohibitions and
restrictions on proprietary trading and investments in or relationships
with covered funds, and explaining the statute's requirements.
(c) Scope. This part implements section 13 of the Bank Holding
Company Act with respect to banking entities for which the SEC is the
primary financial regulatory agency, as defined in this part, but does
not include such entities to the extent they are not within the
definition of banking entity in Sec. 255.2(c).
(d) Relationship to other authorities. Except as otherwise provided
under section 13 of the Bank Holding Company Act, and notwithstanding
any other provision of law, the prohibitions and restrictions under
section 13 of Bank Holding Company Act shall apply to the activities
and investments of a banking entity identified in paragraph (c) of this
section, even if such activities and investments are authorized for the
banking entity under other applicable provisions of law.
(e) Preservation of authority. Nothing in this part limits in any
way the authority of the SEC to impose on a banking entity identified
in paragraph (c) of this section additional
[[Page 62249]]
requirements or restrictions with respect to any activity, investment,
or relationship covered under section 13 of the Bank Holding Company
Act or this part, or additional penalties for violation of this part
provided under any other applicable provision of law.
Sec. 255.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(c) Banking entity. (1) Except as provided in paragraph (c)(2) of
this section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an insured depository institution;
(iii) Any company that is treated as a bank holding company for
purposes of section 8 of the International Banking Act of 1978 (12
U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any entity described in
paragraphs (c)(1)(i), (ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a banking entity under
paragraphs (c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraphs (c)(1)(i), (ii), or (iii) of
this section; or
(iii) The FDIC acting in its corporate capacity or as conservator
or receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(d) Board means the Board of Governors of the Federal Reserve
System.
(e) CFTC means the Commodity Futures Trading Commission.
(f) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(g) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(h) Derivative. (1) Except as provided in paragraph (h)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and the SEC have further defined by joint
regulation, interpretation, guidance, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the immediate family of the
employee.
(j) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(k) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(l) FDIC means the Federal Deposit Insurance Corporation.
(m) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(n) Foreign banking organization has the same meaning as in section
211.21(o) of the Board's Regulation K (12 CFR 211.21(o)), but does not
include a foreign bank, as defined in section 1(b)(7) of the
International Banking Act of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the Commonwealth of Puerto Rico, Guam,
American Samoa, the United States Virgin Islands, or the Commonwealth
of the Northern Mariana Islands.
(o) Foreign insurance regulator means the insurance commissioner,
or a similar official or agency, of any country other than the United
States that is engaged in the supervision of insurance companies under
foreign insurance law.
(p) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(q) Insurance company means a company that is organized as an
insurance company, primarily and predominantly engaged in writing
insurance or reinsuring risks underwritten by insurance companies,
subject to supervision as such by a state insurance regulator or a
foreign insurance regulator, and not operated for the purpose of
evading the provisions of section 13 of the BHC Act (12 U.S.C. 1851).
(r) Insured depository institution, unless otherwise indicated, has
the same meaning as in section 3(c) of the Federal Deposit Insurance
Act (12 U.S.C. 1813(c)), but does not include:
(1) An insured depository institution that is described in section
2(c)(2)(D) of the BHC Act (12 U.S.C. 1841(c)(2)(D)); or
(2) An insured depository institution if it has, and if every
company that controls it has, total consolidated assets of $10 billion
or less and total trading assets and trading liabilities, on a
consolidated basis, that are 5 percent or less of total consolidated
assets.
(s) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(t) Primary financial regulatory agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 5301(12)).
(u) Purchase includes any contract to buy, purchase, or otherwise
acquire. For security futures products, purchase includes any contract,
agreement, or transaction for future delivery. With respect to a
commodity future, purchase includes any contract, agreement, or
transaction for future delivery. With respect to a derivative, purchase
includes the execution, termination (prior to its scheduled maturity
date), assignment, exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a derivative, as the
context may require.
[[Page 62250]]
(v) Qualifying foreign banking organization means a foreign banking
organization that qualifies as such under section 211.23(a), (c) or (e)
of the Board's Regulation K (12 CFR 211.23(a), (c), or (e)).
(w) SEC means the Securities and Exchange Commission.
(x) Sale and sell each include any contract to sell or otherwise
dispose of. For security futures products, such terms include any
contract, agreement, or transaction for future delivery. With respect
to a commodity future, such terms include any contract, agreement, or
transaction for future delivery. With respect to a derivative, such
terms include the execution, termination (prior to its scheduled
maturity date), assignment, exchange, or similar transfer or conveyance
of, or extinguishing of rights or obligations under, a derivative, as
the context may require.
(y) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(z) Security-based swap dealer has the same meaning as in section
3(a)(71) of the Exchange Act (15 U.S.C. 78c(a)(71)).
(aa) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(bb) Separate account means an account established and maintained
by an insurance company in connection with one or more insurance
contracts to hold assets that are legally segregated from the insurance
company's other assets, under which income, gains, and losses, whether
or not realized, from assets allocated to such account, are, in
accordance with the applicable contract, credited to or charged against
such account without regard to other income, gains, or losses of the
insurance company.
(cc) State means any State, the District of Columbia, the
Commonwealth of Puerto Rico, Guam, American Samoa, the United States
Virgin Islands, and the Commonwealth of the Northern Mariana Islands.
(dd) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(ee) State insurance regulator means the insurance commissioner, or
a similar official or agency, of a State that is engaged in the
supervision of insurance companies under State insurance law.
(ff) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
Subpart B--Proprietary Trading
Sec. 255.3 Prohibition on proprietary trading.
(a) Prohibition. Except as otherwise provided in this subpart, a
banking entity may not engage in proprietary trading. Proprietary
trading means engaging as principal for the trading account of the
banking entity in any purchase or sale of one or more financial
instruments.
(b) Definition of trading account. (1) Trading account means any
account that is used by a banking entity to:
(i) Purchase or sell one or more financial instruments principally
for the purpose of:
(A) Short-term resale;
(B) Benefitting from actual or expected short-term price movements;
(C) Realizing short-term arbitrage profits; or
(D) Hedging one or more positions resulting from the purchases or
sales of financial instruments described in paragraphs (b)(1)(i)(A),
(B), or (C) of this section;
(ii) Purchase or sell one or more financial instruments that are
both market risk capital rule covered positions and trading positions
(or hedges of other market risk capital rule covered positions), if the
banking entity, or any affiliate of the banking entity, is an insured
depository institution, bank holding company, or savings and loan
holding company, and calculates risk-based capital ratios under the
market risk capital rule; or
(iii) Purchase or sell one or more financial instruments for any
purpose, if the banking entity:
(A) Is licensed or registered, or is required to be licensed or
registered, to engage in the business of a dealer, swap dealer, or
security-based swap dealer, to the extent the instrument is purchased
or sold in connection with the activities that require the banking
entity to be licensed or registered as such; or
(B) Is engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, to the extent
the instrument is purchased or sold in connection with the activities
of such business.
(2) Rebuttable presumption for certain purchases and sales. The
purchase (or sale) of a financial instrument by a banking entity shall
be presumed to be for the trading account of the banking entity under
paragraph (b)(1)(i) of this section if the banking entity holds the
financial instrument for fewer than sixty days or substantially
transfers the risk of the financial instrument within sixty days of the
purchase (or sale), unless the banking entity can demonstrate, based on
all relevant facts and circumstances, that the banking entity did not
purchase (or sell) the financial instrument principally for any of the
purposes described in paragraph (b)(1)(i) of this section.
(c) Financial instrument. (1) Financial instrument means:
(i) A security, including an option on a security;
(ii) A derivative, including an option on a derivative; or
(iii) A contract of sale of a commodity for future delivery, or
option on a contract of sale of a commodity for future delivery.
(2) A financial instrument does not include:
(i) A loan;
(ii) A commodity that is not:
(A) An excluded commodity (other than foreign exchange or
currency);
(B) A derivative;
(C) A contract of sale of a commodity for future delivery; or
(D) An option on a contract of sale of a commodity for future
delivery; or
(iii) Foreign exchange or currency.
(d) Proprietary trading. Proprietary trading does not include:
(1) Any purchase or sale of one or more financial instruments by a
banking entity that arises under a repurchase or reverse repurchase
agreement pursuant to which the banking entity has simultaneously
agreed, in writing, to both purchase and sell a stated asset, at stated
prices, and on stated dates or on demand with the same counterparty;
(2) Any purchase or sale of one or more financial instruments by a
banking entity that arises under a transaction in which the banking
entity lends or borrows a security temporarily to or from another party
pursuant to a written securities lending agreement under which the
lender retains the economic interests of an owner of such security, and
has the right to terminate the transaction and to recall the loaned
security on terms agreed by the parties;
(3) Any purchase or sale of a security by a banking entity for the
purpose of liquidity management in accordance with a documented
liquidity management plan of the banking entity that:
(i) Specifically contemplates and authorizes the particular
securities to be used for liquidity management purposes, the amount,
types, and risks of these securities that are consistent with liquidity
management, and the liquidity circumstances in which the particular
securities may or must be used;
(ii) Requires that any purchase or sale of securities contemplated
and authorized by the plan be principally for the purpose of managing
the liquidity of
[[Page 62251]]
the banking entity, and not for the purpose of short-term resale,
benefitting from actual or expected short-term price movements,
realizing short-term arbitrage profits, or hedging a position taken for
such short-term purposes;
(iii) Requires that any securities purchased or sold for liquidity
management purposes be highly liquid and limited to securities the
market, credit, and other risks of which the banking entity does not
reasonably expect to give rise to appreciable profits or losses as a
result of short-term price movements;
(iv) Limits any securities purchased or sold for liquidity
management purposes, together with any other instruments purchased or
sold for such purposes, to an amount that is consistent with the
banking entity's near-term funding needs, including deviations from
normal operations of the banking entity or any affiliate thereof, as
estimated and documented pursuant to methods specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of securities that are not permitted under Sec. Sec. 255.6(a) or (b)
of this subpart are for the purpose of liquidity management and in
accordance with the liquidity management plan described in paragraph
(d)(3) of this section; and
(vi) Is consistent with the SEC's supervisory requirements,
guidance, and expectations regarding liquidity management;
(4) Any purchase or sale of one or more financial instruments by a
banking entity that is a derivatives clearing organization or a
clearing agency in connection with clearing financial instruments;
(5) Any excluded clearing activities by a banking entity that is a
member of a clearing agency, a member of a derivatives clearing
organization, or a member of a designated financial market utility;
(6) Any purchase or sale of one or more financial instruments by a
banking entity, so long as:
(i) The purchase (or sale) satisfies an existing delivery
obligation of the banking entity or its customers, including to prevent
or close out a failure to deliver, in connection with delivery,
clearing, or settlement activity; or
(ii) The purchase (or sale) satisfies an obligation of the banking
entity in connection with a judicial, administrative, self-regulatory
organization, or arbitration proceeding;
(7) Any purchase or sale of one or more financial instruments by a
banking entity that is acting solely as agent, broker, or custodian;
(8) Any purchase or sale of one or more financial instruments by a
banking entity through a deferred compensation, stock-bonus, profit-
sharing, or pension plan of the banking entity that is established and
administered in accordance with the law of the United States or a
foreign sovereign, if the purchase or sale is made directly or
indirectly by the banking entity as trustee for the benefit of persons
who are or were employees of the banking entity; or
(9) Any purchase or sale of one or more financial instruments by a
banking entity in the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
financial instrument as soon as practicable, and in no event may the
banking entity retain such instrument for longer than such period
permitted by the SEC.
(e) Definition of other terms related to proprietary trading. For
purposes of this subpart:
(1) Anonymous means that each party to a purchase or sale is
unaware of the identity of the other party(ies) to the purchase or
sale.
(2) Clearing agency has the same meaning as in section 3(a)(23) of
the Exchange Act (15 U.S.C. 78c(a)(23)).
(3) Commodity has the same meaning as in section 1a(9) of the
Commodity Exchange Act (7 U.S.C. 1a(9)), except that a commodity does
not include any security;
(4) Contract of sale of a commodity for future delivery means a
contract of sale (as that term is defined in section 1a(13) of the
Commodity Exchange Act (7 U.S.C. 1a(13)) for future delivery (as that
term is defined in section 1a(27) of the Commodity Exchange Act (7
U.S.C. 1a(27))).
(5) Derivatives clearing organization means:
(i) A derivatives clearing organization registered under section 5b
of the Commodity Exchange Act (7 U.S.C. 7a-1);
(ii) A derivatives clearing organization that, pursuant to CFTC
regulation, is exempt from the registration requirements under section
5b of the Commodity Exchange Act (7 U.S.C. 7a-1); or
(iii) A foreign derivatives clearing organization that, pursuant to
CFTC regulation, is permitted to clear for a foreign board of trade
that is registered with the CFTC.
(6) Exchange, unless the context otherwise requires, means any
designated contract market, swap execution facility, or foreign board
of trade registered with the CFTC, or, for purposes of securities or
security-based swaps, an exchange, as defined under section 3(a)(1) of
the Exchange Act (15 U.S.C. 78c(a)(1)), or security-based swap
execution facility, as defined under section 3(a)(77) of the Exchange
Act (15 U.S.C. 78c(a)(77)).
(7) Excluded clearing activities means:
(i) With respect to customer transactions cleared on a derivatives
clearing organization, a clearing agency, or a designated financial
market utility, any purchase or sale necessary to correct trading
errors made by or on behalf of a customer provided that such purchase
or sale is conducted in accordance with, for transactions cleared on a
derivatives clearing organization, the Commodity Exchange Act, CFTC
regulations, and the rules or procedures of the derivatives clearing
organization, or, for transactions cleared on a clearing agency, the
rules or procedures of the clearing agency, or, for transactions
cleared on a designated financial market utility that is neither a
derivatives clearing organization nor a clearing agency, the rules or
procedures of the designated financial market utility;
(ii) Any purchase or sale in connection with and related to the
management of a default or threatened imminent default of a customer
provided that such purchase or sale is conducted in accordance with,
for transactions cleared on a derivatives clearing organization, the
Commodity Exchange Act, CFTC regulations, and the rules or procedures
of the derivatives clearing organization, or, for transactions cleared
on a clearing agency, the rules or procedures of the clearing agency,
or, for transactions cleared on a designated financial market utility
that is neither a derivatives clearing organization nor a clearing
agency, the rules or procedures of the designated financial market
utility;
(iii) Any purchase or sale in connection with and related to the
management of a default or threatened imminent default of a member of a
clearing agency, a member of a derivatives clearing organization, or a
member of a designated financial market utility;
(iv) Any purchase or sale in connection with and related to the
management of the default or threatened default of a clearing agency, a
derivatives clearing organization, or a designated financial market
utility; and
(v) Any purchase or sale that is required by the rules or
procedures of a clearing agency, a derivatives clearing organization,
or a designated financial market utility to mitigate the risk to the
[[Page 62252]]
clearing agency, derivatives clearing organization, or designated
financial market utility that would result from the clearing by a
member of security-based swaps that reference the member or an
affiliate of the member.
(8) Designated financial market utility has the same meaning as in
section 803(4) of the Dodd-Frank Act (12 U.S.C. 5462(4)).
(9) Issuer has the same meaning as in section 2(a)(4) of the
Securities Act of 1933 (15 U.S.C. 77b(a)(4)).
(10) Market risk capital rule covered position and trading position
means a financial instrument that is both a covered position and a
trading position, as those terms are respectively defined:
(i) In the case of a banking entity that is a bank holding company,
savings and loan holding company, or insured depository institution,
under the market risk capital rule that is applicable to the banking
entity; and
(ii) In the case of a banking entity that is affiliated with a bank
holding company or savings and loan holding company, other than a
banking entity to which a market risk capital rule is applicable, under
the market risk capital rule that is applicable to the affiliated bank
holding company or savings and loan holding company.
(11) Market risk capital rule means the market risk capital rule
that is contained in subpart F of 12 CFR part 3, 12 CFR parts 208 and
225, or 12 CFR part 324, as applicable.
(12) Municipal security means a security that is a direct
obligation of or issued by, or an obligation guaranteed as to principal
or interest by, a State or any political subdivision thereof, or any
agency or instrumentality of a State or any political subdivision
thereof, or any municipal corporate instrumentality of one or more
States or political subdivisions thereof.
(13) Trading desk means the smallest discrete unit of organization
of a banking entity that purchases or sells financial instruments for
the trading account of the banking entity or an affiliate thereof.
Sec. 255.4 Permitted underwriting and market making-related
activities.
(a) Underwriting activities--(1) Permitted underwriting activities.
The prohibition contained in Sec. 255.3(a) does not apply to a banking
entity's underwriting activities conducted in accordance with this
paragraph (a).
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
and reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity, maturity, and depth of the market for the relevant type
of security;
(iii) The banking entity has established and implements, maintains,
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of paragraph (a) of this section,
including reasonably designed written policies and procedures, internal
controls, analysis and independent testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, based on the nature and amount of
the trading desk's underwriting activities, including the reasonably
expected near term demands of clients, customers, or counterparties, on
the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held;
(C) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(D) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis of the basis for any temporary
or permanent increase to a trading desk's limit(s), and independent
review of such demonstrable analysis and approval;
(iv) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(v) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
(3) Definition of distribution. For purposes of this paragraph (a),
a distribution of securities means:
(i) An offering of securities, whether or not subject to
registration under the Securities Act of 1933, that is distinguished
from ordinary trading transactions by the presence of special selling
efforts and selling methods; or
(ii) An offering of securities made pursuant to an effective
registration statement under the Securities Act of 1933.
(4) Definition of underwriter. For purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an issuer or selling security
holder to:
(A) Purchase securities from the issuer or selling security holder
for distribution;
(B) Engage in a distribution of securities for or on behalf of the
issuer or selling security holder; or
(C) Manage a distribution of securities for or on behalf of the
issuer or selling security holder; or
(ii) A person who has agreed to participate or is participating in
a distribution of such securities for or on behalf of the issuer or
selling security holder.
(5) Definition of selling security holder. For purposes of this
paragraph (a), selling security holder means any person, other than an
issuer, on whose behalf a distribution is made.
(6) Definition of underwriting position. For purposes of this
paragraph (a), underwriting position means the long or short positions
in one or more securities held by a banking entity or its affiliate,
and managed by a particular trading desk, in connection with a
particular distribution of securities for which such banking entity or
affiliate is acting as an underwriter.
(7) Definition of client, customer, and counterparty. For purposes
of this paragraph (a), the terms client, customer, and counterparty, on
a collective or individual basis, refer to market participants that may
transact with the banking entity in connection with a particular
distribution for which the banking entity is acting as underwriter.
(b) Market making-related activities--(1) Permitted market making-
related activities. The prohibition contained in Sec. 255.3(a) does
not apply to a banking entity's market making-related activities
conducted in accordance with this paragraph (b).
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure and is
willing and available to
[[Page 62253]]
quote, purchase and sell, or otherwise enter into long and short
positions in those types of financial instruments for its own account,
in commercially reasonable amounts and throughout market cycles on a
basis appropriate for the liquidity, maturity, and depth of the market
for the relevant types of financial instruments;
(ii) The amount, types, and risks of the financial instruments in
the trading desk's market-maker inventory are designed not to exceed,
on an ongoing basis, the reasonably expected near term demands of
clients, customers, or counterparties, based on:
(A) The liquidity, maturity, and depth of the market for the
relevant types of financial instrument(s); and
(B) Demonstrable analysis of historical customer demand, current
inventory of financial instruments, and market and other factors
regarding the amount, types, and risks, of or associated with financial
instruments in which the trading desk makes a market, including through
block trades;
(iii) The banking entity has established and implements, maintains,
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of paragraph (b) of this section,
including reasonably designed written policies and procedures, internal
controls, analysis and independent testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and inventory; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, based on the nature and amount of
the trading desk's market making-related activities, that address the
factors prescribed by paragraph (b)(2)(ii) of this section, on:
(1) The amount, types, and risks of its market-maker inventory;
(2) The amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) The level of exposures to relevant risk factors arising from
its financial exposure; and
(4) The period of time a financial instrument may be held;
(D) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(E) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis that the basis for any temporary
or permanent increase to a trading desk's limit(s) is consistent with
the requirements of this paragraph (b), and independent review of such
demonstrable analysis and approval;
(iv) To the extent that any limit identified pursuant to paragraph
(b)(2)(iii)(C) of this section is exceeded, the trading desk takes
action to bring the trading desk into compliance with the limits as
promptly as possible after the limit is exceeded;
(v) The compensation arrangements of persons performing the
activities described in this paragraph (b) are designed not to reward
or incentivize prohibited proprietary trading; and
(vi) The banking entity is licensed or registered to engage in
activity described in this paragraph (b) in accordance with applicable
law.
(3) Definition of client, customer, and counterparty. For purposes
of paragraph (b) of this section, the terms client, customer, and
counterparty, on a collective or individual basis refer to market
participants that make use of the banking entity's market making-
related services by obtaining such services, responding to quotations,
or entering into a continuing relationship with respect to such
services, provided that:
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with Sec. 255.20(d)(1) of subpart D,
unless:
(A) The trading desk documents how and why a particular trading
desk or other organizational unit of the entity should be treated as a
client, customer, or counterparty of the trading desk for purposes of
paragraph (b)(2) of this section; or
(B) The purchase or sale by the trading desk is conducted
anonymously on an exchange or similar trading facility that permits
trading on behalf of a broad range of market participants.
(4) Definition of financial exposure. For purposes of this
paragraph (b), financial exposure means the aggregate risks of one or
more financial instruments and any associated loans, commodities, or
foreign exchange or currency, held by a banking entity or its affiliate
and managed by a particular trading desk as part of the trading desk's
market making-related activities.
(5) Definition of market-maker inventory. For the purposes of this
paragraph (b), market-maker inventory means all of the positions in the
financial instruments for which the trading desk stands ready to make a
market in accordance with paragraph (b)(2)(i) of this section, that are
managed by the trading desk, including the trading desk's open
positions or exposures arising from open transactions.
Sec. 255.5 Permitted risk-mitigating hedging activities.
(a) Permitted risk-mitigating hedging activities. The prohibition
contained in Sec. 255.3(a) does not apply to the risk-mitigating
hedging activities of a banking entity in connection with and related
to individual or aggregated positions, contracts, or other holdings of
the banking entity and designed to reduce the specific risks to the
banking entity in connection with and related to such positions,
contracts, or other holdings.
(b) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under paragraph (a) of this section only
if:
(1) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(i) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(ii) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(iii) The conduct of analysis, including correlation analysis, and
independent testing designed to ensure that the positions, techniques
and strategies that may be used for hedging may reasonably be expected
to
[[Page 62254]]
demonstrably reduce or otherwise significantly mitigate the specific,
identifiable risk(s) being hedged, and such correlation analysis
demonstrates that the hedging activity demonstrably reduces or
otherwise significantly mitigates the specific, identifiable risk(s)
being hedged;
(2) The risk-mitigating hedging activity:
(i) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(ii) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate and demonstrably reduces or
otherwise significantly mitigates one or more specific, identifiable
risks, including market risk, counterparty or other credit risk,
currency or foreign exchange risk, interest rate risk, commodity price
risk, basis risk, or similar risks, arising in connection with and
related to identified positions, contracts, or other holdings of the
banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(iii) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(iv) Is subject to continuing review, monitoring and management by
the banking entity that:
(A) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1) of this section;
(B) Is designed to reduce or otherwise significantly mitigate and
demonstrably reduces or otherwise significantly mitigates the specific,
identifiable risks that develop over time from the risk-mitigating
hedging activities undertaken under this section and the underlying
positions, contracts, and other holdings of the banking entity, based
upon the facts and circumstances of the underlying and hedging
positions, contracts and other holdings of the banking entity and the
risks and liquidity thereof; and
(C) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading; and
(3) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(c) Documentation requirement--(1) A banking entity must comply
with the requirements of paragraphs (c)(2) and (3) of this section with
respect to any purchase or sale of financial instruments made in
reliance on this section for risk-mitigating hedging purposes that is:
(i) Not established by the specific trading desk establishing or
responsible for the underlying positions, contracts, or other holdings
the risks of which the hedging activity is designed to reduce;
(ii) Established by the specific trading desk establishing or
responsible for the underlying positions, contracts, or other holdings
the risks of which the purchases or sales are designed to reduce, but
that is effected through a financial instrument, exposure, technique,
or strategy that is not specifically identified in the trading desk's
written policies and procedures established under paragraph (b)(1) of
this section or under Sec. 255.4(b)(2)(iii)(B) of this subpart as a
product, instrument, exposure, technique, or strategy such trading desk
may use for hedging; or
(iii) Established to hedge aggregated positions across two or more
trading desks.
(2) In connection with any purchase or sale identified in paragraph
(c)(1) of this section, a banking entity must, at a minimum, and
contemporaneously with the purchase or sale, document:
(i) The specific, identifiable risk(s) of the identified positions,
contracts, or other holdings of the banking entity that the purchase or
sale is designed to reduce;
(ii) The specific risk-mitigating strategy that the purchase or
sale is designed to fulfill; and
(iii) The trading desk or other business unit that is establishing
and responsible for the hedge.
(3) A banking entity must create and retain records sufficient to
demonstrate compliance with the requirements of this paragraph (c) for
a period that is no less than five years in a form that allows the
banking entity to promptly produce such records to the SEC on request,
or such longer period as required under other law or this part.
Sec. 255.6 Other permitted proprietary trading activities.
(a) Permitted trading in domestic government obligations. The
prohibition contained in Sec. 255.3(a) does not apply to the purchase
or sale by a banking entity of a financial instrument that is:
(1) An obligation of, or issued or guaranteed by, the United
States;
(2) An obligation, participation, or other instrument of, or issued
or guaranteed by, an agency of the United States, the Government
National Mortgage Association, the Federal National Mortgage
Association, the Federal Home Loan Mortgage Corporation, a Federal Home
Loan Bank, the Federal Agricultural Mortgage Corporation or a Farm
Credit System institution chartered under and subject to the provisions
of the Farm Credit Act of 1971 (12 U.S.C. 2001 et seq.);
(3) An obligation of any State or any political subdivision
thereof, including any municipal security; or
(4) An obligation of the FDIC, or any entity formed by or on behalf
of the FDIC for purpose of facilitating the disposal of assets acquired
or held by the FDIC in its corporate capacity or as conservator or
receiver under the Federal Deposit Insurance Act or Title II of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
(b) Permitted trading in foreign government obligations--(1)
Affiliates of foreign banking entities in the United States. The
prohibition contained in Sec. 255.3(a) does not apply to the purchase
or sale of a financial instrument that is an obligation of, or issued
or guaranteed by, a foreign sovereign (including any multinational
central bank of which the foreign sovereign is a member), or any agency
or political subdivision of such foreign sovereign, by a banking
entity, so long as:
(i) The banking entity is organized under or is directly or
indirectly controlled by a banking entity that is organized under the
laws of a foreign sovereign and is not directly or indirectly
controlled by a top-tier banking entity that is organized under the
laws of the United States;
(ii) The financial instrument is an obligation of, or issued or
guaranteed by, the foreign sovereign under the laws of which the
foreign banking entity referred to in paragraph (b)(1)(i) of this
section is organized (including any multinational central bank of which
the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign; and
(iii) The purchase or sale as principal is not made by an insured
depository institution.
(2) Foreign affiliates of a U.S. banking entity. The prohibition
contained in Sec. 255.3(a) does not apply to the purchase or sale of a
financial instrument that is an obligation of, or issued or guaranteed
by, a foreign sovereign (including any multinational central bank of
which the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign, by a foreign entity that is
[[Page 62255]]
owned or controlled by a banking entity organized or established under
the laws of the United States or any State, so long as:
(i) The foreign entity is a foreign bank, as defined in section
211.2(j) of the Board's Regulation K (12 CFR 211.2(j)), or is regulated
by the foreign sovereign as a securities dealer;
(ii) The financial instrument is an obligation of, or issued or
guaranteed by, the foreign sovereign under the laws of which the
foreign entity is organized (including any multinational central bank
of which the foreign sovereign is a member), or any agency or political
subdivision of that foreign sovereign; and
(iii) The financial instrument is owned by the foreign entity and
is not financed by an affiliate that is located in the United States or
organized under the laws of the United States or of any State.
(c) Permitted trading on behalf of customers--(1) Fiduciary
transactions. The prohibition contained in Sec. 255.3(a) does not
apply to the purchase or sale of financial instruments by a banking
entity acting as trustee or in a similar fiduciary capacity, so long
as:
(i) The transaction is conducted for the account of, or on behalf
of, a customer; and
(ii) The banking entity does not have or retain beneficial
ownership of the financial instruments.
(2) Riskless principal transactions. The prohibition contained in
Sec. 255.3(a) does not apply to the purchase or sale of financial
instruments by a banking entity acting as riskless principal in a
transaction in which the banking entity, after receiving an order to
purchase (or sell) a financial instrument from a customer, purchases
(or sells) the financial instrument for its own account to offset a
contemporaneous sale to (or purchase from) the customer.
(d) Permitted trading by a regulated insurance company. The
prohibition contained in Sec. 255.3(a) does not apply to the purchase
or sale of financial instruments by a banking entity that is an
insurance company or an affiliate of an insurance company if:
(1) The insurance company or its affiliate purchases or sells the
financial instruments solely for:
(i) The general account of the insurance company; or
(ii) A separate account established by the insurance company;
(2) The purchase or sale is conducted in compliance with, and
subject to, the insurance company investment laws, regulations, and
written guidance of the State or jurisdiction in which such insurance
company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law, regulation, or written guidance described in
paragraph (d)(2) of this section is insufficient to protect the safety
and soundness of the covered banking entity, or the financial stability
of the United States.
(e) Permitted trading activities of foreign banking entities. (1)
The prohibition contained in Sec. 255.3(a) does not apply to the
purchase or sale of financial instruments by a banking entity if:
(i) The banking entity is not organized or directly or indirectly
controlled by a banking entity that is organized under the laws of the
United States or of any State;
(ii) The purchase or sale by the banking entity is made pursuant to
paragraph (9) or (13) of section 4(c) of the BHC Act; and
(iii) The purchase or sale meets the requirements of paragraph
(e)(3) of this section.
(2) A purchase or sale of financial instruments by a banking entity
is made pursuant to paragraph (9) or (13) of section 4(c) of the BHC
Act for purposes of paragraph (e)(1)(ii) of this section only if:
(i) The purchase or sale is conducted in accordance with the
requirements of paragraph (e) of this section; and
(ii)(A) With respect to a banking entity that is a foreign banking
organization, the banking entity meets the qualifying foreign banking
organization requirements of section 211.23(a), (c) or (e) of the
Board's Regulation K (12 CFR 211.23(a), (c) or (e)), as applicable; or
(B) With respect to a banking entity that is not a foreign banking
organization, the banking entity is not organized under the laws of the
United States or of any State and the banking entity, on a fully-
consolidated basis, meets at least two of the following requirements:
(1) Total assets of the banking entity held outside of the United
States exceed total assets of the banking entity held in the United
States;
(2) Total revenues derived from the business of the banking entity
outside of the United States exceed total revenues derived from the
business of the banking entity in the United States; or
(3) Total net income derived from the business of the banking
entity outside of the United States exceeds total net income derived
from the business of the banking entity in the United States.
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including any personnel of the banking entity or its affiliate
that arrange, negotiate or execute such purchase or sale) is not
located in the United States or organized under the laws of the United
States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State;
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State;
(iv) No financing for the banking entity's purchases or sales is
provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State; and
(v) The purchase or sale is not conducted with or through any U.S.
entity, other than:
(A) A purchase or sale with the foreign operations of a U.S. entity
if no personnel of such U.S. entity that are located in the United
States are involved in the arrangement, negotiation, or execution of
such purchase or sale;
(B) A purchase or sale with an unaffiliated market intermediary
acting as principal, provided the purchase or sale is promptly cleared
and settled through a clearing agency or derivatives clearing
organization acting as a central counterparty; or
(C) A purchase or sale through an unaffiliated market intermediary
acting as agent, provided the purchase or sale is conducted anonymously
on an exchange or similar trading facility and is promptly cleared and
settled through a clearing agency or derivatives clearing organization
acting as a central counterparty.
(4) For purposes of this paragraph (e), a U.S. entity is any entity
that is, or is controlled by, or is acting on behalf of, or at the
direction of, any other entity that is, located in the United States or
organized under the laws of the United States or of any State.
(5) For purposes of this paragraph (e), a U.S. branch, agency, or
subsidiary of
[[Page 62256]]
a foreign banking entity is considered to be located in the United
States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(6) For purposes of this paragraph (e), unaffiliated market
intermediary means an unaffiliated entity, acting as an intermediary,
that is:
(i) A broker or dealer registered with the SEC under section 15 of
the Exchange Act or exempt from registration or excluded from
regulation as such;
(ii) A swap dealer registered with the CFTC under section 4s of the
Commodity Exchange Act or exempt from registration or excluded from
regulation as such;
(iii) A security-based swap dealer registered with the SEC under
section 15F of the Exchange Act or exempt from registration or excluded
from regulation as such; or
(iv) A futures commission merchant registered with the CFTC under
section 4f of the Commodity Exchange Act or exempt from registration or
excluded from regulation as such.
Sec. 255.7 Limitations on permitted proprietary trading activities.
(a) No transaction, class of transactions, or activity may be
deemed permissible under Sec. Sec. 255.4 through 255.6 if the
transaction, class of transactions, or activity would:
(1) Involve or result in a material conflict of interest between
the banking entity and its clients, customers, or counterparties;
(2) Result, directly or indirectly, in a material exposure by the
banking entity to a high-risk asset or a high-risk trading strategy; or
(3) Pose a threat to the safety and soundness of the banking entity
or to the financial stability of the United States.
(b) Definition of material conflict of interest. (1) For purposes
of this section, a material conflict of interest between a banking
entity and its clients, customers, or counterparties exists if the
banking entity engages in any transaction, class of transactions, or
activity that would involve or result in the banking entity's interests
being materially adverse to the interests of its client, customer, or
counterparty with respect to such transaction, class of transactions,
or activity, and the banking entity has not taken at least one of the
actions in paragraph (b)(2) of this section.
(2) Prior to effecting the specific transaction or class or type of
transactions, or engaging in the specific activity, the banking entity:
(i) Timely and effective disclosure. (A) Has made clear, timely,
and effective disclosure of the conflict of interest, together with
other necessary information, in reasonable detail and in a manner
sufficient to permit a reasonable client, customer, or counterparty to
meaningfully understand the conflict of interest; and
(B) Such disclosure is made in a manner that provides the client,
customer, or counterparty the opportunity to negate, or substantially
mitigate, any materially adverse effect on the client, customer, or
counterparty created by the conflict of interest; or
(ii) Information barriers. Has established, maintained, and
enforced information barriers that are memorialized in written policies
and procedures, such as physical separation of personnel, or functions,
or limitations on types of activity, that are reasonably designed,
taking into consideration the nature of the banking entity's business,
to prevent the conflict of interest from involving or resulting in a
materially adverse effect on a client, customer, or counterparty. A
banking entity may not rely on such information barriers if, in the
case of any specific transaction, class or type of transactions or
activity, the banking entity knows or should reasonably know that,
notwithstanding the banking entity's establishment of information
barriers, the conflict of interest may involve or result in a
materially adverse effect on a client, customer, or counterparty.
(c) Definition of high-risk asset and high-risk trading strategy.
For purposes of this section:
(1) High-risk asset means an asset or group of related assets that
would, if held by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
(2) High-risk trading strategy means a trading strategy that would,
if engaged in by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
Sec. Sec. 255.8-255.9 [Reserved]
Subpart C--Covered Funds Activities and Investments
Sec. 255.10 Prohibition on acquiring or retaining an ownership
interest in and having certain relationships with a covered fund.
(a) Prohibition. (1) Except as otherwise provided in this subpart,
a banking entity may not, as principal, directly or indirectly, acquire
or retain any ownership interest in or sponsor a covered fund.
(2) Paragraph (a)(1) of this section does not include acquiring or
retaining an ownership interest in a covered fund by a banking entity:
(i) Acting solely as agent, broker, or custodian, so long as;
(A) The activity is conducted for the account of, or on behalf of,
a customer; and
(B) The banking entity and its affiliates do not have or retain
beneficial ownership of such ownership interest;
(ii) Through a deferred compensation, stock-bonus, profit-sharing,
or pension plan of the banking entity (or an affiliate thereof) that is
established and administered in accordance with the law of the United
States or a foreign sovereign, if the ownership interest is held or
controlled directly or indirectly by the banking entity as trustee for
the benefit of persons who are or were employees of the banking entity
(or an affiliate thereof);
(iii) In the ordinary course of collecting a debt previously
contracted in good faith, provided that the banking entity divests the
ownership interest as soon as practicable, and in no event may the
banking entity retain such ownership interest for longer than such
period permitted by the SEC; or
(iv) On behalf of customers as trustee or in a similar fiduciary
capacity for a customer that is not a covered fund, so long as:
(A) The activity is conducted for the account of, or on behalf of,
the customer; and
(B) The banking entity and its affiliates do not have or retain
beneficial ownership of such ownership interest.
(b) Definition of covered fund. (1) Except as provided in paragraph
(c) of this section, covered fund means:
(i) An issuer that would be an investment company, as defined in
the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.), but for
section 3(c)(1) or 3(c)(7) of that Act (15 U.S.C. 80a-3(c)(1) or (7));
(ii) Any commodity pool under section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10)) for which:
[[Page 62257]]
(A) The commodity pool operator has claimed an exemption under 17
CFR 4.7; or
(B)(1) A commodity pool operator is registered with the CFTC as a
commodity pool operator in connection with the operation of the
commodity pool;
(2) Substantially all participation units of the commodity pool are
owned by qualified eligible persons under 17 CFR 4.7(a)(2) and (3); and
(3) Participation units of the commodity pool have not been
publicly offered to persons who are not qualified eligible persons
under 17 CFR 4.7(a)(2) and (3); or
(iii) For any banking entity that is, or is controlled directly or
indirectly by a banking entity that is, located in or organized under
the laws of the United States or of any State, an entity that:
(A) Is organized or established outside the United States and the
ownership interests of which are offered and sold solely outside the
United States;
(B) Is, or holds itself out as being, an entity or arrangement that
raises money from investors primarily for the purpose of investing in
securities for resale or other disposition or otherwise trading in
securities; and
(C)(1) Has as its sponsor that banking entity (or an affiliate
thereof); or
(2) Has issued an ownership interest that is owned directly or
indirectly by that banking entity (or an affiliate thereof).
(2) An issuer shall not be deemed to be a covered fund under
paragraph (b)(1)(iii) of this section if, were the issuer subject to
U.S. securities laws, the issuer could rely on an exclusion or
exemption from the definition of ``investment company'' under the
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) other than the
exclusions contained in section 3(c)(1) and 3(c)(7) of that Act.
(3) For purposes of paragraph (b)(1)(iii) of this section, a U.S.
branch, agency, or subsidiary of a foreign banking entity is located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(c) Notwithstanding paragraph (b) of this section, unless the
appropriate Federal banking agencies, the SEC, and the CFTC jointly
determine otherwise, a covered fund does not include:
(1) Foreign public funds. (i) Subject to paragraphs (ii) and (iii)
below, an issuer that:
(A) Is organized or established outside of the United States;
(B) Is authorized to offer and sell ownership interests to retail
investors in the issuer's home jurisdiction; and
(C) Sells ownership interests predominantly through one or more
public offerings outside of the United States.
(ii) With respect to a banking entity that is, or is controlled
directly or indirectly by a banking entity that is, located in or
organized under the laws of the United States or of any State and any
issuer for which such banking entity acts as sponsor, the sponsoring
banking entity may not rely on the exemption in paragraph (c)(1)(i) of
this section for such issuer unless ownership interests in the issuer
are sold predominantly to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring banking entity or such issuer;
and
(D) Directors and employees of such entities.
(iii) For purposes of paragraph (c)(1)(i)(C) of this section, the
term ``public offering'' means a distribution (as defined in Sec.
255.4(a)(3) of subpart B) of securities in any jurisdiction outside the
United States to investors, including retail investors, provided that:
(A) The distribution complies with all applicable requirements in
the jurisdiction in which such distribution is being made;
(B) The distribution does not restrict availability to investors
having a minimum level of net worth or net investment assets; and
(C) The issuer has filed or submitted, with the appropriate
regulatory authority in such jurisdiction, offering disclosure
documents that are publicly available.
(2) Wholly-owned subsidiaries. An entity, all of the outstanding
ownership interests of which are owned directly or indirectly by the
banking entity (or an affiliate thereof), except that:
(i) Up to five percent of the entity's outstanding ownership
interests, less any amounts outstanding under paragraph (c)(2)(ii) of
this section, may be held by employees or directors of the banking
entity or such affiliate (including former employees or directors if
their ownership interest was acquired while employed by or in the
service of the banking entity); and
(ii) Up to 0.5 percent of the entity's outstanding ownership
interests may be held by a third party if the ownership interest is
acquired or retained by the third party for the purpose of establishing
corporate separateness or addressing bankruptcy, insolvency, or similar
concerns.
(3) Joint ventures. A joint venture between a banking entity or any
of its affiliates and one or more unaffiliated persons, provided that
the joint venture:
(i) Is comprised of no more than 10 unaffiliated co-venturers;
(ii) Is in the business of engaging in activities that are
permissible for the banking entity or affiliate, other than investing
in securities for resale or other disposition; and
(iii) Is not, and does not hold itself out as being, an entity or
arrangement that raises money from investors primarily for the purpose
of investing in securities for resale or other disposition or otherwise
trading in securities.
(4) Acquisition vehicles. An issuer:
(i) Formed solely for the purpose of engaging in a bona fide merger
or acquisition transaction; and
(ii) That exists only for such period as necessary to effectuate
the transaction.
(5) Foreign pension or retirement funds. A plan, fund, or program
providing pension, retirement, or similar benefits that is:
(i) Organized and administered outside the United States;
(ii) A broad-based plan for employees or citizens that is subject
to regulation as a pension, retirement, or similar plan under the laws
of the jurisdiction in which the plan, fund, or program is organized
and administered; and
(iii) Established for the benefit of citizens or residents of one
or more foreign sovereigns or any political subdivision thereof.
(6) Insurance company separate accounts. A separate account,
provided that no banking entity other than the insurance company
participates in the account's profits and losses.
(7) Bank owned life insurance. A separate account that is used
solely for the purpose of allowing one or more banking entities to
purchase a life insurance policy for which the banking entity or
entities is beneficiary, provided that no banking entity that purchases
the policy:
(i) Controls the investment decisions regarding the underlying
assets or holdings of the separate account; or
(ii) Participates in the profits and losses of the separate account
other than in compliance with applicable supervisory guidance regarding
bank owned life insurance.
(8) Loan securitizations. (i) Scope. An issuing entity for asset-
backed securities that satisfies all the conditions of this paragraph
(c)(8) and the assets or holdings of which are comprised solely of:
(A) Loans as defined in Sec. 255.2(s) of subpart A;
(B) Rights or other assets designed to assure the servicing or
timely
[[Page 62258]]
distribution of proceeds to holders of such securities and rights or
other assets that are related or incidental to purchasing or otherwise
acquiring and holding the loans, provided that each asset meets the
requirements of paragraph (c)(8)(iii) of this section;
(C) Interest rate or foreign exchange derivatives that meet the
requirements of paragraph (c)(8)(iv) of this section; and
(D) Special units of beneficial interest and collateral
certificates that meet the requirements of paragraph (c)(8)(v) of this
section.
(ii) Impermissible assets. For purposes of this paragraph (c)(8),
the assets or holdings of the issuing entity shall not include any of
the following:
(A) A security, including an asset-backed security, or an interest
in an equity or debt security other than as permitted in paragraph
(c)(8)(iii) of this section;
(B) A derivative, other than a derivative that meets the
requirements of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities. Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may hold securities if those
securities are:
(A) Cash equivalents for purposes of the rights and assets in
paragraph (c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts previously contracted with
respect to the loans supporting the asset-backed securities.
(iv) Derivatives. The holdings of derivatives by the issuing entity
shall be limited to interest rate or foreign exchange derivatives that
satisfy all of the following conditions:
(A) The written terms of the derivative directly relate to the
loans, the asset-backed securities, or the contractual rights of other
assets described in paragraph (c)(8)(i)(B) of this section; and
(B) The derivatives reduce the interest rate and/or foreign
exchange risks related to the loans, the asset-backed securities, or
the contractual rights or other assets described in paragraph
(c)(8)(i)(B) of this section.
(v) Special units of beneficial interest and collateral
certificates. The assets or holdings of the issuing entity may include
collateral certificates and special units of beneficial interest issued
by a special purpose vehicle, provided that:
(A) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate meets the requirements in
this paragraph (c)(8);
(B) The special unit of beneficial interest or collateral
certificate is used for the sole purpose of transferring to the issuing
entity for the loan securitization the economic risks and benefits of
the assets that are permissible for loan securitizations under this
paragraph (c)(8) and does not directly or indirectly transfer any
interest in any other economic or financial exposure;
(C) The special unit of beneficial interest or collateral
certificate is created solely to satisfy legal requirements or
otherwise facilitate the structuring of the loan securitization; and
(D) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate and the issuing entity
are established under the direction of the same entity that initiated
the loan securitization.
(9) Qualifying asset-backed commercial paper conduits. (i) An
issuing entity for asset-backed commercial paper that satisfies all of
the following requirements:
(A) The asset-backed commercial paper conduit holds only:
(1) Loans and other assets permissible for a loan securitization
under paragraph (c)(8)(i) of this section; and
(2) Asset-backed securities supported solely by assets that are
permissible for loan securitizations under paragraph (c)(8)(i) of this
section and acquired by the asset-backed commercial paper conduit as
part of an initial issuance either directly from the issuing entity of
the asset-backed securities or directly from an underwriter in the
distribution of the asset-backed securities;
(B) The asset-backed commercial paper conduit issues only asset-
backed securities, comprised of a residual interest and securities with
a legal maturity of 397 days or less; and
(C) A regulated liquidity provider has entered into a legally
binding commitment to provide full and unconditional liquidity coverage
with respect to all of the outstanding asset-backed securities issued
by the asset-backed commercial paper conduit (other than any residual
interest) in the event that funds are required to redeem maturing
asset-backed securities.
(ii) For purposes of this paragraph (c)(9), a regulated liquidity
provider means:
(A) A depository institution, as defined in section 3(c) of the
Federal Deposit Insurance Act (12 U.S.C. 1813(c));
(B) A bank holding company, as defined in section 2(a) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(a)), or a subsidiary
thereof;
(C) A savings and loan holding company, as defined in section 10a
of the Home Owners' Loan Act (12 U.S.C. 1467a), provided all or
substantially all of the holding company's activities are permissible
for a financial holding company under section 4(k) of the Bank Holding
Company Act of 1956 (12 U.S.C. 1843(k)), or a subsidiary thereof;
(D) A foreign bank whose home country supervisor, as defined in
Sec. 211.21(q) of the Board's Regulation K (12 CFR 211.21(q)), has
adopted capital standards consistent with the Capital Accord for the
Basel Committee on banking Supervision, as amended, and that is subject
to such standards, or a subsidiary thereof; or
(E) The United States or a foreign sovereign.
(10) Qualifying covered bonds--(i) Scope. An entity owning or
holding a dynamic or fixed pool of loans or other assets as provided in
paragraph (c)(8) of this section for the benefit of the holders of
covered bonds, provided that the assets in the pool are comprised
solely of assets that meet the conditions in paragraph (c)(8)(i) of
this section.
(ii) Covered bond. For purposes of this paragraph (c)(10), a
covered bond means:
(A) A debt obligation issued by an entity that meets the definition
of foreign banking organization, the payment obligations of which are
fully and unconditionally guaranteed by an entity that meets the
conditions set forth in paragraph (c)(10)(i) of this section; or
(B) A debt obligation of an entity that meets the conditions set
forth in paragraph (c)(10)(i) of this section, provided that the
payment obligations are fully and unconditionally guaranteed by an
entity that meets the definition of foreign banking organization and
the entity is a wholly-owned subsidiary, as defined in paragraph (c)(2)
of this section, of such foreign banking organization.
(11) SBICs and public welfare investment funds. An issuer:
(i) That is a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), or that has received from the Small Business Administration
notice to proceed to qualify for a license as a small business
investment company, which notice or license has not been revoked; or
(ii) The business of which is to make investments that are:
(A) Designed primarily to promote the public welfare, of the type
permitted under paragraph (11) of section 5136 of the Revised Statutes
of the United States (12 U.S.C. 24), including the welfare of low- and
moderate-income communities
[[Page 62259]]
or families (such as providing housing, services, or jobs); or
(B) Qualified rehabilitation expenditures with respect to a
qualified rehabilitated building or certified historic structure, as
such terms are defined in section 47 of the Internal Revenue Code of
1986 or a similar State historic tax credit program.
(12) Registered investment companies and excluded entities. An
issuer:
(i) That is registered as an investment company under section 8 of
the Investment Company Act of 1940 (15 U.S.C. 80a-8), or that is formed
and operated pursuant to a written plan to become a registered
investment company as described in Sec. 255.20(e)(3) of subpart D and
that complies with the requirements of section 18 of the Investment
Company Act of 1940 (15 U.S.C. 80a-18);
(ii) That may rely on an exclusion or exemption from the definition
of ``investment company'' under the Investment Company Act of 1940 (15
U.S.C. 80a-1 et seq.) other than the exclusions contained in section
3(c)(1) and 3(c)(7) of that Act; or
(iii) That has elected to be regulated as a business development
company pursuant to section 54(a) of that Act (15 U.S.C. 80a-53) and
has not withdrawn its election, or that is formed and operated pursuant
to a written plan to become a business development company as described
in Sec. 255.20(e)(3) of subpart D and that complies with the
requirements of section 61 of the Investment Company Act of 1940 (15
U.S.C. 80a-60).
(13) Issuers in conjunction with the FDIC's receivership or
conservatorship operations. An issuer that is an entity formed by or on
behalf of the FDIC for the purpose of facilitating the disposal of
assets acquired in the FDIC's capacity as conservator or receiver under
the Federal Deposit Insurance Act or Title II of the Dodd-Frank Wall
Street Reform and Consumer Protection Act.
(14) Other excluded issuers. (i) Any issuer that the appropriate
Federal banking agencies, the SEC, and the CFTC jointly determine the
exclusion of which is consistent with the purposes of section 13 of the
BHC Act.
(ii) A determination made under paragraph (c)(14)(i) of this
section will be promptly made public.
(d) Definition of other terms related to covered funds. For
purposes of this subpart:
(1) Applicable accounting standards means U.S. generally accepted
accounting principles, or such other accounting standards applicable to
a banking entity that the SEC determines are appropriate and that the
banking entity uses in the ordinary course of its business in preparing
its consolidated financial statements.
(2) Asset-backed security has the meaning specified in Section
3(a)(79) of the Exchange Act (15 U.S.C. 78c(a)(79)).
(3) Director has the same meaning as provided in section
215.2(d)(1) of the Board's Regulation O (12 CFR 215.2(d)(1)).
(4) Issuer has the same meaning as in section 2(a)(22) of the
Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(22)).
(5) Issuing entity means with respect to asset-backed securities
the special purpose vehicle that owns or holds the pool assets
underlying asset-backed securities and in whose name the asset-backed
securities supported or serviced by the pool assets are issued.
(6) Ownership interest--(i) Ownership interest means any equity,
partnership, or other similar interest. An ``other similar interest''
means an interest that:
(A) Has the right to participate in the selection or removal of a
general partner, managing member, member of the board of directors or
trustees, investment manager, investment adviser, or commodity trading
advisor of the covered fund (excluding the rights of a creditor to
exercise remedies upon the occurrence of an event of default or an
acceleration event);
(B) Has the right under the terms of the interest to receive a
share of the income, gains or profits of the covered fund;
(C) Has the right to receive the underlying assets of the covered
fund after all other interests have been redeemed and/or paid in full
(excluding the rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event);
(D) Has the right to receive all or a portion of excess spread (the
positive difference, if any, between the aggregate interest payments
received from the underlying assets of the covered fund and the
aggregate interest paid to the holders of other outstanding interests);
(E) Provides under the terms of the interest that the amounts
payable by the covered fund with respect to the interest could be
reduced based on losses arising from the underlying assets of the
covered fund, such as allocation of losses, write-downs or charge-offs
of the outstanding principal balance, or reductions in the amount of
interest due and payable on the interest;
(F) Receives income on a pass-through basis from the covered fund,
or has a rate of return that is determined by reference to the
performance of the underlying assets of the covered fund; or
(G) Any synthetic right to have, receive, or be allocated any of
the rights in paragraphs (d)(6)(i)(A) through (F) of this section.
(ii) Ownership interest does not include: Restricted profit
interest. An interest held by an entity (or an employee or former
employee thereof) in a covered fund for which the entity (or employee
thereof) serves as investment manager, investment adviser, commodity
trading advisor, or other service provider so long as:
(A) The sole purpose and effect of the interest is to allow the
entity (or employee or former employee thereof) to share in the profits
of the covered fund as performance compensation for the investment
management, investment advisory, commodity trading advisory, or other
services provided to the covered fund by the entity (or employee or
former employee thereof), provided that the entity (or employee or
former employee thereof) may be obligated under the terms of such
interest to return profits previously received;
(B) All such profit, once allocated, is distributed to the entity
(or employee or former employee thereof) promptly after being earned
or, if not so distributed, is retained by the covered fund for the sole
purpose of establishing a reserve amount to satisfy contractual
obligations with respect to subsequent losses of the covered fund and
such undistributed profit of the entity (or employee or former employee
thereof) does not share in the subsequent investment gains of the
covered fund;
(C) Any amounts invested in the covered fund, including any amounts
paid by the entity (or employee or former employee thereof) in
connection with obtaining the restricted profit interest, are within
the limits of Sec. 255.12 of this subpart; and
(D) The interest is not transferable by the entity (or employee or
former employee thereof) except to an affiliate thereof (or an employee
of the banking entity or affiliate), to immediate family members, or
through the intestacy, of the employee or former employee, or in
connection with a sale of the business that gave rise to the restricted
profit interest by the entity (or employee or former employee thereof)
to an unaffiliated party that provides investment management,
investment advisory, commodity trading advisory, or other services to
the fund.
(7) Prime brokerage transaction means any transaction that would be
a covered transaction, as defined in section 23A(b)(7) of the Federal
Reserve Act (12 U.S.C. 371c(b)(7)), that is provided in
[[Page 62260]]
connection with custody, clearance and settlement, securities borrowing
or lending services, trade execution, financing, or data, operational,
and administrative support.
(8) Resident of the United States means a person that is a ``U.S.
person'' as defined in rule 902(k) of the SEC's Regulation S (17 CFR
230.902(k)).
(9) Sponsor means, with respect to a covered fund:
(i) To serve as a general partner, managing member, or trustee of a
covered fund, or to serve as a commodity pool operator with respect to
a covered fund as defined in (b)(1)(ii) of this section;
(ii) In any manner to select or to control (or to have employees,
officers, or directors, or agents who constitute) a majority of the
directors, trustees, or management of a covered fund; or
(iii) To share with a covered fund, for corporate, marketing,
promotional, or other purposes, the same name or a variation of the
same name, except as permitted under Sec. 255.11(a)(6).
(10) Trustee. (i) For purposes of paragraph (d)(9) of this section
and Sec. 255.11 of subpart C, a trustee does not include:
(A) A trustee that does not exercise investment discretion with
respect to a covered fund, including a trustee that is subject to the
direction of an unaffiliated named fiduciary who is not a trustee
pursuant to section 403(a)(1) of the Employee's Retirement Income
Security Act (29 U.S.C. 1103(a)(1)); or
(B) A trustee that is subject to fiduciary standards imposed under
foreign law that are substantially equivalent to those described in
paragraph (d)(10)(i)(A) of this section;
(ii) Any entity that directs a person described in paragraph
(d)(10)(i) of this section, or that possesses authority and discretion
to manage and control the investment decisions of a covered fund for
which such person serves as trustee, shall be considered to be a
trustee of such covered fund.
Sec. 255.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
(a) Organizing and offering a covered fund in general.
Notwithstanding Sec. 255.10(a) of this subpart, a banking entity is
not prohibited from acquiring or retaining an ownership interest in, or
acting as sponsor to, a covered fund in connection with, directly or
indirectly, organizing and offering a covered fund, including serving
as a general partner, managing member, trustee, or commodity pool
operator of the covered fund and in any manner selecting or controlling
(or having employees, officers, directors, or agents who constitute) a
majority of the directors, trustees, or management of the covered fund,
including any necessary expenses for the foregoing, only if:
(1) The banking entity (or an affiliate thereof) provides bona fide
trust, fiduciary, investment advisory, or commodity trading advisory
services;
(2) The covered fund is organized and offered only in connection
with the provision of bona fide trust, fiduciary, investment advisory,
or commodity trading advisory services and only to persons that are
customers of such services of the banking entity (or an affiliate
thereof), pursuant to a written plan or similar documentation outlining
how the banking entity or such affiliate intends to provide advisory or
similar services to its customers through organizing and offering such
fund;
(3) The banking entity and its affiliates do not acquire or retain
an ownership interest in the covered fund except as permitted under
Sec. 255.12 of this subpart;
(4) The banking entity and its affiliates comply with the
requirements of Sec. 255.14 of this subpart;
(5) The banking entity and its affiliates do not, directly or
indirectly, guarantee, assume, or otherwise insure the obligations or
performance of the covered fund or of any covered fund in which such
covered fund invests;
(6) The covered fund, for corporate, marketing, promotional, or
other purposes:
(i) Does not share the same name or a variation of the same name
with the banking entity (or an affiliate thereof) except that a covered
fund may share the same name or a variation of the same name with a
banking entity that is an investment adviser to the covered fund if:
(A) The investment adviser is not an insured depository
institution, a company that controls an insured depository institution,
or a company that is treated as a bank holding company for purposes of
section 8 of the International Banking Act of 1978 (12 U.S.C. 3106);
and
(B) The investment adviser does not share the same name or a
variation of the same name as an insured depository institution, a
company that controls an insured depository institution, or a company
that is treated as a bank holding company for purposes of section 8 of
the International Banking Act of 1978 (12 U.S.C. 3106); and
(ii) Does not use the word ``bank'' in its name;
(7) No director or employee of the banking entity (or an affiliate
thereof) takes or retains an ownership interest in the covered fund,
except for any director or employee of the banking entity or such
affiliate who is directly engaged in providing investment advisory,
commodity trading advisory, or other services to the covered fund at
the time the director or employee takes the ownership interest; and
(8) The banking entity:
(i) Clearly and conspicuously discloses, in writing, to any
prospective and actual investor in the covered fund (such as through
disclosure in the covered fund's offering documents):
(A) That ``any losses in [such covered fund] will be borne solely
by investors in [the covered fund] and not by [the banking entity] or
its affiliates; therefore, [the banking entity's] losses in [such
covered fund] will be limited to losses attributable to the ownership
interests in the covered fund held by [the banking entity] and any
affiliate in its capacity as investor in the [covered fund] or as
beneficiary of a restricted profit interest held by [the banking
entity] or any affiliate'';
(B) That such investor should read the fund offering documents
before investing in the covered fund;
(C) That the ``ownership interests in the covered fund are not
insured by the FDIC, and are not deposits, obligations of, or endorsed
or guaranteed in any way, by any banking entity'' (unless that happens
to be the case); and
(D) The role of the banking entity and its affiliates and employees
in sponsoring or providing any services to the covered fund; and
(ii) Complies with any additional rules of the appropriate Federal
banking agencies, the SEC, or the CFTC, as provided in section 13(b)(2)
of the BHC Act, designed to ensure that losses in such covered fund are
borne solely by investors in the covered fund and not by the covered
banking entity and its affiliates.
(b) Organizing and offering an issuing entity of asset-backed
securities. (1) Notwithstanding Sec. 255.10(a) of this subpart, a
banking entity is not prohibited from acquiring or retaining an
ownership interest in, or acting as sponsor to, a covered fund that is
an issuing entity of asset-backed securities in connection with,
directly or indirectly, organizing and offering that issuing entity, so
long as the banking entity and its affiliates comply with all of the
requirements of paragraph (a)(3) through (8) of this section.
(2) For purposes of this paragraph (b), organizing and offering a
covered fund that is an issuing entity of asset-backed securities means
acting as the securitizer, as that term is used in section 15G(a)(3) of
the Exchange Act
[[Page 62261]]
(15 U.S.C. 78o-11(a)(3)) of the issuing entity, or acquiring or
retaining an ownership interest in the issuing entity as required by
section 15G of that Act (15 U.S.C.78o-11) and the implementing
regulations issued thereunder.
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 255.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 255.4(a) or Sec. 255.4(b) of subpart B,
respectively;
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in such covered fund in
compliance with section 15G of that Act (15 U.S.C.78o-11) and the
implementing regulations issued thereunder each as permitted by
paragraph (b) of this section; or, directly or indirectly, guarantees,
assumes, or otherwise insures the obligations or performance of the
covered fund or of any covered fund in which such fund invests, then in
each such case any ownership interests acquired or retained by the
banking entity and its affiliates in connection with underwriting and
market making related activities for that particular covered fund are
included in the calculation of ownership interests permitted to be held
by the banking entity and its affiliates under the limitations of Sec.
255.12(a)(2)(ii) and Sec. 255.12(d) of this subpart; and
(3) With respect to any banking entity, the aggregate value of all
ownership interests of the banking entity and its affiliates in all
covered funds acquired and retained under Sec. 255.11 of this subpart,
including all covered funds in which the banking entity holds an
ownership interest in connection with underwriting and market making
related activities permitted under this paragraph (c), are included in
the calculation of all ownership interests under Sec.
255.12(a)(2)(iii) and Sec. 255.12(d) of this subpart.
Sec. 255.12 Permitted investment in a covered fund.
(a) Authority and limitations on permitted investments in covered
funds. (1) Notwithstanding the prohibition contained in Sec. 255.10(a)
of this subpart, a banking entity may acquire and retain an ownership
interest in a covered fund that the banking entity or an affiliate
thereof organizes and offers pursuant to Sec. 255.11, for the purposes
of:
(i) Establishment. Establishing the fund and providing the fund
with sufficient initial equity for investment to permit the fund to
attract unaffiliated investors, subject to the limits contained in
paragraphs (a)(2)(i) and (iii) of this section; or
(ii) De minimis investment. Making and retaining an investment in
the covered fund subject to the limits contained in paragraphs
(a)(2)(ii) and (iii) of this section.
(2) Investment limits--(i) Seeding period. With respect to an
investment in any covered fund made or held pursuant to paragraph
(a)(1)(i) of this section, the banking entity and its affiliates:
(A) Must actively seek unaffiliated investors to reduce, through
redemption, sale, dilution, or other methods, the aggregate amount of
all ownership interests of the banking entity in the covered fund to
the amount permitted in paragraph (a)(2)(i)(B) of this section; and
(B) Must, no later than 1 year after the date of establishment of
the fund (or such longer period as may be provided by the Board
pursuant to paragraph (e) of this section), conform its ownership
interest in the covered fund to the limits in paragraph (a)(2)(ii) of
this section;
(ii) Per-fund limits. (A) Except as provided in paragraph
(a)(2)(ii)(B) of this section, an investment by a banking entity and
its affiliates in any covered fund made or held pursuant to paragraph
(a)(1)(ii) of this section may not exceed 3 percent of the total number
or value of the outstanding ownership interests of the fund.
(B) An investment by a banking entity and its affiliates in a
covered fund that is an issuing entity of asset-backed securities may
not exceed 3 percent of the total fair market value of the ownership
interests of the fund measured in accordance with paragraph (b)(3) of
this section, unless a greater percentage is retained by the banking
entity and its affiliates in compliance with the requirements of
section 15G of the Exchange Act (15 U.S.C. 78o-11) and the implementing
regulations issued thereunder, in which case the investment by the
banking entity and its affiliates in the covered fund may not exceed
the amount, number, or value of ownership interests of the fund
required under section 15G of the Exchange Act and the implementing
regulations issued thereunder.
(iii) Aggregate limit. The aggregate value of all ownership
interests of the banking entity and its affiliates in all covered funds
acquired or retained under this section may not exceed 3 percent of the
tier 1 capital of the banking entity, as provided under paragraph (c)
of this section, and shall be calculated as of the last day of each
calendar quarter.
(iv) Date of establishment. For purposes of this section, the date
of establishment of a covered fund shall be:
(A) In general. The date on which the investment adviser or similar
entity to the covered fund begins making investments pursuant to the
written investment strategy for the fund;
(B) Issuing entities of asset-backed securities. In the case of an
issuing entity of asset-backed securities, the date on which the assets
are initially transferred into the issuing entity of asset-backed
securities.
(b) Rules of construction--(1) Attribution of ownership interests
to a covered banking entity. (i) For purposes of paragraph (a)(2) of
this section, the amount and value of a banking entity's permitted
investment in any single covered fund shall include any ownership
interest held under Sec. 255__.12 directly by the banking entity,
including any affiliate of the banking entity.
(ii) Treatment of registered investment companies, SEC-regulated
business development companies and foreign public funds. For purposes
of paragraph (b)(1)(i) of this section, a registered investment
company, SEC-regulated business development companies or foreign public
fund as described in Sec. 255__.10(c)(1) of this subpart will not be
considered to be an affiliate of the banking entity so long as the
banking entity:
(A) Does not own, control, or hold with the power to vote 25
percent or more of the voting shares of the company or fund; and
(B) Provides investment advisory, commodity trading advisory,
administrative, and other services to the company or fund in compliance
with the limitations under applicable regulation, order, or other
authority.
(iii) Covered funds. For purposes of paragraph (b)(1)(i) of this
section, a covered fund will not be considered to be an affiliate of a
banking entity so long as the covered fund is held in
[[Page 62262]]
compliance with the requirements of this subpart.
(iv) Treatment of employee and director investments financed by the
banking entity. For purposes of paragraph (b)(1)(i) of this section, an
investment by a director or employee of a banking entity who acquires
an ownership interest in his or her personal capacity in a covered fund
sponsored by the banking entity will be attributed to the banking
entity if the banking entity, directly or indirectly, extends financing
for the purpose of enabling the director or employee to acquire the
ownership interest in the fund and the financing is used to acquire
such ownership interest in the covered fund.
(2) Calculation of permitted ownership interests in a single
covered fund. Except as provided in paragraph (b)(3) or (4), for
purposes of determining whether an investment in a single covered fund
complies with the restrictions on ownership interests under paragraphs
(a)(2)(i)(B) and (a)(2)(ii)(A) of this section:
(i) The aggregate number of the outstanding ownership interests
held by the banking entity shall be the total number of ownership
interests held under this section by the banking entity in a covered
fund divided by the total number of ownership interests held by all
entities in that covered fund, as of the last day of each calendar
quarter (both measured without regard to committed funds not yet called
for investment);
(ii) The aggregate value of the outstanding ownership interests
held by the banking entity shall be the aggregate fair market value of
all investments in and capital contributions made to the covered fund
by the banking entity, divided by the value of all investments in and
capital contributions made to that covered fund by all entities, as of
the last day of each calendar quarter (all measured without regard to
committed funds not yet called for investment). If fair market value
cannot be determined, then the value shall be the historical cost basis
of all investments in and contributions made by the banking entity to
the covered fund;
(iii) For purposes of the calculation under paragraph (b)(2)(ii) of
this section, once a valuation methodology is chosen, the banking
entity must calculate the value of its investment and the investments
of all others in the covered fund in the same manner and according to
the same standards.
(3) Issuing entities of asset-backed securities. In the case of an
ownership interest in an issuing entity of asset-backed securities, for
purposes of determining whether an investment in a single covered fund
complies with the restrictions on ownership interests under paragraphs
(a)(2)(i)(B) and (a)(2)(ii)(B) of this section:
(i) For securitizations subject to the requirements of section 15G
of the Exchange Act (15 U.S.C. 78o-11), the calculations shall be made
as of the date and according to the valuation methodology applicable
pursuant to the requirements of section 15G of the Exchange Act (15
U.S.C. 78o-11) and the implementing regulations issued thereunder; or
(ii) For securitization transactions completed prior to the
compliance date of such implementing regulations (or as to which such
implementing regulations do not apply), the calculations shall be made
as of the date of establishment as defined in paragraph (a)(2)(iv)(B)
of this section or such earlier date on which the transferred assets
have been valued for purposes of transfer to the covered fund, and
thereafter only upon the date on which additional securities of the
issuing entity of asset-backed securities are priced for purposes of
the sales of ownership interests to unaffiliated investors.
(iii) For securitization transactions completed prior to the
compliance date of such implementing regulations (or as to which such
implementing regulations do not apply), the aggregate value of the
outstanding ownership interests in the covered fund shall be the fair
market value of the assets transferred to the issuing entity of the
securitization and any other assets otherwise held by the issuing
entity at such time, determined in a manner that is consistent with its
determination of the fair market value of those assets for financial
statement purposes.
(iv) For purposes of the calculation under paragraph (b)(3)(iii) of
this section, the valuation methodology used to calculate the fair
market value of the ownership interests must be the same for both the
ownership interests held by a banking entity and the ownership
interests held by all others in the covered fund in the same manner and
according to the same standards.
(4) Multi-tier fund investments--(i) Master-feeder fund
investments. If the principal investment strategy of a covered fund
(the ``feeder fund'') is to invest substantially all of its assets in
another single covered fund (the ``master fund''), then for purposes of
the investment limitations in paragraphs (a)(2)(i)(B) and (a)(2)(ii) of
this section, the banking entity's permitted investment in such funds
shall be measured only by reference to the value of the master fund.
The banking entity's permitted investment in the master fund shall
include any investment by the banking entity in the master fund, as
well as the banking entity's pro-rata share of any ownership interest
of the master fund that is held through the feeder fund; and
(ii) Fund-of-funds investments. If a banking entity organizes and
offers a covered fund pursuant to Sec. 255.11 of this subpart for the
purpose of investing in other covered funds (a ``fund of funds'') and
that fund of funds itself invests in another covered fund that the
banking entity is permitted to own, then the banking entity's permitted
investment in that other fund shall include any investment by the
banking entity in that other fund, as well as the banking entity's pro-
rata share of any ownership interest of the fund that is held through
the fund of funds. The investment of the banking entity may not
represent more than 3 percent of the amount or value of any single
covered fund.
(c) Aggregate permitted investments in all covered funds. (1) For
purposes of paragraph (a)(2)(iii) of this section, the aggregate value
of all ownership interests held by a banking entity shall be the sum of
all amounts paid or contributed by the banking entity in connection
with acquiring or retaining an ownership interest in covered funds
(together with any amounts paid by the entity (or employee thereof) in
connection with obtaining a restricted profit interest under Sec.
255__.10(d)(6)(ii) of this subpart), on a historical cost basis.
(2) Calculation of tier 1 capital. For purposes of paragraph
(a)(2)(iii) of this section:
(i) Entities that are required to hold and report tier 1 capital.
If a banking entity is required to calculate and report tier 1 capital,
the banking entity's tier 1 capital shall be equal to the amount of
tier 1 capital of the banking entity as of the last day of the most
recent calendar quarter, as reported to its primary financial
regulatory agency; and
(ii) If a banking entity is not required to calculate and report
tier 1 capital, the banking entity's tier 1 capital shall be determined
to be equal to:
(A) In the case of a banking entity that is controlled, directly or
indirectly, by a depository institution that calculates and reports
tier 1 capital, be equal to the amount of tier 1 capital reported by
such controlling depository institution in the manner described in
paragraph (c)(2)(i) of this section;
(B) In the case of a banking entity that is not controlled,
directly or indirectly, by a depository institution that calculates and
reports tier 1 capital:
[[Page 62263]]
(1) Bank holding company subsidiaries. If the banking entity is a
subsidiary of a bank holding company or company that is treated as a
bank holding company, be equal to the amount of tier 1 capital reported
by the top-tier affiliate of such covered banking entity that
calculates and reports tier 1 capital in the manner described in
paragraph (c)(2)(i) of this section; and
(2) Other holding companies and any subsidiary or affiliate
thereof. If the banking entity is not a subsidiary of a bank holding
company or a company that is treated as a bank holding company, be
equal to the total amount of shareholders' equity of the top-tier
affiliate within such organization as of the last day of the most
recent calendar quarter that has ended, as determined under applicable
accounting standards.
(iii) Treatment of foreign banking entities--(A) Foreign banking
entities. Except as provided in paragraph (c)(2)(iii)(B) of this
section, with respect to a banking entity that is not itself, and is
not controlled directly or indirectly by, a banking entity that is
located or organized under the laws of the United States or of any
State, the tier 1 capital of the banking entity shall be the
consolidated tier 1 capital of the entity as calculated under
applicable home country standards.
(B) U.S. affiliates of foreign banking entities. With respect to a
banking entity that is located or organized under the laws of the
United States or of any State and is controlled by a foreign banking
entity identified under paragraph (c)(2)(iii)(A) of this section, the
banking entity's tier 1 capital shall be as calculated under paragraphs
(c)(2)(i) or (ii) of this section.
(d) Capital treatment for a permitted investment in a covered fund.
For purposes of calculating compliance with the applicable regulatory
capital requirements, a banking entity shall deduct from the banking
entity's tier 1 capital (as determined under paragraph (c)(2) of this
section) the greater of:
(1) The sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
(together with any amounts paid by the entity (or employee thereof) in
connection with obtaining a restricted profit interest under Sec.
255__.10(d)(6)(ii) of subpart C), on a historical cost basis, plus any
earnings received; and
(2) The fair market value of the banking entity's ownership
interests in the covered fund as determined under paragraph (b)(2)(ii)
or (b)(3) of this section (together with any amounts paid by the entity
(or employee thereof) in connection with obtaining a restricted profit
interest under Sec. 255__.10(d)(6)(ii) of subpart C), if the banking
entity accounts for the profits (or losses) of the fund investment in
its financial statements.
(e) Extension of time to divest an ownership interest. (1) Upon
application by a banking entity, the Board may extend the period under
paragraph (a)(2)(i) of this section for up to 2 additional years if the
Board finds that an extension would be consistent with safety and
soundness and not detrimental to the public interest. An application
for extension must:
(i) Be submitted to the Board at least 90 days prior to the
expiration of the applicable time period;
(ii) Provide the reasons for application, including information
that addresses the factors in paragraph (e)(2) of this section; and
(iii) Explain the banking entity's plan for reducing the permitted
investment in a covered fund through redemption, sale, dilution or
other methods as required in paragraph (a)(2) of this section.
(2) Factors governing Board determinations. In reviewing any
application under paragraph (e)(1) of this section, the Board may
consider all the facts and circumstances related to the permitted
investment in a covered fund, including:
(i) Whether the investment would result, directly or indirectly, in
a material exposure by the banking entity to high-risk assets or high-
risk trading strategies;
(ii) The contractual terms governing the banking entity's interest
in the covered fund;
(iii) The date on which the covered fund is expected to have
attracted sufficient investments from investors unaffiliated with the
banking entity to enable the banking entity to comply with the
limitations in paragraph (a)(2)(i) of this section;
(iv) The total exposure of the covered banking entity to the
investment and the risks that disposing of, or maintaining, the
investment in the covered fund may pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of divesting or disposing of the
investment within the applicable period;
(vi) Whether the investment or the divestiture or conformance of
the investment would involve or result in a material conflict of
interest between the banking entity and unaffiliated parties, including
clients, customers or counterparties to which it owes a duty;
(vi) The banking entity's prior efforts to reduce through
redemption, sale, dilution, or other methods its ownership interests in
the covered fund, including activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board believes appropriate.
(3) Authority to impose restrictions on activities or investment
during any extension period. The Board may impose such conditions on
any extension approved under paragraph (e)(1) of this section as the
Board determines are necessary or appropriate to protect the safety and
soundness of the banking entity or the financial stability of the
United States, address material conflicts of interest or other unsound
banking practices, or otherwise further the purposes of section 13 of
the BHC Act and this part.
(4) Consultation. In the case of a banking entity that is primarily
regulated by another Federal banking agency, the SEC, or the CFTC, the
Board will consult with such agency prior to acting on an application
by the banking entity for an extension under paragraph (e)(1) of this
section.
Sec. 255.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 255.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to demonstrably reduce or
otherwise significantly mitigate the specific, identifiable risks to
the banking entity in connection with a compensation arrangement with
an employee of the banking entity or an affiliate thereof that directly
provides investment advisory, commodity trading advisory or other
services to the covered fund.
(2) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures and
[[Page 62264]]
internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate and demonstrably reduces or otherwise
significantly mitigates one or more specific, identifiable risks
arising in connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) The compensation arrangement relates solely to the covered
fund in which the banking entity or any affiliate has acquired an
ownership interest pursuant to this paragraph and such compensation
arrangement provides that any losses incurred by the banking entity on
such ownership interest will be offset by corresponding decreases in
amounts payable under such compensation arrangement.
(b) Certain permitted covered fund activities and investments
outside of the United States. (1) The prohibition contained in Sec.
255.10(a) of this subpart does not apply to the acquisition or
retention of any ownership interest in, or the sponsorship of, a
covered fund by a banking entity only if:
(i) The banking entity is not organized or directly or indirectly
controlled by a banking entity that is organized under the laws of the
United States or of one or more States;
(ii) The activity or investment by the banking entity is pursuant
to paragraph (9) or (13) of section 4(c) of the BHC Act;
(iii) No ownership interest in the covered fund is offered for sale
or sold to a resident of the United States; and
(iv) The activity or investment occurs solely outside of the United
States.
(2) An activity or investment by the banking entity is pursuant to
paragraph (9) or (13) of section 4(c) of the BHC Act for purposes of
paragraph (b)(1)(ii) of this section only if:
(i) The activity or investment is conducted in accordance with the
requirements of this section; and
(ii)(A) With respect to a banking entity that is a foreign banking
organization, the banking entity meets the qualifying foreign banking
organization requirements of section 211.23(a), (c) or (e) of the
Board's Regulation K (12 CFR 211.23(a), (c) or (e)), as applicable; or
(B) With respect to a banking entity that is not a foreign banking
organization, the banking entity is not organized under the laws of the
United States or of one or more States and the banking entity, on a
fully-consolidated basis, meets at least two of the following
requirements:
(1) Total assets of the banking entity held outside of the United
States exceed total assets of the banking entity held in the United
States;
(2) Total revenues derived from the business of the banking entity
outside of the United States exceed total revenues derived from the
business of the banking entity in the United States; or
(3) Total net income derived from the business of the banking
entity outside of the United States exceeds total net income derived
from the business of the banking entity in the United States.
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is sold or has been sold
pursuant to an offering that does not target residents of the United
States.
(4) An activity or investment occurs solely outside of the United
States for purposes of paragraph (b)(1)(iv) of this section only if:
(i) The banking entity acting as sponsor, or engaging as principal
in the acquisition or retention of an ownership interest in the covered
fund, is not itself, and is not controlled directly or indirectly by, a
banking entity that is located in the United States or organized under
the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to acquire or retain the ownership interest or act as
sponsor to the covered fund is not located in the United States or
organized under the laws of the United States or of any State;
(iii) The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State; and
(iv) No financing for the banking entity's ownership or sponsorship
is provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State.
(5) For purposes of this section, a U.S. branch, agency, or
subsidiary of a foreign bank, or any subsidiary thereof, is located in
the United States; however, a foreign bank of which that branch,
agency, or subsidiary is a part is not considered to be located in the
United States solely by virtue of operation of the U.S. branch, agency,
or subsidiary.
(c) Permitted covered fund interests and activities by a regulated
insurance company. The prohibition contained in Sec. 255.10(a) of this
subpart does not apply to the acquisition or retention by an insurance
company, or an affiliate thereof, of any ownership interest in, or the
sponsorship of, a covered fund only if:
(1) The insurance company or its affiliate acquires and retains the
ownership interest solely for the general account of the insurance
company or for one or more separate accounts established by the
insurance company;
(2) The acquisition and retention of the ownership interest is
conducted in compliance with, and subject to, the insurance company
investment laws, regulations, and written guidance of the State or
jurisdiction in which such insurance company is domiciled; and
(3) The appropriate Federal banking agencies, after consultation
with the Financial Stability Oversight Council and the relevant
insurance commissioners of the States and foreign jurisdictions, as
appropriate, have not jointly determined, after notice and comment,
that a particular law, regulation, or written guidance described in
paragraph (c)(2) of this section is insufficient to protect the safety
and soundness of the banking entity, or the financial stability of the
United States.
Sec. 255.14 Limitations on relationships with a covered fund.
(a) Relationships with a covered fund. (1) Except as provided for
in paragraph (a)(2) of this section, no banking entity that serves,
directly or indirectly, as the investment manager, investment adviser,
commodity trading advisor, or sponsor to a covered fund, that organizes
and offers a covered fund pursuant to Sec. 255.11 of this subpart, or
that continues to hold an ownership interest in accordance with Sec.
255.11(b) of this subpart, and no affiliate of such entity, may enter
into a transaction with the covered fund, or with any other covered
fund that is controlled by such covered fund, that would be a covered
transaction as defined in section 23A of the Federal Reserve Act (12
U.S.C. 371c(b)(7)), as if such banking entity and the affiliate thereof
were a member bank and the covered fund were an affiliate thereof.
(2) Notwithstanding paragraph (a)(1) of this section, a banking
entity may:
(i) Acquire and retain any ownership interest in a covered fund in
accordance
[[Page 62265]]
with the requirements of Sec. 255.11, Sec. 255.12, or Sec. 255.13 of
this subpart; and
(ii) Enter into any prime brokerage transaction with any covered
fund in which a covered fund managed, sponsored, or advised by such
banking entity (or an affiliate thereof) has taken an ownership
interest, if:
(A) The banking entity is in compliance with each of the
limitations set forth in Sec. 255.11 of this subpart with respect to a
covered fund organized and offered by such banking entity (or an
affiliate thereof);
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually to the SEC (with a duty to
update the certification if the information in the certification
materially changes) that the banking entity does not, directly or
indirectly, guarantee, assume, or otherwise insure the obligations or
performance of the covered fund or of any covered fund in which such
covered fund invests; and
(C) The Board has not determined that such transaction is
inconsistent with the safe and sound operation and condition of the
banking entity.
(b) Restrictions on transactions with covered funds. A banking
entity that serves, directly or indirectly, as the investment manager,
investment adviser, commodity trading advisor, or sponsor to a covered
fund, or that organizes and offers a covered fund pursuant to Sec.
255.11 of this subpart, or that continues to hold an ownership interest
in accordance with Sec. 255.11(b) of this subpart, shall be subject to
section 23B of the Federal Reserve Act (12 U.S.C. 371c-1), as if such
banking entity were a member bank and such covered fund were an
affiliate thereof.
(c) Restrictions on prime brokerage transactions. A prime brokerage
transaction permitted under paragraph (a)(2)(ii) of this section shall
be subject to section 23B of the Federal Reserve Act (12 U.S.C. 371c-1)
as if the counterparty were an affiliate of the banking entity.
Sec. 255.15 Other limitations on permitted covered fund activities.
(a) No transaction, class of transactions, or activity may be
deemed permissible under Sec. Sec. 255.11 through 255.13 of this
subpart if the transaction, class of transactions, or activity would:
(1) Involve or result in a material conflict of interest between
the banking entity and its clients, customers, or counterparties;
(2) Result, directly or indirectly, in a material exposure by the
banking entity to a high-risk asset or a high-risk trading strategy; or
(3) Pose a threat to the safety and soundness of the banking entity
or to the financial stability of the United States.
(b) Definition of material conflict of interest. (1) For purposes
of this section, a material conflict of interest between a banking
entity and its clients, customers, or counterparties exists if the
banking entity engages in any transaction, class of transactions, or
activity that would involve or result in the banking entity's interests
being materially adverse to the interests of its client, customer, or
counterparty with respect to such transaction, class of transactions,
or activity, and the banking entity has not taken at least one of the
actions in paragraph (b)(2) of this section.
(2) Prior to effecting the specific transaction or class or type of
transactions, or engaging in the specific activity, the banking entity:
(i) Timely and effective disclosure. (A) Has made clear, timely,
and effective disclosure of the conflict of interest, together with
other necessary information, in reasonable detail and in a manner
sufficient to permit a reasonable client, customer, or counterparty to
meaningfully understand the conflict of interest; and
(B) Such disclosure is made in a manner that provides the client,
customer, or counterparty the opportunity to negate, or substantially
mitigate, any materially adverse effect on the client, customer, or
counterparty created by the conflict of interest; or
(ii) Information barriers. Has established, maintained, and
enforced information barriers that are memorialized in written policies
and procedures, such as physical separation of personnel, or functions,
or limitations on types of activity, that are reasonably designed,
taking into consideration the nature of the banking entity's business,
to prevent the conflict of interest from involving or resulting in a
materially adverse effect on a client, customer, or counterparty. A
banking entity may not rely on such information barriers if, in the
case of any specific transaction, class or type of transactions or
activity, the banking entity knows or should reasonably know that,
notwithstanding the banking entity's establishment of information
barriers, the conflict of interest may involve or result in a
materially adverse effect on a client, customer, or counterparty.
(c) Definition of high-risk asset and high-risk trading strategy.
For purposes of this section:
(1) High-risk asset means an asset or group of related assets that
would, if held by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
(2) High-risk trading strategy means a trading strategy that would,
if engaged in by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
Sec. 255.16 Ownership of interests in and sponsorship of issuers of
certain collateralized debt obligations backed by trust-preferred
securities.
(a) The prohibition contained in Sec. 255.10(a)(1) does not apply
to the ownership by a banking entity of an interest in, or sponsorship
of, any issuer if:
(1) The issuer was established, and the interest was issued, before
May 19, 2010;
(2) The banking entity reasonably believes that the offering
proceeds received by the issuer were invested primarily in Qualifying
TruPS Collateral; and
(3) The banking entity acquired such interest on or before December
10, 2013 (or acquired such interest in connection with a merger with or
acquisition of a banking entity that acquired the interest on or before
December 10, 2013).
(b) For purposes of this Sec. 255.16, Qualifying TruPS Collateral
shall mean any trust preferred security or subordinated debt instrument
issued prior to May 19, 2010 by a depository institution holding
company that, as of the end of any reporting period within 12 months
immediately preceding the issuance of such trust preferred security or
subordinated debt instrument, had total consolidated assets of less
than $15,000,000,000 or issued prior to May 19, 2010 by a mutual
holding company.
(c) Notwithstanding paragraph (a)(3) of this section, a banking
entity may act as a market maker with respect to the interests of an
issuer described in paragraph (a) of this section in accordance with
the applicable provisions of Sec. Sec. 255.4 and 255.11.
(d) Without limiting the applicability of paragraph (a) of this
section, the Board, the FDIC and the OCC will make public a non-
exclusive list of issuers that meet the requirements of paragraph (a).
A banking entity may rely on the list published by the Board, the FDIC
and the OCC.
[[Page 62266]]
Sec. Sec. 255.17-255.19 [Reserved]
Subpart D--Compliance Program Requirement; Violations
Sec. 255.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope and detail of the compliance program shall
be appropriate for the types, size, scope and complexity of activities
and business structure of the banking entity.
(b) Contents of compliance program. Except as provided in paragraph
(f) of this section, the compliance program required by paragraph (a)
of this section, at a minimum, shall include:
(1) Written policies and procedures reasonably designed to
document, describe, monitor and limit trading activities subject to
subpart B (including those permitted under Sec. Sec. 255.3 to 255.6 of
subpart B), including setting, monitoring and managing required limits
set out in Sec. 2554 and Sec. 2555, and activities and investments
with respect to a covered fund subject to subpart C (including those
permitted under Sec. Sec. 255.11 through 255.14 of subpart C)
conducted by the banking entity to ensure that all activities and
investments conducted by the banking entity that are subject to section
13 of the BHC Act and this part comply with section 13 of the BHC Act
and this part;
(2) A system of internal controls reasonably designed to monitor
compliance with section 13 of the BHC Act and this part and to prevent
the occurrence of activities or investments that are prohibited by
section 13 of the BHC Act and this part;
(3) A management framework that clearly delineates responsibility
and accountability for compliance with section 13 of the BHC Act and
this part and includes appropriate management review of trading limits,
strategies, hedging activities, investments, incentive compensation and
other matters identified in this part or by management as requiring
attention;
(4) Independent testing and audit of the effectiveness of the
compliance program conducted periodically by qualified personnel of the
banking entity or by a qualified outside party;
(5) Training for trading personnel and managers, as well as other
appropriate personnel, to effectively implement and enforce the
compliance program; and
(6) Records sufficient to demonstrate compliance with section 13 of
the BHC Act and this part, which a banking entity must promptly provide
to the SEC upon request and retain for a period of no less than 5 years
or such longer period as required by the SEC.
(c) Additional standards. In addition to the requirements in
paragraph (b) of this section, the compliance program of a banking
entity must satisfy the requirements and other standards contained in
Appendix B, if:
(1) The banking entity engages in proprietary trading permitted
under subpart B and is required to comply with the reporting
requirements of paragraph (d) of this section;
(2) The banking entity has reported total consolidated assets as of
the previous calendar year end of $50 billion or more or, in the case
of a foreign banking entity, has total U.S. assets as of the previous
calendar year end of $50 billion or more (including all subsidiaries,
affiliates, branches and agencies of the foreign banking entity
operating, located or organized in the United States); or
(3) The SEC notifies the banking entity in writing that it must
satisfy the requirements and other standards contained in Appendix B to
this part.
(d) Reporting requirements under Appendix A to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B shall comply with the reporting requirements described in
Appendix A, if:
(i) The banking entity (other than a foreign banking entity as
provided in paragraph (d)(1)(ii) of this section) has, together with
its affiliates and subsidiaries, trading assets and liabilities
(excluding trading assets and liabilities involving obligations of or
guaranteed by the United States or any agency of the United States) the
average gross sum of which (on a worldwide consolidated basis) over the
previous consecutive four quarters, as measured as of the last day of
each of the four prior calendar quarters, equals or exceeds the
threshold established in paragraph (d)(2) of this section;
(ii) In the case of a foreign banking entity, the average gross sum
of the trading assets and liabilities of the combined U.S. operations
of the foreign banking entity (including all subsidiaries, affiliates,
branches and agencies of the foreign banking entity operating, located
or organized in the United States and excluding trading assets and
liabilities involving obligations of or guaranteed by the United States
or any agency of the United States) over the previous consecutive four
quarters, as measured as of the last day of each of the four prior
calendar quarters, equals or exceeds the threshold established in
paragraph (d)(2) of this section; or
(iii) The SEC notifies the banking entity in writing that it must
satisfy the reporting requirements contained in Appendix A.
(2) The threshold for reporting under paragraph (d)(1) of this
section shall be $50 billion beginning on June 30, 2014; $25 billion
beginning on April 30, 2016; and $10 billion beginning on December 31,
2016.
(3) Frequency of reporting: Unless the SEC notifies the banking
entity in writing that it must report on a different basis, a banking
entity with $50 billion or more in trading assets and liabilities (as
calculated in accordance with paragraph (d)(1) of this section) shall
report the information required by Appendix A for each calendar month
within 30 days of the end of the relevant calendar month; beginning
with information for the month of January 2015, such information shall
be reported within 10 days of the end of each calendar month. Any other
banking entity subject to Appendix A shall report the information
required by Appendix A for each calendar quarter within 30 days of the
end of that calendar quarter unless the SEC notifies the banking entity
in writing that it must report on a different basis.
(e) Additional documentation for covered funds. Any banking entity
that has more than $10 billion in total consolidated assets as reported
on December 31 of the previous two calendar years shall maintain
records that include:
(1) Documentation of the exclusions or exemptions other than
sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940
relied on by each fund sponsored by the banking entity (including all
subsidiaries and affiliates) in determining that such fund is not a
covered fund;
(2) For each fund sponsored by the banking entity (including all
subsidiaries and affiliates) for which the banking entity relies on one
or more of the exclusions from the definition of covered fund provided
by Sec. Sec. 255.10(c)(1), 255.10(c)(5), 255.10(c)(8), 255.10(c)(9),
or 255.10(c)(10) of subpart C, documentation supporting the banking
entity's determination that the fund is not a covered fund pursuant to
one or more of those exclusions;
(3) For each seeding vehicle described in Sec. 255.10(c)(12)(i) or
(iii) of subpart C that will become a registered investment
[[Page 62267]]
company or SEC-regulated business development company, a written plan
documenting the banking entity's determination that the seeding vehicle
will become a registered investment company or SEC-regulated business
development company; the period of time during which the vehicle will
operate as a seeding vehicle; and the banking entity's plan to market
the vehicle to third-party investors and convert it into a registered
investment company or SEC-regulated business development company within
the time period specified in Sec. 255.12(a)(2)(i)(B) of subpart C;
(4) For any banking entity that is, or is controlled directly or
indirectly by a banking entity that is, located in or organized under
the laws of the United States or of any State, if the aggregate amount
of ownership interests in foreign public funds that are described in
Sec. 255.10(c)(1) of subpart C owned by such banking entity (including
ownership interests owned by any affiliate that is controlled directly
or indirectly by a banking entity that is located in or organized under
the laws of the United States or of any State) exceeds $50 million at
the end of two or more consecutive calendar quarters, beginning with
the next succeeding calendar quarter, documentation of the value of the
ownership interests owned by the banking entity (and such affiliates)
in each foreign public fund and each jurisdiction in which any such
foreign public fund is organized, calculated as of the end of each
calendar quarter, which documentation must continue until the banking
entity's aggregate amount of ownership interests in foreign public
funds is below $50 million for two consecutive calendar quarters; and
(5) For purposes of paragraph (e)(4) of this section, a U.S.
branch, agency, or subsidiary of a foreign banking entity is located in
the United States; however, the foreign bank that operates or controls
that branch, agency, or subsidiary is not considered to be located in
the United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(f) Simplified programs for less active banking entities--(1)
Banking entities with no covered activities. A banking entity that does
not engage in activities or investments pursuant to subpart B or
subpart C (other than trading activities permitted pursuant to Sec.
255.6(a) of subpart B) may satisfy the requirements of this section by
establishing the required compliance program prior to becoming engaged
in such activities or making such investments (other than trading
activities permitted pursuant to Sec. 255.6(a) of subpart B).
(2) Banking entities with modest activities. A banking entity with
total consolidated assets of $10 billion or less as reported on
December 31 of the previous two calendar years that engages in
activities or investments pursuant to subpart B or subpart C (other
than trading activities permitted under Sec. 255.6(a) of subpart B)
may satisfy the requirements of this section by including in its
existing compliance policies and procedures appropriate references to
the requirements of section 13 of the BHC Act and this part and
adjustments as appropriate given the activities, size, scope and
complexity of the banking entity.
Sec. 255.21 Termination of activities or investments; penalties for
violations.
(a) Any banking entity that engages in an activity or makes an
investment in violation of section 13 of the BHC Act or this part, or
acts in a manner that functions as an evasion of the requirements of
section 13 of the BHC Act or this part, including through an abuse of
any activity or investment permitted under subparts B or C, or
otherwise violates the restrictions and requirements of section 13 of
the BHC Act or this part, shall, upon discovery, promptly terminate the
activity and, as relevant, dispose of the investment.
(b) Whenever the SEC finds reasonable cause to believe any banking
entity has engaged in an activity or made an investment in violation of
section 13 of the BHC Act or this part, or engaged in any activity or
made any investment that functions as an evasion of the requirements of
section 13 of the BHC Act or this part, the SEC may take any action
permitted by law to enforce compliance with section 13 of the BHC Act
and this part, including directing the banking entity to restrict,
limit, or terminate any or all activities under this part and dispose
of any investment.
Appendix A to Part 255--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
255.20(d), this appendix generally applies to a banking entity that,
together with its affiliates and subsidiaries, has significant
trading assets and liabilities. These entities are required to (i)
furnish periodic reports to the SEC regarding a variety of
quantitative measurements of their covered trading activities, which
vary depending on the scope and size of covered trading activities,
and (ii) create and maintain records documenting the preparation and
content of these reports. The requirements of this appendix must be
incorporated into the banking entity's internal compliance program
under Sec. 255.20 and Appendix B.
b. The purpose of this appendix is to assist banking entities
and the SEC in:
(i) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(ii) Monitoring the banking entity's covered trading activities;
(iii) Identifying covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading activities of
trading desks engaged in market making-related activities subject to
Sec. 255.4(b) are consistent with the requirements governing
permitted market making-related activities;
(v) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. Sec. 255.4, 255.5, or 255.6(a)-(b) (i.e., underwriting and
market making-related related activity, risk-mitigating hedging, or
trading in certain government obligations) are consistent with the
requirement that such activity not result, directly or indirectly,
in a material exposure to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by the SEC of such activities; and
(vii) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. The quantitative measurements that must be furnished pursuant
to this appendix are not intended to serve as a dispositive tool for
the identification of permissible or impermissible activities.
d. In order to allow banking entities and the Agencies to
evaluate the effectiveness of these metrics, banking entities must
collect and report these metrics for all trading desks beginning on
the dates established in Sec. 255.20 of the final rule. The
Agencies will review the data collected and revise this collection
requirement as appropriate based on a review of the data collected
prior to September 30, 2015.
e. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 255.20 and Appendix B to this part. The
effectiveness of particular quantitative measurements may differ
based on the profile of the banking entity's businesses in general
and, more specifically, of the particular trading desk, including
types of instruments traded, trading activities and strategies, and
history and experience (e.g., whether the
[[Page 62268]]
trading desk is an established, successful market maker or a new
entrant to a competitive market). In all cases, banking entities
must ensure that they have robust measures in place to identify and
monitor the risks taken in their trading activities, to ensure that
the activities are within risk tolerances established by the banking
entity, and to monitor and examine for compliance with the
proprietary trading restrictions in this part.
f. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 255.4 through 255.6(a) and (b), or that
result in a material exposure to high-risk assets or high-risk
trading strategies, must be escalated within the banking entity for
review, further analysis, explanation to the SEC, and remediation,
where appropriate. The quantitative measurements discussed in this
appendix should be helpful to banking entities in identifying and
managing the risks related to their covered trading activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 255.2 and 255.3. In addition, for purposes of
this appendix, the following definitions apply:
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of a trading desk's holdings, dividend income, and
interest income and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. Sec. 255.4, 255.5, 255.6(a), or 255.6(b). A banking
entity may include trading under Sec. Sec. 255.3(d), 255.6(c),
255.6(d) or 255.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading desk means the smallest discrete unit of organization of
a banking entity that purchases or sells financial instruments for
the trading account of the banking entity or an affiliate thereof.
III. Reporting and Recordkeeping of Quantitative Measurements
a. Scope of Required Reporting
General scope. Each banking entity made subject to this part by
Sec. 255.20 must furnish the following quantitative measurements
for each trading desk of the banking entity, calculated in
accordance with this appendix:
Risk and Position Limits and Usage;
Risk Factor Sensitivities;
Value-at-Risk and Stress VaR;
Comprehensive Profit and Loss Attribution;
Inventory Turnover;
Inventory Aging; and
Customer-Facing Trade Ratio
b. Frequency of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report each
applicable quantitative measurement to the SEC on the reporting
schedule established in Sec. 255.20 unless otherwise requested by
the SEC. All quantitative measurements for any calendar month must
be reported within the time period required by Sec. 255.20.
c. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the SEC pursuant to this appendix and Sec. 255.20(d),
create and maintain records documenting the preparation and content
of these reports, as well as such information as is necessary to
permit the SEC to verify the accuracy of such reports, for a period
of 5 years from the end of the calendar year for which the
measurement was taken.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Risk and Position Limits and Usage
i. Description: For purposes of this appendix, Risk and Position
Limits are the constraints that define the amount of risk that a
trading desk is permitted to take at a point in time, as defined by
the banking entity for a specific trading desk. Usage represents the
portion of the trading desk's limits that are accounted for by the
current activity of the desk. Risk and position limits and their
usage are key risk management tools used to control and monitor risk
taking and include, but are not limited, to the limits set out in
Sec. 255.4 and Sec. 255.5. A number of the metrics that are
described below, including ``Risk Factor Sensitivities'' and
``Value-at-Risk and Stress Value-at-Risk,'' relate to a trading
desk's risk and position limits and are useful in evaluating and
setting these limits in the broader context of the trading desk's
overall activities, particularly for the market making activities
under Sec. 255.4(b) and hedging activity under Sec. 255.5.
Accordingly, the limits required under Sec. 255.4(b)(2)(iii) and
Sec. 255.5(b)(1)(i) must meet the applicable requirements under
Sec. 255.4(b)(2)(iii) and Sec. 255.5(b)(1)(i) and also must
include appropriate metrics for the trading desk limits including,
at a minimum, the ``Risk Factor Sensitivities'' and ``Value-at-Risk
and Stress Value-at-Risk'' metrics except to the extent any of the
``Risk Factor Sensitivities'' or ``Value-at-Risk and Stress Value-
at-Risk'' metrics are demonstrably ineffective for measuring and
monitoring the risks of a trading desk based on the types of
positions traded by, and risk exposures of, that desk.
ii. General Calculation Guidance: Risk and Position Limits must
be reported in the format used by the banking entity for the
purposes of risk management of each trading desk. Risk and Position
Limits are often expressed in terms of risk measures, such as VaR
and Risk Factor Sensitivities, but may also be expressed in terms of
other observable criteria, such as net open positions. When criteria
other than VaR or Risk Factor Sensitivities are used to define the
Risk and Position Limits, both the value of the Risk and Position
Limits and the value of the variables used to assess whether these
limits have been reached must be reported.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
2. Risk Factor Sensitivities
i. Description: For purposes of this appendix, Risk Factor
Sensitivities are changes in a trading desk's Comprehensive Profit
and Loss that are expected to occur in the event of a change in one
or more underlying variables that are significant sources of the
trading desk's profitability and risk.
ii. General Calculation Guidance: A banking entity must report
the Risk Factor Sensitivities that are monitored and managed as part
of the trading desk's overall risk management policy. The underlying
data and methods used to compute a trading desk's Risk Factor
Sensitivities will depend on the specific function of the trading
desk and the internal risk management models employed. The number
and type of Risk Factor Sensitivities that are monitored and managed
by a trading desk, and furnished to the SEC, will depend on the
explicit risks assumed by the trading desk. In general, however,
reported Risk Factor Sensitivities must be sufficiently granular to
account for a preponderance of the expected price variation in the
trading desk's holdings.
A. Trading desks must take into account any relevant factors in
calculating Risk Factor Sensitivities, including, for example, the
following with respect to particular asset classes:
Commodity derivative positions: Risk factors with
respect to the related commodities set out in 17 CFR 20.2, the
maturity of the positions, volatility and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Credit positions: Risk factors with respect to credit
spreads that are sufficiently granular to account for specific
credit sectors and market segments, the maturity profile of the
positions, and risk factors with respect to interest rates of all
relevant maturities;
Credit-related derivative positions: Risk factor
sensitivities, for example credit spreads, shifts (parallel and non-
parallel) in credit spreads--volatility, and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Equity derivative positions: Risk factor sensitivities
such as equity positions, volatility, and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and the maturity profile of the
positions;
Equity positions: Risk factors for equity prices and
risk factors that differentiate between important equity market
sectors and segments, such as a small capitalization equities and
international equities;
Foreign exchange derivative positions: Risk factors
with respect to major currency pairs and maturities, exposure to
interest rates at relevant maturities, volatility, and/or
[[Page 62269]]
correlation sensitivities (expressed in a manner that demonstrates
any significant non-linearities), as well as the maturity profile of
the positions; and
Interest rate positions, including interest rate
derivative positions: Risk factors with respect to major interest
rate categories and maturities and volatility and/or correlation
sensitivities (expressed in a manner that demonstrates any
significant non-linearities), and shifts (parallel and non-parallel)
in the interest rate curve, as well as the maturity profile of the
positions.
B. The methods used by a banking entity to calculate
sensitivities to a common factor shared by multiple trading desks,
such as an equity price factor, must be applied consistently across
its trading desks so that the sensitivities can be compared from one
trading desk to another.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Value-at-Risk and Stress Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the commonly used percentile measurement of the risk of
future financial loss in the value of a given set of aggregated
positions over a specified period of time, based on current market
conditions. For purposes of this appendix, Stress Value-at-Risk
(``Stress VaR'') is the percentile measurement of the risk of future
financial loss in the value of a given set of aggregated positions
over a specified period of time, based on market conditions during a
period of significant financial stress.
ii. General Calculation Guidance: Banking entities must compute
and report VaR and Stress VaR by employing generally accepted
standards and methods of calculation. VaR should reflect a loss in a
trading desk that is expected to be exceeded less than one percent
of the time over a one-day period. For those banking entities that
are subject to regulatory capital requirements imposed by a Federal
banking agency, VaR and Stress VaR must be computed and reported in
a manner that is consistent with such regulatory capital
requirements. In cases where a trading desk does not have a
standalone VaR or Stress VaR calculation but is part of a larger
aggregation of positions for which a VaR or Stress VaR calculation
is performed, a VaR or Stress VaR calculation that includes only the
trading desk's holdings must be performed consistent with the VaR or
Stress VaR model and methodology used for the larger aggregation of
positions.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into three categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); (ii) profit and loss attributable to new
positions resulting from the current day's trading activity (``new
positions''); and (iii) residual profit and loss that cannot be
specifically attributed to existing positions or new positions. The
sum of (i), (ii), and (iii) must equal the trading desk's
comprehensive profit and loss at each point in time. In addition,
profit and loss measurements must calculate volatility of
comprehensive profit and loss (i.e., the standard deviation of the
trading desk's one-day profit and loss, in dollar terms) for the
reporting period for at least a 30-, 60- and 90-day lag period, from
the end of the reporting period, and any other period that the
banking entity deems necessary to meet the requirements of the rule.
A. The comprehensive profit and loss associated with existing
positions must reflect changes in the value of these positions on
the applicable day. The comprehensive profit and loss from existing
positions must be further attributed, as applicable, to changes in
(i) the specific Risk Factors and other factors that are monitored
and managed as part of the trading desk's overall risk management
policies and procedures; and (ii) any other applicable elements,
such as cash flows, carry, changes in reserves, and the correction,
cancellation, or exercise of a trade.
B. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
C. The portion of comprehensive profit and loss that cannot be
specifically attributed to known sources must be allocated to a
residual category identified as an unexplained portion of the
comprehensive profit and loss. Significant unexplained profit and
loss must be escalated for further investigation and analysis.
ii. General Calculation Guidance: The specific categories used
by a trading desk in the attribution analysis and amount of detail
for the analysis should be tailored to the type and amount of
trading activities undertaken by the trading desk. The new position
attribution must be computed by calculating the difference between
the prices at which instruments were bought and/or sold and the
prices at which those instruments are marked to market at the close
of business on that day multiplied by the notional or principal
amount of each purchase or sale. Any fees, commissions, or other
payments received (paid) that are associated with transactions
executed on that day must be added (subtracted) from such
difference. These factors must be measured consistently over time to
facilitate historical comparisons.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
c. Customer-Facing Activity Measurements
1. Inventory Turnover
i. Description: For purposes of this appendix, Inventory
Turnover is a ratio that measures the turnover of a trading desk's
inventory. The numerator of the ratio is the absolute value of all
transactions over the reporting period. The denominator of the ratio
is the value of the trading desk's inventory at the beginning of the
reporting period.
ii. General Calculation Guidance: For purposes of this appendix,
for derivatives, other than options and interest rate derivatives,
value means gross notional value, for options, value means delta
adjusted notional value, and for interest rate derivatives, value
means 10-year bond equivalent value.
iii. Calculation Period: 30 days, 60 days, and 90 days.
iv. Measurement Frequency: Daily.
2. Inventory Aging
i. Description: For purposes of this appendix, Inventory Aging
generally describes a schedule of the trading desk's aggregate
assets and liabilities and the amount of time that those assets and
liabilities have been held. Inventory Aging should measure the age
profile of the trading desk's assets and liabilities.
ii. General Calculation Guidance: In general, Inventory Aging
must be computed using a trading desk's trading activity data and
must identify the value of a trading desk's aggregate assets and
liabilities. Inventory Aging must include two schedules, an asset-
aging schedule and a liability-aging schedule. Each schedule must
record the value of assets or liabilities held over all holding
periods. For derivatives, other than options, and interest rate
derivatives, value means gross notional value, for options, value
means delta adjusted notional value and, for interest rate
derivatives, value means 10-year bond equivalent value.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Customer-Facing Trade Ratio--Trade Count Based and Value Based
i. Description: For purposes of this appendix, the Customer-
Facing Trade Ratio is a ratio comparing (i) the transactions
involving a counterparty that is a customer of the trading desk to
(ii) the transactions involving a counterparty that is not a
customer of the trading desk. A trade count based ratio must be
computed that records the number of transactions involving a
counterparty that is a customer of the trading desk and the number
of transactions involving a counterparty that is not a customer of
the trading desk. A value based ratio must be computed that records
the value of transactions involving a counterparty that is a
customer of the trading desk and the value of transactions involving
a counterparty that is not a customer of the trading desk.
ii. General Calculation Guidance: For purposes of calculating
the Customer-Facing Trade Ratio, a counterparty is considered to be
a customer of the trading desk if the counterparty is a market
participant that makes use of the banking entity's market making-
related services by obtaining such services, responding to
quotations, or entering into a continuing relationship with respect
to such services. However, a trading
[[Page 62270]]
desk or other organizational unit of another banking entity would
not be a client, customer, or counterparty of the trading desk if
the other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with Sec. 255.20(d)(1) unless the
trading desk documents how and why a particular trading desk or
other organizational unit of the entity should be treated as a
client, customer, or counterparty of the trading desk. Transactions
conducted anonymously on an exchange or similar trading facility
that permits trading on behalf of a broad range of market
participants would be considered transactions with customers of the
trading desk. For derivatives, other than options, and interest rate
derivatives, value means gross notional value, for options, value
means delta adjusted notional value, and for interest rate
derivatives, value means 10-year bond equivalent value.
iii. Calculation Period: 30 days, 60 days, and 90 days.
iv. Measurement Frequency: Daily.
Appendix B to Part 255--Enhanced Minimum Standards for Compliance
Programs
I. Overview
Section 255.20(c) requires certain banking entities to
establish, maintain, and enforce an enhanced compliance program that
includes the requirements and standards in this Appendix as well as
the minimum written policies and procedures, internal controls,
management framework, independent testing, training, and
recordkeeping provisions outlined in Sec. 255.20. This Appendix
sets forth additional minimum standards with respect to the
establishment, oversight, maintenance, and enforcement by these
banking entities of an enhanced internal compliance program for
ensuring and monitoring compliance with the prohibitions and
restrictions on proprietary trading and covered fund activities and
investments set forth in section 13 of the BHC Act and this part.
a. This compliance program must:
1. Be reasonably designed to identify, document, monitor, and
report the permitted trading and covered fund activities and
investments of the banking entity; identify, monitor and promptly
address the risks of these covered activities and investments and
potential areas of noncompliance; and prevent activities or
investments prohibited by, or that do not comply with, section 13 of
the BHC Act and this part;
2. Establish and enforce appropriate limits on the covered
activities and investments of the banking entity, including limits
on the size, scope, complexity, and risks of the individual
activities or investments consistent with the requirements of
section 13 of the BHC Act and this part;
3. Subject the effectiveness of the compliance program to
periodic independent review and testing, and ensure that the
entity's internal audit, corporate compliance and internal control
functions involved in review and testing are effective and
independent;
4. Make senior management, and others as appropriate,
accountable for the effective implementation of the compliance
program, and ensure that the board of directors and chief executive
officer (or equivalent) of the banking entity review the
effectiveness of the compliance program; and
5. Facilitate supervision and examination by the Agencies of the
banking entity's permitted trading and covered fund activities and
investments.
II. Enhanced Compliance Program
a. Proprietary Trading Activities. A banking entity must
establish, maintain and enforce a compliance program that includes
written policies and procedures that are appropriate for the types,
size, and complexity of, and risks associated with, its permitted
trading activities. The compliance program may be tailored to the
types of trading activities conducted by the banking entity, and
must include a detailed description of controls established by the
banking entity to reasonably ensure that its trading activities are
conducted in accordance with the requirements and limitations
applicable to those trading activities under section 13 of the BHC
Act and this part, and provide for appropriate revision of the
compliance program before expansion of the trading activities of the
banking entity. A banking entity must devote adequate resources and
use knowledgeable personnel in conducting, supervising and managing
its trading activities, and promote consistency, independence and
rigor in implementing its risk controls and compliance efforts. The
compliance program must be updated with a frequency sufficient to
account for changes in the activities of the banking entity, results
of independent testing of the program, identification of weaknesses
in the program, and changes in legal, regulatory or other
requirements.
1. Trading Desks: The banking entity must have written policies
and procedures governing each trading desk that include a
description of:
i. The process for identifying, authorizing and documenting
financial instruments each trading desk may purchase or sell, with
separate documentation for market making-related activities
conducted in reliance on Sec. 255.4(b) and for hedging activity
conducted in reliance on Sec. 255.5;
ii. A mapping for each trading desk to the division, business
line, or other organizational structure that is responsible for
managing and overseeing the trading desk's activities;
iii. The mission (i.e., the type of trading activity, such as
market-making, trading in sovereign debt, etc.) and strategy (i.e.,
methods for conducting authorized trading activities) of each
trading desk;
iv. The activities that the trading desk is authorized to
conduct, including (i) authorized instruments and products, and (ii)
authorized hedging strategies, techniques and instruments;
v. The types and amount of risks allocated by the banking entity
to each trading desk to implement the mission and strategy of the
trading desk, including an enumeration of material risks resulting
from the activities in which the trading desk is authorized to
engage (including but not limited to price risks, such as basis,
volatility and correlation risks, as well as counterparty credit
risk). Risk assessments must take into account both the risks
inherent in the trading activity and the strength and effectiveness
of controls designed to mitigate those risks;
vi. How the risks allocated to each trading desk will be
measured;
vii. Why the allocated risks levels are appropriate to the
activities authorized for the trading desk;
viii. The limits on the holding period of, and the risk
associated with, financial instruments under the responsibility of
the trading desk;
ix. The process for setting new or revised limits, as well as
escalation procedures for granting exceptions to any limits or to
any policies or procedures governing the desk, the analysis that
will be required to support revising limits or granting exceptions,
and the process for independently reviewing and documenting those
exceptions and the underlying analysis;
x. The process for identifying, documenting and approving new
products, trading strategies, and hedging strategies;
xi. The types of clients, customers, and counterparties with
whom the trading desk may trade; and
xii. The compensation arrangements, including incentive
arrangements, for employees associated with the trading desk, which
may not be designed to reward or incentivize prohibited proprietary
trading or excessive or imprudent risk-taking.
2. Description of risks and risk management processes: The
compliance program for the banking entity must include a
comprehensive description of the risk management program for the
trading activity of the banking entity. The compliance program must
also include a description of the governance, approval, reporting,
escalation, review and other processes the banking entity will use
to reasonably ensure that trading activity is conducted in
compliance with section 13 of the BHC Act and this part. Trading
activity in similar financial instruments should be subject to
similar governance, limits, testing, controls, and review, unless
the banking entity specifically determines to establish different
limits or processes and documents those differences. Descriptions
must include, at a minimum, the following elements:
i. A description of the supervisory and risk management
structure governing all trading activity, including a description of
processes for initial and senior-level review of new products and
new strategies;
ii. A description of the process for developing, documenting,
testing, approving and reviewing all models used for valuing,
identifying and monitoring the risks of trading activity and related
positions, including the process for periodic independent testing of
the reliability and accuracy of those models;
iii. A description of the process for developing, documenting,
testing, approving and reviewing the limits established for each
trading desk;
iv. A description of the process by which a security may be
purchased or sold pursuant to the liquidity management plan,
including
[[Page 62271]]
the process for authorizing and monitoring such activity to ensure
compliance with the banking entity's liquidity management plan and
the restrictions on liquidity management activities in this part;
v. A description of the management review process, including
escalation procedures, for approving any temporary exceptions or
permanent adjustments to limits on the activities, positions,
strategies, or risks associated with each trading desk; and
vi. The role of the audit, compliance, risk management and other
relevant units for conducting independent testing of trading and
hedging activities, techniques and strategies.
3. Authorized risks, instruments, and products. The banking
entity must implement and enforce limits and internal controls for
each trading desk that are reasonably designed to ensure that
trading activity is conducted in conformance with section 13 of the
BHC Act and this part and with the banking entity's written policies
and procedures. The banking entity must establish and enforce risk
limits appropriate for the activity of each trading desk. These
limits should be based on probabilistic and non-probabilistic
measures of potential loss (e.g., Value-at-Risk and notional
exposure, respectively), and measured under normal and stress market
conditions. At a minimum, these internal controls must monitor,
establish and enforce limits on:
i. The financial instruments (including, at a minimum, by type
and exposure) that the trading desk may trade;
ii. The types and levels of risks that may be taken by each
trading desk; and
iii. The types of hedging instruments used, hedging strategies
employed, and the amount of risk effectively hedged.
4. Hedging policies and procedures. The banking entity must
establish, maintain, and enforce written policies and procedures
regarding the use of risk-mitigating hedging instruments and
strategies that, at a minimum, describe:
i. The positions, techniques and strategies that each trading
desk may use to hedge the risk of its positions;
ii. The manner in which the banking entity will identify the
risks arising in connection with and related to the individual or
aggregated positions, contracts or other holdings of the banking
entity that are to be hedged and determine that those risks have
been properly and effectively hedged;
iii. The level of the organization at which hedging activity and
management will occur;
iv. The manner in which hedging strategies will be monitored and
the personnel responsible for such monitoring;
v. The risk management processes used to control unhedged or
residual risks; and
vi. The process for developing, documenting, testing, approving
and reviewing all hedging positions, techniques and strategies
permitted for each trading desk and for the banking entity in
reliance on Sec. 255.5.
5. Analysis and quantitative measurements. The banking entity
must perform robust analysis and quantitative measurement of its
trading activities that is reasonably designed to ensure that the
trading activity of each trading desk is consistent with the banking
entity's compliance program; monitor and assist in the
identification of potential and actual prohibited proprietary
trading activity; and prevent the occurrence of prohibited
proprietary trading. Analysis and models used to determine, measure
and limit risk must be rigorously tested and be reviewed by
management responsible for trading activity to ensure that trading
activities, limits, strategies, and hedging activities do not
understate the risk and exposure to the banking entity or allow
prohibited proprietary trading. This review should include periodic
and independent back-testing and revision of activities, limits,
strategies and hedging as appropriate to contain risk and ensure
compliance. In addition to the quantitative measurements reported by
any banking entity subject to Appendix A to this part, each banking
entity must develop and implement, to the extent appropriate to
facilitate compliance with this part, additional quantitative
measurements specifically tailored to the particular risks,
practices, and strategies of its trading desks. The banking entity's
analysis and quantitative measurements must incorporate the
quantitative measurements reported by the banking entity pursuant to
Appendix A (if applicable) and include, at a minimum, the following:
i. Internal controls and written policies and procedures
reasonably designed to ensure the accuracy and integrity of
quantitative measurements;
ii. Ongoing, timely monitoring and review of calculated
quantitative measurements;
iii. The establishment of numerical thresholds and appropriate
trading measures for each trading desk and heightened review of
trading activity not consistent with those thresholds to ensure
compliance with section 13 of the BHC Act and this part, including
analysis of the measurement results or other information,
appropriate escalation procedures, and documentation related to the
review; and
iv. Immediate review and compliance investigation of the trading
desk's activities, escalation to senior management with oversight
responsibilities for the applicable trading desk, timely
notification to the SEC, appropriate remedial action (e.g.,
divesting of impermissible positions, cessation of impermissible
activity, disciplinary actions), and documentation of the
investigation findings and remedial action taken when quantitative
measurements or other information, considered together with the
facts and circumstances, or findings of internal audit, independent
testing or other review suggest a reasonable likelihood that the
trading desk has violated any part of section 13 of the BHC Act or
this part.
6. Other Compliance Matters. In addition to the requirements
specified above, the banking entity's compliance program must:
i. Identify activities of each trading desk that will be
conducted in reliance on exemptions contained in Sec. Sec. 255.4
through 255.6, including an explanation of:
A. How and where in the organization the activity occurs; and
B. Which exemption is being relied on and how the activity meets
the specific requirements for reliance on the applicable exemption;
ii. Include an explanation of the process for documenting,
approving and reviewing actions taken pursuant to the liquidity
management plan, where in the organization this activity occurs, the
securities permissible for liquidity management, the process for
ensuring that liquidity management activities are not conducted for
the purpose of prohibited proprietary trading, and the process for
ensuring that securities purchased as part of the liquidity
management plan are highly liquid and conform to the requirements of
this part;
iii. Describe how the banking entity monitors for and prohibits
potential or actual material exposure to high-risk assets or high-
risk trading strategies presented by each trading desk that relies
on the exemptions contained in Sec. Sec. 255.3(d)(3), and 255.4
through 255.6, which must take into account potential or actual
exposure to:
A. Assets whose values cannot be externally priced or, where
valuation is reliant on pricing models, whose model inputs cannot be
externally validated;
B. Assets whose changes in value cannot be adequately mitigated
by effective hedging;
C. New products with rapid growth, including those that do not
have a market history;
D. Assets or strategies that include significant embedded
leverage;
E. Assets or strategies that have demonstrated significant
historical volatility;
F. Assets or strategies for which the application of capital and
liquidity standards would not adequately account for the risk; and
G. Assets or strategies that result in large and significant
concentrations to sectors, risk factors, or counterparties;
iv. Establish responsibility for compliance with the reporting
and recordkeeping requirements of subpart B and Sec. 255.20; and
v. Establish policies for monitoring and prohibiting potential
or actual material conflicts of interest between the banking entity
and its clients, customers, or counterparties.
7. Remediation of violations. The banking entity's compliance
program must be reasonably designed and established to effectively
monitor and identify for further analysis any trading activity that
may indicate potential violations of section 13 of the BHC Act and
this part and to prevent actual violations of section 13 of the BHC
Act and this part. The compliance program must describe procedures
for identifying and remedying violations of section 13 of the BHC
Act and this part, and must include, at a minimum, a requirement to
promptly document, address and remedy any violation of section 13 of
the BHC Act or this part, and document all proposed and actual
remediation efforts. The compliance program must include specific
written policies and procedures that are reasonably designed to
assess the extent to which any activity indicates that modification
to the banking entity's compliance program is warranted and to
ensure that appropriate modifications are implemented. The written
policies and procedures must provide for prompt
[[Page 62272]]
notification to appropriate management, including senior management
and the board of directors, of any material weakness or significant
deficiencies in the design or implementation of the compliance
program of the banking entity.
b. Covered Fund Activities or Investments. A banking entity must
establish, maintain and enforce a compliance program that includes
written policies and procedures that are appropriate for the types,
size, complexity and risks of the covered fund and related
activities conducted and investments made, by the banking entity.
1. Identification of covered funds. The banking entity's
compliance program must provide a process, which must include
appropriate management review and independent testing, for
identifying and documenting covered funds that each unit within the
banking entity's organization sponsors or organizes and offers, and
covered funds in which each such unit invests. In addition to the
documentation requirements for covered funds, as specified under
Sec. 255.20(e), the documentation must include information that
identifies all pools that the banking entity sponsors or has an
interest in and the type of exemption from the Commodity Exchange
Act (whether or not the pool relies on section 4.7 of the
regulations under the Commodity Exchange Act), and the amount of
ownership interest the banking entity has in those pools.
2. Identification of covered fund activities and investments.
The banking entity's compliance program must identify, document and
map each unit within the organization that is permitted to acquire
or hold an interest in any covered fund or sponsor any covered fund
and map each unit to the division, business line, or other
organizational structure that will be responsible for managing and
overseeing that unit's activities and investments.
3. Explanation of compliance. The banking entity's compliance
program must explain how:
i. The banking entity monitors for and prohibits potential or
actual material conflicts of interest between the banking entity and
its clients, customers, or counterparties related to its covered
fund activities and investments;
ii. The banking entity monitors for and prohibits potential or
actual transactions or activities that may threaten the safety and
soundness of the banking entity related to its covered fund
activities and investments; and
iii. The banking entity monitors for and prohibits potential or
actual material exposure to high-risk assets or high-risk trading
strategies presented by its covered fund activities and investments,
taking into account potential or actual exposure to:
A. Assets whose values cannot be externally priced or, where
valuation is reliant on pricing models, whose model inputs cannot be
externally validated;
B. Assets whose changes in values cannot be adequately mitigated
by effective hedging;
C. New products with rapid growth, including those that do not
have a market history;
D. Assets or strategies that include significant embedded
leverage;
E. Assets or strategies that have demonstrated significant
historical volatility;
F. Assets or strategies for which the application of capital and
liquidity standards would not adequately account for the risk; and
G. Assets or strategies that expose the banking entity to large
and significant concentrations with respect to sectors, risk
factors, or counterparties;
4. Description and documentation of covered fund activities and
investments. For each organizational unit engaged in covered fund
activities and investments, the banking entity's compliance program
must document:
i. The covered fund activities and investments that the unit is
authorized to conduct;
ii. The banking entity's plan for actively seeking unaffiliated
investors to ensure that any investment by the banking entity
conforms to the limits contained in Sec. 255.12 or registered in
compliance with the securities laws and thereby exempt from those
limits within the time periods allotted inSec. 255.12; and
iii. How it complies with the requirements of subpart C.
5. Internal Controls. A banking entity must establish, maintain,
and enforce internal controls that are reasonably designed to ensure
that its covered fund activities or investments comply with the
requirements of section 13 of the BHC Act and this part and are
appropriate given the limits on risk established by the banking
entity. These written internal controls must be reasonably designed
and established to effectively monitor and identify for further
analysis any covered fund activity or investment that may indicate
potential violations of section 13 of the BHC Act or this part. The
internal controls must, at a minimum require:
i. Monitoring and limiting the banking entity's individual and
aggregate investments in covered funds;
ii. Monitoring the amount and timing of seed capital investments
for compliance with the limitations under subpart C (including but
not limited to the redemption, sale or disposition requirements) of
Sec. 255.12, and the effectiveness of efforts to seek unaffiliated
investors to ensure compliance with those limits;
iii. Calculating the individual and aggregate levels of
ownership interests in one or more covered fund required by Sec.
255.12;
iv. Attributing the appropriate instruments to the individual
and aggregate ownership interest calculations above;
v. Making disclosures to prospective and actual investors in any
covered fund organized and offered or sponsored by the banking
entity, as provided under Sec. 255.11(a)(8);
vi. Monitoring for and preventing any relationship or
transaction between the banking entity and a covered fund that is
prohibited under Sec. 255.14, including where the banking entity
has been designated as the sponsor, investment manager, investment
adviser, or commodity trading advisor to a covered fund by another
banking entity; and
vii. Appropriate management review and supervision across legal
entities of the banking entity to ensure that services and products
provided by all affiliated entities comply with the limitation on
services and products contained in Sec. 255.14.
6. Remediation of violations. The banking entity's compliance
program must be reasonably designed and established to effectively
monitor and identify for further analysis any covered fund activity
or investment that may indicate potential violations of section 13
of the BHC Act or this part and to prevent actual violations of
section 13 of the BHC Act and this part. The banking entity's
compliance program must describe procedures for identifying and
remedying violations of section 13 of the BHC Act and this part, and
must include, at a minimum, a requirement to promptly document,
address and remedy any violation of section 13 of the BHC Act or
this part, including Sec. 255.21, and document all proposed and
actual remediation efforts. The compliance program must include
specific written policies and procedures that are reasonably
designed to assess the extent to which any activity or investment
indicates that modification to the banking entity's compliance
program is warranted and to ensure that appropriate modifications
are implemented. The written policies and procedures must provide
for prompt notification to appropriate management, including senior
management and the board of directors, of any material weakness or
significant deficiencies in the design or implementation of the
compliance program of the banking entity.
III. Responsibility and Accountability for the Compliance Program
a. A banking entity must establish, maintain, and enforce a
governance and management framework to manage its business and
employees with a view to preventing violations of section 13 of the
BHC Act and this part. A banking entity must have an appropriate
management framework reasonably designed to ensure that: Appropriate
personnel are responsible and accountable for the effective
implementation and enforcement of the compliance program; a clear
reporting line with a chain of responsibility is delineated; and the
compliance program is reviewed periodically by senior management.
The board of directors (or equivalent governance body) and senior
management should have the appropriate authority and access to
personnel and information within the organizations as well as
appropriate resources to conduct their oversight activities
effectively.
1. Corporate governance. The banking entity must adopt a written
compliance program approved by the board of directors, an
appropriate committee of the board, or equivalent governance body,
and senior management.
2. Management procedures. The banking entity must establish,
maintain, and enforce a governance framework that is reasonably
designed to achieve compliance with section 13 of the BHC Act and
this part, which, at a minimum, provides for:
i. The designation of appropriate senior management or committee
of senior management with authority to carry out the management
responsibilities of the banking
[[Page 62273]]
entity for each trading desk and for each organizational unit
engaged in covered fund activities;
ii. Written procedures addressing the management of the
activities of the banking entity that are reasonably designed to
achieve compliance with section 13 of the BHC Act and this part,
including:
A. A description of the management system, including the titles,
qualifications, and locations of managers and the specific
responsibilities of each person with respect to the banking entity's
activities governed by section 13 of the BHC Act and this part; and
B. Procedures for determining compensation arrangements for
traders engaged in underwriting or market making-related activities
under Sec. 255.4 or risk-mitigating hedging activities under Sec.
255.5 so that such compensation arrangements are designed not to
reward or incentivize prohibited proprietary trading and
appropriately balance risk and financial results in a manner that
does not encourage employees to expose the banking entity to
excessive or imprudent risk.
3. Business line managers. Managers with responsibility for one
or more trading desks of the banking entity are accountable for the
effective implementation and enforcement of the compliance program
with respect to the applicable trading desk(s).
4. Board of directors, or similar corporate body, and senior
management. The board of directors, or similar corporate body, and
senior management are responsible for setting and communicating an
appropriate culture of compliance with section 13 of the BHC Act and
this part and ensuring that appropriate policies regarding the
management of trading activities and covered fund activities or
investments are adopted to comply with section 13 of the BHC Act and
this part. The board of directors or similar corporate body (such as
a designated committee of the board or an equivalent governance
body) must ensure that senior management is fully capable,
qualified, and properly motivated to manage compliance with this
part in light of the organization's business activities and the
expectations of the board of directors. The board of directors or
similar corporate body must also ensure that senior management has
established appropriate incentives and adequate resources to support
compliance with this part, including the implementation of a
compliance program meeting the requirements of this appendix into
management goals and compensation structures across the banking
entity.
5. Senior management. Senior management is responsible for
implementing and enforcing the approved compliance program. Senior
management must also ensure that effective corrective action is
taken when failures in compliance with section 13 of the BHC Act and
this part are identified. Senior management and control personnel
charged with overseeing compliance with section 13 of the BHC Act
and this part should review the compliance program for the banking
entity periodically and report to the board, or an appropriate
committee thereof, on the effectiveness of the compliance program
and compliance matters with a frequency appropriate to the size,
scope, and risk profile of the banking entity's trading activities
and covered fund activities or investments, which shall be at least
annually.
6. CEO attestation. Based on a review by the CEO of the banking
entity, the CEO of the banking entity must, annually, attest in
writing to the SEC that the banking entity has in place processes to
establish, maintain, enforce, review, test and modify the compliance
program established under this Appendix and Sec. 255.20 of this
part in a manner reasonably designed to achieve compliance with
section 13 of the BHC Act and this part. In the case of a U.S.
branch or agency of a foreign banking entity, the attestation may be
provided for the entire U.S. operations of the foreign banking
entity by the senior management officer of the United States
operations of the foreign banking entity who is located in the
United States.
IV. Independent Testing
a. Independent testing must occur with a frequency appropriate
to the size, scope, and risk profile of the banking entity's trading
and covered fund activities or investments, which shall be at least
annually. This independent testing must include an evaluation of:
1. The overall adequacy and effectiveness of the banking
entity's compliance program, including an analysis of the extent to
which the program contains all the required elements of this
appendix;
2. The effectiveness of the banking entity's internal controls,
including an analysis and documentation of instances in which such
internal controls have been breached, and how such breaches were
addressed and resolved; and
3. The effectiveness of the banking entity's management
procedures.
b. A banking entity must ensure that independent testing
regarding the effectiveness of the banking entity's compliance
program is conducted by a qualified independent party, such as the
banking entity's internal audit department, compliance personnel or
risk managers independent of the organizational unit being tested,
outside auditors, consultants, or other qualified independent
parties. A banking entity must promptly take appropriate action to
remedy any significant deficiencies or material weaknesses in its
compliance program and to terminate any violations of section 13 of
the BHC Act or this part.
V. Training
Banking entities must provide adequate training to personnel and
managers of the banking entity engaged in activities or investments
governed by section 13 of the BHC Act or this part, as well as other
appropriate supervisory, risk, independent testing, and audit
personnel, in order to effectively implement and enforce the
compliance program. This training should occur with a frequency
appropriate to the size and the risk profile of the banking entity's
trading activities and covered fund activities or investments.
VI. Recordkeeping
Banking entities must create and retain records sufficient to
demonstrate compliance and support the operations and effectiveness
of the compliance program. A banking entity must retain these
records for a period that is no less than 5 years or such longer
period as required by the SEC in a form that allows it to promptly
produce such records to the SEC on request.
Dated: August 19, 2019.
Joseph M. Otting,
Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System, October 9, 2019.
Ann E. Misback,
Secretary of the Board.
Dated at Washington, DC, on August 20, 2019.
By order of the Board of Directors.
Federal Deposit Insurance Corporation.
Valerie Jean Best,
Assistant Executive Secretary.
By the Securities and Exchange Commission.
Dated: September 18, 2019.
Vanessa A. Countryman.
Issued in Washington, DC, on October 11, 2019, by the Commodity
Futures Trading Commission.
Christopher Kirkpatrick,
Secretary of the Commodity Futures Trading Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Revisions to Prohibitions and Restrictions on Proprietary
Trading and Certain Interests in, and Relationships With, Hedge Funds
and Private Equity Funds--Commission Voting Summary and Commissioners'
Statements
Appendix 1--CFTC Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz and
Stump voted in the affirmative. Commissioners Behnam and Berkovitz
voted in the negative. The document submitted to the CFTC
Commissioners for a vote did not include Section V.F. SEC Economic
Analysis or Section V.G. Congressional Review Act.
Appendix 2--Statement of CFTC Chairman Heath Tarbert in Support of
Revisions to the Volcker Rule
I have voted to approve revisions to the Volcker Rule, among the
most well-intentioned but poorly designed regulations in the history
of American finance. My involvement with the Volcker Rule started
nearly a decade ago when I served as special counsel to the Senate
Banking Committee before the passage of the Dodd-Frank Act. In fact,
I was the staff member responsible for arranging for former Federal
Reserve Chairman Paul Volcker to testify before the committee on the
original version of the rule that now bears his name. Having had the
[[Page 62274]]
opportunity to interact with Chairman Volcker at various points
throughout my career, I have always had immense respect for him. He
had a clear-cut vision: Banks should be barred from speculating in
the markets (a practice known as proprietary trading) and from
running hedge funds and private-equity firms. ``If you are doing
this stuff,'' he would say, ``you should not be a commercial bank.''
Five federal agencies--the Federal Reserve, the FDIC, the OCC,
the SEC, and the CFTC (together, the ``Agencies'')--issued final
regulations in December 2013 to implement the statutory language of
the Volcker Rule in Title VI of the Dodd-Frank Act. The basic
premise of this law is to restrict financial institutions with
deposits insured by the Federal Government from engaging in
proprietary trading, but permit trading for market making, hedging,
and other traditional financial services activities.
We now have five years of experience with the initial version of
the regulations implementing the Volcker Rule, and over that time, a
number of legitimate concerns have arisen. In my view, the initial
regulations adopted by the Agencies have metastasized from Mr.
Volcker's original, simple vision to the degree where his
distinction between proprietary and non-proprietary trading is
hardly recognizable. I agree with Mr. Volcker that the rule has
become overly complex and hard to understand; \1\ at this point it
is also nearly unadministrable. Among other things, the regulations
create confusion over what is acceptable activity for banking
entities.\2\ Indeed, the Agencies have had to issue 21 sets of
frequently asked questions (``FAQs'') in the first three years since
the regulations were adopted.\3\ This is not a model of clear
rulemaking. Furthermore, the Volcker Rule imposes highly intensive
compliance burdens that unfairly benefit large Wall Street banks
over smaller regional ones. No one ever intended these results.
---------------------------------------------------------------------------
\1\ See, e.g., ``Why Paul Volcker Soured on His Own Rule,'' Time
(Oct. 25, 2011), available at: https://business.time.com/2011/10/25/why-paul-volcker-soured-on-the-volcker-rule; ``Paul Volcker Says
Volcker Rule Too Complicated,'' Reuters (Nov. 9, 2011), available at
https://www.reuters.com/article/us-regulation-volcker/paul-volcker-says-volcker-rule-too-complicated. This is not to suggest that Mr.
Volcker agrees with the proposed changes now before the interagency
process. See ``Volcker the Man Blasts Volcker the Rule in Letter to
Fed Chair,'' Bloomberg (Sept. 10, 2019), available at https://www.bloomberg.com/news/articles/2019-09-10/volcker-the-man-blasts-volcker-the-rule-in-letter-to-fed-chair (describing a private letter
purportedly criticizing the proposed amendments to the current
regulations).
\2\ I have written a number of legal articles over the years to
help market participants make sense of the Volcker Rule and how it
might apply to them. See, e.g., The Vagaries of the Volcker Rule,
Int'l Fin. L. Rev. (Sept. 2010); The Volcker Rule and the Future of
Private Equity (co-author), Rev. of Banking & Fin. Serv. (May 2011);
and CLOs and the Volcker Rule (co-author), Rev. of Banking & Fin.
Serv. (Aug. 2015).
\3\ See FAQ on Conformance Period (June 10, 2014); FAQ on
Foreign Public Fund Seeding Vehicles (June 10, 2014); FAQ on Loan
Securitization Servicing Assets (June 10, 2014); FAQ on Namesharing
Prohibition (June 10, 2014); FAQ on Metrics Reporting Date (June 10,
2014); FAQ on Trading Desk (June 10, 2014); FAQ on Mortgage-Backed
Securities of Government-Sponsored Enterprises (November 12, 2014);
FAQ on Metrics Reporting During the Conformance Period (Nov. 13,
2014); FAQ on Annual CEO Attestation (Sept. 10, 2014); FAQ on
Metrics Reporting and Confidentiality (Dec. 23, 2014); FAQ on
Treasury STRIPS (Jan. 29, 2015); FAQ on 30-Day Metrics Reporting
During the Conformance Period (Jan. 29, 2015); FAQ on SOTUS Covered
Fund Exemption: Marketing Restriction (Feb. 27, 2015); FAQ on
Foreign Public Funds Sponsored by Banking Entities (June 12, 2015);
FAQ on Joint Venture Exclusion for Covered Funds (June 12, 2015);
FAQ on Seeding Period Treatment of Registered Investment Companies
and Foreign Public Funds (June 16, 2015); FAQ on CEO Certification
for Prime Brokerage Transactions (Sept. 25, 2015); FAQ on Compliance
for Market Making and the Identification of Covered Funds (Sept. 25,
2015); FAQ on Termination of Market-making Activity (Nov. 20, 2015);
FAQ on Applicability of the Restrictions in Section 13(f) of the BHC
Act (Nov. 20, 2015); FAQ on Capital Treatment of Banking Entity
Investments in TruPS CDOs (Mar. 4, 2016).
---------------------------------------------------------------------------
In addition, the Volcker Rule has an extraterritorial reach that
is breathtaking in its expansiveness, something I witnessed
personally several years ago in Australia. There I met with a senior
executive at a local, Australian financial institution. He handed me
his business card, and it listed his title as ``Head of Volcker Rule
Compliance.'' In Australia! We have created a mess not just for the
United States, but for the whole world.
I do not doubt the good intentions of the original drafters of
both the Volcker Rule and its implementing regulations. I continue
to affirm that deposit insurance underwritten by the FDIC and
discount window access provided by the Federal Reserve--both
ultimately backstopped by U.S. taxpayers--should not subsidize non-
banking activities.\4\ I will not raise the related question whether
non-banks affiliated with insured depository institutions should be
allowed to engage in proprietary trading. I recognize that this is a
decision for Congress, not me.\5\
---------------------------------------------------------------------------
\4\ See Hearing Before the Committee on Banking, Housing, and
Urban Affairs, United States Senate, 150th Congress, Session 1 (May
17, 2017) at 22 (``I [Heath Tarbert] believe that Federal deposit
insurance should not subsidize nonbanking activities. . . . [This]
should not be controversial.'').
\5\ It is worth noting that the Dodd-Frank Act of 2010 contained
a provision addressing the specific issue of insured banks engaging
in trading activities perceived to go beyond traditional banking
services. The ``push-out'' rule of Section 716, also known as the
Lincoln Amendment, would have confined an insured depository
institution's trading of swaps to those used for hedging or
otherwise related to the well-known list of eligible (and
appropriately conservative) investments permissible for national
banks. Exotic and non-traditional products such as credit default
swaps, equity swaps, and most physical commodity swaps would have
been effectively ``pushed out'' out of insured banks and into non-
bank affiliates not directly backstopped by U.S. taxpayers. Whatever
the merits of the Lincoln Amendment, no one can deny that it was a
clear rule aimed at an equally clear and widely-shared policy
objective. But it was not to last. In December 2014, a bipartisan
Congress passed--and President Obama signed into law--a budget bill
containing a provision that largely gutted the original push-out
rule of the Dodd-Frank Act. See Consolidated and Further Continuing
Appropriations Act, 2015, Public Law 113-235, 128 Stat. 2130 at
section 630 (2014).
---------------------------------------------------------------------------
As Chairman of the CFTC, my job is to ensure that the
derivatives markets are liquid, resilient, and vibrant so they can
serve the price discovery and risk management functions critical to
our real economy. I have seen reports that liquidity in bond markets
may have been adversely affected by the Volcker Rule.\6\ I am
concerned that the Volcker Rule may also affect liquidity in the
derivatives markets. This could negatively impact the ability of
agricultural, energy, manufacturing, and other companies in the real
economy to engage in risk mitigation activities.
---------------------------------------------------------------------------
\6\ See, e.g., M. Allahrakha & J. Cetina, et al., ``The Effects
of the Volcker Rule on Corporate Bond Trading: Evidence from the
Underwriting Exemption,'' OFR Working Paper (Aug. 6, 2019); J. Bao,
& M. O'Hara, et al., The Volcker Rule and Market-Making in Times of
Stress, J. of Fin. Econ. (2018); H. Bessembinder & S. Jacobsen, et
al., Capital Commitment and Illiquidity in Corporate Bonds, J. of
Fin. (Aug. 2018).
---------------------------------------------------------------------------
I am happy to say that the amended regulations we have now
adopted help to simplify the Volcker Rule and include a number of
important amendments that lessen the burden on smaller regional
banks and benefit end users of derivatives. The amendments seek to
tailor the Volcker Rule to increase efficiency, right-size firms'
compliance obligations, and allow banking entities--especially
smaller ones--to provide services to clients more efficiently.
The amended regulations adopt a risk-based approach that relies
on a set of clearly articulated standards for prohibited and
permitted activities and investments. In particular, the new
regulations revise elements of the prohibition on proprietary
trading to provide banking entities--including CFTC-registered swap
dealers and futures commission merchants (``FCMs'')--with greater
flexibility in their trading activities and simplified compliance
procedures.
The final regulations also expand existing, and include
additional, exclusions from the definition of proprietary trading.
For example, the amended regulations add an exclusion for matched
derivatives transactions to facilitate customer-driven swaps,
especially by customers of small regional banks, which should
benefit end users who rely on derivatives to hedge their commercial
risks. The amended final regulations also expand the list of
permissible products for the liquidity management exclusion to
include FX forwards/swaps and cross-currency swaps. Banking entities
commonly purchase and sell these instruments for the purpose of
managing their liquidity and funding needs. This can ultimately
benefit commercial firms who use banks for loans and other products
to hedge their foreign exchange risks arising from import and export
transactions.
In addition, the final regulations tailor the compliance and
metrics reporting requirements of the Volcker Rule to focus on
entities with relatively large trading operations. As a result,
financial institutions on Wall Street will retain their reporting
procedures, while smaller and more traditional commercial banks
without major trading operations will get some relief. What
[[Page 62275]]
is more, the new regulations simplify requirements by clarifying
prohibited and permissible activities, so that all institutions--
including those headquartered abroad but who lend and deploy capital
in the United States--have a better understanding of how to comply
with our laws.
I believe laws should be as clear and concise as possible. The
point of having laws is for people to follow them, but before they
can follow them they first have to understand them. As Judge Learned
Hand put it 90 years ago, ``The language of the law must not be
foreign to the ears of those who are to obey it.'' \7\ For too long
the Volcker Rule has been just that--very peculiar and virtually
unintelligible to market participants and regulators alike.
---------------------------------------------------------------------------
\7\ Hand, L. Is There a Common Will? in The Spirit of Liberty:
Papers and Addresses of Learned Hand 56 (I. Dilliard, 3d ed. 1960)
(quoting from address before the American Law Institute in 1929).
---------------------------------------------------------------------------
In short, the amended regulations will provide banking entities
and their affiliates (including a number of swap dealers, FCMs, and
commodity pools subject to CFTC oversight) with greater clarity and
certainty about what activities are permitted under the Volcker
Rule. The revised regulations will also generally reduce the
compliance burden for these entities, which will benefit those end
users of derivatives who are critical to our real economy. These
changes, which will make the Volcker Rule simpler without reducing
its fundamental benefits, are something we should all support.
Appendix 3--Supporting Statement of CFTC Commissioner Brian Quintenz
I support today's targeted amendments to the Volcker Rule, which
I believe will simplify firms' compliance with the statutory ban on
proprietary trading and improve the agencies' supervision of banking
entities. Based upon the agencies' implementation experience since
2013, it has become apparent that the rule as originally adopted has
resulted in ambiguity over permissible activities, an overbroad
application, and unnecessarily complex compliance processes. The
revised rule before us today tailors and simplifies the rule to
enable banking entities to effectively provide traditional banking
services to their clients in a manner that is consistent with the
statute.
Adopting a risk-based approach, the revised rule tailors the
scale of a banking entity's compliance program to be commensurate
with the firm's size and level of trading activities. Under the
final rule, the most stringent compliance requirements apply to
those entities with the most significant amount of trading
activities, while banks with simpler business models and more
limited trading operations would be subject to tiered compliance
requirements tailored to the complexity and scope of their
activities. As a result, firms with little or no activity subject to
the Volcker Rule's prohibitions will face lower compliance costs and
reduced regulatory burdens. However, because activity implicated by
the Volcker Rule is concentrated in a small number of banks, the
agencies estimate that, even under this tiered approach,
approximately 93% of the trading assets and liabilities in the U.S.
banking system would continue to be held by firms subject to the
strictest compliance standards.
The final rule also clarifies and simplifies the application of
the short-term intent prong. Under the 2013 rule, the purchase (or
sale) of a financial instrument by a banking entity was presumed to
be for the trading account if the banking entity held the financial
instrument for fewer than sixty days (or substantially transferred
the risk of the financial instrument within 60 days of purchase or
sale). In practice, firms have found it difficult to rebut the
presumption, with the result that the short term intent prong has
captured many activities that should not be included in the
definition of proprietary trading. The final rule addresses this
issue by reversing the rebuttable presumption, providing that the
purchase or sale of a financial instrument presumptively lacks
short-term trading intent if the banking entity holds the financial
instrument for 60 days or longer. In addition, the final rule
includes new or expanded exclusions from the definition of
proprietary trading for liquidity management programs, certain
customer-driven swaps, error trades, and certain traditional banking
activities, such as the hedging of mortgage servicing rights. These
modifications clarify the scope of permissible activities and ensure
that the application of the proprietary trading ban is not
overbroad.
I believe today's final rule serves as an example of effective
cooperation among five regulators: The CFTC; the Securities and
Exchange Commission; the Federal Reserve Board; the Office of the
Comptroller of the Currency; and the Federal Deposit Insurance
Corporation. The agencies have come together to address many of the
unintended consequences of the prior rule, while continuing to
comply with statutory requirements. Finally, I would like to thank
the staff of the Division of Swap Dealer and Intermediary Oversight
for their efforts on this matter.
Appendix 4--Dissenting Statement of CFTC Commissioner Rostin Behnam
I respectfully dissent as to the Commission's decision to
approve revisions to the Volcker Rule. In June 2018, when I voted
against the proposed rule, I expressed that my biggest concern was
that our action would encourage a return to the risky activities
that led to the financial crisis, and perhaps further consolidate
trading activity into a few institutions.\1\ My concern last June
was that we were weakening the Volcker Rule around the edges, and I
raised specific issues regarding unnecessary complexity, lack of
clarity, and a flawed process that chilled dissent. Unfortunately,
today's final rule does not do anything to assuage these concerns.
To make matters worse, while the proposal merely threatened to kill
Volcker through a thousand little cuts, the final rule goes for the
throat. It significantly weakens the prohibition on proprietary
trading by narrowing the scope of financial instruments subject to
the Volcker Rule. What remains is so watered down that it leaves one
questioning whether it should be called the Volcker rule at all. To
that point, Paul Volcker himself recently sent a letter to the
Chairman of the Federal Reserve criticizing the rule and stating
that the rule ``amplifies risk in the financial system, increases
moral hazard and erodes protections against conflicts of interest
that were so glaringly on display during the last crisis.'' \2\
---------------------------------------------------------------------------
\1\ Opening Statement of Commissioner Rostin Behnam Before the
Open Commission Meeting on June 4, 2018 (Jun. 4, 2018), https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement060418.
\2\ Jesse Hamilton and Yalman Onaran, ``Vocker the Man Blasts
Volcker the Rule in Letter to Fed Chair,'' Bloomberg (Sep. 10,
2019), https://www.bloomberg.com/news/articles/2019-09-10/volcker-the-man-blasts-volcker-the-rule-in-letter-to-fed-chair.
---------------------------------------------------------------------------
In my dissent last June, I pointed out that the proposal further
complicated the Volcker rule while calling it simplification. We do
the same thing in the final rule. Where once there was one set of
rules for all banking entities, there will now be three categories
of banking entities with different rules for each: Banking entities
with Significant trading assets and liabilities, banking entities
with Limited trading assets and liabilities, banking entities in
between with Moderate trading assets and liabilities. While numerous
commenters expressed concerns with this three-tiered compliance
framework, we nonetheless are finalizing this needlessly complex
system. In addition, the majority today makes ``targeted
adjustments'' that further complicate matters. In some instances,
these adjustments are at least requested by the commenters. In
others, they are invented seemingly out of whole cloth.
The most troubling aspect of today's rule, though, is something
new. The final rule includes changes to the definition of ``trading
account'' that will significantly reduce the scope of financial
instruments subject to the Volcker Rule's prohibition on proprietary
trading. This change is described in the preamble to the final rule
as avoiding having the trading account definition ``inappropriately
scope in'' certain financial instruments, almost as if they were
included in the proposal's scope by mistake. However, these
financial instruments were within the scope of the 2013 rule, and
they were within the scope of the proposal. Removing them now limits
the scope of the Volcker rule so significantly that it no longer
will provide meaningful constraints on speculative proprietary
trading by banks. As such, I cannot vote for the rule.
Appendix 5--Dissenting Statement of CFTC Commissioner Dan M. Berkovitz
Congress adopted the statute commonly known as the ``Volcker
Rule'' in the wake of the 2008 financial crisis to prevent banks
that benefit from federal depository insurance or other government
support from taking excessive risks that could lead to future
taxpayer bailouts. The Volcker Rule prohibits proprietary trading
and the owning of hedge funds and private equity funds by banks and
their subsidiaries (``banking entities''), with certain exceptions
and exemptions. In 2013 the Commission and other financial
regulators adopted regulations to implement
[[Page 62276]]
the Volcker Rule. The final rule before the Commission today
(``revised Volcker Rule'') substantially weakens these implementing
regulations.
The revised Volcker Rule eliminates or reduces a variety of
substantive standards in the current rule. The revised Volcker Rule
will render enforcement of the rule difficult if not impossible by
leaving implementation of significant requirements to the discretion
of the banking entities, creating presumptions of compliance that
would be nearly impossible to overcome, and eliminating numerous
reporting requirements. The revised Volcker Rule also substantially
reduces the bank trading activity covered by the rule. Finally, the
revised Volcker Rule includes a number of changes and additions not
contemplated or adequately discussed in the notice of proposed
rulemaking (NPRM) in violation of the Administrative Procedure Act
(``APA'') requirements for public notice and comment for
rulemakings.
For these reasons, I dissent.
Weak Regulation and Enforceability Concerns
Nearly every amending provision of the revised Volcker Rule
adopts the weakened provisions from the NPRM, further weakens the
proposed changes, or makes new changes that weaken or eliminate
existing requirements and standards. New presumptions of compliance
favoring the banking entities, regulatory determinations left to the
banking entities, and reductions in reporting requirements by the
banking entities will make the revised Volcker Rule more difficult
to enforce. The cumulative effect of this myriad of changes is a set
of regulations that is ineffective and unenforceable. Although a
single chip off a sculpture, by itself, may not create a noticeable
blemish, widespread chiseling will disfigure the object. Such is the
result here.
The ``trading account'' definition and related regulatory
exclusions in the 2013 rule determine which financial transactions
are subject to the restrictions on proprietary trading. Financial
transactions of banking entities are subject to the Volcker
regulations if they fall within certain ``prongs'' established in
the trading account provision. The revised Volcker Rule rejects the
``accounting prong'' proposed in the NPRM and effectively jettisons
the existing ``short-term intent prong'' for most entities.\1\ In
addition, there are a number of newly created outright exclusions of
whole types of transactions and broadening of existing exclusions
under the revised Volcker Rule.
---------------------------------------------------------------------------
\1\ While the short-term intent prong remains for a limited
number of banks not subject to the market risk capital rules in
banking regulations, compliance with the short-term intent prong is
now optional if those banking entities instead elect to comply with
the market risk capital rules for Volcker compliance.
---------------------------------------------------------------------------
FDIC Commissioner Martin Gruenberg provided an analysis of how
these changes will significantly reduce the banking activity subject
to Volcker oversight. ``By excluding these financial instruments
from the Volcker Rule, the final rule . . . opens up vast new
opportunity--hundreds of billions of dollars of financial
instruments--at both the bank and bank holding company level, for
speculative proprietary trading funded by the public safety net.''
\2\
---------------------------------------------------------------------------
\2\ Statement by Martin J. Gruenberg, Member, FDIC Board of
Directors, The Volcker Rule (Aug. 20, 2019) at 3, available at
https://www.fdic.gov/news/news/speeches/spaug2019b.pdf.
---------------------------------------------------------------------------
The 2013 Volcker rules define the ``trading desk'' as the
``smallest discrete unit of organization'' that purchases and sells
financial instruments. The revised Volcker Rule removes the quoted
text, and instead provides four broad criteria for designating a
trading desk. The rule then allows the banking entities to designate
the trading desks for purposes of Volcker.
The new trading desk designation criteria appear to be broad
enough that a ``trading desk'' could include whole business lines,
divisions, or an entire swap dealer. The opportunities for
undertaking greater amounts of proprietary trading expand
significantly when the limits (which are set by the banking entities
themselves), the desk-specific positions being hedged, and reporting
requirements are applied to much larger trading portfolios. Because
the revised Volcker Rule effectively presumes that these trading
desk designations by the banking entities are valid, it will be more
difficult for the applicable regulator to reign in proprietary
trading undertaken by more expansively designated trading desks.
How much proprietary trading can occur under the market making
exemption in the revised Volcker Rule will be determined by the risk
limits set for each trading desk. The risk limits are to be
established at the discretion of each banking entity and, as noted
above, the scope of a trading desk also will be determined by the
banking entity within broad criteria. ``Reasonably expected near-
term demand'' (``RENTD'') of customers is included in the Volcker
statute to establish the level of market making permissible. While
the RENTD concept is still in the revised Volcker Rule, a
presumption has been added that the RENTD levels set by each banking
entity are correct.
Because these determinations will be established by the banking
entity and presumed to be compliant, it will be difficult for any
regulator to challenge them or take any enforcement action--even if
a banking entity experiences large losses from proprietary trading--
so long as the trading is found to be within the set limits.
These concerns about enforcement and oversight are exacerbated
by the reduced metrics and other reporting, documentation, and
compliance requirements. Numerous changes are made both as proposed
and added on in this final rule. To name a few, stressed value at
risk, daily risk factor sensitivities, and risk limit breaches need
not be reported. In some cases, changes to reporting requirements
make sense if experience shows a metric has little or no regulatory
value. But most of these changes in the revised Volcker Rule are
purportedly justified because they reduce the burden on banking
entities and the cumulative effect on the ability of a regulator to
monitor for compliance and potential significant issues is not
addressed.
Logical Outgrowth Concerns
The revised Volcker Rule includes a number of new rules and
amendments that were not mentioned or adequately described in the
NPRM. The APA requires that a proposed rulemaking be published in
the Federal Register and that interested persons be given an
opportunity to comment.\3\ A ``notice of proposed rulemaking must
provide sufficient factual detail and rationale for the rule to
permit interested parties to comment meaningfully.'' \4\
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\3\ 5 U.S.C. 553(b) and (c).
\4\ Honeywell Int'l, Inc. v. EPA, 372 F.3d 441, 445 (D.C. Cir.
2004) (internal quotation marks omitted).
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In comparing the revised Volcker Rule to the NPRM, there are a
number of changes that were either not addressed in the NPRM or at
best are based on comments received in response to general
questions. For example, the NPRM included a proposal to replace the
short-term intent prong with what is commonly referred to as the
``accounting prong.'' In the revised Volcker Rule, the accounting
prong was rejected, but the short-term interest prong also is
eliminated for most banking entities.\5\ While replacing the short-
term intent prong was discussed in the proposal, effectively
eliminating the prong without a replacement was not proposed.
Similarly the option for certain banking entities to now elect to
comply with the market risk capital rule prong rather than the
short-term intent prong was not discussed as an alternative. Nor was
the replacement of the rebuttable presumption of proprietary trading
for positions held shorter than 60 days with the opposite
presumption that positions held longer than 60 days are not
proprietary trading for purposes of the Volcker Rule. Agencies
cannot ``pull a surprise switcheroo'' in the rulemaking process.\6\
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\5\ Firms subject to, or which elect to be subject to, the
market risk capital rule prong are no longer subject to the short-
term intent prong.
\6\ Environmental Integrity Project v. EPA, 425 F.3d 992, 996
(D.C. Cir. 2005).
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Furthermore, the NPRM appears to not even contemplate excluding
government bond assets and liabilities, mortgage servicing rights
hedges, or financial instruments that are not trading assets or
trading liabilities from counting as proprietary trading. Other
changes, such as the elimination of incentive compensation limits,
the matched derivatives transaction exclusion, and elimination of
risk factor sensitivity metrics reporting appear to be based on
general questions in the NPRM. In each case, no draft rule text or
adequate discussion of such amendments was provided that would allow
the public to have anticipated those amendments. Rather, many of
these changes appear to be based on de novo comments made by banks
or their trade organizations. ``[I]f the final rule `substantially
departs from the terms or substance of the proposed rule,' the
notice is inadequate.'' \7\
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\7\ Chocolate Manufacturers Assoc. of the United States v.
Block, 755 F.2d 1098, 1105 (4th Cir. 1985) (quoting Rowell v.
Andrus, 631 F.2d 699, 702 n.2 (10th Cir. 1980).
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[[Page 62277]]
Conclusion
Self-regulation failed us in the early part of this century.
Dodd-Frank, including the Volcker Rule, has helped this country
rebuild a strong and better managed financial sector. To maintain a
robust financial sector that benefits the American people, we must
maintain strong standards and vigorous oversight. Otherwise, it is
only a matter of time before the memory of the huge losses and
resulting pressures for a taxpayer bailout fades and excessive risk
taking comes home to roost. While the Dodd-Frank regulations may not
be perfect and modest adjustments may be appropriate, the wholesale
revision of regulations that greatly weaken the enforceability of
those regulations such as we have before us today will, in the long
run, weaken the financial sector and pose risks to the American
public.
[FR Doc. 2019-22695 Filed 11-13-19; 8:45 am]
BILLING CODE P
