Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 46422-46530 [2020-15525]

Download as PDF 46422 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations DEPARTMENT OF TREASURY Office of the Comptroller of the Currency 12 CFR Part 44 [Docket No. OCC–2020–0002] RIN 1557–AE67 FEDERAL RESERVE SYSTEM 12 CFR Part 248 [Docket No. R–1694] RIN 7100–AF70 FEDERAL DEPOSIT INSURANCE CORPORATION 12 CFR Part 351 RIN 3064–AF17 COMMODITY FUTURES TRADING COMMISSION 17 CFR Part 75 RIN 3038–AE93 SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 255 [Release No. BHCA–9; File No. S7–02–20] RIN 3235–AM70 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 (together, the agencies) are adopting amendments to the regulations implementing section 13 of the Bank Holding Company Act (BHC Act). Section 13 contains certain restrictions on the ability of a banking entity or 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 (covered funds). These final amendments are intended to improve and streamline the regulations implementing section 13 of the BHC Act by modifying and clarifying SUMMARY: VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 requirements related to the covered fund provisions of the rules. DATES: Effective date: The final rule is effective October 1, 2020. 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, Elizabeth MacDonald, Manager, (202) 475–6316, Cecily Boggs, Senior Financial Institution Policy Analyst, (202) 530– 6209, Brendan Rowan, Senior Financial Institution Policy Analyst, (202) 475– 6685, Christopher Powell, Senior Financial Institution Policy Analyst, (202) 452–3442, Nathaniel Grant, Lead Financial Institution Policy Analyst, (202) 452–3105, 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, 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 Insurance Corporation, 550 17th Street NW, Washington, DC 20429. CFTC: Cantrell Dumas, Special Counsel, (202) 418–5043, cdumas@ 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. SEC: Juliet M. Han, Senior Counsel, William Miller, Senior Counsel, Benjamin A. Tecmire, Senior Counsel, or Jennifer Songer, Branch Chief at (202) 551–6787 or IArules@sec.gov, Investment Adviser Regulation Office, Division of Investment Management, PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 and Katherine Hsu, Office Chief, or Benjamin Meeks, Special Counsel at (202) 551–3850, Office of Structured Finance, Division of Corporation Finance, U.S. Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549. SUPPLEMENTARY INFORMATION: Table of Contents I. Background II. Notice of Proposed Rulemaking III. Overview of the Final Rule IV. Summary of the Final Rule A. Qualifying Foreign Excluded Funds B. Modifications to Existing Covered Fund Exclusions 1. Foreign Public Funds 2. Loan Securitizations 3. Public Welfare and Small Business Funds C. Additional Covered Fund Exclusions 1. Credit Funds 2. Venture Capital Funds 3. Family Wealth Management Vehicles 4. Customer Facilitation Vehicles D. Limitations on Relationships With a Covered Fund E. Ownership Interest F. Parallel Investments G. Technical Amendments 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 F. SEC Economic Analysis G. Congressional Review Act I. Background Section 13 of the BHC Act,1 also known as the Volcker Rule, 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 hedge fund or private equity fund (covered fund).2 The statute expressly exempts from these prohibitions various activities, including, among other things: • Underwriting and market makingrelated activities; • Risk-mitigating hedging activities; • Activities on behalf of customers; • Activities for the general account of insurance companies; and • Trading and covered fund activities and investments by non-U.S. banking entities solely outside the United States.3 In addition, section 13 of the BHC Act contains an exemption that permits banking entities to organize and offer, including sponsor, covered funds, subject to certain restrictions, including 1 12 U.S.C. 1851. 2 Id. 3 12 E:\FR\FM\31JYR4.SGM U.S.C. 1851(d)(1). 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations that banking entities do not rescue investors in those funds from loss, and are not themselves exposed to significant losses due to investments in or other relationships with these funds.4 Authority under section 13 of the BHC Act for developing and adopting regulations to implement the prohibitions, restrictions, and exemptions of section 13 is shared among the Board, the FDIC, the OCC, the SEC, and the CFTC (individually, an agency, and collectively, the agencies).5 The agencies originally issued a final rule implementing section 13 in December 2013 (the 2013 rule), and those provisions became effective on April 1, 2014.6 The agencies published a notice of proposed rulemaking in July 2018 (the 2018 proposal) that proposed several amendments to the 2013 rule.7 These proposed revisions sought to provide greater clarity and certainty about what activities are prohibited under the 2013 rule—in particular, under the prohibition on proprietary trading—and to better tailor the compliance requirements based on the risk of a banking entity’s trading activities. The agencies issued a final rule implementing amendments to the 2013 rule in November 2019 (the 2019 amendments), and those provisions became effective in January 2020.8 As part of the 2018 proposal, the agencies proposed targeted changes to the provisions of the 2013 rule relating to acquiring or retaining an ownership interest in, sponsoring, or having certain relationships with a fund and sought comments on other aspects of the 4 12 U.S.C. 1851(d)(1)(G). Other restrictions and requirements include: (1) The banking entity provides bona fide trust, fiduciary, or investment advisory services; (2) the fund is organized and offered only to customers in connection with the provision of such services; (3) the banking entity does not have an ownership interest in the fund, except for a de minimis investment; (4) the banking entity complies with certain marketing restrictions related to the fund; (5) no director or employee of the banking entity has an ownership interest in the fund, with certain exceptions; and (6) the banking entity discloses to investors that it does not guarantee the performance of the fund. Id. 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). 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 Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 84 FR 61974 (Nov. 14, 2019). The regulations implementing section 13 of the BHC Act, as amended through June 1, 2020, are referred throughout as the ‘‘implementing regulations.’’ VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 covered fund provisions beyond those changes for which specific rule text was proposed.9 The 2019 amendments finalized those changes to the covered fund provisions for which specific rule text was proposed in the 2018 proposal.10 The agencies indicated they would issue a separate proposal addressing and requesting comment on the covered fund provisions of the rule and other fund-related issues, and, in February 2020, the agencies issued a separate notice of proposed rulemaking that specifically addressed those areas (the 2020 proposal).11 II. Notice of Proposed Rulemaking In the 2020 proposal, the agencies proposed revisions to a number of the provisions regarding covered fund investments and activities as well as to other provisions of the implementing regulations related to the treatment of funds. The proposed changes, which were based on comments received in response to the agencies’ questions in the 2018 proposal and the agencies’ experience with the implementing regulations, were intended to reduce the extraterritorial impact of the implementing regulations, improve and streamline the covered fund provisions, and provide clarity to banking entities regarding the provision of financial services and the conduct of permissible activities in a manner that is consistent with the requirements of section 13 of the BHC Act. To better limit the extraterritorial impact of the implementing regulations, the 2020 proposal would have exempted the activities of certain funds that are organized outside of the United States and offered to foreign investors (qualifying foreign excluded funds) from the restrictions of the implementing regulations. Under the 2013 rule, in certain circumstances, some foreign funds that are not ‘‘covered funds’’ may be subject to the implementing regulations as ‘‘banking entities,’’ if they are controlled by a foreign banking entity, and thus could be subject to more onerous compliance obligations than are imposed on similarly-situated U.S. covered funds, even though the foreign funds have limited nexus to the United States. Accordingly, the 2020 FR 33471–87. response to the 2018 proposal, the agencies received numerous comments related to covered fund issues for which no specific rule text was proposed. However, in the preamble to the 2019 amendments, the agencies generally deferred public consideration of such comments to a future proposed rulemaking. 84 FR 62016. 11 Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 85 FR 12120 (Feb. 28, 2020). PO 00000 9 83 10 In Frm 00003 Fmt 4701 Sfmt 4700 46423 proposal would have codified an existing policy statement by the Federal banking agencies (the OCC, Board, and FDIC) that addresses the potential issues related to a foreign banking entity controlling qualifying foreign excluded funds. The 2020 proposal also would have made modifications to several existing exclusions from the covered fund provisions to provide clarity and simplify compliance with the requirements of the implementing regulations. First, the 2020 proposal would have revised certain restrictions in the foreign public funds exclusion to more closely align the provision with the exclusion for similarly-situated U.S. registered investment companies. Second, the 2020 proposal would have permitted loan securitizations excluded from the definition of covered fund to hold a small amount of non-loan assets, consistent with past industry practice, and would have codified existing stafflevel guidance regarding this exclusion. In addition, the 2020 proposal would have revised the exclusion for small business investment companies to account for the life cycle of those companies and requested comment on whether to clarify the scope of the exclusion for public welfare and other investments to include rural business investment companies and qualified opportunity funds. Finally, the 2020 proposal would have addressed concerns about certain components of the preamble to the 2013 rule related to calculating a banking entity’s ownership interests in covered funds. The agencies also included in the 2020 proposal several new exclusions from the covered fund definition in order to more directly align the regulation with the purpose of the statute. For example, the agencies recognized that the implementing regulations have inhibited banking entities’ ability to extend credit by restricting their relationships with credit funds, and the 2020 proposal would have created a new exclusion for such funds. Under the 2020 proposal, banking entities would have been able to invest in and have certain relationships with credit funds that extend the type of credit that a banking entity may provide directly, subject to certain safeguards. Relatedly, the 2020 proposal would have established an exclusion from the definition of covered fund for venture capital funds. This provision was intended to facilitate banking entities’ abilities to engage in this important type of development and investment activity, which may facilitate capital formation and provide important financing for small E:\FR\FM\31JYR4.SGM 31JYR4 46424 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations businesses, particularly in areas where such financing may not be readily available. In addition, the agencies believed that excluding such activities would be consistent with the purpose of the statute, as it would exclude fund activities that do not present the risks that section 13 of the BHC Act was intended to address. The 2020 proposal also would have allowed a banking entity to provide certain traditional financial services to its customers via a fund structure, subject to certain safeguards and limitations. First, the 2020 proposal would have excluded from the definition of covered fund an entity created and used to facilitate customer exposures to a transaction, investment strategy, or other service. Second, the 2020 proposal would have excluded from the covered fund definition wealth management vehicles that manage the investment portfolio of a family and certain other closely related persons. Both of these provisions were intended to allow a banking entity to provide such services in the manner best suited to its customers. In addition, the 2020 proposal would have permitted a banking entity to engage in a limited set of covered transactions with a covered fund that the banking entity sponsors or advises or with which the banking entity has certain other relationships. The implementing regulations generally prohibit all covered transactions between a covered fund and its banking entity sponsor or investment adviser. The agencies, in the 2020 proposal, recognized that the existing restrictions have prevented banking entities from providing certain traditional banking services to covered funds, such as standard payment, clearing, and settlement services. Lastly, the 2020 proposal would have clarified certain aspects of the definition of ownership interest. Currently, due to the broad definition of ownership interest, some loans by banking entities to covered funds could be deemed ownership interests. The 2020 proposal included a safe harbor for bona fide senior loans or senior debt instruments to make clear that an ‘‘ownership interest’’ in a fund would not include such credit interests in the fund. In addition, the 2020 proposal would have clarified the types of creditor rights that may attach to an interest without necessarily causing such an interest to fall within the scope of the definition of ownership interest. Finally, the 2020 proposal would have simplified compliance efforts by tailoring the calculation of a banking entity’s compliance with the implementing VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 regulations’ aggregate fund limit and covered fund deduction and provided clarity to banking entities regarding their permissible investments made alongside covered funds.12 The agencies invited comment on all aspects of the 2020 proposal, including specific proposed revisions and questions posed by the agencies. The agencies received approximately 40 unique comments from banking entities and industry groups, public interest groups, and other organizations and individuals. In addition, the agencies received six letters related to the subject matter considered in the 2020 proposal prior to the formal comment period. The agencies are now finalizing the 2020 proposal, with certain changes based on public comments, as described in detail below.13 III. Overview of the Final Rule Similar to the 2020 proposal, the final rule clarifies and simplifies compliance with the implementing regulations, refines the extraterritorial application of section 13 of the BHC Act, and permits additional fund activities that do not present the risks that section 13 was intended to address. The agencies received comments from a diverse set of commenters: Comments from banking entities and financial services industry trade groups were generally supportive of the 2020 proposal and recommended additional modifications, while several organizations and individuals were generally opposed to the 2020 proposal. 12 Separately, the agencies proposed various technical edits to the implementing regulations. See infra Section IV.G (Technical Amendments). 13 Comments are generally discussed in the relevant sections, infra. The agencies also received several miscellaneous comments. One commenter suggested revising § ll.21 (Termination of activities or investments; penalties for violations) of the implementing regulations to provide for mandatory prison time for violations of the implementing regulations. Anonymous. The agencies believe that this comment is beyond the scope of the current rulemaking. Another commenter encouraged the agencies to exempt from the implementing regulations international banks with a small presence in the United States. Institute of International Bankers (IIB). The agencies believe that this comment is beyond the scope of the current rulemaking. A third commenter claimed that the 2020 proposal improperly assumed that the implementing regulations have certain burdens and that it did not adequately assess the costs and benefits of the proposed revisions to the implementing regulations. Occupy the SEC (Occupy). Contrary to the commenter’s suggestions, the Federal Register notice for the 2020 proposal contained extensive discussion of the costs and benefits of the 2020 proposal. See 85 FR 12151–76. This final rule contains similar analyses. See infra, Section IV (Administrative Law Matters). Several commenters expressed support for the comment letters submitted by other organizations. E.g., IIB; European Banking Federation (EBF); Goldman Sachs Group, Inc. (Goldman Sachs); and Canadian Bankers Association (CBA). Finally, one comment was not relevant. See Charity Colleen Crouse. PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 As described further below, the agencies have adopted many of the proposed changes to the implementing regulations, with certain targeted adjustments. To reduce the extraterritorial impact of the implementing regulations, the final rule, similar to the 2020 proposal, exempts the activities of certain funds that are organized outside of the United States and offered to foreign investors (qualifying foreign excluded funds) from certain restrictions of the implementing regulations. Specifically, the final rule codifies an existing policy statement by the Federal banking agencies that addresses the potential issues related to a foreign banking entity controlling a qualifying foreign excluded fund. The final rule contains some modifications to the proposed exemption—the antievasion provision and compliance program requirements—to address comments that the proposed exemption would have unintentionally continued to subject qualifying foreign excluded funds to these requirements. The final rule also revises, as proposed, but with some modifications, several existing exclusions from the covered fund provisions, to provide clarity and simplify compliance with the requirements of the implementing regulations. First, the final rule revises certain restrictions in the foreign public funds exclusion to more closely align the provision with the exclusion for similarly situated U.S. registered investment companies. Second, the final rule permits loan securitizations excluded from the definition of covered fund to hold a small amount of debt securities, consistent with past industry practice, and codifies existing staff-level guidance regarding this exclusion. In addition, the final rule revises the exclusion for small business investment companies to account for the life cycle of those companies and clarifies the scope of the exclusion for public welfare and other investments to include rural business investment companies and qualified opportunity funds. Finally, the final rule clarifies the calculation of ownership interests in covered funds that are attributed to a banking entity. The final rule adopts—as proposed, with some modifications—several new exclusions from the covered fund definition to more closely align the regulation with the purpose of the statute. First, the final rule establishes a new exclusion for funds that extend credit to permit the same credit-related activities that banking entities can engage in directly. In addition, the final rule creates an exclusion for venture capital funds to help ensure that banking entities can indirectly facilitate E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations this important type of development and investment activity to the same degree that banking entities can do so directly. Finally, the final rule adopts two exclusions for family wealth management and customer facilitation vehicles to provide banking entities flexibility to provide advisory and other traditional banking services to customers through a fund structure. In an effort to clarify and simplify compliance with the implementing regulations, the final rule adopts revisions to the provisions that govern the relationship between a banking entity and a fund and the definition of ownership interest. Specifically, the final rule permits established, codified categories of limited low-risk transactions between a banking entity and a related fund, including riskless principal transactions, and allows a banking entity to engage in certain transactions with a related fund in connection with payment, clearing, and settlement activities. In addition, the final rule would provide an express safe harbor for senior loans and senior debt and provide clarity about the types of creditor rights that would be considered within the scope of the definition of ownership interest. Finally, the agencies are adopting revisions, as proposed, to provide clarity regarding a banking entity’s permissible investments in the same investments as a covered fund organized or offered by such banking entity. Frequently Asked Questions The staffs of the agencies have addressed several questions concerning the implementing regulations through a series of staff Frequently Asked Questions (FAQs).14 In the 2020 proposal, the agencies indicated that the proposed rule would not modify or revoke any previously issued staff FAQs, unless otherwise specified.15 Several commenters recommended codifying specific FAQs and making explicit that other FAQs would continue to be in effect, unmodified.16 Consistent with the 2020 proposal and commenters’ suggestions, the final rule does not modify or revoke any 14 See https://www.occ.treas.gov/topics/ capitalmarkets/financial-markets/tradingvolckerrule/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). 15 85 FR 12122–23. 16 E.g., Securities Industry and Financial Markets Association (SIFMA); Financial Services Forum (FSF); and IIB. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 previously issued staff FAQs, unless otherwise specified.17 Comment Period Since the issuance of the 2020 proposal, the COVID–19 global pandemic has substantially disrupted activity in the United States and in other countries. The effects of the COVID–19 disruptions have created many challenges for households and businesses, and the agencies received comments requesting that the agencies extend the comment period for the 2020 proposal or delay the rulemaking more generally.18 In contrast, one commenter expressed support for the rapid approval of the 2020 proposal, to provide banking entities regulatory relief during a period of financial stress.19 The agencies announced on April 2, 2020, that they would consider comments submitted before May 1, 2020.20 The agencies, however, do not believe that further delay of the rule is warranted, given the volume, depth, and diversity of comments submitted. The agencies believe, as well, that the final rule may provide clarity to banking entities that will enable banking entities to engage in financial services and other permissible activities in a manner that both is consistent with the requirements of section 13 of the BHC Act and will facilitate capital formation and economic activity. Effective and Compliance Dates The Federal Register notice accompanying the finalization of the 2019 amendments provided for a rolling compliance system.21 The effective date of the amendments was January 1, 2020, and firms are required to comply with the revisions by January 1, 2021. Until the mandatory compliance date, banking entities are required to comply with the 2013 rule, or alternatively, a banking entity may voluntarily comply, in whole or in part, with the 2019 amendments prior to the compliance date. Several commenters on the 2020 proposal suggested that the agencies provide for voluntary early compliance with the final rule.22 One commenter also suggested establishing a transition period of at least one year.23 FR 12122–23. Better Markets, Inc. (Better Markets) and Kathy Bowman. 19 American Bankers Association (ABA). 20 https://www.federalreserve.gov/newsevents/ pressreleases/bcreg20200402a.htm. 21 84 FR 61974. 22 E.g., SIFMA; FSF; Japanese Bankers Association (JBA); and ABA. 23 JBA. PO 00000 17 85 18 E.g., Frm 00005 Fmt 4701 Sfmt 4700 46425 The effective date for the final rule will be October 1, 2020, to accommodate the requirements of the Riegle Community Development and Regulatory Improvement Act.24 The agencies do not believe an extended compliance or transition period is necessary because the final rule largely tailors the regulations implementing section 13 of the BHC Act rather than increases compliance burdens. IV. Summary of the Final Rule A. Qualifying Foreign Excluded Funds Since the adoption of the 2013 rule, a number of foreign banking entities, foreign government officials, and other market participants have expressed concerns regarding instances in which certain funds offered and sold outside of the United States are excluded from the covered fund definition but still could be considered banking entities in certain circumstances (foreign excluded funds).25 This situation may occur if a foreign banking entity controls the foreign fund. A foreign banking entity could be considered to control the fund based on common corporate governance structures abroad, such as where the fund’s sponsor selects the majority of the fund’s directors or trustees, or the foreign banking entity otherwise controls the fund for purposes of section 13 of the BHC Act. As a result, such a fund would be subject to the requirements of section 13 and the implementing regulations, including restrictions on proprietary trading, restrictions on investing in or sponsoring covered funds, and compliance obligations. The Federal banking agencies released a policy statement on July 21, 2017 (the policy statement), to address concerns about the possible unintended consequences and extraterritorial impact of section 13 and the implementing regulations for foreign excluded funds.26 The policy statement noted that the Federal banking agencies would not take action against a foreign banking entity 27 based on attribution of 24 See infra, Section V.D (Riegle Community Development and Regulatory Improvement Act). 25 The implementing regulations generally exclude covered funds from the definition of ‘‘banking entity.’’ 2013 rule § ll.2(c)(2)(i). However, because foreign excluded funds are not covered funds, they can become banking entities through affiliation with other banking entities. 26 Statement regarding Treatment of Certain Foreign Funds under the Rules Implementing Section 13 of the Bank Holding Company Act (July 21, 2017), available at https:// www.federalreserve.gov/newsevents/pressreleases/ files/bcreg20170721a1.pdf. 27 ‘‘Foreign banking entity’’ was defined for purposes of the policy statement to mean a banking E:\FR\FM\31JYR4.SGM Continued 31JYR4 46426 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations the activities and investments of a qualifying foreign excluded fund to a foreign banking entity, or against a qualifying foreign excluded fund as a banking entity, for a period of one year while staffs of the agencies considered alternative ways in which the implementing regulations could be amended, or other appropriate action could be taken, to address the issue. The policy statement has since been extended and is currently scheduled to expire on July 21, 2021.28 For purposes of the policy statement, a ‘‘qualifying foreign excluded fund’’ means, with respect to a foreign banking entity, an entity that: (1) Is organized or established outside the United States and the ownership interests of which are offered and sold solely outside the United States; (2) Would be a covered fund were the entity organized or established in the United States, or is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments; (3) Would not otherwise be a banking entity except by virtue of the foreign banking entity’s acquisition or retention of an ownership interest in, or sponsorship of, the entity; (4) Is established and operated as part of a bona fide asset management business; and (5) Is not operated in a manner that enables the foreign banking entity to evade the requirements of section 13 or implementing regulations. To be eligible for this relief, the foreign banking entity’s acquisition or retention of any ownership interest in, or sponsorship of, the qualifying foreign excluded fund must 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 implementing regulations, as if the qualifying foreign excluded fund were a covered fund. To provide greater clarity and certainty to banking entities and qualifying foreign excluded funds, and to limit the extraterritoriality of the rule, the 2020 proposal included a permanent 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. Id. 28 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. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 exemption from the section 13 restrictions on proprietary trading and investing in or sponsoring covered funds for the activities of qualifying foreign excluded funds. The proposed exemption generally included the same eligibility criteria from the policy statement, although it included a modified version of the anti-evasion provision such that, in order to qualify, a fund could not be operated in a manner that enables ‘‘any other banking entity’’ (rather than ‘‘the foreign banking entity’’) to evade the requirements of section 13 or the implementing regulations. The agencies requested comment on all aspects of this exemption. Commenters were generally supportive of the 2020 proposal to exempt qualifying foreign excluded funds from certain requirements of the implementing regulations.29 Two commenters expressed opposition to the proposed exemption.30 Some commenters requested that qualifying foreign excluded funds be excluded from the definition of banking entity.31 One commenter expressed concern that the 2020 proposal would require qualifying foreign excluded funds to establish section 13 of the BHC Act compliance programs, imposing costs on qualifying foreign excluded funds.32 This commenter noted that there may be situations under section 13 of the BHC Act where a foreign banking entity controls a qualifying foreign excluded fund, but under foreign law does not have the necessary authority to require it to adopt a section 13 compliance program. As such, this commenter advocated for either excluding this type of fund from the definition of banking entity or exempting this type of fund from the compliance program requirements under the rule.33 One commenter expressed concern that a qualifying foreign excluded fund would still need to comply with various restrictions under section 13, including the provisions of § ll.14 of the implementing regulations (i.e., Super 23A) and the compliance program requirements.34 Some commenters requested that the agencies change the anti-evasion 29 SIFMA; Bank Policy Institute (BPI); Bundesverband Investment und Asset Management e.V. (BVI); American Investment Council (AIC); ABA; European Fund and Asset Management Association (EFAMA); Shareholder Advocacy Forum (SAF); IIB; JBA; CBA; and Credit Suisse. 30 Occupy and Data Boiler Technologies LLC (Data Boiler). 31 IIB; JBA; CBA; Credit Suisse; and EBF. 32 JBA. 33 JBA. 34 Credit Suisse. PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 provision of the qualifying foreign excluded funds definition so that it would only apply to the specific foreign banking entity, in a manner consistent with the policy statement.35 One of these commenters suggested, as an alternative, revising the provision so that it would only apply to ‘‘any affiliated banking entities.’’ 36 One commenter requested an antievasion safe harbor and changes to allow a fund to be a qualifying foreign excluded fund when a non-U.S. banking entity serves as a management company to the fund and is approved to provide fund management in accordance with local law.37 This commenter also requested that the agencies limit the requirements in the proposed qualifying foreign excluded funds definition to only those set forth in § ll.13(b) of the rule for covered fund activities conducted by foreign banking entities solely outside the United States, and treat as qualifying foreign excluded funds those funds for which the foreign banking entity cannot exercise voting rights. Pursuant to their authority under section 13(d)(1)(J) of the BHC Act, the agencies are adopting the exemption for the activities of qualifying foreign excluded funds substantially as proposed, but with modifications to the anti-evasion provision and compliance program requirements. Specifically, the agencies are exempting the activities of qualified foreign excluded funds from the restrictions on proprietary trading and investing in or sponsoring covered funds, if the acquisition or retention of the ownership interest in, or sponsorship of, the qualifying foreign excluded fund by the foreign banking entity meets the requirements for permitted covered fund activities and investments conducted solely outside the United States, as provided in § ll.13(b) of the rule.38 Under the final rule, a qualifying foreign excluded fund has the same meaning as in the policy statement as described above and in the 2020 proposal, except for the modification to the anti-evasion provision, as described below. Section 13(d)(1)(J) of the BHC Act gives the agencies rulemaking authority to exempt activities from the prohibitions of section 13, provided the agencies determine that the activity in question would promote and protect the safety and soundness of the banking entity and the financial stability of the 35 IIB; JBA; Credit Suisse; and EBF. Suisse. 37 JBA. 38 See final rule § ll.13(b). 36 Credit E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations United States.39 For the reasons described below, the agencies have determined that exempting the activities of qualifying foreign excluded funds promotes and protects the safety and soundness of banking entities and U.S. financial stability. This relief is expected to promote and protect the safety and soundness of such funds and their foreign banking entity sponsors by putting them on a level playing field with their foreign competitors that are not subject to the implementing regulations. If the activities of these foreign funds were subject to the restrictions applicable to banking entities, their asset management activities could be significantly disrupted, and their foreign banking entity sponsors may be at a competitive disadvantage to other foreign bank and non-bank market participants conducting asset management business outside of the United States. Exempting the activities of these foreign funds allows their foreign banking entity sponsors to continue to conduct their asset management business outside the United States as long as the foreign banking entity’s acquisition of an ownership interest in or sponsorship of the fund meets the requirements in § ll.13(b) of the implementing regulations. Thus, the exemption is expected to have the effect of promoting the safety and soundness of these foreign funds and their sponsors, while at the same time limiting the extraterritorial impact of the implementing regulations, consistent with the purposes of sections 13(d)(1)(H) and (I) of the BHC Act. The exemption is also expected to promote and protect U.S. financial stability. While qualifying foreign excluded funds have a very limited nexus to the U.S. financial system, the exemption would promote U.S. financial stability by providing additional capital and liquidity to U.S. capital markets without a concomitant increase in risk borne by U.S. entities. Because the exemption requires that the foreign banking entity’s acquisition of an ownership interest in or sponsorship of the fund meets the requirements in § ll.13(b) of the final rule, the exemption will help ensure that the risks of investments made by these foreign funds will be booked at foreign entities in foreign jurisdictions, thus promoting and protecting U.S. financial stability. Additionally, subjecting such funds to the requirements of the implementing regulations could precipitate disruptions in foreign capital 39 12 U.S.C. 1851(d)(1)(J). VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 markets, which could generate spillover effects in the U.S. financial system. In response to comments regarding the anti-evasion provision, the final rule specifies that the qualifying foreign excluded fund must not be operated in a manner that enables the banking entity that sponsors or controls the qualifying foreign excluded fund, or any other affiliated banking entity (other than a qualifying foreign excluded fund), to evade the requirements of section 13 of the BHC Act or the final rule. This change is meant to clarify the scope of the anti-evasion provision and provide certainty for banking entities that sponsor or control the qualifying foreign excluded fund. Consistent with feedback from several commenters, the agencies also have modified compliance requirements with respect to qualifying foreign excluded funds. While, under the final rule, the activities of a qualifying foreign excluded fund are exempted from the proprietary trading restrictions of § ll.3(a) and the covered fund restrictions of § ll.10(a) of the final rule, the qualifying foreign excluded fund is still a banking entity. Absent any additional changes, the qualifying foreign excluded fund could become subject to the compliance requirements of § ll.20. However, since these qualifying foreign excluded funds are exempted from the proprietary trading requirements of § ll.3(a) and covered fund restrictions of § ll.10(a) of the final rule, the agencies believe that requiring a compliance program for the fund itself is overly burdensome and unnecessary. The requirements in § ll.20 are intended to ensure and monitor compliance with the proprietary trading and covered fund provisions, and there would be no benefit to applying these requirements to an entity that is exempt from those provisions. Therefore, under the final rule, qualifying foreign excluded funds are not required to have compliance programs or comply with the reporting and additional documentation requirements under § ll.20. However, any banking entity that owns or sponsors a qualifying foreign excluded fund will still be required to have in place appropriate compliance programs for itself and its other subsidiaries and provide reports and additional documentation as required by § ll.20. The final rule does not amend the definition of ‘‘banking entity’’ as requested by several commenters. Because ‘‘banking entity’’ is specifically defined in section 13 of the BHC Act, the agencies find it appropriate to address concerns related to foreign PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 46427 excluded funds through their exemptive rulemaking authority. The agencies are not making any change regarding the applicability of § ll.14 of the implementing regulations, which imposes limitations on relationships with covered funds, with respect to qualifying foreign excluded funds. The agencies believe it is appropriate to retain the application of § ll.14 to qualifying foreign excluded funds to limit risks that may be borne by banking entities located in the United States through transactions with such funds.40 Further, given the limited set of circumstances in which § ll.14 would apply (i.e., a transaction between a foreign excluded fund and a covered fund that is sponsored or advised by the same banking entity), the agencies do not believe that it is overly burdensome for a banking entity that sponsors or controls a qualifying foreign excluded fund to ensure that it is not in violation of § ll.14. B. Modifications To Existing Covered Fund Exclusions In the preamble to the 2013 rule, the agencies acknowledged that the covered fund definition was expansive.41 To effectively tailor the covered fund provisions to the types of entities that section 13 of the BHC Act was intended to cover, the 2013 rule excluded various types of entities from the covered fund definition.42 In response to comments received on the 2020 proposal, and based on experience implementing the rule, the agencies are modifying certain of the existing exclusions, as described below, to make them more appropriately structured to effectuate the intent of the statute and its implementing regulations. 1. Foreign Public Funds 2013 Rule To provide consistent treatment for U.S. registered investment companies and their foreign equivalents, the implementing regulations exclude foreign public funds from the definition of covered fund.43 A foreign public fund 40 A U.S. banking entity’s exposure to a fund that would be a qualifying foreign excluded fund with respect to a foreign banking entity may still be a covered fund with respect to a U.S. banking entity under § ll.10(b)(1)(iii) of the implementing regulations. A U.S. banking entity’s investment in and relationship with such a fund could therefore be subject to the entirety of the applicable prohibitions and restrictions of Subpart C of the implementing regulations. 41 See 79 FR 5677. 42 See id. 43 In adopting the foreign public fund exclusion, the agencies’ view was that it was appropriate to exclude these funds from the ‘‘covered fund’’ E:\FR\FM\31JYR4.SGM Continued 31JYR4 46428 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations is generally defined under the 2013 rule as any issuer that is organized or established outside of the United States and the ownership interests of which are (1) authorized to be offered and sold to retail investors in the issuer’s home jurisdiction and (2) sold predominantly through one or more public offerings outside of the United States.44 The agencies stated in the preamble to the 2013 rule that they generally expect that an offering is made predominantly outside of the United States if 85 percent or more of the fund’s interests are sold to investors that are not residents of the United States.45 The 2013 rule defines ‘‘public offering’’ for purposes of this exclusion to mean a ‘‘distribution,’’ as defined in § ll.4(a)(3) of subpart B, of securities in any jurisdiction outside the United States to investors, including retail investors, provided that the distribution complies with all applicable requirements in the jurisdiction in which such distribution is being made; the distribution does not restrict availability to only investors with a minimum level of net worth or net investment assets; and the issuer has filed or submitted, with the appropriate regulatory authority in such jurisdiction, offering disclosure documents that are publicly available.46 The 2013 rule places an additional condition on a U.S. banking entity’s ability to rely on the foreign public fund exclusion with respect to any foreign fund it sponsors.47 The foreign public fund exclusion is only available to a U.S. banking entity with respect to a foreign fund sponsored by the U.S. banking entity if, in addition to the requirements discussed above, the fund’s ownership interests are sold predominantly to persons other than the sponsoring banking entity, the issuer (or affiliates of the sponsoring banking entity or issuer), and employees and directors of such entities.48 The agencies stated in the preamble to the 2013 rule that, consistent with the agencies’ view concerning whether a foreign public fund has been sold predominantly definition because they are sufficiently similar to U.S. registered investment companies. 79 FR 5678. 44 2013 rule § ll.10(c)(1); see also 79 FR 5678. 45 79 FR 5678. 46 2013 rule § ll.10(c)(1)(iii). 47 Although the discussion of this condition generally refers to U.S. banking entities for ease of reading, the condition also applies to foreign subsidiaries of a U.S. banking entity. See 2013 rule § ll.10(c)(1)(ii) (applying this limitation ‘‘[w]ith 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’’). 48 See 2013 rule § ll.10(c)(1)(ii). VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 outside of the United States, the agencies generally expect that a foreign public fund would satisfy this additional condition if 85 percent or more of the fund’s interests are sold to persons other than the sponsoring U.S. banking entity and the specified persons connected to that banking entity.49 2020 Proposal In the 2020 proposal, the agencies acknowledged that some of the conditions of the 2013 rule’s foreign public fund exclusion may not be necessary to ensure consistent treatment of foreign public funds and U.S. registered investment companies. Moreover, some conditions may make it difficult for a non-U.S. fund to qualify for the exclusion or for a banking entity to validate whether a non-U.S. fund qualifies for the exclusion, resulting in certain non-U.S. funds that are similar to U.S. registered investment companies being treated as covered funds. To address these concerns, the 2020 proposal would have made certain modifications to the foreign public fund exclusion. First, the agencies proposed to replace the requirement that the fund be authorized to be offered and sold to retail investors in the issuer’s home jurisdiction (the home jurisdiction requirement) and the requirement that the fund interests be sold predominantly through one or more public offerings outside of the United States, with a requirement that the fund is authorized to offer and sell ownership interests, and such interests are offered and sold, through one or more public offerings outside of the United States. This change would have permitted foreign funds to qualify for the exclusion if they are organized in one jurisdiction but only authorized to be sold to retail investors in another jurisdiction, as this is a fairly common way for foreign retail funds to be organized. Also, no longer requiring a fund to be sold predominantly through one or more public offerings was intended to reduce the difficulty that banking entities have described in determining and monitoring the distribution history and patterns of a third-party sponsored fund or a sponsored fund whose interests are sold through third-party distributors. The agencies also proposed modifying the definition of ‘‘public offering’’ from the implementing regulations to add a new requirement that the distribution be subject to substantive disclosure and retail investor protection laws or regulations, to help ensure that foreign funds qualifying for this exclusion are PO 00000 49 79 FR 5678. Frm 00008 Fmt 4701 Sfmt 4700 sufficiently similar to U.S. registered investment companies. Additionally, the 2020 proposal would have only applied the condition that the distribution comply with all applicable requirements in the jurisdiction where it is made to instances in which the banking entity acts as the investment manager, investment adviser, commodity trading advisor, commodity pool operator, or sponsor. This proposed change was intended to address the potential difficulty that a banking entity investing in a third-party sponsored fund may have in determining whether the distribution of such fund complied with all the requirements in the jurisdiction where it was made. To simplify the requirements of the exclusion and address concerns described by banking entities with the difficulty in tracking the sale of ownership interests to employees and their immediate family members, the 2020 proposal would have eliminated the limitation on selling ownership interests of the issuer to employees (other than senior executive officers) of the sponsoring banking entity or the issuer (or affiliates of the banking entity or issuer). This change was intended to help align the treatment of foreign public funds with that of U.S. registered investment companies, as the exclusion for U.S. registered investment companies has no such limitation. The 2020 proposal would have continued to limit the sale of ownership interests to directors or senior executive officers of the sponsoring banking entity or the issuer (or their affiliates), as the agencies believed that such a requirement would be simpler for a banking entity to track. Finally, the 2020 proposal requested comment on the appropriateness of the expectation stated in the preamble to the 2013 rule that, for a U.S. banking entity-sponsored foreign fund to satisfy the condition that it be ‘‘predominantly’’ sold to persons other than the sponsoring U.S. banking entity and certain persons connected to that banking entity, at least 85 percent of the ownership interests in the fund should be sold to such other persons. Discussion of Comments and the Final Rule The agencies are adopting all of the proposed changes and are making certain adjustments in response to comments received, as discussed below. Commenters on the 2020 proposal generally supported the proposed changes to the foreign public funds E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations exclusion.50 Specifically, commenters supported the elimination of the home jurisdiction requirement and the requirement that the fund be sold predominantly through one or more public offerings.51 Commenters supported the proposed change to the ‘‘public offering’’ definition to include a requirement that a distribution be subject to substantive disclosure and retail investor protection laws or regulations,52 but did not recommend further specifying what substantive disclosure and investor protection requirements should apply because they generally viewed it as unnecessary and overly prescriptive.53 Commenters also supported eliminating the restriction on share ownership by employees (other than senior executives and directors) of the U.S. banking entity that sponsors the foreign public fund.54 In response to a specific question in the 2020 proposal, one commenter indicated that the proposed changes to the foreign public funds exclusion would not increase the risk of evasion of the requirements of section 13 and the implementing regulations, and thus no additional antievasion measures were necessary.55 Another commenter stated that the proposed changes were less than ideal but were acceptable after balancing compliance costs and benefits.56 Commenters also recommended additional changes to further align the treatment of foreign public funds with that of U.S. registered investment companies or to prevent evasion of the rule.57 Specifically, some commenters recommended eliminating the requirement that a fund actually be sold through a public offering and, instead, only require that a fund be authorized 50 IIB; SIFMA; BPI; ABA; EBF; EFAMA; FSF; Investment Company Institute (ICI); BVI; CBA; Committee on Capital Markets Regulation (CCMR); Data Boiler; Goldman Sachs; Investment Adviser Association (IAA); JBA; SAF; and U.S. Chamber of Commerce Center for Capital Markets Competitiveness (CCMC). 51 IIB; SIFMA; BPI; ABA; EBF; EFAMA; FSF; ICI; BVI; and CBA. 52 IIB; EFAMA; FSF; ICI; and BVI. 53 IIB; ICI; and CBA. One commenter supported this assertion by stating that 95 percent of the world’s securities markets, including all major emerging markets, have substantive disclosure and retail investor protection rules that are guided by the International Organization of Securities Commissions’ common principles for retail funds and the detailed policy work that informs those principles. ICI. 54 FSF. 55 SIFMA. 56 Data Boiler. 57 One commenter recommended that the agencies create an exclusion from the ‘‘proprietary trading’’ definition for the activities of regulated funds, including foreign public funds, under certain circumstances. ICI. The agencies note that such a change is not within the scope of this rulemaking. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 to be sold through a public offering.58 These commenters generally viewed this requirement as burdensome and difficult to administer and noted that U.S. registered investment companies are not required to be sold in public distributions. The agencies do not consider the fact that there is no requirement for U.S. registered investment companies to be actually sold through public offerings as a sufficient rationale for removing this requirement from the foreign public fund exclusion. Requiring foreign public funds to be sold through one or more public offerings is intended to ensure that such funds are in fact public funds and thus sufficiently similar to U.S. registered investment companies. While there may be certain limited scenarios where a U.S. registered investment company is not sold to retail investors, the agencies believe that the vast majority of U.S. registered investment companies are sold to retail investors. Furthermore, U.S. registered investment companies are subject to robust registration, reporting, and other requirements that are familiar to the agencies, whereas foreign public funds are subject to a differing array of requirements depending on the jurisdiction where they are authorized to be sold. These other jurisdictions may have less developed requirements for retail funds, which may increase the likelihood of a fund seeking authorization for public distribution in certain foreign jurisdictions solely as a means of avoiding the covered fund prohibition. The agencies believe that eliminating this requirement would increase the risk of evasion by permitting foreign funds that may be authorized for sale to retail investors in a foreign jurisdiction—but are only sold through private offerings where no substantive disclosure or retail investor protections exist—to qualify for the exclusion. Such funds would not be comparable to U.S. registered investment companies and would not be the type of fund that foreign public fund exclusion was intended to address. Accordingly, the agencies are not adopting this suggested modification. One trade association commenter suggested eliminating a provision in the ‘‘public offering’’ requirement that prohibits a distribution from being limited to investors with a minimum net worth or net investment assets because some of its members distribute funds, including mutual funds, in offerings that do not meet this requirement but that are nonetheless subject to substantive disclosure and retail PO 00000 58 IIB; SIFMA; and EBF. Frm 00009 Fmt 4701 Sfmt 4700 46429 investor protection requirements. Similar to the reasons for retaining the requirement that a foreign public fund actually be sold through one or more public offerings, the agencies believe that retaining this requirement is necessary to ensure that funds qualifying for this exclusion are sufficiently similar to U.S. registered investment companies. In fact, one of the identifying characteristics of a covered fund is that its offerings are limited to investors with minimum net worth or net investment assets.59 The agencies therefore believe that foreign funds that limit their offerings to investors with a minimum net worth or net investment assets are generally not sufficiently similar to U.S. registered investment companies, and thus the agencies are not adopting this suggested change to the ‘‘public offering’’ definition. One commenter opposed the proposed elimination of the requirement in the ‘‘public offering’’ definition that a distribution comply with all applicable requirements in the jurisdiction in which such distribution is being made for a banking entity that does not serve as the fund’s investment manager, investment adviser, commodity trading advisor, commodity pool operator, or sponsor.60 The final rule adopts this modification as proposed, because the agencies believe the other eligibility criteria for a fund to qualify under the foreign public fund exclusion are sufficient to appropriately identify these funds. In addition, the agencies recognize that it may be difficult or impossible for a banking entity that invests in a third-party fund to know whether the fund’s distribution complied with all applicable requirements in the jurisdiction where it was distributed. One commenter recommended that the agencies require 85 percent of a foreign public fund’s ownership interests be sold to and owned by ‘‘bona fide’’ retail investors in the fund’s home jurisdiction.61 However, for the same reasons that the agencies are eliminating the home jurisdiction requirement and the requirement that a fund be sold predominantly through public offerings, 59 Under the Investment Company Act, certain funds whose offerings are limited to investors with minimum net worth or net investment assets are exempt from registration as investment companies. See 15 U.S.C. 80a–3(c)(7). These funds are generally treated as covered funds under section 13 of the BHC Act and the implementing regulations. See 12 U.S.C. 1851(h)(2); implementing regulations § ll.10(b)(1)(i). 60 Data Boiler. 61 Oleh Zadorestskyy. This commenter also suggested that the agencies require proof that the investors were non-U.S. persons. E:\FR\FM\31JYR4.SGM 31JYR4 46430 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations the agencies are not adopting this requirement. Some commenters suggested that the agencies identify common foreign fund types that are presumed to qualify for the exclusion for foreign public funds for the purpose of improving efficiency and simplifying compliance with the rule.62 Other commenters recommended that issuers listed on an internationallyrecognized exchange and available in retail-level denominations should automatically qualify for the exclusion for similar reasons.63 Although the agencies expect many such funds will qualify for the exclusion, the agencies decline to adopt either of these suggested changes, as both would require the agencies’ review and ongoing monitoring of foreign laws and regulations to ensure that the types of funds that would qualify under these provisions are sufficiently similar to U.S. registered investment companies and that their exclusion as foreign public funds would continue to be appropriate. Some commenters recommended that the agencies entirely eliminate the restrictions on share ownership by parties affiliated with a U.S. banking entity sponsor of a foreign public fund.64 Other commenters suggested that, if the restrictions on share ownership by banking entities affiliated with the sponsor were retained, the restrictions on share ownership by senior executives and directors should be removed.65 The commenters generally viewed these requirements as unnecessary and burdensome to track and monitor. As discussed in the preamble to the 2013 rule, these requirements are intended to prevent evasion of section 13 of the BHC Act.66 Additionally, the agencies note that U.S. banking entity sponsors of foreign public funds would need to track the ownership of such funds by their affiliates and management officials even if the requirements were eliminated in order to determine whether they control such funds for BHC Act purposes.67 Thus, for a U.S. banking entity relying on this exclusion with respect to a fund that it sponsors, the agencies are retaining the requirement that the fund be sold predominantly to persons other 62 IIB and EBF. SIFMA; BPI; ABA; FSF; and CBA. 64 SIFMA and FSF. 65 SIFMA; BPI; ICI; and CCMC. 66 79 FR 5678–79. 67 See 12 CFR 225.2(e); 12 CFR 225.31(d)(2)(ii). If a foreign public fund is controlled by a banking entity for BHC Act purposes, such fund could also be being treated as a banking entity under section 13. See implementing regulations § ll.2(c); FAQ 14. 63 IIB; VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 than the U.S. banking entity sponsor, the fund, affiliates of such sponsoring banking entity or fund, and the directors and senior executive officers of such entities (collectively, ‘‘U.S. banking entity sponsor and associated parties’’). Relatedly, some commenters recommended that the agencies modify their expectation of the level of ownership of a foreign public fund that would satisfy the requirement that a fund be ‘‘predominantly’’ sold to persons other than its U.S. banking entity sponsor and associated parties,68 which, in the preamble to the 2013 rule, the agencies stated was 85 percent or more (which would permit the U.S. banking entity sponsor and associated parties to own the remaining 15 percent). These commenters asserted that the relevant ownership threshold for U.S. registered investment companies is 25 percent, and that, for foreign public funds, the threshold should be the same. The agencies agree that the permitted ownership level of a foreign public fund by a U.S. banking entity sponsor and associated parties should be aligned with the functionally equivalent threshold for banking entity investments in U.S. registered investment companies, which is 24.9 percent.69 Accordingly, the agencies have amended this provision in the final rule to require that more than 75 percent of the fund’s interests be sold to persons other than the U.S. banking entity sponsor and associated parties.70 One commenter recommended that, with respect to foreign public funds FSF; ICI; and CCMC. the implementing regulations do not explicitly prohibit a banking entity from acquiring 25 percent or more of a U.S. registered investment company, a U.S. registered investment company would become a banking entity if it is affiliated with another banking entity (other than as described in § ll.12(b)(1)(ii) of the implementing regulations). See 79 FR 5732 (‘‘[F]or purposes of section 13 of the BHC Act and the final rule, a registered investment company . . . will not be considered to be an affiliate of the banking entity if the banking entity owns, controls, or holds with the power to vote less than 25 percent of the voting shares of the company or fund, and provides investment advisory, commodity trading advisory, administrative, and other services to the company or fund only in a manner that complies with other limitations under applicable regulation, order, or other authority.’’). 70 For a U.S. banking entity that sponsors a foreign public fund, crossing the 24.9 percent ownership threshold (other than during a permitted seeding period) would cause the fund to be a covered fund (if no other exclusion applied), in which case the banking entity would be in violation of the 3 percent per-fund investment limit. See implementing regulations § ll.12(a)(2)(ii)(A). The agencies believe that such a strict prohibition against a U.S. banking entity acquiring 25 percent or more of a foreign public fund that it sponsors is appropriate because of the elevated risk of evasion by the sponsoring banking entity, which may be able to control the investments made by the fund. PO 00000 68 BPI; 69 Although Frm 00010 Fmt 4701 Sfmt 4700 sponsored by U.S. affiliates of foreign banking entities, the agencies exclude the sponsoring U.S. banking entity’s non-U.S. affiliates and their directors and employees from the restrictions on share ownership, provided that such non-U.S. affiliates are not controlled by a U.S. banking entity.71 This commenter asserted that there is no U.S. financial stability or safety and soundness benefit to applying this restriction to such nonU.S. affiliates and their directors and employees, as the risks of any such investments are borne solely outside the United States. However, with the change described above, which permits a U.S. banking entity sponsor and associated parties to hold less than 25 percent of a foreign public fund, the agencies do not believe that this change is necessary. Even if the requirement were modified as the commenter suggested, the banking entity and its affiliates would still be limited to owning less than 25 percent of the fund without the fund becoming a banking entity. One commenter requested that the agencies modify § ll.12(b)(1) of the implementing regulations, which governs attribution of ownership interests in covered funds to banking entities, to clarify that the banking entity ‘‘or an affiliate’’ can provide the advisory, administrative, or other services required in § ll.12(b)(1)(ii)(B) for the non-attribution rule to apply. The commenter requested this clarification because § ll.12(b)(1)(ii)(B) is cross-referenced by FAQ 14, which, as discussed above, states that a foreign public fund will not be treated as a banking entity if it complies with the test in § ll.12(b)(1)(ii) (i.e., the banking entity holds less than 25 percent of the voting shares in the foreign public fund and provides advisory, administrative, or other services to the fund). The agencies confirm that the requested interpretation is correct and, accordingly, have amended § ll.12(b)(1)(ii) of the implementing regulations to clarify that the ownership limit applies to the banking entity and its affiliates, in the aggregate, and the requirement that the banking entity provide advisory or other services can be satisfied by the banking entity or its affiliates. One commenter noted that FAQ 16, which relates to the seeding period for foreign public funds, uses 3 years as an example of the duration of such a seeding period, and requested that the agencies confirm that a foreign public fund’s seeding period can be longer than 71 IIB. E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations 3 years.72 Another commenter requested that the agencies codify the 3-year seeding period in the implementing regulations.73 The agencies believe that, depending on the facts and circumstances of a particular foreign public fund, the appropriate duration of its seeding period may vary and, under certain facts and circumstances, may exceed three years. The agencies believe that this flexibility is appropriate and thus decline to further specify such a limit. Another commenter requested that the agencies codify the foreign public fund seeding FAQ,74 FAQ 14, and FAQ 16, both described above, in the implementing regulations.75 The agencies decline to codify these FAQs at this time but note that the final rule does not modify or revoke any previously issued staff FAQs, unless otherwise specified. In the final rule, the agencies are adopting the amendments to the foreign public funds exclusion as proposed, with the additional modifications described above. The agencies believe the revised requirements will make the foreign public fund exclusion more effective by expanding its availability, providing clarity, and simplifying compliance with its requirements, while continuing to ensure that the funds that qualify are sufficiently similar to U.S. registered investment companies. 2. Loan Securitizations Section 13 of the BHC Act provides that ‘‘[n]othing in this section shall be construed to limit or restrict the ability of a banking entity . . . to sell or securitize loans in a manner otherwise permitted by law.’’ 76 To effectuate this statutory mandate, the 2013 rule excluded from the definition of covered fund loan securitizations that issue asset-backed securities and hold only loans, certain rights and assets that arise from the structure of the loan securitization or from the loans supporting a loan securitization, and a small set of other financial instruments (permissible assets).77 Since the adoption of the 2013 rule, several banking entities and other 72 IAA. 73 CCMC. 74 The foreign public fund seeding FAQ states that staffs of the agencies would not advise that a seeding vehicle that is operated pursuant to a written plan to become a foreign public fund and that meets certain conditions be treated as a covered fund during such seeding period. 75 IIB. 76 12 U.S.C. 1851(g)(2). 77 See 2013 rule § ll.10(c)(8). Loan is further defined as any loan, lease, extension of credit, or secured or unsecured receivable that is not a security or derivative. Implementing regulations § ll.2(t). VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 participants in the loan securitization industry have commented that the limited set of permissible assets has inappropriately restricted their ability to use the loan securitization exclusion. In the 2018 proposal, the agencies asked several questions regarding the efficacy and scope of the exclusion and the Loan Securitization Servicing FAQ.78 Comments focused on permitting small amounts of non-loan assets and clarifying the treatment of leases and related assets. In response to these concerns, the 2020 proposal would have codified the Loan Securitization Servicing FAQ and permitted loan securitizations to hold a small amount of non-loan assets. The agencies requested comment on all aspects of the proposed changes to the loan securitization exclusion, and comments were generally supportive of the proposed revisions.79 Several commenters also suggested revisions to the 2020 proposal.80 Comments are discussed in detail below.81 Servicing Assets The implementing regulations permit loan securitizations to hold rights or other assets (servicing assets) that arise from the structure of the loan securitization or from the loans supporting a loan securitization.82 Rights or other servicing assets are assets designed to facilitate the servicing of the underlying loans or the distribution of proceeds from those loans to holders of the asset-backed securities.83 In response to confusion regarding the scope of the provisions permitting servicing assets and a separate provision limiting the types of FR 33480–81. SIFMA; BPI; Managed Funds Association (MFA); PNC Financial Services Group, Inc. (PNC); Goldman Sachs; Loan Syndications and Trading Association (LSTA); and Structured Finance Association (SFA). 80 E.g., SIFMA; CCMC; BPI; and IIB. 81 One commenter suggested that some jurisdictions’ risk retention rules may vary from the regulations implementing section 15G of the Exchange Act (15 U.S.C. 78o–11), which requires a banking entity to retain and maintain a certain minimum interest in certain asset-backed securities. See IIB. This commenter recommended allowing banking entities to hold certain investments in compliance with certain foreign laws (e.g., European risk retention rules). The agencies understand that rules for risk retention vary across jurisdictions. However, the agencies believe that the requested action is outside the scope of the current rulemaking. In addition, another commenter requested that the agencies clarify the definition of asset-backed securities as used in the loan securitization exclusions. See Arnold & Porter Kaye Scholer LLP (Arnold & Porter). The agencies discuss the definition of asset-backed securities in Section IV.C.1.iii (Credit Funds), infra. 82 §§ ll.2(t); ll.10(c)(8)(i)(D); ll.10(c)(8)(v). 83 See, e.g., FASB Statement No. 156: Accounting for Servicing of Financial Assets, ¶ 61 (FAS 156). PO 00000 78 83 79 E.g., Frm 00011 Fmt 4701 Sfmt 4700 46431 permitted securities, the staffs of the agencies released the Loan Securitization Servicing FAQ. The FAQ clarified that a servicing asset may or may not be a security, but if the servicing asset is a security, it must be a permitted security under the rule. The 2020 proposal would have codified the Loan Securitization Servicing FAQ in the implementing regulations to clarify the scope of the servicing asset provision.84 Commenters generally supported the codification of the Loan Securitization Servicing FAQ, indicating that such a codification would promote transparency and ensure continued use of the loan securitization exclusion.85 For the above reasons, the final rule adopts the codification of the Loan Securitization Servicing FAQ as proposed. Cash Equivalents The loan securitization exclusion permits issuers relying on the exclusion to hold certain types of contractual rights or assets related to the loans underlying the securitization, including cash equivalents. In response to questions about the scope of the cash equivalents provision, the Loan Securitization Servicing FAQ stated that ‘‘cash equivalents’’ means high quality, highly liquid investments whose maturity corresponds to the securitization’s expected or potential need for funds and whose currency corresponds to either the underlying loans or the asset-backed securities.86 To promote transparency and clarity, the 2020 proposal would have codified this additional language in the Loan Securitization Servicing FAQ regarding the meaning of ‘‘cash equivalents.’’ 87 The agencies did not propose requiring ‘‘cash equivalents’’ to be ‘‘short term,’’ because the agencies recognized that a loan securitization may need greater flexibility to match the maturity of high quality, highly liquid investments to its expected or potential need for funds. Commenters generally supported the codification of the definition of ‘‘cash equivalents’’ in the loan securitization 84 The 2020 proposal also clarified that special units of beneficial interest and collateral certificates meeting the requirements of paragraph (c)(8)(v) of the exclusion that are securities need not meet the requirements of paragraph (c)(8)(iii) of the exclusion. See 2020 proposal § ll.10(c)(8)(i)(B). The agencies are adopting this revision, as proposed. 85 E.g., SIFMA; PNC; and SFA. One commenter indicated that the current Loan Securitization Servicing FAQ was sufficient and that codifying the FAQ was not necessary; however, the commenter did not elaborate on or justify this position. Data Boiler. 86 See supra, n.14. 87 2020 proposed rule § ll.10(c)(8)(iii)(A). E:\FR\FM\31JYR4.SGM 31JYR4 46432 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations exclusion.88 The final rule adopts the codification of ‘‘cash equivalents’’ as proposed. Limited Holdings of Certain Debt Securities In the preamble to the 2013 rule, the agencies declined to permit loan securitizations to hold a certain amount of non-loan assets.89 The agencies supported a narrow scope of permissible assets in loan securitizations, suggesting that such an approach would be consistent with the purpose of section 13 of the BHC Act.90 Several commenters on the 2018 proposal disagreed with the agencies’ views and supported expanding the range of permissible assets in an excluded loan securitization. After considering the comments received on the 2018 proposal, the 2020 proposal would have allowed a loan securitization vehicle to hold up to five percent of the fund’s total assets in nonloan assets. The agencies indicated that authorizing loan securitizations to hold small amounts of non-loan assets could, consistent with section 13 of the BHC Act, permit loan securitizations to respond to investor demand and reduce compliance costs associated with the securitization process without significantly increasing risk to banking entities and the financial system.91 The agencies requested comment on, among other things, the maximum amount of permitted non-loan assets, the methodology for calculating the cap on non-loan assets, and whether the agencies should limit the type of assets that could be held under the non-loan asset provision. Specifically, the agencies requested comment on whether the non-loan asset provision should be limited to debt securities or should exclude certain financial instruments such as derivatives and collateralized debt obligations. Commenters were generally supportive of allowing loan securitizations to hold a limited amount of non-loan assets.92 These commenters indicated that the requirements for the current loan securitization exclusion are too restrictive and excessively limit use of the exclusion and prevent issuers from responding to investor demand, and suggested that a limited bucket of non-loan assets would not 88 E.g., LSTA; PNC; and SIFMA. One commenter expressed opposition to this codification but did not elaborate or justify this position. See Data Boiler. 89 79 FR 5687–88. 90 79 FR 5687. 91 85 FR 12128–29. 92 E.g., SIFMA; CCMC; ABA; Credit Suisse; MFA; Goldman Sachs; LSTA; BPI; and SFA. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 fundamentally alter the characteristics and risks of securitizations or otherwise increase risks in banking entities or the financial system.93 Several commenters recommended against limiting the type of assets that could be held per the non-loan asset provision.94 For example, one commenter stated that allowing excluded loan securitizations to invest in any class of asset would allow those vehicles to achieve investment goals during periods of constrained loan supply, while another commenter indicated that such a restriction would be unnecessary given that the low limit on non-loan assets would constrain risks.95 In contrast, one commenter suggested limiting the type of permissible assets to securities with risk characteristics similar to loans.96 Numerous commenters suggested raising the cap on non-loan assets from five percent of assets to ten percent of assets,97 while one commenter indicated that a five percent cap would be sufficient.98 Commenters that supported an elevated limit on non-loan assets generally argued that a ten percent limit would further reduce compliance burdens while not materially increasing risk.99 Several commenters also suggested a method for calculating the cap on nonloan assets: The par value of assets on the day they are acquired.100 These commenters suggested that relying on par value is accepted practice in the loan securitization industry and would obviate concerns related to tracking amortization or prepayment of loans in a securitization portfolio.101 One of these commenters further specified that the limit should be calculated (1) according to the par value of the acquired assets on the date of investment over the securitization’s total collateral pool and (2) only at the time of investment.102 Another commenter indicated that the cap should be calculated as the lower of the purchase price and par value of the nonLSTA and Goldman Sachs. MFA; LSTA; and SFA. One commenter also requested that the agencies make clear that the non-loan assets would not be subject to the other provisions of the loan securitization exclusion. LSTA. 95 SFA and LSTA. 96 JBA. 97 SIFMA; CCMC; ABA; Credit Suisse; MFA; Goldman Sachs; LSTA; and SFA. 98 PNC. Another commenter who generally supported the proposed modifications to the loan securitization exclusion did not urge the agencies to raise the cap on non-loan assets. See BPI. 99 E.g., LSTA; SIFMA; and Goldman Sachs. 100 SIFMA; BPI; ABA; and LSTA. 101 SIFMA and BPI. 102 BPI. PO 00000 93 E.g., 94 E.g., Frm 00012 Fmt 4701 Sfmt 4700 qualifying assets over the issuer’s aggregate capital commitments plus its subscription based credit facility.103 A third commenter suggested having a separate valuation mechanism for equity securities, which the commenter suggested should be market value upon acquisition.104 Finally, two commenters opposed allowing excluded loan securitizations to hold non-loan assets and suggested that such a change would be contrary to the purpose of section 13 of the BHC Act or would result in loan securitizations with differing risk characteristics, potentially increasing monitoring costs on investors.105 In addition, a commenter claimed that the 2020 proposal to allow excluded loan securitizations to hold non-loan assets would be contrary to section 13 of the BHC Act.106 Specifically, this commenter suggested that the rule of construction in 12 U.S.C. 1851(g)(2) only permits the securitization or sale of loans and that legislative history supports this reading of the statute. The agencies previously concluded and continue to believe they have legal authority to adopt the proposed allowance for a limited amount of nonloan assets.107 Section 13(g)(2) of the BHC Act states, ‘‘[n]othing in this section shall be construed to limit or restrict the ability of a banking entity or nonbank financial company supervised by the Board to sell or securitize loans in a manner otherwise permitted by law.’’ 108 This rule of construction is permissive—it allows the agencies to design the regulations implementing section 13 in a way that accommodates and does not unduly ‘‘limit or restrict’’ the ability of banking entities to sell or securitize loans. Contrary to the commenter’s argument, this provision does not mandate that any loan securitization exclusion only relate to loans. As discussed in this section and the preamble to the 2020 proposal,109 the agencies believe that allowing excluded loan securitizations to hold limited amounts of non-loan assets would, in fact, promote the ability of 103 Goldman Sachs. 104 SFA. 105 JBA and Data Boiler. 106 Occupy. 107 See 79 FR 5688–92 (stating, for example, that ‘‘[t]he [a]gencies also do not believe that they lack the statutory authority to permit a loan securitization relying on the loan securitization exclusion to use derivative[s,] as suggested by [Occupy]’’ and that, more broadly, the agencies have the authority to allow excluded loan securitizations to hold non-loan assets). 108 12 U.S.C. 1851(g)(2). 109 85 FR 12128–29. E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations banking entities to sell or securitize loans. After considering the foregoing comments, the agencies are revising the loan securitization exclusion to permit a loan securitization to hold a limited amount of debt securities. Loan securitizations provide an important mechanism for banking entities to fund lending programs. Allowing loan securitizations to hold a small amount of debt securities in response to customer and market demand may increase a banking entity’s capacity to provide financing and lending. To minimize the potential for banking entities to use this exclusion to engage in impermissible activities or take on excessive risk, the final rule permits a loan securitization to hold debt securities (excluding asset-backed securities and convertible securities), as opposed to any non-loan assets, as the 2020 proposal would have allowed.110 Although several commenters supported allowing a loan securitization to hold any non-loan asset to provide flexibility and allow the issuer’s investment manager to respond to changing market demands, the agencies believe that limiting the assets to debt securities is more consistent with the activities of an issuer focused on securitizing loans, rather than engaging in other activities. The agencies have determined, consistent with the views of another commenter, that non-loan assets with materially different risk characteristics from loans could change the character and complexity of an issuer and raise the type of concerns that section 13 of the BHC Act was intended to address. Moreover, as described further below, limiting the assets to those with risk characteristics that are similar to loans will allow for a simpler and more transparent calculation of the five percent limit, which will facilitate banking entities’ compliance with the exclusion. For the same reasons, the final rule does not permit a loan securitization to hold asset-backed securities or convertible securities as part of its five percent allowance for debt securities. This helps to ensure that a loan securitization will not be exposed to complex financial instruments and will retain the general characteristic of a loan securitization issuer. Similarly, to reduce potential risktaking and to ensure that the fund is composed almost entirely of loans with minimal non-loan assets, the final rule retains the 2020 proposal’s five percent limit on non-loan assets. Commenters differed on whether raising the limit on 110 Final rule § ll.10(c)(8)(i)(E). VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 non-loan assets was appropriate or necessary to ensure flexibility, and it is not clear what benefit would accrue to issuers who could hold debt securities of, for example, seven or ten percent versus five percent. The amount of nonloan assets held by a fund should not be so significant that it fundamentally changes the character of the fund from one that is engaged in securitizing loans to one that is engaged in investing in other types of assets. The agencies are also clarifying the methodology for calculating the five percent limit on non-convertible debt securities.111 The 2020 proposal only provided that ‘‘the aggregate value of any such other assets must not exceed five percent of the aggregate value of the issuing entity’s assets’’ and requested comment about how the agencies should calculate this limit.112 As suggested by several commenters, the final rule specifies that the limit on nonconvertible debt securities must be calculated at the most recent time of acquisition of such assets. Specifically, the aggregate value of debt securities held under § ll.10(c)(8)(i)(E) of the final rule may not exceed five percent of the aggregate value of loans held under § ll.10(c)(8)(i)(A), cash and cash equivalents held under § ll.10(c)(8)(iii)(A), and debt securities held under § ll.10(c)(8)(i)(E), where the value of the loans, cash and cash equivalents, and debt securities is calculated at par value at the time any such debt security is purchased.113 The agencies have chosen the most recent time of acquisition of nonconvertible debt securities as the moment of calculation to simplify the manner in which the 5 percent cap applies. This would permit an issuer that, at some point in its life, held debt securities in excess of five percent of its assets to qualify for the exclusion if it came into compliance with the five percent limit prior to a banking entity relying on the exclusion with respect to such issuer. The agencies believe that a continuous monitoring obligation could impose significant burdens on excluded issuers and could cause an issuer to be disqualified from the loan securitization exclusion based on market events not under its control. It is also unnecessary to require this calculation at other intervals because limiting permissible assets to those that have similar characteristics as loans addresses the potential for evasion of the five percent rule § ll.10(c)(8)(i)(E)(1)–(2). 112 2020 proposal § ll.10(c)(8)(i)(E); 85 FR 12129. 113 Final rule § ll.10(c)(8)(i)(E)(1)–(2). PO 00000 111 Final Frm 00013 Fmt 4701 Sfmt 4700 46433 limit that could arise if the issuer held more volatile assets.114 In the final rule, this measurement is based only on the value of the loans and debt securities held under §§ ll.10(c)(8)(i)(A) and (E) and the cash and cash equivalents held under § ll.10(c)(8)(iii)(A) rather than the aggregate value of all of the issuing entity’s assets. The purpose of the five percent limit is to ensure the investment pool of a loan securitization is composed of loans. Therefore, the calculation takes into account the assets that should make up the issuing entity’s investment pool and excludes the value of other rights or incidental assets, as well as derivatives held for risk management. This further simplifies the calculation methodology by excluding assets that may be more complex to value and that are ancillary to the loan securitization’s investment activities. This straightforward calculation methodology will ensure that the loan securitization exclusion remains easy to use and will facilitate banking entities’ compliance with the exclusion. The agencies recognize that a loan securitization’s transaction agreements may require that some categories of loans, cash equivalents, or debt securities be valued at fair market value for certain purposes. To accommodate such situations, the exclusion provides that the value of any loan, cash equivalent, or permissible debt security may be based on its fair market value if (1) the issuing entity is required to use the fair market value of such loan or debt security for purposes of calculating compliance with concentration limitations or other similar calculations under its transaction agreements and (2) the issuing entity’s valuation methodology values similarly situated assets, for example non-performing loans, consistently. This provision is intended to provide issuers with the flexibility to leverage existing calculation methodologies while preventing issuers from using inconsistent methodologies in a manner to evade the requirements of the exclusion. Leases A commenter on the 2018 proposal suggested that the loan securitization exclusion be expanded to cover leases and related assets, including operating or capital leases.115 In response, in the 2020 proposal the agencies stated that they were ‘‘not proposing to separately 114 The agencies also have authority to address acts that function as an evasion of the requirements of the exclusion. See implementing regulations § ll.21. 115 See 85 FR 12128. E:\FR\FM\31JYR4.SGM 31JYR4 46434 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations list leases within the loan securitization exclusion because leases are included in the definition of loan and thus are permitted assets for loan securitizations under the current exclusion.’’ 116 That same commenter made a comment on the 2020 proposal urging the agencies to reconsider explicitly including operating leases and leased properties in the loan securitization exclusion.117 This commenter asserted that unless the agencies specifically revise the definition of ‘‘rights or other assets’’ to explicitly include leased property, then securitization vehicles with operating leases that rely on the residual property value after expiration of the lease to support their asset-backed securities would not be able to qualify under the loan securitization exemption, despite the 2013 rule’s provisions for special units of beneficial interest and collateral certificates. Consistent with the 2020 proposal, the agencies are not separately listing leases within the loan securitization exclusion because leases are included in the definition of loan and thus are permitted assets for loan securitizations under the current exclusion. The agencies are also not modifying the definition of ‘‘rights or other assets’’ to explicitly include leased property, as any residual value of such leased property upon expiration of an operating lease should meet the requirements to constitute an asset that is related or incidental to purchasing or otherwise acquiring and holding loans. 3. Public Welfare and Small Business Funds i. Public Welfare Funds Section 13(d)(1)(E) of the BHC Act permits, among other things, a banking entity to make and retain investments that are designed primarily to promote the public welfare of the type permitted under 12 U.S.C. 24(Eleventh).118 Consistent with the statute, the implementing regulations exclude from the definition of ‘‘covered fund’’ issuers that make investments that are 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) (the public welfare investment exclusion).119 116 Id. 117 SFA. 118 See 12 U.S.C. 1851(d)(1)(E). regulations § ll.10(c)(11)(ii)(A). 119 Implementing VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 The 2020 proposal noted that the OCC’s regulations implementing 12 U.S.C. 24(Eleventh) provide that investments that receive consideration as qualified investments under the regulations implementing the Community Reinvestment Act (CRA) are public welfare investments for national banks.120 The 2020 proposal requested comment on whether any change should be made to clarify that all permissible public welfare investments, under any agency’s regulation, are excluded from the covered fund restrictions.121 The 2020 proposal specifically asked whether investments that would receive consideration as qualified investments under the CRA should be excluded from the definition of covered fund, either by incorporating these investments into the public welfare investment exclusion or by establishing a new exclusion for CRA-qualifying investments.122 In addition, the 2020 proposal requested comment on whether Rural Business Investment Companies (RBICs) are typically excluded from the definition of ‘‘covered fund’’ because of the public welfare investment exclusion or another exclusion and on whether the agencies should expressly exclude RBICs from the definition of covered fund.123 RBICs are licensed under a program designed to promote economic development and job creation in rural communities by investing in companies involved in the production, processing, and supply of food and agriculturerelated products.124 The Tax Cuts and Jobs Act established the ‘‘opportunity zone’’ program to provide tax incentives for long-term investing in designated economically distressed communities.125 The program allows taxpayers to defer and reduce taxes on capital gains by reinvesting gains in ‘‘qualified opportunity funds’’ (QOF) that are required to have at least 90 percent of their assets in designated low-income zones.126 The 2020 proposal requested comment on whether many or all QOFs would meet the terms of the public welfare investment exclusion and on whether the agencies should expressly exclude QOFs from the definition of covered fund.127 85 FR 12130; 12 CFR 24.3. 85 FR 12130 (noting that such a change could provide additional certainty regarding community development investments made through fund structures). 122 See id. 123 See id. 124 See id. 125 See id. 126 See id. 127 See id. PO 00000 120 See 121 See Frm 00014 Fmt 4701 Sfmt 4700 Commenters generally supported clarifying that funds that make investments that qualify for consideration under the CRA qualify for the public welfare investment exclusion.128 Commenters noted that this clarification would be consistent with the OCC’s regulations concerning public welfare investments and the CRA, provide greater certainty, and avoid unnecessarily chilling public welfare investment activities.129 One commenter stated that some banking entities have been reluctant to invest in certain community development funds due to uncertainty as to whether these funds were covered funds.130 This commenter stated that explicitly excluding funds that qualify for consideration under the CRA from the definition of covered fund would eliminate this uncertainty and would help support the type of community development efforts that the public welfare investment exclusion was designed to promote.131 In addition, some commenters recommended excluding funds that qualify for the public welfare investment exclusion from the definition of ‘‘banking entity.’’ 132 Commenters also generally favored explicitly excluding RBICs and QOFs from the definition of ‘‘covered fund,’’ either by adopting new exclusions, or by clarifying the scope of the public welfare investment exclusion.133 Commenters stated that explicitly excluding these funds from the definition of ‘‘covered fund’’ would be consistent with the statutory provision permitting public welfare investments. Commenters stated that RBICs and QOFs must make investments that are clearly designed primarily to promote the public welfare because they are required to invest primarily in ways that promote job creation in rural communities (which may have significant low- and moderate-income populations or be economically disadvantaged and in need of revitalization or stabilization) and in economically distressed communities, respectively.134 Commenters stated that 128 See SIFMA; FSF; BPI; ABA; PNC; Community Development Venture Capital Alliance (CDVCA); IIB; and Data Boiler (stating that incorporating the CRA public welfare exemption may ease some challenges faced by communities during the current COVID pandemic, but all PWI should not be excluded). 129 See SIFMA; FSF; and CDVCA. 130 See CDVCA. 131 See id. 132 See SIFMA; BPI; ABA; and IIB. 133 See SIFMA; FSF; ABA (addressing QOFs); and Small Business Investor Alliance (SBIA) (addressing RBICs). 134 See SIFMA and FSF. E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations certain RBICs and QOFs qualify for the public welfare investment exclusion, but providing an express exclusion for these funds would reduce uncertainty and associated compliance burdens and would encourage banking entities to provide capital to projects that promote economic development in rural and low-income communities.135 One commenter stated that RBICs and QOFs engage in investments that are substantively similar or identical to those of public welfare investment funds that are already excluded from the definition of covered fund and of the type that Congress recognized that section 13 of the BHC Act was not designed to prohibit.136 Another commenter stated that explicitly excluding RBICs would result in the provision of valuable expertise and services to RBICs and provide funding and assistance to small businesses and low- and moderate-income communities.137 One commenter expressed skepticism about providing a new exclusion for RBICs and QOFs but suggested that certain of these funds may currently qualify for the public welfare investment exclusion.138 Another commenter stated that it is not necessary to expressly exclude QOFs from the definition of covered fund, noting that these funds should be of the type primarily intended to promote the public welfare of low- and moderateincome areas and should therefore qualify for the current public welfare investment exclusion.139 After carefully considering the comments received, the agencies are revising the public welfare investment exclusion to explicitly incorporate funds, the business of which is to make investments that qualify for consideration under the Federal banking agencies’ regulations implementing the CRA.140 Explicitly excluding these types of investments from the definition of covered fund clarifies and gives full effect to the statutory exemption for public welfare investments.141 In addition, this clarification will reduce uncertainty and will facilitate public welfare investments by banking entities. The agencies are also adopting explicit exclusions from the definition 135 See SIFMA and FSF. 136 See SIFMA. 137 See SBIA. 138 See Data Boiler. 139 See PNC. 140 Final rule § ll.10(c)(11)(ii)(A). 141 See 12 U.S.C. 1851(d)(1)(E). A banking entity must have independent authority to make a public welfare investment. For example, a banking entity that is a state member bank may make a public welfare investment to the extent permissible under 12 U.S.C. 338a and 12 CFR 208.22. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 of covered fund for RBICs and QOFs in § ll.10(c)(11) of the final rule. These types of funds were created by Congress to promote development in rural and low-income communities, and, due to their similarity to SBICs and public welfare investments, the agencies believe that section 13 of the BHC Act was not intended to restrict the types of funds that engage in those activities. RBICs are companies licensed under the Rural Business Investment Program, a program designed to promote economic development and the creation of wealth and job opportunities among individuals living in rural areas and to help meet the equity capital investment needs primarily of smaller enterprises located in such areas.142 Likewise, QOFs were developed as part of a program to promote long-term investing in designated economically distressed communities and are required to have at least 90 percent of their assets in designated low-income zones.143 Congress created RBICs and QOFs to encourage investment in rural areas, small enterprises, and low-income areas. Providing an explicit exclusion for these funds in the implementing regulations gives effect to section 13 of the BHC Act’s provision permitting public welfare investments and avoids chilling the activities of funds that were not the target of section 13 of the BHC Act.144 Although many of these funds may already qualify for the public welfare investment exclusion, the agencies are explicitly excluding these funds from the definition of covered fund to reduce uncertainty and compliance burden. Thus, under the final rule, a covered fund does not include an issuer that has elected to be regulated or is regulated as a RBIC, as described in 15 U.S.C. 80b–3(b)(8)(A) or (B), or that has terminated its participation as a RBIC in accordance with 7 CFR 4290.1900 and does not make any new investments (other than investments in cash equivalents, which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to the issuer’s 142 See, e.g., Rural Business Investment Company (RBIC) Program, 85 FR 16519, 16520 (Mar. 24, 2020). 143 See 26 U.S.C. 1400Z–2(d). 144 See 12 U.S.C. 1851(d)(1)(E); 156 Cong. Rec. S5896 (daily ed. July 15, 2010) (Statement of Sen. Merkley) (noting that Section 13(d)(1)(E) permits investments ‘‘of the type’’ permitted under 12 U.S.C. 24 (Eleventh), including ‘‘a range of lowincome community development and other projects,’’ but ‘‘is flexible enough to permit the [agencies] to include other similar low-risk investments with a public welfare purpose’’). PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 46435 assets) after such termination.145 Likewise, under the final rule, a covered fund does not include an issuer that is a QOF, as defined in 26 U.S.C. 1400Z– 2(d).146 The final rule does not exclude funds that qualify for the public welfare investment exclusion from the definition of ‘‘banking entity’’ as requested by some commenters.147 The term ‘‘banking entity’’ is specifically defined in section 13 of the BHC Act.148 In addition, the agencies do not believe that applying the definition of banking entity places an undue burden on banking entities’ public welfare investments. The agencies believe that banking entities are able to design their permissible public welfare investments so as not to cause the investment fund to become a banking entity. For public welfare investment funds that are banking entities, the agencies believe that the burden-reducing amendments adopted in this final rule and the 2019 amendments should mitigate concerns about compliance burdens. ii. Small Business Investment Companies Consistent with section 13 of the BHC Act,149 the implementing regulations exclude from the definition of ‘‘covered fund’’ SBICs and issuers that have received notice from the Small Business Administration to proceed to qualify for a license as an SBIC, which notice or license has not been revoked.150 The agencies proposed revising the exclusion for SBICs to clarify how the exclusion would apply to SBICs that surrender their licenses during winddown phases.151 Specifically, the agencies proposed revising the exclusion for SBICs to apply explicitly to an issuer that has voluntarily surrendered its license to operate as an SBIC in accordance with 13 CFR 107.1900 and does not make new investments (other than investments in cash equivalents) after such voluntary 145 Final rule § ll.10(c)(11)(iii). As with SBICs, discussed below, the final rule contemplates that an issuer that ceases to be a RBIC during wind-down may continue to qualify for the exclusion from the definition of ‘‘covered fund’’ for RBICs if the issuer satisfies certain conditions designed to prevent abuse. 146 Final rule § ll.10(c)(11)(iv). As with other types of issuers excluded from the covered fund definition, a banking entity must have independent authority to invest in a QOF. 147 See SIFMA and BPI. 148 12 U.S.C. 1851(h)(1). 149 See 12 U.S.C. 1851(d)(1)(E) (permitting investments in SBICs). 150 See implementing regulations § ll.10(c)(11)(i). 151 See 85 FR 12131. E:\FR\FM\31JYR4.SGM 31JYR4 46436 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations surrender.152 The agencies explained that applying the exclusion to an issuer that has surrendered its SBIC license is appropriate because of the statutory exemption for investments in SBICs and because banking entities may otherwise become discouraged from investing in SBICs due to concerns that an SBIC may become a covered fund during its winddown phase.153 The agencies further noted that the proposed revisions included a number of requirements designed to ensure that the exclusion would not be abused.154 In particular, the exclusion would apply only to an issuer that voluntarily surrenders its license in accordance with 13 CFR 107.1900 and that does not make any new investments (other than investments in cash equivalents).155 Most commenters that directly addressed the 2020 proposal’s revisions concerning SBICs supported the proposed revisions, stating that the proposed revisions would provide greater certainty to banking entities wishing to invest in SBICs and would increase investment in small businesses.156 One commenter stated that revising the exclusion for SBICs would prevent a banking entity from being forced to sell an interest in an SBIC that became a covered fund for reasons outside of the banking entity’s control.157 Commenters further noted that the proposed revisions included sufficient safeguards against evasion and did not present safety or soundness concerns.158 One commenter recommended against revising the exclusion from the definition of covered fund for SBICs. This commenter expressed concern about frequent buying and selling of SBICs and noted that section 13 of the BHC Act and its implementing regulations do not prohibit a banking entity from lending to small businesses.159 The commenter further expressed concern that an SBIC that surrenders its license may be doing so because it has failed or no longer wishes to comply with the Small Business Administration’s regulations.160 After carefully considering the comments received, the agencies are adopting the revisions to the exclusion from the definition of covered fund for SBICs, as proposed.161 The revisions 152 See id. id.; 12 U.S.C 1851(d)(1)(E). 154 See 85 FR 12131. 155 See id. 156 See SIFMA; BPI; ABA; PNC; and SBIA. 157 See SBIA. 158 See SIFMA; BPI; and SBIA. 159 See SIFMA; BPI; and SBIA. 160 See Data Boiler. 161 See final rule § ll10(c)(11)(i). 153 See VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 will provide greater certainty to banking entities, give full effect to the provision of section 13 of the BHC Act that permits investments in SBICs, and support capital formation for small businesses. In response to one commenter’s concerns regarding the exclusion for SBICs,162 the agencies note that a banking entity’s investment in an SBIC must comply with all applicable laws and regulations, including the prohibition against proprietary trading under section 13 of the BHC Act and its implementing regulations. Furthermore, as noted above, the revised exclusion for SBICs includes safeguards designed to prevent abuse or evasion. In particular, the exclusion would only apply to an issuer that has voluntarily surrendered its license to operate as an SBIC in accordance with 13 CFR 107.1900 and that does not make new investments (other than investments in cash equivalents) after such voluntary surrender. C. Additional Covered Fund Exclusions In addition to modifying certain existing exclusions, the agencies are creating four new exclusions from the definition of ‘‘covered fund’’ to better tailor the provision to the types of entities that section 13 was intended to cover. These exclusions are for credit funds, venture capital funds, family wealth management vehicles, and customer facilitation vehicles. General Comments Many commenters were broadly supportive of the proposed new exclusions from the definition of ‘‘covered fund.’’ 163 Some commenters recommended adopting additional exclusions for an array of fund types and situations, including for tender bond vehicles,164 ownership interests erroneously acquired or retained,165 certain real estate funds,166 and funds in their seeding period.167 The agencies are declining to adopt these suggested exclusions because the requested actions are outside the scope of the current rulemaking. In addition, one commenter urged the agencies to redefine the definition of ‘‘covered fund,’’ to rely on a characteristics-based approach.168 The agencies decline to revise the definition of ‘‘covered fund’’ Data Boiler. SIFMA; JBA; Credit Suisse; and SAF. 164 SIFMA. 165 SIFMA and BPI. 166 IAA. 167 ABA. 168 JBA. for the reasons articulated in the preamble to the 2013 rule.169 1. Credit Funds i. Background and 2020 Proposal In the preamble to the 2013 rule, the agencies declined to establish an exclusion from the definition of covered fund for funds that make loans, invest in debt, or otherwise extend the type of credit that banking entities may provide directly under applicable banking law (credit funds).170 The agencies cited concerns about whether credit funds could be distinguished from private equity funds and hedge funds and the possible evasion of the requirements of section 13 of the BHC Act through the availability of such an exclusion. In addition, the agencies suggested that some credit funds would be able to operate using other exclusions from the definition of covered fund in the 2013 rule, such as the exclusion for joint ventures or the exclusion for loan securitizations.171 However, commenters on the 2018 proposal noted that many credit funds have not been able to utilize the joint venture and loan securitization exclusions. In response, the agencies included in the 2020 proposal a specific exclusion for credit funds. Under the 2020 proposal, a credit fund would have been an issuer whose assets consist solely of: • Loans; • Debt instruments; • Related rights and other assets that are related or incidental to acquiring, holding, servicing, or selling loans, or debt instruments; and • Certain interest rate or foreign exchange derivatives.172 The proposed exclusion would have been subject to certain additional requirements to reduce evasion concerns and help ensure that banking entities invest in, sponsor, or advise credit funds in a safe and sound manner. For example, the proposed exclusion would have imposed (1) certain activity requirements on the credit fund, including a prohibition on proprietary trading; 173 (2) disclosure and safety and soundness requirements on banking entities that sponsor or serve as an advisor for a credit fund; 174 (3) safety and soundness requirements on all banking entities that invest in or have certain relationships with a credit 162 See 163 E.g., PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 169 See 170 See 79 FR 5671. 79 FR 5705. 171 Id. proposal § ll.10(c)(15)(i). proposal § ll.10(c)(15)(ii). 174 2020 proposal § ll.10(c)(15)(iii). 172 2020 173 2020 E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations fund; 175 and (4) restrictions on the banking entity’s investment in, and relationship with, a credit fund.176 The proposed exclusion also would have permitted a credit fund to receive and hold a limited amount of equity securities (or rights to acquire equity securities) that were received on customary terms in connection with the credit fund’s loans or debt instruments.177 ii. Comments The agencies requested comment on all aspects of the proposed credit fund exclusion. In addition, the agencies solicited comment on specific provisions of the proposed exclusion, including the permissibility of certain assets and requirements related to the activities of the credit fund and the relationship between a banking entity and a credit fund.178 General Commenters were generally supportive of adopting an exclusion for credit funds, and several commenters suggested specific revisions to the proposed exclusion.179 Several commenters supportive of the 2020 proposal urged the agencies not to adopt any further limitations on the proposed exclusion and indicated that the proposed exclusion would not increase the risk of evasion of the requirements of section 13 of the BHC Act.180 Two commenters expressed general opposition to or concern about the proposed credit fund exclusion.181 Asset Requirements Commenters were generally supportive of allowing a credit fund to invest broadly in loans and debt instruments, certain related assets, and certain derivatives.182 One commenter recommended against delineating between permissible and nonpermissible types of loans and debt instruments, arguing that credit funds proposal § ll.10(c)(15)(iv). proposal § ll.10(c)(15)(v). 177 2020 proposal § ll.10(c)(15)(i)(C)(1)(iii). 178 See 85 FR 12133. 179 E.g., CCMC; AIC; SIFMA; FSF; ABA; Arnold & Porter; and Goldman Sachs. 180 E.g., SIFMA; Credit Suisse; Goldman Sachs; and Arnold & Porter. 181 Better Markets and Data Boiler. One of these commenters suggested that banking entities should instead rely on the exclusions for joint ventures and loan securitizations. Data Boiler. 182 E.g., SIFMA; Arnold & Porter; and ABA. One commenter also noted that the permissible holding period for debt previously contracted varies depending on applicable regulations and suggested that the agencies specify the holding period for debt previously contracted assets owned by a credit fund and provide for an extension process. Arnold & Porter. 175 2020 176 2020 VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 should be able to extend credit to the same degree as would be permitted for the banking entity to extend directly.183 Another commenter encouraged the agencies to clarify and expand the definition of debt instrument and derivatives, to include all tranches of debt, collateralized loan and collateralized debt obligations, and any derivatives related to hedging credit risk, such as credit default swaps and total return swaps.184 In addition, a commenter suggested clarifying that no specific credit standard applies to loans held by a credit fund.185 One commenter also urged the agencies to establish a safe harbor to the permissible asset restrictions for banking entities that rely, in good faith, on a representation by the credit fund that the credit fund only invests in permissible assets.186 Two commenters recommended limiting permissible assets to only loans or debt instruments, and not equity.187 In contrast, a range of commenters argued that allowing a credit fund to receive certain assets, like equity, related to an extension of credit would promote the sale of loans and extensions of credit.188 Some of these commenters suggested that taking equity as partial consideration for extending credit is commonplace in the debt and loan markets and that such a provision could ensure that credit funds are able to facilitate loan and debt workouts and restructurings, a critical financial intermediation function.189 Most commenters supportive of the 2020 proposal were generally opposed to a 183 SIFMA. The same commenter also urged the agencies to permit credit funds to hold commodity forward contracts, which the commenter argued may be an appropriate hedge for extensions of credit to agricultural businesses. SIFMA. 184 Credit Suisse. See also Arnold & Porter (recommending expanding the types of permissible derivatives, to allow for more effective hedging and easier disposal of portfolio assets). 185 ABA. 186 Arnold & Porter. 187 Data Boiler and Better Markets. One of these commenters argued that the inclusion of non-loan instruments would be contrary to the purpose of section 13 of the BHC Act. Data Boiler. As indicated by the agencies in the preamble to the 2020 proposal, taking limited amounts of non-loan or debt assets as consideration for an extension of credit is common and is a permitted practice for insured depository institutions. Therefore, the agencies believe it would not be inconsistent with section 13 of the BHC Act to facilitate the sale of loans by establishing a credit fund exclusion that allows a credit fund to hold a limited amount of certain equity instruments related to extensions of credit. See also the discussion about permitting excluded loan securitizations to hold a small amount of non-loan assets, supra Section IV.B.2 (Loan Securitizations). 188 E.g., SIFMA; Credit Suisse; ABA; and Arnold & Porter. 189 E.g., SIFMA; Credit Suisse; and Arnold & Porter. PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 46437 quantitative limit on the amount of equity securities (or rights to acquire an equity security) received on customary terms in connection with such loans or debt instruments that could be held by a credit fund, citing compliance costs and diminished flexibility,190 but some commenters indicated that a limitation of 20 or 25 percent of total assets could be acceptable if the agencies were to impose a limit.191 Commenters supportive of allowing credit funds to hold certain related assets, such as equity, in connection with an extension of credit suggested that the provision would not raise significant safety and soundness or evasion concerns. For example, one commenter claimed that such a provision would not raise the risk of evasion, in part, because equity options received as consideration generally expire unexercised.192 Other commenters argued that the activity requirements of the exclusion would prevent a credit fund from becoming actively involved in the purchase and sale of equity instruments.193 Another commenter suggested that the agencies could impose a requirement that nonloan or non-debt assets be acquired on arms-length terms and adhere to bank safety and soundness standards.194 Separately, several commenters recommended allowing excluded credit funds to hold any type of asset, up to a certain percentage of aggregate assets, either 20 or 25 percent of a credit fund’s total assets.195 These commenters asserted that permitting a credit fund to own equity securities and other assets would help the fund more effectively provide credit, without altering the character of the credit fund, and would reduce compliance burdens associated with launching and operating a credit fund.196 In addition, these commenters claimed that a limited bucket for nonloan and non-debt assets would be consistent with the ability of banking entities and some business development companies to invest in equity.197 Banking Entity and Issuer Requirements Generally, commenters either agreed that certain restrictions to ensure that a credit fund is actually engaged in prudently providing credit and credit 190 SIFMA; FSF; CCMC; AIC; ABA; and Goldman Sachs. 191 SIFMA and CCMC. 192 Arnold & Porter. 193 Goldman Sachs and FSF. 194 ABA. 195 SIFMA; FSF; Credit Suisse; ABA; and Goldman Sachs. One commenter also suggested a formula for determining the cap. Goldman Sachs. 196 E.g., SIFMA and Goldman Sachs. 197 Id. E:\FR\FM\31JYR4.SGM 31JYR4 46438 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations intermediation and is not operated for the purpose of evading the provisions of section 13 of the BHC Act were appropriate or did not object to the inclusion of these requirements.198 Several commenters, however, offered revisions to the activities, sponsor or advisor, banking entity, or investment and relationship limit requirements. For example, several commenters requested clarification on the prohibition on proprietary trading by an excluded credit fund contained in § ll.10(c)(15)(ii)(A) of the 2020 proposal. One commenter suggested that the definition of proprietary trading for a credit fund should depend on the definition used by the banking entity.199 Another commenter encouraged the agencies to incorporate the exclusions and exemptions from the prohibition on proprietary trading into the credit fund exclusion’s prohibition on proprietary trading.200 A third commenter recommended making explicit that exercising rights for certain related assets, such as an equity warrant, is not proprietary trading.201 Commenters also requested revisions to and clarification about the limits on a banking entity’s investment in, and relationship with, a credit fund. One commenter argued that the imposition of § ll.14 of the implementing regulations (which imposes limitations on the relationship between a banking entity and a fund it sponsors or advises) would be duplicative of (1) the requirement that the banking entity not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the credit fund and (2) certain conflict of interest, high-risk, and safety and soundness restrictions.202 Another commenter claimed that there was little benefit to imposing the requirements of § ll.14 (described above) and § ll.15 (which imposes certain material conflicts of interest, high-risk investments, and safety and soundness and financial stability requirements on permitted covered fund activities) of the implementing regulations in the context of credit funds and suggested that the partial application of § ll.14, in particular, could lead to unexpected and 198 E.g., SIFMA; Better Markets; FSF; and Goldman Sachs. One commenter also indicated that the disclosure requirement for banking entities that sponsor or advise funds is appropriate. Arnold & Porter. 199 SIFMA. For example, the commenter suggested that a credit fund sponsored by a banking entity subject to the market risk rule should be permitted to use the definitions of proprietary trading and trading account in § ll.3(b)(1)(ii). 200 FSF. 201 Arnold & Porter. 202 SIFMA. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 inappropriate outcomes, such as allowing a banking entity to invest in the equity of a credit fund, but not the debt instruments issued by that same credit fund.203 That same commenter also recommended eliminating § ll.10(c)(15)(v)(B) of the 2020 proposal—which would have required that the banking entity’s investment in, and relationship with, the credit fund be conducted in compliance with, and subject to, applicable banking laws and regulations—because applicable banking laws and regulations apply regardless of the banking entity’s use of the credit fund exclusion.204 In addition, a commenter argued that banking entities that serve as investment advisers or commodity trading advisors to credit funds should not be subject to the disclosure and safety and soundness requirements of § ll.10(c)(15)(iii) of the 2020 proposal since investment advisers and commodity trading advisors who do not otherwise sponsor or invest in a fund are generally not subject to section 13 of the BHC Act. The commenter argued that § ll.10(c)(15)(iii) of the 2020 proposal would impose differing requirements on a credit fund depending on whether the investment adviser or commodity trading advisor was an insured depository institution or a bank holding company. That commenter also claimed that the portfolio requirements in § ll.10(c)(15)(iv)(B) of the 2020 proposal could require banking entities to establish complex compliance programs to assess credit fund compliance with state and foreign laws and that the agencies should limit the scope of the provision to only federal banking laws and regulations.205 Finally, one commenter contended that the application of certain requirements in the exclusion is contingent on the type of banking entity that invests in or sponsors a credit fund and urged the agencies to make explicit that only the identity of the sponsor of the credit fund, and not its affiliates or third-party investors, determines which portfolio quality and safety and soundness requirements apply to the credit fund.206 More generally, this commenter asked the agencies to make explicit in the preamble to the final rule that the actions of unaffiliated, thirdparty banking entities do not affect whether a banking entity may invest in a fund.207 PO 00000 203 Arnold 204 Arnold & Porter. & Porter. 205 Id. 206 Id. 207 Id. Frm 00018 Fmt 4701 Sfmt 4700 Other Comments Commenters also submitted several miscellaneous comments about the proposed exclusion for credit funds. One commenter requested that the agencies clarify the definition of assetbacked securities as used in the proposed credit fund exclusion and the current loan securitization exclusion.208 That same commenter also urged the agencies to revise the proposed credit fund exclusion to allow banking entities with more stringent credit requirements, such as insured depository institutions, to invest in credit funds that hold distressed debt.209 Finally, the 2020 proposal requested comment on whether to combine the proposed credit fund exclusion with the loan securitization exclusion. Commenters were generally opposed to combining the two exclusions, citing different classes of assets in which the two types of issuers invest and a fundamental difference in structure (loan securitizations issue asset-backed securities, while credit funds do not).210 In addition, one commenter argued that while combining the two exclusions would increase the simplicity of the rule, such an amalgamated exclusion could result in increased compliance burdens for issuers who are accustomed to the lack of credit requirements in the current loan securitization exclusion.211 iii. Final Exclusion After consideration of the comments, the agencies are adopting the credit fund exclusion as proposed, with certain modifications. The agencies believe that the credit fund exclusion in the final rule (1) addresses the application of the covered fund provisions to credit-related activities that certain banking entities are permitted to engage in directly and (2) is consistent with Congress’s intent that section 13 of the BHC Act limit banking entities’ investment in and relationships with hedge funds and private equity funds, but not limit or restrict banking entities’ ability to extend credit.212 The agencies also believe that the credit fund exclusion in the final rule, with the eligibility criteria described below, will address concerns the agencies expressed in the preamble to the 2013 208 Id. 209 Id. 210 SIFMA; FSF; CCMC; Credit Suisse; and Data Boiler. 211 Arnold & Porter. 212 See 12 U.S.C. 1851(g)(2), (h)(2). Paragraph (g)(2) of section 13 of the BHC Act makes clear that the Volcker rule is not intended to impede banking entities’ ability to extend credit by, for example, selling loans or securitize loans. See 12 U.S.C. 1851(g)(2). E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations rule about the ability to administer an exclusion for credit funds and the potential evasion of section 13 of the BHC Act.213 Banking entities already have experience using and complying with the loan securitization exclusion. Establishing an exclusion for credit funds based on the framework provided by the loan securitization exclusion allows banking entities to provide traditional extensions of credit regardless of the specific form, whether directly via a loan made by a banking entity, or indirectly through an investment in or relationship with a credit fund that transacts primarily in loans and certain debt instruments. The credit fund exclusion limits the universe of potential funds that can rely on the exclusion by clearly specifying the types of activities in which those funds may engage. Excluded credit funds can transact in or hold only loans; debt instruments that would be permissible for the banking entity relying on the exclusion to hold directly; certain rights or assets that are related or incidental to the loans or debt instruments, including equity securities (or rights to acquire an equity security) received on customary terms in connection with such loans or debt instruments; and certain interest rate and foreign exchange derivatives. The credit fund exclusion, with these eligibility criteria, should not raise evasion concerns. Similarly, the agencies’ expectations regarding the amount of permissible equity securities (or rights to acquire an equity security) held and the requirement that the credit fund not engage in activities that would constitute proprietary trading should help to ensure that the extensions of credit, whether directly originated or acquired from a third party, are held by the credit fund for the purpose of facilitating lending and not for the purpose of evading the requirements of section 13. Finally, the restrictions on guarantees and other limitations should eliminate the ability and incentive for either the banking entity sponsoring a credit fund or any affiliate to provide additional support beyond the ownership interest retained by the sponsor. Thus, the agencies expect that, together, the criteria for the credit fund exclusion will prevent a banking entity from having any incentive to bail out such funds in periods of financial stress or otherwise expose the banking entity to the types of risks that the covered fund provisions of section 13 were intended to address. Consistent with commenters’ suggestions, the agencies are keeping 213 See 79 FR 5705. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 separate the credit fund exclusion and the loan securitization exclusion because the structures and purposes of those two types of issuers differ sufficiently to warrant different requirements. For example, loan securitizations and credit funds have different asset composition and different financing and legal structures. Therefore, the agencies are finalizing a credit fund exclusion separate from the loan securitization exclusion. Asset Requirements Under the final rule, a credit fund, for the purposes of the credit fund exclusion, is an issuer whose assets consist solely of: • Loans; • Debt instruments; • Related rights and other assets that are related or incidental to acquiring, holding, servicing, or selling loans, or debt instruments; and • Certain interest rate or foreign exchange derivatives.214 Several provisions of the exclusion are similar to and modeled on conditions in the loan securitization exclusion to ease compliance burdens. For example, any derivatives held by the credit fund must relate to loans, permissible debt instruments, or other rights or assets held and reduce the interest rate and/or foreign exchange risks related to these holdings.215 In addition, any related rights or other assets held that are securities must be cash equivalents, securities received in lieu of debts previously contracted with respect to loans held or, unique to the credit fund exclusion, equity securities (or rights to acquire equity securities) received on customary terms in connection with the credit fund’s loans or debt instruments.216 In the 2020 proposal, the agencies requested comment on whether to impose a limit on the amount of equity securities (or rights to acquire equity securities) that may be held by an excluded credit fund.217 After a review of the comments and further deliberation, the agencies are not adopting a quantitative limit on the amount of equity securities (or rights to acquire equity securities) that may be held by an excluded credit fund. Any such equity securities or rights are rule § ll.10(c)(15)(i). rule § ll.10(c)(15)(i)(D). 216 Final rule § ll.10(c)(15)(i)(C). In a minor change from the 2020 proposal, the agencies are making clear that rights or other assets held under paragraph (c)(15)(i)(C) of that section may not include any derivative, other than a derivative that meets the requirements of paragraph (c)(15)(i)(D) of that section. 217 85 FR 12133. PO 00000 214 Final 215 Final Frm 00019 Fmt 4701 Sfmt 4700 46439 limited by the requirements that they be (a) received on customary terms in connection with the fund’s loans or debt instruments and (b) related or incidental to acquiring, holding, servicing, or selling those loans or debt instruments. The agencies generally expect that the equity securities or rights satisfying those criteria in connection with an investment in loans or debt instruments of a borrower (or affiliated borrowers) would not exceed five percent of the value of the fund’s total investment in the borrower (or affiliated borrowers) at the time the investment is made. The agencies understand that the value of those equity securities or other rights may change over time for a variety of reasons, including as a result of market conditions and business performance, as well as more fundamental changes in the business and the credit fund’s corresponding management of the investment (e.g., exchanges of debt instruments for equity in connection with mergers and restructurings or a disposition of all portion of the credit investment without a corresponding disposition of the equity securities or rights due to differences in market conditions or other factors). Accordingly, the agencies can foresee various circumstances where the relative value of such equity securities or rights in a borrower (or affiliated borrowers) would over the life of the investment exceed five percent on a basis consistent with the requirements. Nonetheless, the agencies expect that the fund’s exposure to equity securities (or other rights), individually and collectively and when viewed over time, would be managed on a basis consistent with the fund’s overall purpose. The agencies are also not imposing additional restrictions on the types of equity securities (or rights to acquire an equity security) that a credit fund may hold. The final rule prevents a banking entity from relying on the credit fund exclusion unless any debt instruments and equity securities (or rights to acquire an equity security) held by the credit fund and received on customary terms in connection with the credit fund’s loans or debt instruments are permissible for the banking entity to acquire and hold directly and a sponsor of a credit fund must ensure that the credit fund complies with certain safety and soundness standards.218 Combined with the prohibition on proprietary trading by a credit fund,219 these limitations are expected to prevent evasion of section 13 of the BHC Act and should be sufficient to prevent 218 Final 219 Final E:\FR\FM\31JYR4.SGM rule § ll.10(c)(15)(iv)(B), (iii)(B). rule § ll.10(c)(15)(ii)(A). 31JYR4 46440 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations banking entities from investing in or sponsoring credit funds that hold excessively risky equity securities (or rights to acquire an equity security).220 The agencies are, however, clarifying that the provision allowing related rights and other assets does not separately permit the holding of derivatives. The preamble to the 2020 proposal made clear that ‘‘any derivatives held by the credit fund must relate to loans, permissible debt instruments, or other rights or assets held, and reduce the interest rate and/ or foreign exchange risks related to these holdings.’’ 221 The agencies suggested then and currently believe that allowing a credit fund issuer to hold derivatives not related to interest rate or foreign exchange hedging would not be necessary to facilitate the indirect extension of credit by banking entities and may pose the very risks that section 13 of the BHC Act was intended to reach. To ensure that the credit fund exclusions does not inadvertently allow the holding of certain derivatives unrelated to interest rate and/or foreign exchange risks, the final rule explicitly excludes derivatives from permissible related right and other assets.222 The agencies are not adopting a broad expansion of permissible assets, as recommended by several commenters. Contrary to commenters’ suggestions, allowing credit funds to hold unlimited amounts of non-debt instruments or derivatives, such as credit default or total return swaps, could present evasion concerns and is not necessary for effectuating the rule of construction.223 The agencies believe 220 One commenter suggested requiring that equity securities (or rights to acquire an equity security) be acquired via arms-length market transactions and adhere to bank safety and soundness standards. See ABA. Under the final rule, a banking entity may not rely on the credit fund exclusion unless any equity securities (or rights to acquire an equity security) held by the credit fund are permissible for the banking entity to acquire and hold directly under applicable federal banking laws and regulations. Final rule § ll.10(c)(15)(iv)(B). In addition, the final rule requires that equity securities (or rights to acquire an equity security) related or incidental to acquiring, holding, servicing, or selling such loans or debt instruments must be received on customary terms in connection with such loans or debt instruments. Final rule § ll.10(c)(15)(i)(C)(1)(iii). Finally, a banking entity’s investment in, and relationship with, the issuer must comply with the limitations imposed in § ll.15, as if the issuer were a covered fund. Final rule § ll.10(c)(15)(v)(A). 221 85 FR 12132. 222 Final rule § ll.10(c)(15)(i)(C)(2). 223 The agencies’ rationale, in the preamble to the 2013 rule, for limiting the permissible assets for the loan securitization exclusion is particularly relevant. See 79 FR 5691 (‘‘Under the final rule as adopted, an excluded loan securitization would not be able to hold derivatives that would relate to risks VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 that only those instruments that facilitate the extension of credit and directly-related hedging activities should be permitted under the exclusion. For example, allowing the unlimited holding of credit default swaps by a majority owned or sponsored credit fund could raise the risks that section 13 of the BHC Act was intended to address. Moreover, permitting excluded credit funds to invest up to 25 percent of total assets in any type of asset could turn the exclusion for credit funds into an exclusion for the type of funds that section 13 of the BHC Act was intended to address. Such a result would be contrary to section 13 of the BHC Act. There are several additional changes recommended by commenters that the agencies are not including in the final rule. Specifically, the final rule does not: • Allow excluded credit funds to hold commodity forward contracts. Although these contracts have legitimate value as hedging instruments, the agencies do not believe this type of hedging activity is consistent with the purpose of the exclusion for credit funds, which is to allow banking entities to share the risks of their permissible lending activities or to engage in permissible lending activities indirectly through a fund structure. • Permit banking entities that are insured depository institutions or their operating subsidiaries to invest in credit funds through a contribution to a credit fund of troubled loans and debt previously contracted assets from the banking entity’s portfolio. The conditions in the final rule are intended to ensure that a credit fund generally engages in activities that the banking entity may engage in directly and that the banking entity’s investment in and relationship with the fund are conducted in a safe and sound manner. to counterparties or issuers of the underlying assets referenced by these derivatives because the operation of derivatives, such as these, that expand potential exposures beyond the loans and other assets, would not in the Agencies’ view be consistent with the limited exclusion contained in the rule of construction under section 13(g)(2) of the BHC Act, and could be used to circumvent the restrictions on proprietary trading and prohibitions in section 13(f) of the BHC Act. The Agencies believe that the use of derivatives by an issuing entity for asset-backed securities that is excluded from the definition of covered fund under the loan securitization exclusion should be narrowly tailored to hedging activities that reduce the interest rate and/or foreign exchange risks directly related to the asset-backed securities or the loans supporting the asset-backed securities because the use of derivatives for purposes other than reducing interest rate risk and foreign exchange risks would introduce credit risk without necessarily relating to or involving a reduction of interest rate risk or foreign exchange risk.’’). PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 The agencies decline to deviate from these standards for any particular type of credit fund because doing so could permit activities that raise the type of concerns that section 13 of the BHC Act was intended to address. • Further specify the holding period for securities held in lieu of debts previously contracted held by a credit fund. Generally, a banking entity may not rely on this exclusion unless any debt instruments and equity securities (or rights to acquire equity securities) held by the fund would be permissible for the banking entity to acquire and hold directly under applicable federal banking laws and regulations. However, the requirement that a banking entity be able to hold a given asset directly does not apply to securities held in lieu of debts previously contracted under the final regulations. Because a banking entity’s ability to invest in or sponsor an excluded credit fund is not contingent on how long the credit fund holds securities held in lieu of debts previously contracted, the agencies do not believe it is necessary to amend the regulations to impose a specific holding period on securities held by a credit fund in lieu of debts previously contracted.224 • Revise or expand on the definition of debt instrument. The agencies believe that the term debt instrument already has a general meaning that is used in the marketplace and by regulators and that a new definition is unnecessary given this widely understood meaning and could cause confusion. • Adopt a safe harbor for banking entities that rely, in good faith, on a representation by the credit fund that it only invests in permissible assets. It is the responsibility of the banking entity to ensure that it complies with section 13 of the BHC Act and the implementing regulations, and such responsibility cannot be substituted solely with a representation from a credit fund. Activity Requirements The agencies are adopting the activity requirements for issuers in the 2020 proposal without revision. Under the final rule, a credit fund is not a covered fund, provided that: • The fund does not engage in activities that would constitute proprietary trading, as defined in § ll.3(b)(1)(i) of the rule, as if the fund were a banking entity; 225 and 224 The agencies note that banking entities must otherwise comply with applicable law. See infra, Additional Banking Entity Requirements. 225 Final rule § ll.10(c)(15)(ii)(A). E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations • The fund does not issue assetbacked securities.226 The agencies decline to adopt changes recommended by commenters because the agencies believe the activity requirements are clear and appropriate. The first provision explicitly references the prohibition on proprietary trading by a banking entity in § ll.3 of the implementing regulations and, in particular, the short-term intent prong contained in § ll.3(b)(1)(i). For the avoidance of doubt, a credit fund would not be able to elect a different definition of proprietary trading or trading account. Varying the definition of proprietary trading depending on the type of banking entity that sponsors or invests in the credit fund, as suggested by a commenter, could result in conflicting requirements for credit funds with multiple banking entity investors and generally increase compliance burdens on credit funds. The agencies also note that activities permitted under § ll.10(c)(15) generally would not be considered proprietary trading, provided that an excluded credit fund does not purchase or sell one or more financial instruments principally for the purpose of short-term resale, benefit from actual or expected short-term price movements, realize short-term arbitrage profits, or hedge one or more of the positions resulting from the purchases or sales of financial instruments. The agencies are not expressly incorporating the permitted activities in §§ ll.4, ll.5, and ll.6 of the implementing regulations into the text of the final credit fund exclusion. The exclusion for credit funds is intended to allow banking entities to share the risks of otherwise permissible lending activities. Accordingly, the agencies would not expect that a credit fund would be formed for the purpose of engaging, or in the ordinary course would be engaged, in the activities permitted under §§ ll.4, ll.5, and ll.6 of the implementing regulations. Nevertheless, to the extent that a credit fund seeks to engage in any of those activities as an exemption from the prohibition on engaging in proprietary trading, as defined in § ll.3(b)(1)(i) of the final rule, and does so in compliance with the requirements and conditions of the applicable exemption, then the final rule would not preclude such activities.227 Similarly, with rule § ll.10(c)(15)(ii)(B). 227 The agencies recognize, however, that compliance with certain requirements and conditions in §§ ll.4, ll.5, and ll.6 of the implementing regulations may be inapt and/or highly impractical in the context of a credit fund, particularly given the asset and activity restrictions contained in § ll.10(c)(15). For example, the 226 Final VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 respect to the exclusions from the definition of proprietary trading contained in § ll.3(d) of the implementing regulations, the agencies note that the trading activities identified in § ll.3(d) are by definition not deemed to be proprietary trading, such that the performance by an excluded credit fund of those activities would not be inconsistent with the final credit fund exclusion.228 Finally, the agencies are not revising the definition of ‘‘asset-backed security’’ in the implementing regulations. The definition of ‘‘asset-backed security’’ in the implementing regulations specifically refers to the meaning specified in section 3(a)(79) of the Exchange Act (15 U.S.C. 78c(a)(79)).229 This definition is used elsewhere in banking law,230 and banking entities and others in the loan securitization industry have adapted their operations in reliance of the definition contained in the Exchange Act. Moreover, the 2013 rule included the requirement that the fund issue asset backed securities as part of the loan securitization criteria, and banking entities have become familiar with this definition, as they have implemented and utilized the exclusion. Requirements for a Sponsor, Investment Adviser, or Commodity Trading Advisor The agencies are adopting the proposed requirements for a sponsor, investment adviser, or commodity trading advisor to an excluded credit fund with one modification. Investors in a credit fund that a banking entity sponsors or for which the banking entity serves as an investment adviser or commodity trading advisor may have expectations related to the performance of the credit fund that raise bailout concerns. To ensure that these investors are adequately informed of the banking entity’s role in the credit fund, the final rule requires a banking entity that acts as a sponsor, investment adviser, or commodity trading advisor exemptions for underwriting and market makingrelated activities in § ll.4 require that a banking entity relying on such exemptions, among other things, be licensed or registered to engage in the applicable activity in accordance with applicable law. Moreover, to the extent that a credit fund is a banking entity with significant trading assets and liabilities (i.e., because it, together with its affiliates and subsidiaries, has trading assets and liabilities that equal or exceed $20 billion over the four previous calendar quarters), it also would be required to maintain a separate compliance program specific to those exemptions. 228 Similarly, trading activity that satisfies the 60day rebuttable presumption in § ll.3(b)(4) would be presumed not to be proprietary trading for these purposes. 229 Implementing regulations § ll.10(d)(2). 230 See 12 CFR 244 (Credit Risk Retention). PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 46441 to an excluded credit fund to provide prospective and actual investors the disclosures specified in § ll.11(a)(8) of the implementing regulations.231 Second, a banking entity that acts as a sponsor, investment adviser, or commodity trading advisor must ensure that the activities of the credit fund are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly.232 The agencies note, contrary to the suggestion of a commenter, that this provision does not apply to any investment adviser or commodity trading advisor to a credit fund who does not also sponsor or acquire an ownership interest in the credit fund. Rather, the requirements in § ll.10(c)(15) apply only to a sponsor, investment adviser, or commodity trading adviser that relies on the exclusion to sponsor or acquire an ownership interest in the credit fund. The covered fund provisions in § ll.10 of the implementing regulations only affect the operations of banking entities that, as principal, directly or indirectly, acquire or retain any ownership interest in or sponsor a covered fund.233 Thus, the safety and soundness provision only applies to banking entities that sponsor an excluded credit fund or that have an ownership interest in an excluded credit fund and also serve as an investment adviser or commodity trading advisor to the fund. More generally, to clarify an issue raised by some commenters, the agencies note that whether a specific banking entity may use the credit fund exclusion to make or have an otherwise impermissible investment in or relationship with a credit fund is contingent on the permissible activities of the banking entity. That is, the same fund may be a covered fund with respect to one banking entity and an excluded credit fund with respect to a different banking entity. A banking entity continues to be responsible for ensuring that its particular investment, sponsorship, or adviser activities comply with section 13 of the BHC Act and its implementing regulations. This principle applies to paragraphs (iii), (iv), and (v) of the credit fund exclusion. 231 Final rule § ll.10(c)(15)(iii)(A). These disclosures include, among other things, that losses are borne solely by investors and not the banking entity, that investors should examine fund documents, and that ownership interests are not insured by the FDIC or guaranteed. Final rule § ll.11(a)(8). 232 Final rule § ll.10(c)(15)(iii)(B). 233 Implementing regulations § ll.10(a)(1). E:\FR\FM\31JYR4.SGM 31JYR4 46442 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations The final rule moves the requirement that the banking entity must comply with § ll.14 of the implementing regulations to § ll.10(c)(15)(iii). This organizational change is in response to commenters that requested the agencies confirm that that the § ll.14 limitations do not apply to a banking entity that merely invests in a credit fund, as opposed to a banking entity that sponsors or advises the fund. The agencies believe this change is appropriate because the limitations on banking entities’ relationships with a covered fund in § ll.14 only apply when a banking entity serves, directly or indirectly, as the investment manager, investment adviser, commodity trading advisor, or sponsor to a covered fund.234 In addition, the agencies appreciate that mere investment by a banking entity in a credit fund does not raise the type of concerns Super 23A was intended to address, and thus the agencies are applying § ll.14 only when a banking entity acts as a sponsor, investment adviser, or commodity trading advisor to a credit fund, in each case as though the credit fund were a covered fund.235 The limitations in § ll.15 of the implementing regulations regarding material conflicts of interest, high-risk investments, and safety and soundness and financial stability remain applicable to banking entities’ investment in, and relationship with, excluded credit funds. Additional Banking Entity Requirements As provided in the 2020 proposal, a banking entity may not rely on the credit fund exclusion if it guarantees the performance of the fund.236 In a revision to the 2020 proposal, under the final rule a banking entity may not rely on the credit fund exclusion if the fund holds any debt instruments or equities (or rights to acquire an equity security) received on customary terms in connection with loans or debt instruments held by the credit fund that the banking entity is not permitted to acquire and hold directly under applicable federal banking laws and regulations.237 This change is to clarify, as suggested by a commenter, that this requirement is specific only to federal banking laws and regulations. Whether a credit fund’s holdings are permissible for a banking entity to hold under state or foreign laws is not relevant to compliance with section 13 of the BHC Act. That said, the agencies note that banking entities must comply with the rule § ll.14(a)(1). rule § ll.10(c)(15)(iii)(C). 236 Final rule § ll.10(c)(15)(iv). 237 Final rule § ll.10(c)(15)(iv)(B). 234 Final 235 Final VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 laws of the jurisdiction applicable to its activities and operations and should be cognizant of whether a credit fund it sponsors or in which it invests complies with the laws of the jurisdictions in which the credit fund operates.238 Investment and Relationship Limits Finally, the agencies are adopting the proposed provisions related to a banking entity’s investment in and relationship with a credit fund with one revision. Under the final rule, a banking entity’s investment in, and relationship with, the issuer must comply with the limitations in § ll.15 of the implementing regulations regarding material conflicts of interest, high-risk investments, and safety and soundness and financial stability, in each case as though the credit fund were a covered fund.239 In addition, a banking entity’s investment in, and relationship with, a credit fund must be conducted in compliance with, and subject to, applicable banking laws and regulations, including the safety and soundness standards applicable to the banking entity.240 The agencies believe it is important to highlight that the requirements applicable to the banking entity also govern the ability of the banking entity to invest in a fund that relies on the credit fund exclusion as well as the types of transactions that a banking entity may conduct with such funds.241 This means, for example, that a banking entity that invests in or has a relationship with a credit fund is subject to capital charges and other requirements under applicable banking law.242 2. Venture Capital Funds i. Venture Capital Funds 2020 Proposal The 2020 proposal included an exclusion for ‘‘qualifying venture capital funds.’’ 243 As described in the 2020 proposal, venture capital funds that provide capital to small and start-up 238 For example, banking entities that are organized under state or foreign laws may, depending on the nature of the organization, need to comply with other laws. 239 Final rule § ll.10(c)(15)(v)(A). 240 Final rule § ll.10(c)(15)(v)(B). 241 The agencies also note that § ll.10(c)(15)(v)(B) does not impose any additional burdens and should not generate confusion. 242 For example, a banking entity’s investment in or relationship with a credit fund could be subject to the regulatory capital adjustments and deductions relating to investments in financial subsidiaries or in the capital of unconsolidated financial institutions, if applicable. See 12 CFR 217.22. 243 2020 proposal § ll.10(c)(16). PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 businesses are covered funds unless they can rely on an exclusion other than section 3(c)(1) or 3(c)(7) to avoid registration under the Investment Company Act of 1940 (Investment Company Act) or qualify for an exclusion under the implementing regulations. Under the 2020 proposal, the exclusion would have been available to ‘‘qualifying venture capital funds,’’ which the 2020 proposal defined as an issuer that meets the definition in 17 CFR 275.203(l)–1 (Rule 203(l)–1), as well as several additional criteria. Specifically, the agencies proposed to exclude from the definition of covered fund an issuer that: • Is a venture capital fund as defined in Rule 203(l)–1; and • Does not engage in any activity that would constitute proprietary trading, under § ll.3(b)(1)(i), as if it were a banking entity. With respect to any banking entity that acts as sponsor, investment adviser, or commodity trading advisor to the issuer, and that relies on the exclusion to sponsor or acquire an ownership interest in the qualifying venture capital fund, the banking entity would have been required to: • Provide in writing to any prospective and actual investor the disclosures required under § ll.11(a)(8), as if the issuer were a covered fund; and • Ensure that the activities of the issuer are consistent with the safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly. In addition, a banking entity that relied on the exclusion would not have been permitted, directly or indirectly, to guarantee, assume, or otherwise insure the obligations or performance of the issuer. Finally, the 2020 proposal would have required a banking entity’s ownership interest in or relationship with a qualifying venture capital fund to: • Comply with the limitations imposed in § ll.14 (except the banking entity may acquire and retain any ownership interest in the issuer) and § ll.15 of the implementing regulations, as if the issuer were a covered fund; and • Be conducted in compliance with and subject to applicable banking laws and regulations, including applicable safety and soundness standards. E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations Comments Several commenters supported an exclusion for venture capital funds.244 Some of these commenters argued the Volcker Rule has severely impacted investment in venture funds and businesses and that venture capital is a critical financing source for innovative businesses.245 These commenters described their view of the positive economic impact of venture capital investment.246 For example, these commenters said companies funded with venture capital promote research and development and job creation.247 Similarly, several commenters argued that venture capital investments by banking entities can contribute to economic growth, innovation, and job creation.248 At least one commenter said increased venture capital investment may increase employment by small employers.249 Several commenters said an exclusion for venture capital funds would benefit underserved regions where venture capital funding is not readily available currently.250 One commenter said venture capital fund sizes are often too small for institutional investors, and banks have historically served an important source of investment for small and regional venture capital funds.251 This commenter said the loss of banking entities as limited partners in venture capital funds has had a disproportionate impact on cities and regions with emerging entrepreneurial ecosystems areas outside of Silicon Valley and other traditional technology centers.252 Two commenters noted that an exclusion for venture capital funds would promote investments in and financing to small businesses and startups in a broad range of geographic areas, industries, and sectors.253 Commenters said that an exclusion for venture capital funds would promote the safety and soundness of banking entities.254 One commenter said the exclusion would allow banks to diversify and to compete with non244 Representatives Gonzalez, Steil, Stivers, Barr, Hill, Riggleman, Zeldin, Davidson, Budd, Gooden, Rose, Emmer, Timmons, Posey, Kustoff, and Loudermilk (Gonzalez et al.); Crapo; FSF; SIFMA; CCMC; IIB; Goldman Sachs; Credit Suisse; AIC; National Venture Capital Association (NVCA); ABA; and SAF. 245 E.g., Gonzalez et al. and NVCA. 246 Gonzalez et al.; NVCA; and CCMC. 247 Id. 248 E.g., FSF; SIFMA; and Goldman Sachs. 249 SAF. 250 FSF; SIFMA; CCMC; and NVCA. 251 NVCA. 252 Id. 253 FSF and SIFMA. 254 FSF; SIFMA; and Goldman Sachs. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 banking entities.255 Commenters also said that the proposed exclusion allows banking entities to make investments indirectly through a fund structure that they could make directly 256 and incorporates criteria and activity restrictions that address any concerns about safety and soundness or evasion.257 Several commenters supported defining a qualifying venture capital fund by reference to Rule 203(l)–1 as proposed.258 These commenters also said the rule should not incorporate additional criteria as discussed in the preamble to the 2020 proposal, such as additional limitations on revenues or qualifying investments.259 These commenters said additional criteria are unnecessary to ensure that the fund is a bona fide venture capital fund and could unnecessarily limit the scope of qualifying venture capital funds.260 On the other hand, one commenter said the rule should include additional criteria to ensure qualifying venture capital funds serve the public interest and do not cause the harms at which section 13 of the Bank Holding Company Act was directed.261 One commenter argued defining venture capital fund by reference to Rule 203(l)–1 would be too narrow because it would exclude shares of emerging growth companies (EGCs) from being classified as qualifying investments and would not reflect certain companies that operate as venture investors and are exempt from having to register as an investment company but may not meet the technical definition of a venture capital fund under Rule 203(l)–1 (e.g., startup incubators).262 While supporting an exclusion for qualifying venture capital funds generally, a few commenters recommended revisions to the proposed exclusion.263 Some commenters proposed changes to the requirement that the fund not engage in any activity that would constitute proprietary trading, under § ll.3(b)(1)(i), as if it were a banking entity.264 One of these commenters said qualifying venture capital funds should be permitted to engage in permitted proprietary trading consistent with §§ ll.4, ll.5, and ll.6 of the implementing PO 00000 255 SIFMA. regulations.265 Another commenter said the definition of proprietary trading for funds should be the same as the definition that applies to the banking entity and that having two definitions is not reasonable or cost-effective.266 Commenters also supported changes to the requirement that the banking entity’s investment in and relationship with qualifying venture capital funds must comply with § ll.14 of the implementing regulations. One commenter recommended eliminating the requirement that would apply § ll.14 to a banking entity’s relationship with a venture capital fund.267 This commenter said that other proposed conditions adequately address bailout and safety and soundness concerns.268 Other commenters said the agencies should clarify that § ll.14 does not apply to a banking entity that simply invests in a qualifying venture capital fund (as opposed to a banking entity that sponsors or advises the fund).269 Other commenters did not support the proposed exclusion for qualifying venture capital funds.270 One of these commenters said if the agencies do adopt an exclusion for qualifying venture capital funds, the exclusion must include additional requirements to ensure that excluded venture capital funds serve the public interest and do not cause the harms at which section 619 of the Dodd-Frank Act was directed. Specifically, this commenter said the rule should: (1) Restrict all fund investments to ‘‘qualifying investments’’ or at least very significantly restrict investments in non-qualifying investments (e.g., limit them to no more than five percent of the fund’s aggregate capital), (2) impose a minimum securities holding period and portfolio company revenue limitation of $35 million (or a similarly appropriate and low figure) to ensure the fund is truly focused on medium-to-long term venture (as opposed to growth stage) investments, and (3) quantitatively limit the use of leverage as a key means for distinguishing excluded venture capital funds from statutorily prohibited activities involving private equity funds.271 265 FSF. 256 NVCA. 257 FSF and SIFMA. NVCA; FSF; and ABA. 259 SIFMA; NVCA; FSF; and ABA. 260 Id. 261 Better Markets. 262 CCMC. 263 FSF and SIFMA. 264 FSF and SIFMA. 258 SIFMA; Frm 00023 46443 Fmt 4701 Sfmt 4700 266 SIFMA. 267 SIFMA. 268 Id. 269 NVCA and ABA. Markets and Data Boiler. Another commenter said an exemption for venture capital funds was not supported by the 2020 proposal and not permitted under the law. Occupy. 271 Better Markets. 270 Better E:\FR\FM\31JYR4.SGM 31JYR4 46444 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations Final Exclusion The final rule adopts the proposed exclusion for qualifying venture capital funds with one clarifying change. The exclusion for qualifying venture capital funds will be available to an issuer that: • Is a venture capital fund as defined in Rule 203(l)–1; and • Does not engage in any activity that would constitute proprietary trading, under § ll.3(b)(1)(i), as if it were a banking entity. 272 With respect to any banking entity that acts as sponsor, investment adviser, or commodity trading advisor to the issuer, and that relies on the exclusion to sponsor or acquire an ownership interest in the qualifying venture capital fund, the banking entity will be required to: • Provide in writing to any prospective and actual investor the disclosures required under § ll.11(a)(8), as if the issuer were a covered fund; • Ensure that the activities of the issuer are consistent with the safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly; and • Comply with the restrictions imposed in § ll.14 (except the banking entity may acquire and retain any ownership interest in the issuer), as if the issuer were a covered fund.273 Like the 2020 proposal, a banking entity that relies on the exclusion may not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the issuer.274 Finally, like the 2020 proposal, the final rule requires a banking entity’s ownership interest in or relationship with a qualifying venture capital fund to: • Comply with the limitations imposed in § ll.15 of the implementing regulations, as if the issuer were a covered fund; and • Be conducted in compliance with and subject to applicable banking laws and regulations, including applicable safety and soundness standards.275 The agencies believe the exclusion for qualifying venture capital funds will support capital formation, job creation, and economic growth, particularly with respect to small businesses and start-up companies. These banking entity investments in qualifying venture capital funds can benefit the broader financial system by improving the flow of financing to small businesses and start-ups. The agencies expect that the new exclusion for qualifying venture capital funds will provide banking entities with an additional avenue for providing funding to smaller businesses, which can help to support job creation and economic growth. As described further below, the requirements of the exclusion, including the SEC’s definition of venture capital fund in Rule 203(l)–1, address the concerns the agencies expressed in the preamble to the 2013 rule that the activities and risk profiles of venture capital funds are not readily distinguishable from those of funds that section 13 of the BHC Act was intended to capture. Accordingly, the agencies determined these requirements will give effect to the language and purpose of section 13 of the BHC Act without allowing banking entities to evade the requirements of section 13. An exclusion for qualifying venture capital funds is permitted by the statutory language of section 13 of the BHC Act. As the agencies discussed in the preamble to the 2013 final rule, the language, structure, and purpose of section 13 of the BHC Act authorize the agencies to adopt a tailored definition of ‘‘covered fund’’ that focuses on vehicles used for purposes that were the target of the funds prohibition.276 The agencies do not believe the fact that Congress expressly distinguished venture capital funds from other types of private funds in other contexts is dispositive. In this context, the agencies do not believe that the differences in how the terms private equity fund and venture capital fund are used in the Dodd-Frank Act prohibit this exclusion. Rather, the text of section 619 and the Dodd-Frank Act as a whole indicate that venture capital funds were not the intended target of the funds prohibition. The plain language of the statutory prohibition applies to hedge funds and private equity funds.277 This language is silent with respect to venture capital funds. In Title IV of the Dodd-Frank Act, Congress mandated specific treatment for venture capital funds for purposes of the registration requirements under the Investment Advisers Act of 1940 (‘‘Advisers Act’’).278 This provision suggests that Congress knew how to accord specific treatment for venture capital funds. Yet, Congress did not list venture capital funds among the types of funds that were restricted under rule § ll.10(c)(16)(i). rule § ll.10(c)(16)(ii). 274 Final rule § ll.10(c)(16)(iii). 275 Final rule § ll.10(c)(16)(iv). 272 Final 273 Final VerDate Sep<11>2014 20:59 Jul 30, 2020 276 79 FR 5671. U.S.C. 1851(a)(1)(B). 278 15 U.S.C. 80b–3(l). 277 12 Jkt 250001 PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 section 13.279 That Congress did not intend to prohibit venture capital fund investments is further supported by the legislative history of section 13, in which several Members of Congress specifically addressed venture capital funds in the context of the funds prohibition.280 Like the 2020 proposal, the final rule incorporates the definition of venture capital fund from Rule 203(l)–1. Most commenters accepted or supported the proposed approach to incorporate the definition of venture capital fund in Rule 203(l)–1.281 For the reasons discussed in the 2020 proposal,282 the agencies believe this definition 279 In the preamble to the 2013 final rule, the agencies cited to Congressional reports related to Title IV that characterized venture capital funds as ‘‘a subset of private investment funds specializing in long-term equity investment in small or start-up businesses.’’ 79 FR 5704 (quoting S. Rep. No. 111– 176 (2010)). However, there is no indication in the statutory text itself that Congress intended to treat venture capital funds identically to private equity funds. Moreover, the agencies did not address the difference in terminology that Congress used in section 402 of the Dodd-Frank Act (‘‘private funds’’) and section 619 (‘‘hedge funds’’ and ‘‘private equity funds’’). The difference between these two terms— specifically, the broader term ‘‘private funds’’ used in Title IV—may indicate why Congress found it necessary to exclude venture capital explicitly in section 407 but not in section 619. 280 See 156 Cong. Rec. E1295 (daily ed. July 13, 2010) (statement of Rep. Eshoo) (‘‘the purpose of the Volcker Rule is to eliminate risk-taking activities by banks and their affiliates while at the same time preserving safe, sound investment activities that serve the public interest . . . Venture capital funds do not pose the same risk to the health of the financial system. They promote the public interest by funding growing companies critical to spurring innovation, job creation, and economic competitiveness. I expect the regulators to use the broad authority in the Volcker Rule wisely and clarify that funds . . . such as venture capital funds, are not captured under the Volcker Rule and fall outside the definition of ‘private equity.’ ’’); 156 Cong. Rec. S5905 (daily ed. July 15, 2010) (statement of Sen. Dodd) (confirming ‘‘the purpose of the Volcker rule is to eliminate excessive risk taking activities by banks and their affiliates while at the same time preserving safe, sound investment activities that serve the public interest’’ and stating ‘‘properly conducted venture capital investment will not cause the harms at which the Volcker rule is directed. In the event that properly conducted venture capital investment is excessively restricted by the provisions of section 619, I would expect the appropriate Federal regulators to exempt it using their authority under section 619[d][1](J) . . .’’); and 156 Cong. Rec. S6242 (daily ed. July 26, 2010) (statement of Sen. Scott Brown) (‘‘One other area of remaining uncertainty that has been left to the regulators is the treatment of bank investments in venture capital funds. Regulators should carefully consider whether banks that focus overwhelmingly on lending to and investing in start-up technology companies should be captured by one-size-fits-all restrictions under the Volcker rule. I believe they should not be. Venture capital investments help entrepreneurs get the financing they need to create new jobs. Unfairly restricting this type of capital formation is the last thing we should be doing in this economy.’’). 281 SIFMA; NVCA; FSF; ABA; and Goldman Sachs. 282 85 FR 12135–12136. E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations accurately identifies venture capital funds and addresses the concerns the agencies identified in declining to adopt an exclusion for venture capital funds in the 2013 rule. The SEC has defined ‘‘venture capital fund’’ as any private fund 283 that: • Represents to investors and potential investors that it pursues a venture capital strategy; • Immediately after the acquisition of any asset, other than qualifying investments or short-term holdings, holds no more than 20 percent of the amount of the fund’s aggregate capital contributions and uncalled committed capital in assets (other than short-term holdings) that are not qualifying investments, valued at cost or fair value, consistently applied by the fund; • Does not borrow, issue debt obligations, provide guarantees or otherwise incur leverage, in excess of 15 percent of the private fund’s aggregate capital contributions and uncalled committed capital, and any such borrowing, indebtedness, guarantee or leverage is for a non-renewable term of no longer than 120 calendar days, except that any guarantee by the private fund of a qualifying portfolio company’s obligations up to the amount of the value of the private fund’s investment in the qualifying portfolio company is not subject to the 120 calendar day limit; • Only issues securities the terms of which do not provide a holder with any right, except in extraordinary circumstances, to withdraw, redeem or require the repurchase of such securities but may entitle holders to receive distributions made to all holders pro rata; and • Is not registered under section 8 of the Investment Company Act, and has not elected to be treated as a business development company pursuant to section 54 of that Act.284 ‘‘Qualifying investment’’ is defined in the SEC’s regulation to be: (1) An equity security issued by a qualifying portfolio company that has been acquired directly by the private fund from the qualifying portfolio company; (2) any equity security issued by a qualifying portfolio company in exchange for an equity security issued by the qualifying portfolio company described in (1); or (3) any equity security issued by a company of which a qualifying portfolio company is a majority-owned subsidiary, as defined in section 2(a)(24) of the Investment Company Act, or a 283 For purposes of 17 CFR 275.203(l)–1, ‘‘private fund’’ is defined as ‘‘an issuer that would be an investment company, as defined in section 3 of the Investment Company Act, but for section 3(c)(1) or 3(c)(7) of that Act.’’ 15 U.S.C. 80b–2(a)(29). 284 17 CFR 275.203(l)–1(a). VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 predecessor, and is acquired by the private fund in exchange for an equity security described in (1) or (2).285 ‘‘Qualifying portfolio company,’’ in turn, is defined in the SEC’s regulation to be a company that: (1) At the time of any investment by the private fund, is not reporting or foreign traded and does not control, is not controlled by or under common control with another company, directly or indirectly, that is reporting or foreign traded; (2) does not borrow or issue debt obligations in connection with the private fund’s investment in such company and distribute to the private fund the proceeds of such borrowing or issuance in exchange for the private fund’s investment; and (3) is not an investment company, a private fund, an issuer that would be an investment company but for the exemption provided by 17 CFR 270.3a–7, or a commodity pool.286 The SEC explained that the definitions of ‘‘qualifying investment’’ and ‘‘qualifying portfolio company’’ reflect the typical characteristics of investments made by venture capital funds and that these definitions work together to cabin the definition of venture capital fund to only the funds that Congress understood to be venture capital funds during the passage of the Dodd-Frank Act.287 In the preamble to the regulation adopting this definition of venture capital fund, the SEC explained that the definition’s criteria distinguish venture capital funds from other types of funds, including private equity funds and hedge funds. For example, the SEC explained that it understood the criteria for ‘‘qualifying portfolio companies’’ to be characteristic of issuers of portfolio securities held by venture capital funds and, taken together, would operate to exclude most private equity funds and hedge funds from the venture capital fund definition.288 The SEC also explained that the criteria for ‘‘qualifying investments’’ under the SEC’s regulation would help to differentiate venture capital funds from other types of private funds, such as leveraged buyout funds.289 The SEC further explained that its regulation’s restriction on the amount of borrowing, CFR 275.203(l)–1(c)(3). CFR 275.203(l)–1(c)(4). 287 See Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers, 76 FR 39646, 39657 (Jul. 6, 2011). 288 76 FR 39656. 289 See, e.g., 76 FR 39653 (explaining that a limitation on secondary market purchases of a qualifying portfolio company’s shares would recognize ‘‘the critical role this condition played in differentiating venture capital funds from other types of private funds’’). PO 00000 285 17 286 17 Frm 00025 Fmt 4701 Sfmt 4700 46445 debt obligations, guarantees or other incurrence of leverage was appropriate to differentiate venture capital funds from other types of private funds that may engage in trading strategies that use financial leverage and may contribute to systemic risk.290 This definition of venture capital fund helps to distinguish the investment activities of venture capital funds from those of hedge funds and private equity funds, which was one of the agencies’ primary concerns in declining to adopt an exclusion for venture capital funds in the 2013 rule. Further, this definition includes criteria reflecting the characteristics of venture capital funds that the agencies believe may pose less potential risk to a banking entity sponsoring or investing in venture capital funds and to the financial system—specifically, the smaller role of leverage financing and a lesser degree of interconnectedness with the public markets.291 These characteristics help to address the concern expressed in the preamble to the 2013 rule that the activities and risk profiles for banking entities regarding sponsorship of, and investment in, venture capital fund activities are not readily distinguishable from those funds that section 13 of the BHC Act was intended to capture. One commenter said requiring that a fund satisfy the requirements of Rule 203(l)–1 would have the effect of making the exclusion too narrow. This commenter said the exclusion for qualifying venture capital funds should permit investments in EGCs and, more generally, should ‘‘reflect the evolving nature of the venture capital industry and not rely solely on the existing SEC definition.’’ 292 The final rule does not modify the requirement that a qualifying venture capital fund must satisfy the requirements of Rule 203(l)–1. These requirements focus the exclusion on the types of less mature and start-up portfolio companies that characterize traditional venture capital activities. At the same time, the definition of qualifying venture capital fund does not preclude investments in EGCs because a qualifying venture capital fund could make investments in EGCs within the 20 percent limit for non-qualifying investments. Because the requirement that a qualifying venture capital fund 290 76 FR 39662. See also 76 FR 39657 (‘‘We proposed these elements of the qualifying portfolio company definition because of the focus on leverage in the Dodd-Frank Act as a potential contributor to systemic risk as discussed by the Senate Committee report, and the testimony before Congress that stressed the lack of leverage in venture capital investing.’’). 291 76 FR 39662. 292 CCMC. E:\FR\FM\31JYR4.SGM 31JYR4 46446 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations must satisfy the requirements of Rule 203(l)–1 does not preclude investments in EGCs and helps to distinguish qualifying venture capital funds from the type of funds that section 13 of the BHC Act was intended to restrict, the agencies have determined to adopt the requirement that a qualifying venture capital fund must be a venture capital fund as defined in Rule 203(l)–1. The final rule adopts the requirement that a qualifying venture capital fund may not engage in any activity that would constitute proprietary trading under § ll.3(b)(1)(i), as if the issuer were a banking entity.293 As described in the 2020 proposal, this requirement helps to promote the specific purposes of section 13 of the BHC Act.294 The agencies are not adopting any changes to this requirement, as recommended by some commenters. The agencies are not expressly incorporating the permitted activities in §§ ll.4, ll.5, and ll.6 of the implementing regulations into the text of the qualifying venture capital fund exclusion. The exclusion for qualifying venture capital funds is intended to allow banking entities to share the risks of otherwise permissible long-term venture capital activities. Accordingly, the agencies would not expect that a qualifying venture capital fund would be formed for the purpose of engaging, or in the ordinary course would be engaged, in the activities permitted under §§ ll.4, ll.5, and ll.6 of the implementing regulations. Moreover, such activities could reflect a purpose other than making long-term venture capital investments. Nevertheless, to the extent that a qualifying venture capital fund seeks to engage in any of those activities as an exemption from the prohibition on engaging in proprietary trading, as defined in § ll.3(b)(1)(i) of the final rule, and does so in compliance with the requirements and conditions of those permitted activities, then the final rule would not preclude such activities.295 Similarly, with respect to rule § ll.10(c)(16)(i)(B). FR 12136. 295 As the agencies noted in the discussion of the final credit fund exclusion, compliance with certain requirements and conditions in ll.4, ll.5, and ll.6 of the implementing regulations may be inapt and/or highly impractical in the context of a qualifying venture capital fund, particularly given the activity restrictions contained in § ll.10(c)(16). For example, the exemptions for underwriting and market making-related activities in ll.4 require that a banking entity relying on such exemptions, among other things, be licensed or registered to engage in the applicable activity in accordance with applicable law. Moreover, to the extent that a qualifying venture capital fund is a banking entity with significant trading assets and liabilities (i.e., because it, together with its affiliates and subsidiaries, has trading assets and liabilities 293 Final 294 85 VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 the exclusions from the definition of proprietary trading in § ll.3(d) of the implementing regulations, the agencies note that that the trading activities identified in § ll.3(d) are by definition not deemed to be proprietary trading, such that the performance by an qualifying fund of those activities would not be inconsistent with the final qualifying venture capital fund exclusion.296 The final rule does not define proprietary trading by reference to the prong of paragraph ll.3(b)(1) that would apply to the banking entity, as recommended by some commenters, because the agencies do not believe this change would be effective or simplify the exclusion. Unlike some banking entities, venture capital funds (that are not themselves banking entities) are not subject to the market risk capital rule, and thus there is generally no need to evaluate a venture capital fund’s investments under the market risk capital framework. Moreover, applying the prong that would apply to the relevant banking entity could result in one venture capital fund becoming subject to both prongs. The agencies believe this would complicate evaluation of a qualifying venture capital fund’s eligibility for the exclusion, both for banking entities and the agencies. The agencies do not agree with one commenter’s argument that requiring funds sponsored by banking entities that are subject to the market risk capital rule test to apply the shortterm intent test for purposes of the covered funds provisions would introduce unnecessary complexity and compliance costs for these banking entities. As the agencies described in the preamble to the 2019 final rule, the Federal banking agencies’ market risk capital rule 297 incorporates the same short-term intent standard as the shortterm intent test in § ll.3(b)(1)(i).298 Therefore, market risk capital rule covered banking entities continue to apply the short-term intent standard as part of their compliance with the market risk capital rule. Similar processes may be employed to apply the short-term intent standard to qualifying venture capital funds. that equal or exceeds $20 billion over the four previous calendar quarters), it also would be required to maintain a separate compliance program specific to those exemptions. 296 Similarly, and consistent with the discussion of the final credit fund exclusion, trading activity that satisfies the 60-day rebuttable presumption in § ll.3(b)(4) would be presumed not to be proprietary trading for these purposes. 297 See 12 CFR part 3, subpart F; part 217, subpart F; part 324, subpart F. 298 84 FR 61986. PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 The final rule adopts the requirement that a banking entity that serves as a sponsor, investment adviser, or commodity trading advisor to a qualifying venture capital fund may not rely on the exclusion for qualifying venture capital funds unless it provides the disclosures required under § ll.11(a)(8) to prospective and actual investors in the fund. This requirement promotes one of the purposes of section 13 of the BHC Act, which is to prevent banking entities from bailing out funds that they sponsor or advise. The final rule also adopts the requirement that a banking entity that serves as a sponsor, investment adviser, or commodity trading advisor to a qualifying venture capital fund must ensure the activities of the qualifying venture capital fund are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activity directly. Therefore, a banking entity may not rely on this exclusion to sponsor or invest in an investment fund that exposes the banking entity to the type of high-risk trading and investment activities that the covered fund provisions of section 13 of the BHC Act were intended to restrict. In the final rule, the requirement that the banking entity must comply with § ll.14 of the implementing regulations is moved to § ll.10(c)(16)(ii). This change clarifies that this requirement applies to a banking entity that acts as sponsor, investment adviser, or commodity trading adviser to the qualifying venture capital fund and does not apply to a banking entity that merely invests in a qualifying venture capital fund. The final rule does not eliminate the requirement that a banking entity’s investment in or relationship with a qualifying venture capital fund must comply with § ll.14 of the implementing regulations, as recommended by one commenter. The agencies do not agree that applying the requirements of § ll.14 is duplicative of the requirement that the banking entity not directly or indirectly guarantee, assume, or otherwise insure the obligations or performance of the issuer. In addition to prohibiting guarantees, § ll.14 also prohibits other types of transactions that function as extensions of credit or that could raise the type of bail-out concerns that section 13 of the BHC Act was intended to address. The agencies also do not agree that applying the requirements of § ll.14 is duplicative of the requirement that the banking entity’s investment in and relationships with E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations the qualifying venture capital fund must comply with the backstop provisions in § ll.15. The backstop provisions in § ll.15 address high-risk assets and high-risk trading strategies, and material conflicts of interest, but do not address extensions of credit that may not entail a ‘‘substantial financial loss’’ to the banking entity. The agencies do not expect that applying § ll.14 to a banking entity that sponsors or advises a qualifying venture capital fund will unduly interfere with the effectiveness of the exclusion. The final rule incorporates revisions to § ll.14 that will improve banking entities’ ability to enter into certain ordinary course transactions with sponsored and advised funds.299 The agencies expect these changes will mitigate concerns that applying the requirements of § ll.14 to qualifying venture capital funds will limit the exclusion’s utility.300 The final rule adopts the requirement that the banking entity must not guarantee, assume, or otherwise insure the obligations or performance of a qualifying venture capital fund.301 The final rule also adopts the requirements that a banking entity’s ownership in or relationship with a qualifying venture capital fund must comply with the limitations in § ll.15 of the implementing regulations, as if the issuer were a covered fund, and be conducted in compliance with, and subject to, applicable banking laws and regulations, including applicable safety and soundness standards.302 These requirements promote several of the purposes of section 13 of the BHC Act. The requirement that the banking entity not guarantee, assume, or otherwise ensure the obligations or performance of a qualifying venture capital fund promotes the purpose of preventing banking entities from bailing out the fund. The requirements that a banking entity’s ownership in or relationship with a qualifying venture capital fund must comply with the limitations in § ll.15 of the implementing regulations, as if the issuer were a covered fund, and be conducted in compliance with, and subject to, 299 See infra, Section IV.D (Limitations on Relationships with a Covered Fund). 300 The commenter that recommended eliminating the requirement that the banking entity’s investment in or relationship with a qualifying venture capital fund said that doing so would ‘‘limit the utility and related benefits of the qualifying venture capital fund exclusion, regardless of the proposed new exceptions to Super 23A.’’ SIFMA. However, the commenter did not provide any examples or further explain how the utility of the exclusion would be impacted. 301 Final rule § ll.10(c)(16)(iii). 302 Final rule § ll.10(c)(16)(iv). VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 applicable banking laws and regulations, including applicable safety and soundness standards, prevent a qualifying venture capital fund from being used to expose a banking entity to the type of high-risk trading and investment activities that the covered fund provisions of section 13 of the BHC Act were intended to restrict. To the extent a fund would expose a banking entity to a high-risk assets or a high-risk trading strategy, the fund would not be a qualifying venture capital fund. Therefore, prior to making an investment in a qualifying venture capital fund, a banking entity would need to ensure that the fund’s investment mandate and strategy would satisfy the requirements of § ll.15. In addition, a banking entity would need to monitor the activities of a qualifying venture capital fund to ensure it satisfies these requirements on an ongoing basis. The agencies do not believe that any additional conditions to the exclusion for qualifying venture capital funds are necessary. One commenter said that the exclusion should (1) restrict all fund investments to ‘‘qualifying investments’’ or at least very significantly restrict investments in non-qualifying investments (e.g., limit them to no more than five percent of the fund’s aggregate capital), (2) impose a minimum securities holding period and portfolio company revenue limitation of $35 million (or a similarly appropriate and low figure) to ensure the fund is truly focused on medium-to-long term venture (as opposed to growth stage) investments, and (3) quantitatively limit the use of leverage as a key means for distinguishing excluded venture capital funds from statutorily prohibited activities involving private equity funds.303 The agencies have determined not to impose any additional criteria for the reasons discussed below. First, the agencies decline to limit a qualifying venture capital fund’s nonqualifying investments to five percent or less of total assets. The agencies agree with commenters that it is necessary to provide some amount of flexibility for a venture capital fund to make investments that deviate from the typical form of venture capital investment activity. For example, the agencies understand that certain common venture capital fund activities, such as secondary acquisition of portfolio company shares from founders, are not qualifying investments under Rule 203(l)–1. The agencies agree with commenters, as well as with the rationale the SEC provided in the 2011 PO 00000 303 Better Markets. Frm 00027 Fmt 4701 Sfmt 4700 46447 adopting release, that said providing flexibility for this type of non-qualifying investment is consistent with the overall goal of identifying funds engaged in a venture capital strategy. In making this determination, the agencies find it significant that the SEC considered this issue as part of its 2011 rulemaking and concluded that a 20 percent bucket for non-qualifying investments was appropriate.304 Moreover, all activities of a qualifying venture capital fund, including any investments that would be non-qualifying investments under Rule 203(l)–1, will be subject to the other requirements in § ll.10(c)(16), including the requirement that the fund not engage in proprietary trading and not result in a material exposure by the banking entity to a high-risk asset or high-risk trading strategy. The agencies also decline to impose additional requirements, such as a minimum securities holding period or a portfolio company revenue limitation. The agencies believe a minimum securities holding period is unnecessary in light of the requirements that the fund (1) represent to investors and potential investors that it pursues a venture capital strategy 305 and (2) not engage in any activity that would constitute proprietary trading under § ll.3(b)(1)(i), as if it were a banking entity.306 The agencies also considered whether to include a portfolio company revenue limitation, as discussed in the preamble to the 2020 proposal. Most commenters did not support imposing a revenue limitation, while one commenter supported imposing a limitation of $35 million. After considering all comments received, the agencies determined that a revenue limit could unnecessarily disadvantage certain companies because the revenues of startups can vary greatly based on industry and geography. The agencies determined it would be unnecessarily restrictive to create a revenue limit that could limit funding to otherwise eligible portfolio companies. Again, the agencies found it significant that the SEC expressly considered this issue as part of the 2011 rulemaking and determined that any ‘‘single factor test could ignore the complexities of doing business in different industries or regions’’ and ‘‘could inadvertently restrict venture capital funds from funding otherwise promising young small companies.’’ 307 In addition, the definition of ‘‘qualifying portfolio company’’ in the SEC’s rule 304 76 FR 39683. CFR 275.203(l)–(1)(a)(1). 306 Final rule § ll.10(c)(16)(i)(B). 307 76 FR 39649. 305 17 E:\FR\FM\31JYR4.SGM 31JYR4 46448 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations incorporates appropriate standards that distinguish newer ventures from more established companies. In particular, a ‘‘qualifying portfolio company’’ may not be ‘‘reporting or foreign traded’’ and may not control, be controlled by or under common control with another company that is reporting or foreign traded.308 A ‘‘reporting or foreign traded’’ company for these purposes means a company that is subject to the reporting requirements under section 13 or 15(d) of the Securities Exchange Act of 1934 or having a security listed or traded on any exchange or organized market operating in a foreign jurisdiction.309 In addition to publicly offered companies, this definition excludes issuers if they have more than $10 million in total assets and a class of equity securities, such as common stock, that is held of record by either 2,000 or more persons or 500 or more persons who are not accredited investors.310 In adopting the ‘‘reporting or foreign traded’’ requirement of Rule 203(l)–1, the SEC explained that it found ‘‘a key consideration by Congress’’ was that venture capital funds ‘‘are less connected with the public markets and may involve less potential systemic risk.’’ 311 This condition that qualifying portfolio companies not be capitalized by the public markets serves to limit the type of companies in which a qualifying venture capital fund may invest. Finally, the agencies determined it is unnecessary to include an additional quantitative limit on the use of leverage because the exclusion incorporates a leverage limit. Specifically, Rule 203(l)– 1 provides that a venture capital fund may not borrow or otherwise incur leverage in excess of 15 percent of the fund’s aggregate capital contributions and uncalled capital commitments, and then only on a short-term basis. Because the exclusion already incorporates a limit on leverage for a qualifying venture capital fund, it is not necessary for the final rule to incorporate an additional limit on leverage. ii. Long-Term Investment Funds In the preamble to the 2020 proposal, the agencies asked whether the final rule should include an exclusion for long-term investment funds. In the preamble, the agencies asked if an exclusion should be provided for issuers (1) that make long-term investments that a banking entity could make directly, (2) that hold themselves out as entities or 308 17 CFR 275.203(l)–1(c)(4). CFR 275.203(l)–1(c)(5). 310 15 U.S.C. 78l(g). 311 76 FR 39656. 309 17 VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 arrangements that make investments that they intend to hold for a set minimum time period, such as two years, (3) whose relevant offering and governing documents reflect a long-term investment strategy, and (4) that meet all other requirements of the proposed qualifying venture capital fund exclusion (other than that the issuers would be venture capital funds as defined in Rule 203(l)–1. Several commenters supported an exclusion for long-term investment funds.312 Many of these commenters said an exclusion for qualifying longterm investment funds would help to close gaps in the availability of financing that exist under the implementing regulations while promoting and protecting the safety and soundness of the banking entity and the financial stability of the U.S.313 These commenters said the exclusion would allow banking entities to diversify their assets and income streams, thereby reducing the overall risk of their assets and operations and increasing their resiliency against failure.314 Several of these commenters supported an exclusion for long-term investment funds because they said it would allow banking entities to do indirectly through a fund structure the same activities they may conduct directly.315 Some 312 Gonzalez et al.; Crapo; FSF; SIFMA; CCMC; CCMR; IIB; Goldman Sachs; AIC; and ABA. One commenter said the final rule should exclude an issuer with the following characteristics: (1) Its investment strategy or business purpose is to invest in assets in which a financial holding company would be permitted to invest directly; (2) it holds itself out to investors as acquiring and holding longterm assets for at least two years; (3) it does not engage in activities that would constitute impermissible proprietary trading (as defined in the implementing regulations) if conducted directly by a banking entity; and (4) if it is sponsored by a banking entity, (A) the sponsoring banking entity and its affiliates cannot, directly or indirectly, guarantee, assume or otherwise insure its obligations, (B) it must comply with the disclosure obligations under § ll.11(a)(8) of the rule and (C) the sponsoring banking entity must comply with the limitations imposed by § ll.14 (except that the banking entity may acquire and retain any ownership interest in the issuer) and § ll.15, as if the vehicle were a covered fund. The commenter said these conditions would adequately address concerns regarding evasion, promote long-term capital formation, and exclude certain entities that are inadvertently captured by the definition of ‘‘covered fund’’ such as certain incubators. Goldman Sachs. 313 SIFMA; AIC; and CCMR. One commenter said an exclusion for long-term investment funds is necessary because the proposed exclusion for qualifying venture capital funds would not address incubators and other issuers that do not hold themselves out as pursuing a venture capital strategy. Goldman Sachs. Two commenters said excluding long-term investment funds would provide certainty for banking entities that hold interests in ‘‘inadvertent’’ or ‘‘accidental’’ investment companies. SIFMA and Goldman Sachs. 314 Id. 315 FSF; CCMR; AIC; CCMC; and SIFMA. PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 commenters said long-term investment vehicles do not engage in short-term proprietary trading or the high-risk activities that section 619’s backstop provisions are intended to address.316 One commenter said the rule should not establish an exclusion for long-term investment vehicles because section 619 of the Dodd-Frank Act was put in place to reorient banks away from risky speculative activities and toward responsible lending to businesses and households.317 The final rule does not include an exclusion for long-term investment funds. After reviewing all comments received, the agencies determined that it remains difficult to distinguish effectively such funds from the type of funds that section 13 of the BHC Act was designed to restrict. A general exclusion for long-term investment funds would be too broad of an approach for addressing specific types of issuers, such as inadvertent investment companies and incubators that do not hold themselves out as engaging in a venture capital strategy, as described by some commenters. An exclusion based primarily on the length of time that an issuer holds its investments could be overbroad because it could also permit funds that are engaged in the type of investment activity that section 13 of the BHC Act was designed to restrict. Moreover, the agencies believe the exclusions for credit funds and qualifying venture capital funds will improve banking entities’ ability to provide long-term financing through certain fund structures in a manner that is consistent with the statute. 3. Family Wealth Management Vehicles The agencies are adopting an exclusion from the definition of ‘‘covered fund’’ under § ll.10(b) of the rule for any entity that acts as a ‘‘family wealth management vehicle.’’ This exclusion is available to an entity that 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. For family wealth management vehicles that are trusts, the grantor(s) must be family customers.318 For non-trust family 316 ABA and CCMC. Rutowski. 318 Under § ll.10(c)(17)(iii)(B) of the final rule, a ‘‘family customer’’ is a ‘‘family client,’’ as defined in Rule 202(a)(11)(G)–1(d)(4) of the Advisers Act (17 CFR 275.202(a)(11)(G)–1(d)(4)); or any natural person who is a father-in-law, mother-in-law, brother-in-law, sister-in-law, son-in-law or daughter-in-law of a family client, or a spouse or 317 Robert E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations wealth management vehicles, family customers must own a majority of the voting interests (directly or indirectly) as well as a majority of interests in the entity. Ownership of non-trust family wealth management vehicles is generally limited to family customers and up to five closely related persons of the family customers.319 However, there is a de minimis ownership allowance that permits one or more entities, including a banking entity, that are not family customers or closely related persons, to acquire or retain, as principal, up to an aggregate 0.5 percent of the family wealth management vehicle’s outstanding ownership interests for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns.320 In addition, a banking entity may rely on the exclusion only if the banking entity: (1) Provides bona fide trust, fiduciary, investment advisory, or commodity trading advisory services to the entity; (2) does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such entity; (3) complies with the disclosure obligations under § ll.11(a)(8), as if such entity were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the entity; (4) does not acquire or retain, as principal, an ownership interest in the entity, other than up to an aggregate 0.5 percent of the family wealth management vehicle’s outstanding ownership interests for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns; (5) complies with the requirements of §§ ll.14(b) and ll.15, as if such entity were a covered fund; and (6) except for riskless principal transactions as defined in § ll.10(d)(11),321 complies with the spousal equivalent of any of the foregoing. All terms defined in Rule 202(a)(11)(G)–1 of the Advisers Act (17 CFR 275.202(a)(11)(G)–1) have the same meaning in the family wealth management vehicle exclusion. 319 Under § ll.10(c)(17)(iii)(A) of the final rule, ‘‘closely related person’’ means ‘‘a natural person (including the estate and estate planning vehicles of such person) who has longstanding business or personal relationships with any family customer.’’ 320 This 0.5 percent ownership interest represents the aggregate amount of a family wealth management vehicle’s ownership interests that may be acquired or retained by all entities that are neither a family customer nor a closely related person. 321 ‘‘Riskless principal transaction’’ means a transaction in which a banking entity, after VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the entity were an affiliate thereof.322 In the 2020 proposal, the agencies requested comment on whether to exclude family wealth management vehicles from the definition of ‘‘covered fund.’’ 323 Several commenters supported this exclusion stating, generally, that it would reduce uncertainty for banking entities about the permissibility of providing traditional banking, investment management, and trust and estate planning services to family wealth management vehicle clients.324 As discussed below, other commenters opposed the exclusion or recommended revisions to it.325 The agencies believe that the exclusion for family wealth management vehicles will appropriately allow banking entities to structure services or transactions for customers, or to otherwise provide traditional customer-facing banking and asset management services, through a vehicle, even though such a vehicle may rely on section 3(c)(1) or 3(c)(7) of the Investment Company Act or would otherwise be a covered fund under the implementing regulations.326 The agencies believe the exclusion for family wealth management vehicles will effectively tailor the definition of covered fund by permitting banking entities to continue to provide traditional banking and asset management services that do not involve the types of risks section 13 of the BHC Act was designed to address. As the agencies noted in the preamble to the 2013 rule, section 13 and the implementing regulations were designed in part to permit banking entities to continue to provide clientreceiving an order to buy (or sell) a security from a customer, purchases (or sells) the security in the secondary market for its own account to offset a contemporaneous sale to (or purchase from) the customer. Final rule § ll.10(d)(11). The allowance for riskless principal transactions in the final rule does not affect the independent application of the Board’s Regulation W (12 CFR part 223). 322 Final rule § ll.10(c)(17)(ii). 323 85 FR 12120. 324 See, e.g., Goldman Sachs; FSF; CCMR; IAA; ABA; BPI; PNC; and SIFMA. 325 See, e.g., Better Markets, Data Boiler; SIFMA; BPI; ABA. 326 Several commenters supported the exclusion, with two stating that many family wealth management vehicles do not rely on the exclusions in 3(c)(1) and (c)(7) of the Investment Company Act and are not covered funds under the implementing regulations. See ABA and PNC. Banking entities that sponsor or invest in family wealth management vehicles that are not subject to the covered funds provisions under section 13 of the BHC Act or the implementing regulations would not need to rely on this exclusion. PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 46449 oriented financial services, including asset management services.327 Furthermore, the agencies believe that the provisions of the exclusion will work together to sufficiently reduce the likelihood that these vehicles could be used to evade the requirements of section 13 or the implementing regulations. One of the commenters that opposed the exclusion expressed concern with the agencies adding an exclusion from the definition of ‘‘covered fund’’ that they believed would only benefit a few wealthy families.328 Banking entities may provide asset management services to families through a trust structure. The agencies believe that banking entities should have flexibility to offer such asset management services to families through a fund structure subject to appropriate limits. As noted above, the agencies believe the exclusion for family wealth management vehicles will effectively tailor the definition of covered fund by permitting banking entities to continue to provide traditional banking and asset management services that do not involve the types of risks section 13 was designed to address. The agencies continue to believe that the exclusion for family wealth management vehicles is consistent with section 13(d)(1)(D), which permits banking entities to engage in transactions on behalf of customers, when those transactions would otherwise be prohibited under section 13.329 The exclusion will similarly allow banking entities to provide traditional services to customers through vehicles used to manage the wealth and other assets of those customers and their families. Another commenter suggested that, rather than providing an exclusion for family wealth management vehicles through a rulemaking, the agencies should instead provide no-action relief on a case-by-case basis.330 The agencies do not believe that a case-by case approach would further the aims of section 13 or the implementing regulations. The agencies believe that a case-by-case approach would be 327 See 79 FR 5541 (describing the 2013 rule as ‘‘permitting banking entities to continue to provide, and to manage and limit the risks associated with providing, client-oriented financial services that are critical to capital generation for businesses of all sizes, households and individuals, and that facilitate liquid markets. These 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.’’). 328 See Better Markets. 329 12 U.S.C. 1851(d)(1)(D). 330 Data Boiler. E:\FR\FM\31JYR4.SGM 31JYR4 46450 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations unnecessarily burdensome and difficult to administer. This approach would also unnecessarily deviate from the agencies’ treatment of other excluded entities under the implementing regulations and hinder transparency and consistency. The agencies believe that the adopted exclusion for a family wealth management vehicle will appropriately distinguish it from the type of entity that the covered funds provisions of section 13 of the BHC Act were intended to capture. The exclusion requires that a family wealth management vehicle not raise money from investors primarily for the purpose of investing in securities for resale or other disposition or otherwise trading in securities. This aspect of the exclusion will help to differentiate family wealth management vehicles from covered funds, which raise money from investors for this purpose. In addition, the family wealth management vehicle exclusion contains ownership limits designed to ensure that the vehicle is used to manage the wealth and other assets of customers and their families. One such limit is the definition of ‘‘family customer.’’ As proposed, the definition of ‘‘family customer’’ is based on the definition of ‘‘family client’’ in rule 202(a)(11)(G)– 1(d)(4) under the Advisers Act (the family office rule), and also incorporates certain in-laws and their spouses and spousal equivalents. Several commenters supported this approach,331 however, one commenter suggested that the agencies exclude in-laws, their spouses and their spousal equivalents from the definition of ‘‘family customer.’’ 332 The agencies believe that in-laws, their spouses and spousal equivalents share the same close familial relations as others included in the definition of ‘‘family client.’’ Furthermore, the agencies believe that the final rule’s definition of ‘‘family customer’’ reflects the types of relationships typically present in family wealth management vehicles.333 Reflecting those relationships prevents unnecessary constraints on the utility of the exclusion and will allow banking entities to provide traditional banking services to these clients. Another ownership limit designed to ensure that a family wealth management vehicle is used to manage the wealth and other assets of customers and their families is the requirement that a majority of the interests in the entity are owned by family customers.334 The inclusion of this limit in the final rule is a modification from the 2020 proposal which only required family customers to own a majority of the voting interests (directly or indirectly) in the entity. One commenter suggested this modification to ensure that the exclusion is not used to evade the intent of section 13 and the implementing regulations.335 The agencies believe this modification is an appropriate means of ensuring that the exclusion is used by banking entities that are providing services to family wealth management vehicles, rather than to hedge funds or private equity funds. Another commenter suggested additional ownership limits for family wealth management vehicles, including limits on the vehicle’s ability to restructure, to prevent evasion of the prohibitions of section 13 and the implementing regulations.336 However, as discussed above, the agencies believe that the requirements of the exclusion, along with the conditions a banking entity must meet in order to rely on it, will help to ensure that banking entities will not be able to use family wealth management vehicles as a means to evade section 13 and the implementing regulations. Another ownership limit designed to ensure that a family wealth management vehicle is used to manage the wealth and other assets of customers and their families is the requirement that only up to five closely related persons of family customers may hold ownership interests in the vehicle.337 The agencies proposed to permit three closely related persons to hold ownership interests. Several commenters supported allowing a finite number of closely related persons of family customers to hold ownership interests.338 However, some commenters suggested that the proposed limit of three closely related persons did not reflect the typical manner in which family wealth management vehicles are constituted and would unnecessarily constrain the availability of the exclusion.339 These commenters recommended that the agencies modify the proposed rule to allow for up to ten closely related persons to invest in family wealth management vehicles.340 One of these commenters stated that increasing the number of closely related persons would allow banking entities to provide traditional wealth management and estate planning services to family ABA. Data Boiler. 337 Final rule § ll.10(c)(17)(i)(B)(3). 338 See, e.g., BPI; SIFMA; PNC; and ABA. 339 See, e.g., BPI; SIFMA; ABA; and PNC. 340 See, e.g., SIFMA; BPI; ABA; and PNC. 335 See 336 See 331 See, e.g., SIFMA; BPI; and ABA. 332 See Better Markets. 333 See, e.g., SIFMA; BPI; and ABA. 334 Final rule § ll.10(c)(17)(i)(B)(2). VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 PO 00000 wealth management vehicles and that the other conditions imposed by the proposed rule would keep such vehicles from evading the covered fund provisions of the implementing regulations.341 The commenter further noted that a limit of ten closely related persons would align the exclusion with the numerical limitation of unaffiliated owners provided for in the joint venture exclusion.342 The final rule will allow up to five closely related persons to hold ownership interests in a family wealth management vehicle. Commenters indicated that many family wealth management vehicles currently include more than three closely related persons.343 The agencies believe that the final rule will more closely align the exclusion with the current composition of family wealth management vehicles, thereby increasing the utility of the exclusion without allowing such a large number of non-family customer owners to suggest the entity is in reality a hedge fund or private equity fund. Additionally, the agencies believe that requiring family customers to own a majority of the interests in the family wealth management vehicle will serve as an additional safeguard against evasion of the provisions of section 13 of the BHC Act. As proposed, the final rule’s definition of ‘‘closely related person’’ is ‘‘a natural person (including the estate and estate planning vehicles of such person) who has longstanding business or personal relationships with any family customer.’’ 344 One commenter suggested that the definition of ‘‘closely related person’’ should include only persons with personal relationships with family customers and not also business relationships.345 The agencies believe that it is not practical or worthwhile to exclude business relationships from the definition of ‘‘closely related person’’ because it would require banking entities to engage in an assessment of relationships that are likely to include elements common in both personal and business relationships. The agencies also believe that requiring these relationships to be ‘‘longstanding’’ will help ensure that they are bona fide established relationships and not simply related to the planned investment activities through the family wealth management vehicle. Frm 00030 Fmt 4701 Sfmt 4700 341 See SIFMA. SIFMA. 343 See, e.g., BPI; ABA; and PNC. 344 Final rule § ll.10(c)(17)(iii)(A). 345 See, e.g., Better Markets. 342 See E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations In a change to the 2020 proposal, the final rule permits any entity, or entities—not only banking entities—to acquire or retain, as principal, up to an aggregate 0.5 percent of the entity’s outstanding ownership interests, for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns.346 Some commenters requested that the agencies include this modification because often, family wealth management vehicles use unaffiliated third parties—such as thirdparty trustees or similar service providers—when structuring family wealth management vehicles.347 The agencies believe that permitting de minimis ownership by non-banking entity third parties is appropriate and in some cases necessary to reflect the typical structure of family wealth management vehicles. The de minimis ownership provision recognizes that ownership by an entity other than a family customer or closely related person may be necessary under certain circumstances—such as establishing corporate separateness or addressing bankruptcy, insolvency, or similar matters. Whether the entity that owns a de minimis amount is a banking entity or some other third party does not raise any concerns that are not sufficiently addressed by the aggregate ownership limit and the narrow circumstances in which such entities may take an ownership interest. The agencies recognize that without this modification, family wealth management vehicles may be forced to engage in less effective and/or efficient means of structuring and organization because the exclusion would limit the vehicle’s access to some customary service providers that have traditionally taken small ownership interests for structuring purposes. The agencies are therefore expanding the types of entities that may acquire or retain the de minimis ownership interest to include any third party. However, the aggregate de minimis amount and the purpose for which it may be owned is unchanged from the 2020 proposal. As stated above, under the final rule, a banking entity may only rely on the exclusion with respect to a family wealth management vehicle if the banking entity meets certain conditions.348 The agencies believe that, collectively, the conditions of the exclusion will help to ensure that family wealth management vehicles are used for client-oriented financial services rule § ll.10(c)(17)(i)(C). e.g., SIFMA and BPI. 348 Final rule § ll.10(c)(17)(ii). 346 Final 347 See, VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 provided on arms-length, market terms, and to prevent evasion of the requirements of section 13 of the BHC Act and the implementing regulations. In addition, these conditions are based on existing conditions in other provisions of the implementing regulations,349 which the agencies believe will facilitate banking entities’ compliance with the exclusion. As proposed, the agencies are not applying § ll.14(a), which applies section 23A of the Federal Reserve Act to banking entities’ relationships with covered funds, to family wealth management vehicles because the agencies understand that the application of § ll.14(a) to family wealth management vehicles could prohibit banking entities from providing the full range of banking and asset management services to customers using these vehicles.350 The agencies are, however, applying §§ ll.14(b) and ll.15 to family wealth management vehicles, as proposed, because the agencies continue to believe that it will help ensure that banking entities and their affiliates’ exposure to risk remains appropriately limited. The agencies are also adopting a prohibition, with modifications described below, on banking entity purchases of low-quality assets from family wealth management vehicles that would be prohibited under Regulation W concerning transactions with affiliates (12 CFR 223.15(a))—as if such banking entity were a member bank and the entity were an affiliate thereof—to prevent banking entities from ‘‘bailing out’’ family wealth management vehicles.351 Regulation W (12 CFR 349 See implementing regulations §§ ll.11(a)(5) (imposing, as a condition of the exemption for organizing and offering a covered fund, that a 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); ll.11(a)(8) (imposing, as a condition of the exemption for organizing and offering a covered fund, that the banking entity provide certain disclosures to any prospective and actual investor in the covered fund); ll.10(c)(2)(ii) (allowing, as a condition of the exclusion from the covered fund definition for wholly-owned subsidiaries, for the holding of up to 0.5 percent of outstanding ownership interests by a third party for limited purposes); and ll.14(b) (subjecting certain transactions with covered funds to section 23B of the Federal Reserve Act). 350 See SIFMA (stating that it agreed with the agencies’ approach of not applying § ll.14 to relationships between banking entities and family wealth management vehicles because doing so would prevent banking entities from making ordinary extensions of credit and entering into a number of other transactions with family wealth management vehicles that are critical to the banking entity providing traditional asset management and estate planning services). 351 Final rule § ll.10(c)(17)(ii)(F). PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 46451 223.15(a)) provides that a member bank may not purchase a low-quality asset from an affiliate unless, pursuant to an independent credit evaluation, the member bank had committed itself to purchase the asset before the time the asset was acquired by the affiliate.352 Several commenters requested clarification that the exclusion permits banking entities to engage in riskless principal transactions to purchase assets—including low quality assets for purposes of section 223.15 of the Board’s Regulation W—from family wealth management vehicles.353 Commenters stated that the need for such asset purchases may arise as a result of a family customer’s preferences and that permitting the banking entities to engage in such purchases may facilitate the family customer’s sale of the asset.354 Commenters stated that allowing these transactions would pose minimal market or credit risk to a banking entity because the banking entity would purchase and sell the same asset contemporaneously.355 Furthermore, one commenter stated that without clarity on the permissiveness of riskless principal transactions, family wealth management vehicles would be forced to obtain the services of a thirdparty service provider to sell low quality assets, which would increase costs and operational complexity of the family wealth management vehicles without furthering the aims of section 13 of the BHC Act or the implementing regulations.356 The agencies believe that permitting a banking entity to engage in riskless principal transactions that involve the purchase of low-quality assets from a family wealth management vehicle is unlikely to pose a substantive risk of evading section 13 of the BHC Act. In a riskless principal transaction, the riskless principal (the banking entity) buys and sells the same security contemporaneously, and the asset risk passes promptly from the customer (family wealth management vehicle, in this context) through the riskless principal to a third-party.357 The agencies are adopting the condition that banking entities and their affiliates comply with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the entity were an affiliate. However, in a change from the 2020 proposal and in response to the concerns raised by 352 12 CFR 223.15(a). e.g., BPI and SIFMA. 354 See, e.g., BPI and SIFMA. 355 See, e.g., SIFMA and BPI. 356 See SIFMA. 357 See 67 FR 76597. 353 See, E:\FR\FM\31JYR4.SGM 31JYR4 46452 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations commenters, the condition will explicitly exclude from those requirements transactions that meet the definition of riskless principal transactions as defined in § ll.10(d)(11). The definition of riskless principal transactions adopted in § ll.10(d)(11) is similar to the definition adopted in the Board’s Regulation W, as this definition is appropriately narrow and generally familiar to banking entities.358 The agencies expect that, together, the adopted criteria for the family wealth management vehicle exclusion will prevent a banking entity from being able to bail out such entities in periods of financial stress or otherwise expose the banking entity to the types of risks that the covered fund provisions of section 13 were intended to address. Several commenters requested that the agencies remove the condition that banking entities and their affiliates comply with the disclosure obligations under § ll.11(a)(8) of the final rule, as if the vehicle were a covered fund, because such disclosures would not apply to a vehicle that a banking entity was not organizing and offering pursuant to § ll.11(a) of the final rule and therefore would be confusing.359 In particular, these commenters stated that the required disclosure under § ll.11(a)(8) concerning the banking entity’s ‘‘ownership interests’’ in the fund and referencing the fund’s ‘‘offering documents’’ may create confusion in circumstances where the banking entity does not own an interest in the family wealth management vehicle, or where such vehicles do not have offering documents. Also, commenters requested confirmation from the agencies that banking entities would be permitted to (i) modify the required disclosures to reflect the specific circumstances of their relationship with, and the particular structure of, their family wealth management vehicle clients; and (ii) satisfy the written disclosure requirement by means other than including such disclosures in the governing document(s) of the family wealth management vehicle(s).360 The agencies are adopting the condition that banking entities and their affiliates comply with the disclosure obligations under § ll.11(a)(8) of the final rule with respect to family wealth management vehicles. However, in a change from the 2020 proposal and in response to the concerns raised by commenters, the condition will 358 12 CFR 223.3(ee). e.g., ABA and PNC. 360 See, e.g., BPI. 359 See, VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 explicitly permit banking entities and their affiliates to modify the content of such disclosures to prevent the disclosure from being misleading and also permit banking entities to modify the manner of disclosure to accommodate the specific circumstances of the entity.361 The obligations under § ll.11(a)(8) of the final rule apply in connection with the exemption for organizing and offering covered funds, which would typically require the preparation and distribution of offering documents. The agencies, however, understand that many family wealth management vehicles may not have offering documents. The agencies have an interest in providing family wealth management vehicle customers with the substance of the disclosure, rather than a concern with the specific wording of the disclosure or with the document in which the disclosure is provided. Accordingly, the agencies have provided that the content of the disclosure may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the family wealth management vehicle. For example, § ll.11(a)(8) requires disclosure that an investor ‘‘should read the fund offering documents before investing in the covered fund.’’ In order to accurately reflect the specific circumstances of a family wealth management vehicle for which there are no offering documents, the modified provision will allow the banking entity to revise this disclosure to reference the appropriate disclosure documents, if any, provided in connection with the vehicle. Similarly, the agencies understand the specific wording of the disclosures in § ll.11(a)(8) of the rule may need to be modified to accurately reflect the specific circumstances of the banking entity’s relationship with the family wealth management vehicle. For example, a banking entity that holds no ownership interest in the family wealth management vehicle may modify the disclosure required in § ll.11(a)(8)(i)(A) to reflect its lack of ownership. Moreover, § ll.11(a)(8) requires that the banking entity provide these disclosures, ‘‘such as through disclosure in the . . . offering documents.’’ The agencies expect that a banking entity could satisfy these 361 In the 2020 proposal, the agencies had indicated that for purposes of the proposed exclusion, a banking entity could satisfy these written disclosure obligations in a number of ways and could modify the specific wording of the disclosures in § ll.11(a)(8) to accurately reflect the specific circumstances of the family wealth management vehicle. PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 disclosure delivery obligations in a number of ways, such as by including them in the family wealth management vehicle’s governing documents, in account opening materials or in supplementary materials (e.g., a separate disclosure document provided by the banking entity solely for purposes of complying with this exclusion and providing the required disclosures). 4. Customer Facilitation Vehicles The agencies are adopting an exclusion from the definition of ‘‘covered fund’’ under § ll.10(b) of the rule for any issuer that acts as a ‘‘customer facilitation vehicle.’’ The customer facilitation vehicle exclusion will, as proposed, be available for any issuer that is formed by or at the request of a customer of the banking entity for the purpose of providing such customer (which may include one or more affiliates of such customer) with exposure to a transaction, investment strategy, or other service provided by the banking entity.362 A banking entity may only rely on the exclusion with respect to an issuer provided that: (1) All of the ownership interests of the issuer are owned by the customer (which may include one or more of its affiliates) for whom the issuer was created; 363 and (2) the banking entity and its affiliates: (i) Maintain documentation outlining how the banking entity intends to facilitate the customer’s exposure to such transaction, investment strategy, or service; (ii) do not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such issuer; (iii) comply with the disclosure obligations under § ll.11(a)(8), as if such issuer were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the issuer; (iv) do not acquire or retain, as principal, an ownership interest in the issuer, other than up to an aggregate 0.5 percent of the issuer’s outstanding ownership interests for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns; (v) comply with the rule § ll.10(c)(18)(i). this condition, up to an aggregate 0.5 percent of the issuer’s outstanding ownership interests may be acquired or retained by one or more entities that are not customers if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns. Final rule § ll.10(c)(18)(ii)(B). 362 Final 363 Notwithstanding E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations requirements of §§ ll.14(b) and ll.15, as if such issuer were a covered fund; and (vi) except for riskless principal transactions as defined in § ll.10(d)(11), comply with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the entity were an affiliate thereof.364 The agencies continue to believe that this exclusion will appropriately allow banking entities to structure certain types of services or transactions for customers, or to otherwise provide traditional customer-facing banking and asset management services, through a vehicle, even though such a vehicle may rely on section 3(c)(1) or 3(c)(7) of the Investment Company Act or would otherwise be a covered fund under the final rule. Most commenters that addressed this exclusion were supportive,365 stating that it would provide banking entities with greater flexibility to meet client needs and objectives.366 Some commenters found the exclusion’s conditions to be reasonable and sufficient.367 However, two commenters recommended that the agencies impose additional limitations on the exclusion.368 One of these commenters argued that the exclusion would permit, and possibly encourage, banking entities to increase their risk exposures through the use of customer facilitation vehicles, and the agencies should minimize such risk exposures and promote risk monitoring and management.369 The agencies continue to believe that these vehicles do not expose banking entities to the types of risks that section 13 of the BHC Act was intended to restrict, and that this exclusion is consistent with section 13(d)(1)(D), which permits banking entities to engage in transactions on behalf of customers, when such transactions would otherwise be prohibited under section 13. The agencies have elsewhere tailored the 2013 rule to allow banking entities to meet their customers’ needs.370 This exclusion will similarly rule § ll.10(c)(18)(ii). e.g., SIFMA; BPI; ABA; Credit Suisse; FSF; Goldman Sachs; and IAA. 366 See, e.g., SIFMA; BPI; ABA; and Goldman Sachs. 367 See, e.g., SIFMA; FSF; and SAF. 368 See Better Markets and Data Boiler. 369 See Better Markets. 370 For example, the agencies in 2019 amended the exemption for risk-mitigating hedging activities to allow banking entities to acquire or retain an ownership interest in a covered fund as a riskmitigating hedge when acting as an 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. See 2019 amendments § ll.13(a)(1)(ii). See also 2019 364 Final 365 See, VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 allow banking entities to provide customer-oriented financial services through a vehicle when that vehicle’s purpose is to facilitate a customer’s exposure to those services.371 As stated in the 2020 proposal, the agencies do not believe that section 13 of the BHC Act was intended to interfere unnecessarily with the ability of banking entities to provide services to their customers simply because the customer may prefer to receive those services through a vehicle or through a transaction with a vehicle instead of directly with the banking entity.372 Some commenters agreed, stating that customer facilitation vehicles would not expose banking entities to the types of risks that section 13 was intended to prohibit or limit, particularly given that such vehicles will be subject to a number of conditions, as discussed below.373 The exclusion will, as proposed, require that the vehicle be formed by or at the request of the customer.374 One commenter suggested that the agencies remove this requirement, arguing that it would inhibit a banking entity’s ability to provide customers with services in a timely manner.375 However, the agencies continue to believe that this requirement is an important component of the exclusion because it helps differentiate customer facilitation vehicles from covered funds that are organized and offered by the banking entity. As stated in the 2020 proposal, the requirement will not preclude a banking entity from marketing its customer facilitation vehicle services or discussing with its customers prior to the formation of such vehicles the amendments § ll.3(d)(11) (excluding from the definition of ‘‘proprietary trading’’ the entering into of customer-driven swaps or customer-driven security-based swaps and matched swaps or security-based swaps under certain conditions). 371 This exclusion does not require that the customer relationship be pre-existing. In other words, the exclusion will be available for an issuer that is formed for the purpose of facilitating the exposure of a customer of the banking entity where the customer relationship begins only in connection with the formation of that issuer. The agencies took a similar approach to this question in describing the exemption for activities related to organizing and offering a covered fund under § ll.11(a) of the 2013 rule. See 79 FR 5716. The agencies indicated that section 13(d)(1)(G), under which the exemption under § ll.11(a) was adopted, did not explicitly require that the customer relationship be preexisting. Similarly, section 13(d)(1)(D) does not explicitly require a pre-existing customer relationship. 372 85 FR 12120. 373 See SIFMA and ABA. 374 Final rule § ll.10(c)(18)(i). 375 SIFMA (stating that requiring a banking entity to wait for a customer to request formation would delay the banking entity’s ability to provide services to the customer without any corresponding regulatory benefit). PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 46453 potential benefits of structuring such services through a vehicle.376 As in the 2020 proposal, the agencies are not specifying the types of transaction, investment strategy or other service that a customer facilitation vehicle may be formed to facilitate.377 One commenter recommended specifying that the exclusion only allow vehicles to be formed for extensions of intraday credit, and payment, clearing, and settlement services, and only for purposes of operational efficiency.378 Another commenter argued that attempting to specify may prevent banking entities from being able to appropriately respond to a customer’s requests.379 The agencies continue to believe that providing flexibility enhances the utility of this exclusion. Specifically, the agencies note that the purpose of this exclusion is to allow banking entities to provide customeroriented financial services through vehicles, providing customers with exposure to a transaction, investment strategy, or other service that the banking entity may provide to such customers directly. Limiting the type of transaction, investment strategy, or service for which the customer facilitation vehicle may be formed would interfere with this purpose. Accordingly, the agencies are adopting this requirement as proposed. Under the final rule, similar to the 2020 proposal, a banking entity will be able to rely on the customer facilitation vehicle exclusion only under certain conditions, as stated above.380 Commenters supported most of the conditions, stating that the exclusion imposes reasonable conditions that provide safeguards.381 Commenters also suggested modifications to certain conditions, as discussed below.382 The agencies are adopting the conditions, largely as proposed. However, the agencies are modifying the conditions that relate to de minimis ownership of the vehicle, the requirements of 12 CFR 223.15(a), and the disclosure obligations under § ll.11(a)(8), as discussed below. As proposed, the exclusion would have permitted banking entities and their affiliates to acquire or retain, as principal, an ownership interest in the issuer up to 0.5 percent of the issuer’s outstanding ownership interests, for the purpose of and to the extent necessary 376 85 FR 12120. rule § ll.10(c)(18)(i). 378 See Data Boiler. 379 See SIFMA. 380 Final rule § ll.10(c)(18)(ii). 381 See, e.g., SIFMA; FSF; and SAF. 382 See, e.g., SIFMA; BPI; and FSF. 377 Final E:\FR\FM\31JYR4.SGM 31JYR4 46454 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns.383 Similar to their request for family wealth management vehicles, commenters suggested that the agencies specifically allow any party that is unaffiliated with the customer, rather than only the banking entities and their affiliates, to own this de minimis interest.384 For the same reasons as discussed above with respect to family wealth management vehicles, the agencies are modifying the de minimis ownership provision such that up to an aggregate 0.5 percent of the issuer’s outstanding ownership interests may be acquired or retained by one or more entities that are not customers if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns.385 The agencies are adopting, with modifications, the condition for a banking entity to comply with the requirements of 12 CFR 223.15(a), as if such banking entity were a member bank and the issuer were an affiliate thereof.386 As discussed above, several commenters recommended that the agencies clarify that the family wealth management vehicle exclusion permits banking entities to engage in riskless principal transactions to purchase assets—including low quality assets for purposes of section 223.15 of the Board’s Regulation W—from family wealth management vehicles.387 One such commenter also suggested that, for purposes of consistency, the agencies should similarly clarify that banking entities are permitted to engage in such riskless principal transactions with customer facilitation vehicles.388 The purpose of the proposed requirement that a customer facilitation vehicle must comply with 12 CFR 223.15(a) was the same for both the family wealth management vehicle and the customer facilitation vehicle exclusions—to help ensure that the exclusions do not allow banking entities to ‘‘bail out’’ either vehicle.389 For the 383 See 2020 proposed rule § ll.10(c)(18)(ii)(B)(4). 384 See SIFMA; BPI; and FSF. 385 Final rule § ll.10(c)(18)(ii)(B). 386 Final rule § ll.10(c)(18)(ii)(C)(6). 12 CFR 223.15(a) provides that a member bank may not purchase a low-quality asset from an affiliate unless, pursuant to an independent credit evaluation, the member bank had committed itself to purchase the asset before the time the asset was acquired by the affiliate. 12 CFR 223.15(a). 387 See, e.g., BPI and SIFMA. See supra, Section IV.C.3 (Family Wealth Management Vehicles). 388 See BPI. 389 See 85 FR 12120. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 same reasons discussed above with respect to family wealth management vehicles, the agencies have modified the requirement to exclude from the requirements of 12 CFR 223.15(a) transactions that meet the definition of riskless principal transactions as defined in § ll.10(d)(11).390 Similar to the agencies’ approach with respect to family wealth management vehicles, the agencies expect that, together, the adopted criteria for this exclusion will prevent a banking entity from being able to bail out customer facilitation vehicles in periods of financial stress or otherwise expose the banking entity to the types of risks that the covered fund provisions of section 13 of the BHC Act were intended to address. The agencies are modifying the condition that the banking entity and its affiliates comply with the disclosure obligations under § ll.11(a)(8), as if such issuer were a covered fund, to provide clarification that the content of the disclosure may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the issuer.391 Commenters requested that the agencies provide such clarification in the context of family wealth management vehicles.392 Although the agencies did not receive any comments with respect to this condition in the context of this exclusion, the agencies are similarly modifying this condition under this exclusion. The agencies believe that these disclosures will provide important information to the customers for whom these vehicles will be used to provide services—whether they are family customers under the family wealth management vehicle exclusion or other customers under this exclusion. The agencies’ treatment of this condition for family wealth management vehicles, as described above, will similarly apply to this condition for customer facilitation vehicles.393 The agencies are adopting, as proposed, the condition that all of the ownership interests of the issuer are owned by the customer (which may include one or more of the customer’s affiliates) for whom the issuer was created (other than a de minimis interest that may be held by others, as discussed above).394 The agencies continue to believe that this condition is rule § ll.10(c)(18)(ii)(C)(6). rule § ll.10(c)(18)(ii)(C)(3). 392 See supra, Section IV.C.3 (Family Wealth Management Vehicles). 393 Id. 394 Final rule §§ ll.10(c)(18)(ii)(A)–(B). PO 00000 390 Final 391 Final Frm 00034 Fmt 4701 Sfmt 4700 appropriate to prevent banking entities from using this exclusion for customer facilitation vehicles to evade the restrictions of section 13 of the BHC Act. To help track compliance, a banking entity and its affiliates will, as proposed, have to maintain documentation outlining how the banking entity intends to facilitate the customer’s exposure to a transaction, investment strategy, or service.395 The agencies are also adopting, as proposed, the condition that the banking entity and its affiliates do not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such issuer.396 The agencies continue to believe that this condition is appropriate and consistent with the goal of preventing banking entities from bailing out their customer facilitation vehicles. Commenters generally agreed, supporting the condition as one that is reasonable and appropriate in addressing the agencies’ potential evasion concerns.397 Finally, the agencies are adopting, as proposed, the condition that the banking entity and its affiliates comply with the requirements of §§ ll.14(b) and ll.15, as if such issuer were a covered fund.398 The agencies requested comment in the 2020 proposal whether this exclusion should also require that the banking entity and its affiliates comply with the requirements of all of § ll.14. One commenter argued that requiring compliance with the requirements of all of § ll.14 would eliminate the utility of this exclusion.399 The same commenter supported the condition, as proposed, stating that requiring compliance with only § ll.14(b), which would apply the requirements in section 23B of the Federal Reserve Act, and the application of the prudential backstops under § ll.15 would serve as adequate safeguards to avoid the risk of bailout or other evasion concerns.400 The agencies continue to believe that this condition will help ensure that banking entities and their affiliates’ exposure to risk remains appropriately limited. The agencies continue to believe that, collectively, the conditions on the exclusion will help to ensure that rule § ll.10(c)(18)(ii)(C)(1). rule § ll.10(c)(18)(ii)(C)(2). 397 See, e.g., SIFMA; FSF; and Data Boiler. 398 Final rule § ll.10(c)(18)(ii)(C)(5). 399 See FSF (stating that if banking entities were required to comply with all of § ll.14, they would not be able to enter into swaps and other covered transactions with the customer facilitation vehicle for their clients, many of whom seek such transactions through the use of such vehicles). 400 See FSF. 395 Final 396 Final E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations customer facilitation vehicles are used for customer-oriented financial services provided on arms-length, market terms, and to prevent evasion of the requirements of section 13 of the BHC Act and the final rule. The agencies also continue to believe that the adopted conditions will be consistent with the purposes of section 13. As in the 2020 proposal, the agencies will not apply § ll.14(a) to customer facilitation vehicles because the agencies understand that this would prohibit banking entities from providing the full range of banking and asset management services to customers using these vehicles. Commenters generally supported this approach,401 and one noted that applying § ll.14(a) to these vehicles would undo any practical utility of the exclusion.402 D. Limitations on Relationships With a Covered Fund In the 2020 proposal, the agencies proposed to amend the regulations implementing section 13(f)(1) of the BHC Act to permit banking entities to engage in a limited set of covered transactions with covered funds for which the banking entity directly or indirectly serves as investment manager, investment adviser, or sponsor, or that the banking entity organizes and offers pursuant to section 13(d)(1)(G) of the BHC Act (such funds, related covered funds).403 Section 13(f)(1) of the BHC Act generally prohibits a banking entity from entering into a transaction with a related covered fund that would be a covered transaction as defined in section 23A of the Federal Reserve Act as if the banking entity was a member bank and the covered fund was an affiliate.404 The 2020 proposal would have amended the application of section 13(f)(1) of the BHC Act in limited circumstances, by allowing a banking entity to enter into certain covered transactions with a related covered fund that would be permissible without limit for a state member bank to enter into with an affiliate under section 23A of 401 See, e.g., SIFMA and BPI. SIFMA. 403 See 2020 proposal § ll.14(a)(2), (3); 85 FR 12143–12146. 404 12 U.S.C. 1851(f)(1); see also 12 U.S.C. 371c. Section 13(f)(3) of the BHC Act also provides an exemption for prime brokerage transactions between a banking entity and a covered fund in which a covered fund managed, sponsored, or advised by that banking entity has taken an ownership interest. 12 U.S.C. 1851(f)(3). In addition, section 13(f)(2) subjects any transaction permitted under section 13(f) (including a permitted prime brokerage transaction) between a banking entity and covered fund to section 23B of the Federal Reserve Act. 12 U.S.C. 1851(f)(2); see 12 U.S.C. 371c–1. 402 See VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 the Federal Reserve Act. In addition, the 2020 proposal would have allowed a banking entity to enter into short-term extensions of credit with, and purchase assets from, a related covered fund in connection with payment, clearing, and settlement activities. The agencies invited comment on the past interpretation of section 13(f)(1) of the BHC Act,405 and the proposed amendments to the regulations implementing section 13(f)(1).406 As described in the 2020 proposal, the agencies believe the statutory rulemaking authority under paragraph (d)(1)(J) of section 13 of the BHC Act permits the agencies to determine that banking entities may enter into covered transactions with related covered funds that would otherwise be prohibited by section 13(f)(1) of the BHC Act, provided that the rulemaking complies with applicable statutory requirements.407 This interpretation of the agencies’ rulemaking authority is supported both by the inclusion of other covered transactions within the permitted activities listed in paragraph (d)(1) of section 13 and by the manner in which section 13(f)(1) of the BHC Act is incorporated in the list of permitted activities in paragraph (d)(1), as described below. Section 23A of the Federal Reserve Act limits the aggregate amount of covered transactions between a member bank and its affiliates, while section 13(f)(1) of the BHC Act generally prohibits covered transactions between a banking entity and a related covered fund, with no minimum amount of permissible covered transactions.408 405 In the preamble to the 2013 rule, the agencies noted that ‘‘[s]ection 13(f) of the BHC Act does not incorporate or reference the exemptions contained in section 23A of the FR Act or the Board’s Regulation W.’’ 79 FR 5746. 406 85 FR 12145–46. 407 12 U.S.C. 1851(b)(2), (d)(1)(J), (d)(2). 408 12 U.S.C. 371c, 12 U.S.C. 1851(f)(1). The term ‘‘covered transaction’’ is defined in section 23A of the Federal Reserve Act to mean, with respect to an affiliate of a member bank, (1) a loan or extension of credit to the affiliate, including a purchase of assets subject to an agreement to repurchase; (2) a purchase of or an investment in securities issued by the affiliate; (3) a purchase of assets from the affiliate, except such purchase of real and personal property as may be specifically exempted by the Board by order or regulation; (4) the acceptance of securities or other debt obligations issued by the affiliate as collateral security for a loan or extension of credit to any person or company; (5) the issuance of a guarantee, acceptance, or letter of credit, including an endorsement or standby letter of credit, on behalf of an affiliate; (6) a transaction with an affiliate that involves the borrowing or lending of securities, to the extent that the transaction causes a member bank or a subsidiary to have credit exposure to the affiliate; or (7) a derivative transaction, as defined in paragraph (3) of section 5200(b) of the Revised Statutes of the United States (12 U.S.C. 84(b)), with an affiliate, to PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 46455 Despite the general prohibition on certain covered transactions in section 13(f)(1), section 13 also authorizes a banking entity to own an interest in a related covered fund, which would be a ‘‘covered transaction’’ for purposes of section 23A of the Federal Reserve Act.409 In addition to this apparent conflict between paragraphs 13(d) and (f) with respect to covered fund ownership, there are other elements of these paragraphs that introduce ambiguity about the interpretation of the term ‘‘covered transaction’’ as used in section 13(f) of the BHC Act. For example, despite the general prohibition on covered funds, another part of section 13 permits a bank entity ‘‘to acquire or retain an ownership interest in a covered fund in accordance with the requirements of section 13.’’ 410 In the preamble to the 2013 rule, the agencies specifically interpreted section 13 to allow such investments noting that a contrary interpretation would make the specific language that permits covered transactions between a banking entity and a related covered fund ‘‘mere surplusage.’’ 411 The statute also prohibits a banking entity that organizes or offers a hedge fund or private equity fund from directly or indirectly guaranteeing, assuming, or otherwise insuring the obligations or performance of the fund (or of any hedge fund or private equity fund in which such hedge fund or private equity fund invests).412 To the extent that section 13(f) prohibits all covered transactions between a banking entity and a related covered fund, however, the independent prohibition on guarantees in section 13(d)(1)(G)(v) would seem to be unnecessary and redundant.413 Although the agencies previously expressed doubt about their ability to permit banking entities to enter into covered transactions with related covered funds pursuant to their authority under section 13(d)(1)(J) of the BHC Act,414 the activities permitted pursuant to paragraph (d) specifically contemplate allowing a banking entity to enter into certain covered the extent that the transaction causes a member bank or a subsidiary to have credit exposure to the affiliate. See 12 U.S.C. 371c(b)(7), as amended by Pub. L. 111.203, section 608 (July 21, 2010). Section 13(f) of the BHC Act does not alter the applicability of section 23A of the Federal Reserve Act and the Board’s Regulation W to covered transactions between insured depository institutions and their affiliates. 409 12 U.S.C. 1851(d)(1)(G); (d)(4). 410 79 FR 5746. 411 Id. 412 12 U.S.C. 1851(d)(1)(G)(v). 413 See 12 U.S.C. 371c(b)(7)(E); 12 CFR 223.3(h)(4). 414 See 76 FR 68912 n.313. E:\FR\FM\31JYR4.SGM 31JYR4 46456 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations transactions with related funds.415 The exceptions in section 13(f)(1) are also expressly incorporated into the statutory list of permitted activities, specifically in section 13(d)(1)(G)(iv).416 By virtue of the conflict between paragraphs (d) and (f) of section 13, and the inclusion of specific covered transactions within the permitted activities in paragraph (d) of section 13, the agencies continue to believe that the authority granted pursuant to paragraph (d)(1)(J) to determine that other activities are not prohibited by the statute authorizes the agencies to exercise rulemaking authority to determine that banking entities may enter into covered transactions with related covered funds that would otherwise be prohibited by section 13(f)(1) of the BHC Act, provided that the rulemaking complies with applicable statutory requirements.417 Several commenters expressed support for the proposed amendments to the regulations implementing section 13(f)(1) of the BHC Act that would have permitted a banking entity to engage in a limited set of covered transactions with a related covered fund.418 Some commenters recommended that the agencies clarify whether a banking entity may enter into exempt transactions with a related covered fund in the circumstance where such transactions would be exempt from section 23A of the Federal Reserve Act only if a bank entered into such transactions with a securities affiliate.419 A few commenters also recommended that the agencies adopt a new exclusion allowing a banking entity to offer other types of extensions of credit to a related covered fund, including extensions of credit in the ordinary course of business.420 Other commenters recommended that the agencies clarify that section 13(f)(1) does not apply outside of the United States.421 The commenters noted that such an approach would limit the extraterritorial effect of section 13(f)(1), and would better align section 13(f)(1) with the manner in which section 23A of the Federal Reserve Act applies outside of the United States. As discussed below, the final rule adopts the proposed amendments from the 2020 proposal with minor modifications. The agencies believe that, under certain circumstances, it is 415 12 U.S.C. 1851(d)(1)(G); (d)(4). U.S.C. 1851(d)(1)(G)(iv). 417 12 U.S.C. 1851(b)(2), (d)(1)(J), (d)(2). 418 See, e.g., ABA; BPI; CBA; Data Boiler; EBF; FSF; IIB; PNC; and SIFMA. 419 ABA; BPI; FSF; and SIFMA. 420 BPI and PNC. 421 CBA; EBF; and IIB. appropriate to permit banking entities to enter into certain covered transactions with related covered funds, in the manner described in the amendments to § ll.14 of the implementing regulations. Consistent with the 2020 proposal, these amendments do not modify the definition of ‘‘covered transaction’’ but instead authorize banking entities to engage in limited transactions with related covered funds. Any transactions permitted by these revisions must still meet the eligibility requirements for the particular transaction, and the banking entity must also comply with certain conflict of interest, high-risk, and safety and soundness restrictions with respect to such transactions. The agencies are also expressly providing that a banking entity may enter into certain riskless principal transactions with a related covered fund, as described below. Exempt Transactions Under Section 23A and the Board’s Regulation W; Riskless Principal Transactions The final rule adopts the amendments to the regulations implementing section 13(f)(1) of the BHC Act to permit banking entities to enter into exempt transactions permitted under section 23A and the Board’s Regulation W. Specifically, the final rule permits a banking entity to engage in certain covered transactions with a related covered fund that would be exempt from the quantitative limits, collateral requirements, and low-quality asset prohibition under section 23A of the Federal Reserve Act, including certain transactions that would be exempt pursuant to section 223.42 of the Board’s Regulation W.422 Section 23A of the Federal Reserve Act is designed to protect against a depository institution suffering losses in transactions with affiliates, and to limit the ability of a depository institution to transfer to its affiliates the ‘‘subsidy’’ arising from the depository institution’s access to the Federal safety net.423 Nevertheless, a member bank may enter into certain ‘‘exempt’’ covered transactions set forth in section 23A of the Federal Reserve Act and the Board’s Regulation W, without regard to the quantitative limits, collateral requirements, and low-quality asset prohibition of section 23A and the Board’s Regulation W, provided such transactions meet the criteria specified in Regulation W.424 416 12 VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 12 U.S.C. 371c(d); 12 CFR 223.42. a brief background on section 23A of the Federal Reserve Act, see Transactions Between Member Banks and Their Affiliates, 67 FR 76560– 765561 (December 12, 2002). 424 See 12 U.S.C. 371c(d); 12 CFR 223.42. PO 00000 422 See 423 For Frm 00036 Fmt 4701 Sfmt 4700 Under the Board’s Regulation W, a member bank may enter into certain exempt covered transactions only with a securities affiliate. Specifically, under these exempt covered transactions, a member bank may enter into transactions to purchase marketable securities, to purchase municipal securities, and to enter into riskless principal transactions only with a securities affiliate.425 In permitting such transactions under Regulation W, the Board previously concluded that the condition that such transactions were permissible only with a securities affiliate was an important consideration that helped justify the exemption, noting that securities affiliates generally must be registered as broker-dealers, and are therefore subject to SEC supervision and examination, and are required to keep detailed records concerning each securities transaction.426 The exempt transactions specified in section 23A of the Federal Reserve Act and Regulation W are structured in a manner so as not to present the same concerns about a depository institution suffering losses or transferring the subsidy arising from the depository institution’s access to the Federal safety net. The agencies believe that the same rationale that supports the exemptions in section 23A of the Federal Reserve Act and the Board’s Regulation W also supports exempting such transactions from the prohibition on covered transactions between a banking entity and related covered funds under section 13(f)(1) of the BHC Act, provided that such transactions are subject to the same requirements and conditions specified in Regulation W. In particular, the agencies note that these exemptions generally do not present significant risks of loss and serve important public policy objectives.427 Several commenters recommended that the agencies clarify whether a banking entity may enter into certain transactions with a related covered fund that would be permissible under the Board’s Regulation W if entered into between a bank and a securities affiliate, 425 12 CFR 223.42(f), (g), (m). FR 76591 (December 12, 2002); see 67 FR 76593, 76597. 427 For example, intraday extensions of credit are exempt covered transactions under section 23A of the Federal Reserve Act. The Board previously has noted that ‘‘[i]ntraday overdrafts and other forms of intraday credit generally are not used as a means of funding or otherwise providing financial support for an affiliate. Rather, these credit extensions typically facilitate the settlement of transactions between an affiliate and its customers when there are mismatches between the timing of funds sent and received during the business day.’’ 67 FR 76596. 426 67 E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations even if the covered fund would not meet the eligibility criteria to be a ‘‘securities affiliate’’ under the Board’s Regulation W.428 As noted above, Regulation W imposes various conditions and requirements on transactions that a bank enters into with its affiliates, and permits a bank to enter into transactions involving the purchase of marketable securities, the purchase of municipal securities, and riskless principal transactions only with an affiliate that is a ‘‘securities affiliate’’ as defined in Regulation W. With respect to purchases of marketable securities and municipal securities, the final rule follows the approach adopted in Regulation W, and permits a banking entity to enter into such covered transactions with a related covered fund only if those transactions would meet all of the eligibility criteria to qualify as exempt transactions under Regulation W, including the requirement that the related covered fund meets the requirements to be a securities affiliate.429 As noted above, the exempt transactions specified in Regulation W include various limits and conditions that both limit the risks of such transactions and allow the Federal banking agencies to monitor compliance. Generally, the final rule retains the eligibility criteria for exempt covered transactions defined in Regulation W. The agencies believe that these conditions serve important policies, and appropriately limit the scope of the exempt transactions permissible under the implementing regulations. The final rule permits banking entities to enter into riskless principal transactions with a related covered fund, including in circumstances where the covered fund is not a ‘‘securities affiliate.’’ 430 In a riskless principal transaction, the riskless principal (the banking entity) buys and sells the same security contemporaneously, and the asset risk passes promptly from the affiliate (the related covered fund) through the riskless principal to a third party.431 In permitting such transactions under Regulation W, the Board 428 ABA; BPI; FSF; and SIFMA. Under the Board’s Regulation W, a ‘‘securities affiliate’’ is defined as ‘‘[a]n affiliate of the member bank that is registered with the Securities and Exchange Commission as a broker or dealer; or . . . [a]ny other securities broker or dealer affiliate of a member bank that is approved by the Board.’’ 12 CFR 223.3(gg). 429 In addition to requiring that an affiliate be a securities affiliate, the exemptions under Regulation W permitting a bank to purchase marketable securities or municipal securities in certain circumstances require the bank to retain records about the underlying transaction. See 12 CFR 223.42(f)(6), (g)(3)(iii)(B). 430 Cf. 12 CFR 223.42(m). 431 See 67 FR 76597. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 previously found that there was no regulatory benefit to subjecting riskless principal transactions to section 23A of the Federal Reserve Act, because such transactions closely resemble securities brokerage transactions, and these transactions do not allow the affiliate to transfer risk to the affiliate acting as a riskless principal.432 Although the 2020 proposal would have permitted a banking entity to enter into a riskless principal transaction with a covered fund provided it met the criteria in Regulation W, the final rule adopts a standalone exception to differentiate riskless principal transactions specifically from other transactions that would be exempt transactions under the Board’s Regulation W.433 In connection with permitting banking entities to enter into riskless principal transactions with related covered funds in a separate exception from Super 23A, the agencies are defining riskless principal transactions in § ll.10 of the regulations. The definition of riskless principal transactions adopted in the final rule is similar to the definition adopted in the Board’s Regulation W, as this definition is appropriately narrow and generally familiar to banking entities.434 In addition, and as discussed in more detail below, banking entities may separately rely on the independent exception for acquisitions of assets in connection with payment, clearing, and settlement services. The agencies expect that in many instances, subject to other applicable laws and regulations, a banking entity may be able to engage in acquisitions of assets in connection with payment, clearing, and settlement services, without relying on the exception permitting banking entities to enter into covered transactions with their related covered funds that would be exempt under Regulation W. Short-Term Extensions of Credit and Acquisitions of Assets in Connection With Payment, Clearing, and Settlement Services The final rule adopts the proposed amendments in the 2020 proposal that would have permitted a banking entity to provide short-term extensions of credit to, and purchase assets from, a related covered fund, subject to appropriate limits. Under the final rule, each short-term extension of credit or purchase of assets must be made in the ordinary course of business in connection with payment transactions; PO 00000 432 Id. 433 12 CFR 223.42. 12 CFR 223.3(ee). securities, derivatives, or futures clearing; or settlement services. In addition, each extension of credit must be required to be repaid, sold, or terminated no later than five business days after it was originated. Additionally, the proposed five business day criterion is consistent with the Federal banking agencies’ capital rules and would generally limit banking entities to transactions with normal settlement periods, which have lower risk of delayed settlement or failure, when providing short-term extensions of credit.435 Each short-term extension of credit must also meet the same requirements applicable to intraday extensions of credit under section 223.42(l)(1)(i) and (ii) of the Board’s Regulation W (as if the extension of credit was an intraday extension of credit, regardless of the duration of the extension of credit). Under these requirements, the banking entity making a short-term extension would have to meet the same requirements as it would to engage in an intraday extension of credit under Regulation W (and as incorporated in the implementing regulations). Specifically, the banking entity would need to have policies and procedures to manage the credit exposure and must have no reason to believe that the related covered fund will have difficulty repaying the extension of credit in accordance with its terms. Finally, each extension of credit or purchase of assets permitted by these revisions must also comply with certain conflict of interest, high-risk, and safety and soundness restrictions, and must otherwise be permissible for the banking entity to enter into with the fund.436 435 See 78 FR 62110 (October 11, 2013). While the Federal banking agencies require firms to track and monitor the credit risk exposure for transactions involving securities, foreign exchange instruments, and commodities that have a risk of delayed settlement, this requirement does not apply to other types of transactions which may be used in providing a short-term extension of credit (e.g., repo-style transactions). Additionally, banking entities typically monitor credit extensions by counterparty, and not by transaction type. Thus, the final rule is consistent with the approach taken in the Federal banking agencies’ capital rule, without imposing an additional compliance burden without a corresponding benefit. See, e.g., 12 CFR 3.2; 217.2; 324.2 (defining derivative contract to include unsettled securities with a contractual settlement or delivery lag that is longer than the lesser of the market standard for the particular instrument or five business days); 12 CFR 3.38(d); 217.38(d); 324.38(d) (noting that an institution must hold riskbased capital against any delivery-versus-payment or payment-versus-payment transaction with a normal settlement period if the counterparty has not made delivery within five business days after settlement). 436 For example, an investment fund with respect to which a member bank or its affiliate is an 434 See Frm 00037 Fmt 4701 Sfmt 4700 46457 Continued E:\FR\FM\31JYR4.SGM 31JYR4 46458 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations The agencies do not believe it would be appropriate to permit banking entities to enter into other covered transactions with a related covered fund, outside of the exceptions noted above. Although some commenters recommended expanding this exception to allow banking entities to enter into limited amounts of covered transactions with related covered funds, the agencies believe that permitting banking entities to engage in other covered transactions with related covered funds would potentially raise the concerns that paragraph 13(f)(1) was intended to address. The agencies also do not believe that it would be appropriate to limit the application of section 13(f)(1) to the United States as some commenters recommended, at this time. The agencies note that other amendments in the final rule (for example, amendments to the treatment of foreign excluded funds and foreign public funds) may help address some of the commenters’ concerns about the extraterritorial application of section 13(f)(1). Impact of the Amendments on Safety and Soundness and U.S. Financial Stability The agencies expect that the amendments in the final rule described above would generally promote and protect the safety and soundness of banking entities and U.S. financial stability. In comments previously submitted to the agencies, banking entities that sponsor or serve as the investment adviser to covered funds have argued that the inability to engage in any covered transactions with such funds, particularly those types of transactions that are expressly exempted under section 23A of the Federal Reserve Act and the Board’s Regulation W, has limited the services that they or their affiliates can provide. The commenters said that amending the regulations to permit limited covered transactions with related covered funds would not create any new incentives for the banking entity to financially support the related covered fund in times of stress and would not otherwise permit the banking entity to indirectly engage in proprietary trading through the related covered fund.437 For example, when a banking entity sponsors or advises a covered fund, the prohibition on covered transactions between the banking entity (and its affiliates) and the covered fund may limit the ability of the investment adviser may be subject to additional restrictions under Section 23A of the Federal Reserve Act. See 12 U.S.C. 371c(b)(1)(D). 437 See 85 FR 12144. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 banking entity and its affiliates to provide other services, such as trade settlement services, to the covered fund. As discussed below, the agencies believe that the exceptions in the final rule would generally promote and protect the safety and soundness of banking entities and U.S. financial stability by allowing banking entities to reduce operational risk. Currently, the restrictions under section 13(f)(1) of the BHC Act substantially limit the ability of a banking entity to both (1) organize and offer a covered fund, or act as an investment adviser to the covered fund, and (2) provide custody or other services to the fund. As a result, a third party is required to provide other necessary services for the fund’s operation, including payment, clearing, and settlement services that are generally provided by the fund’s custodian, even when the banking entity sponsor of the fund typically provides those services to other funds it sponsors. This is the case even when the third party may not offer the same quality of services available through an affiliate, or where the third party may charge more for the same services that could be provided by an affiliate. This increases the potential for problems at the thirdparty service provider (e.g., an operational failure or a disruption to normal functioning) to affect the banking entity or the fund, which were required to use the third-party service provider as a result of the restrictions under section 13(f)(1). Those problems may then spread among financial institutions or markets and thereby threaten the stability of the U.S. financial system. By amending § ll.14(a), therefore, the final rule allows a banking entity to reduce both operational risk and interconnectedness to other financial institutions by directly providing a broader array of services to a fund it organizes and offers, or advises. The agencies believe that reducing these risks will promote and protect the safety and soundness of banking entities.438 The final rule also would promote and protect U.S. financial stability by reducing interconnectedness among firms. The provision of custodial services among depository institutions in the United States is highly concentrated, with the four largest 438 The agencies believe that the same rationales that supported exempting certain covered transactions in section 23A of the Federal Reserve Act and the Board’s Regulation W also support permitting a banking entity to engage in those exempt covered transactions with a related covered fund, subject to the same terms and conditions as applicable under section 23A and Regulation W. PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 providers, all of which remain subject to the Volcker Rule, holding more than 85 percent of custodial assets. Requiring a banking entity that organizes and offers a covered fund to use a third party to provide these services could increase the interconnections between these firms and the risk that distress at one banking entity would be spread to the others. The authorized covered transactions would permit banking entities to provide a more comprehensive suite of services to related covered funds, reducing interconnectedness by reducing the need to rely on third parties to provide such services. The final rule also retains important limits on the transactions that a banking entity may enter into with a related covered fund, including limitations that apply to transactions within the new exceptions in the regulations implementing § ll.14(a). As specified in the statute, such activities are permissible only ‘‘to the extent permitted by any other provision of Federal or state law, and subject to the limitations under section 13(d)(2) of the BHC Act and any restrictions or limitations that the appropriate Federal banking agencies, the Securities and Exchange Commission, and the Commodity Futures Trading Commission, may determine . . .’’ 439 Section 13(d)(2) of the BHC Act also imposes additional restrictions on any activities authorized pursuant to section (d)(1), including those activities authorized by rulemaking pursuant to section (d)(1)(J).440 Sections ll.14(b) and ll.14(c) of the regulations implementing section 13 of the BHC Act both generally require that a banking entity may enter into certain transactions specified in section 23B of the Federal Reserve Act (including ‘‘covered transactions’’ as defined in section 23A of the Federal Reserve Act) with related covered funds only on terms and under circumstances that are substantially the same (or at least as favorable) as to the banking entity as those prevailing at the time for comparable transactions with or involving other nonaffiliated companies, or in the absence of comparable transactions, on terms and under circumstances that the banking entity in good faith would offer to, or would apply to, nonaffiliated companies.441 439 12 U.S.C. 1851(d)(1). U.S.C. 1851(d)(2); see also 2013 rule §§ ll.7 and ll.15. 441 12 U.S.C. 1851(f)(2); see 12 U.S.C. 371c– 1(a)(1). 440 12 E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations The agencies therefore have determined that the amendments to § ll.14(a) of the final rule, in the manner described above, would promote and protect both the safety and soundness of banking entities, and U.S. financial stability. E. Ownership Interest 1. Definition of ‘‘Ownership Interest’’ The 2013 rule defines an ‘‘ownership interest’’ in a covered fund to mean any equity, partnership, or other similar interest. Some banking entities have expressed concern about the inclusion of the term ‘‘other similar interest’’ in the definition of ‘‘ownership interest,’’ and have indicated that the definition of this term could lead to the inclusion of debt instruments that have standard covenants within the definition of ownership interest. Under the 2013 rule, ‘‘other similar interest’’ is defined as an interest that: • 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); • Has the right under the terms of the interest to receive a share of the income, gains or profits of the covered fund; • 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); • 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); • 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; • 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 VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 • Any synthetic right to have, receive, or be allocated any of the rights above.442 This definition focuses on the attributes of the interest and whether it provides a banking entity with economic exposure to the profits and losses of the covered fund, rather than its form. Under the 2013 rule, a debt interest in a covered fund can be an ownership interest if it has the same characteristics as an equity or other ownership interest (e.g., provides the holder with certain voting rights; the right or ability to share in the covered fund’s profits or losses; or the ability, directly or pursuant to a contract or synthetic interest, to earn a return based on the performance of the fund’s underlying holdings or investments). In the 2018 proposal, the agencies requested comment on all aspects of the 2013 rule’s application to securitization transactions, including the definition of ownership interest. Specifically, the agencies asked whether there were any modifications that should be made to the 2013 rule’s definition of ownership interest.443 Among other things, the agencies requested comments on whether they should modify § ll.10(d)(6)(i)(A) to provide that the ‘‘rights of a creditor to exercise remedies upon the occurrence of an event of default or an acceleration event’’ include the right to participate in the removal of an investment manager for cause, or to nominate or vote on a nominated replacement manager upon an investment manager’s resignation or removal.444 A number of comments received on the 2018 proposal supported the agencies’ suggestion to modify § ll.10(d)(6)(i)(A) and to expressly permit creditors to participate in the removal of an investment manager for cause, or to nominate or vote on a nominated replacement manager upon an investment manager’s resignation or removal without causing an interest to become an ownership interest.445 However, a few of these commenters on the 2018 proposal noted that this modification would not address all issues with the condition as banks sometimes have contractual rights to participate in the selection or removal of a general partner, managing member or member of the board of directors or trustees of a borrower that are not limited to the exercise of a remedy upon an event of default or other default PO 00000 rule § ll.10(d)(6)(i). FR 33481. 442 2013 443 83 444 Id. 445 See, e.g., SFIG; JBA; LSTA; and IAA. Frm 00039 Fmt 4701 Sfmt 4700 46459 event.446 Therefore, these commenters proposed eliminating the ‘‘other similar interest’’ clause from the definition altogether or, alternatively, replacing the definition of ownership interest with the definition of ‘‘voting securities’’ from the Board’s Regulation Y. A number of commenters on the 2018 proposal argued that debt interests issued by covered funds and loans to third-party covered funds not advised or managed by a banking entity should be excluded from the definition of ownership interest.447 Other commenters suggested reducing the scope of the definition of ownership interest to apply only to equity and equity-like interests that are commonly understood to indicate a bona fide ownership interest in a covered fund.448 One other commenter asked the agencies to clarify conditions under the ‘‘other similar interest’’ clause.449 Specifically, the commenter asked the agencies to clarify whether the right to receive all or a portion of the spread extends to using the excess spread or any debt repaid from collections on underlying assets of a special purpose entity to pay principal or interest that is otherwise owed is not an ownership interest. Another commenter asked the agencies not to modify the definition of ownership interest as, the commenter argued, there is nothing under section 13 of the BHC Act that limits or restricts the ability of a banking entity or nonbank financial company to sell or securitize loans in a manner permitted by law.450 In response to comments received on the 2018 proposal and in order to provide clarity about the types of interests that would be considered within the scope of the definition of ownership interest, the 2020 proposal would have amended the parenthetical in § ll.10(d)(6)(i)(A) to specify that creditors’ remedies upon the occurrence of an event of default or an acceleration event, which include, for example, the right to participate in the removal of an investment manager for cause or to nominate or vote on a nominated replacement manager upon an occurrence of an event of default, would not be considered an ownership interest for this reason alone.451 The 2020 proposal also sought comment on whether it would be appropriate to 446 See SFIG. e.g., Capital One et al. and BPI. 448 See, e.g., ABA and CAE. 449 See SFIG. 450 See Data Boiler. 451 The definition of ‘‘ownership interest’’ in the implementing regulations is independent from the definition of ‘‘voting securities’’ in the Board’s Regulation Y. 447 See, E:\FR\FM\31JYR4.SGM 31JYR4 46460 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations further allow for an interest to confer the right to participate in any removal of an investment manager for cause, or to nominate or vote on a nominated replacement manager upon an investment manager’s resignation or removal, whether or not an event of default or an acceleration event has occurred, without that interest being deemed an ownership interest. Such additional ‘‘for cause’’ termination events may include the insolvency of the investment manager, the breach by the investment manager of certain representations or warranties, or the occurrence of a ‘‘key person’’ event or a change in control with respect to the investment manager. Commenters on the 2020 proposal generally supported the proposed amendment to the definition of ownership interest to specify that creditors’ remedies upon the occurrence of an event of default or an acceleration event include the right to participate in the removal of an investment manager for cause or to nominate or vote on a nominated replacement manager upon an occurrence of an event of default. In the view of these commenters, the proposed clarification would appropriately recognize that the ability of a holder to vote on removal or appointment of managers for cause is not a right limited to equity holders. However, many of these commenters asserted that creditors’ rights are also provided to debt holders in circumstances other than an event of default or acceleration. These commenters therefore recommended the proposed amendments be expanded to include additional for cause events that are independent of an event of default or acceleration, such as the insolvency of the investment manager or breach of the investment management or collateral management agreement.452 In light of comments received on the 2020 proposal, the agencies recognize that it is customary for debt holders to hold certain rights to participate in the removal or replacement of an investment manager for cause that may be triggered by events other than default or acceleration events. The agencies believe that debt interests that include the rights of a creditor to participate in the for-cause removal or replacement of an investment manager under certain circumstances do not necessarily constitute the type of interest Section 13 of the BHC Act is intended to capture as an ownership interest. The agencies are therefore finalizing, with certain modifications, the amendments to § ll.10(d)(6)(i)(A) in order to provide 452 See, clarity about the types of creditor rights that may attach to an interest without that interest being deemed an ownership interest. The agencies have modified the scope of the definition of ownership interest in the final rule to allow for certain additional rights of creditors that are not triggered exclusively by an event of default or acceleration to attach to a debt interest without such interests being deemed ownership interests. In addition to such rights arising under events of default or acceleration, under the final rule, the definition of ownership interest does not include rights of a creditor to participate in the removal or replacement of an investment manager for cause in connection with: (1) The bankruptcy, insolvency, conservatorship or receivership of the investment manager; (2) the breach by the investment manager of any material provision of the covered fund’s transaction agreements applicable to the investment manager; (3) the breach by the investment manager of material representations or warranties; (4) the occurrence of an act that constitutes fraud or criminal activity in the performance of the investment manager’s obligations under the covered fund’s transaction agreements; (5) the indictment of the investment manager for a criminal offense, or the indictment of any officer, member, partner or other principal of the investment manager for a criminal offense materially related to his or her investment management activities; (6) a change in control with respect to the investment manager; (7) the loss, separation or incapacitation of an individual critical to the operation of the investment manager or primarily responsible for the management of the covered fund’s assets; or (8) other similar events that constitute ‘‘cause’’ for removal of an investment manager, provided that such events are not solely related to the performance of the covered fund or to the investment manager’s exercise of investment discretion under the covered fund’s transaction agreements. The 2020 proposal also would have provided a safe harbor from the definition of ownership interest, as suggested by some commenters to the 2018 proposal.453 The safe harbor was intended to address concerns of commenters to the 2018 proposal that some ordinary debt interests could be construed as an ownership interest. The 2020 proposal, therefore, would have e.g., SIFMA. VerDate Sep<11>2014 20:59 Jul 30, 2020 453 See Jkt 250001 PO 00000 SFIG. Frm 00040 Fmt 4701 Sfmt 4700 provided that any senior loan or other senior debt interest that meets all of the following characteristics would not be considered to be an ownership interest: (1) The holders of such interest do not receive any profits of the covered fund but may only receive: (i) Interest payments which are not dependent on the performance of the covered fund; and (ii) fixed principal payments on or before a maturity date (which may include prepayment premiums intended solely to reflect, and compensate holders of the interest for, foregone income resulting from an early prepayment); (2) The entitlement to payments on the interest is absolute and may not be reduced because of the losses arising from the covered fund, such as allocation of losses, write-downs or charge-offs of the outstanding principal balance, or reductions in the principal and interest payable; and (3) The holders of the interest are not entitled 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). Commenters on the 2020 proposal generally supported the proposed safe harbor from the definition of ownership interest for certain senior loans or senior debt interests that do not have equity-like characteristics.454 However, certain commenters also requested that the agencies clarify that the safe harbor is available to senior loans and senior debt interests where repayment of principal may vary as a result of acceleration or amortization provisions.455 Additionally, certain commenters also requested that the agencies clarify that the reference to senior loans or senior debt interests in the proposed safe harbor includes all exposures that would meet the definition of ‘‘investment grade’’ found in 12 CFR part 1 and implementing guidelines, as long as such exposures comply with the proposed conditions.456 The agencies intended for the proposed conditions of the safe harbor to provide clarity and predictability to banking entities by enabling them to determine more readily whether an interest would be an ownership interest under the regulations implementing section 13 of the BHC Act. After considering comments received, the 454 See, e.g., SIFMA; BPI; LSTA; Mortgage Bankers Association; and PNC. 455 See SIFMA. 456 See, e.g., LSTA and SFA. E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations agencies have included the conditions from the 2020 proposal for the safe harbor with a modification to § ll.10(d)(6)(ii)(B)(1)(ii). The modification requires that the senior loan or senior debt interest involves, among other things, repayment of a fixed principal amount, on or before a maturity date, in a contractuallydetermined manner (which may include prepayment premiums intended solely to reflect, and compensate holders of the interest for, forgone income resulting from an early prepayment). The agencies believe this modification will provide additional clarity that the safe harbor is available to senior loan and senior debt interests where contractual principal payments vary over the life of a senior loan or senior debt interest for reasons such as amortization and acceleration provided that the total amount of principal required to be repaid over the life of the instrument does not change. The agencies believe this modification to the safe harbor under the final rule will ensure that debt interests that do not have equitylike characteristics are not considered ownership interests. Additionally, the agencies believe that the conditions are rigorous enough to prevent banking entities from evading the prohibition on acquiring or retaining an ownership interest in a covered fund. Further, in response to certain commenters’ request that the agencies clarify that the reference to senior loans or senior debt interests in the proposed safe harbor includes all exposures that would meet the definition of ‘‘investment grade’’ found in 12 CFR part 1 and implementing guidelines, the agencies have determined that such a provision would be inappropriate for purposes of the safe harbor conditions in the final rule. Unlike the safe harbor provisions in the final rule regarding ownership interests, such a provision would not ensure that debt interests that have equity-like characteristics are treated as ownership interests for purposes of subpart C of the final rule. In response to the 2020 proposal, one commenter requested that the agencies modify the condition in § ll.10(d)(6)(i)(B) of the implementing regulations and § ll.10(d)(6)(ii)(B)(1) of the 2020 proposal, which states that an interest that has the right to receive a share of the income, gains or profits of the covered fund is considered an ownership interest, to clarify that the condition would not include amounts payable to securitization noteholders in accordance with a contractual priority of payments, commonly referred to as a ‘‘waterfall,’’ so long as such amounts are limited to fixed principal and interest VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 determined on a fixed or typical index floating rate basis.457 Specifically, the commenter suggested a modification to this condition to clarify that the term ‘‘profit’’ is intended to mean ‘‘net profits’’ out of concern for the potential ambiguity of how the condition would apply to amounts received by securitization noteholders in accordance with the securitization’s waterfall of payment. Another commenter disagreed with any revision to the 2020 proposed rule that would only cover as an ownership interest an interest which has the right to receive a share of the ‘‘net’’ income, gains or profits of the covered fund.458 The final rule does not modify § ll.10(d)(6)(i)(B) of the implementing regulations or § ll.10(d)(6)(ii)(B)(1) of the 2020 proposal. However, the agencies clarify that a debt interest in a covered fund would not be considered an ownership interest solely because the interest is entitled to receive an allocation of collections from the covered fund’s underlying financial assets in accordance with a contractual priority of payments. 2. Fund Limits and Covered Fund Deduction The 2020 proposal included amendments to the implementing regulations to better align the manner in which a banking entity calculates the aggregate fund limit and covered fund deduction with the manner in which it calculates the per fund limit, as it relates to investments by employees of the banking entity. Specifically, consistent with how investments by employees and directors are treated generally under the existing rule of construction in § ll.12(b)(1)(iv), the 2020 proposal would have modified §§ ll.12(c) and ll.12(d) to require attribution of amounts paid by an employee or director to acquire a restricted profit interest only when the banking entity has financed the acquisition. The 2013 rule excludes from the definition of ownership interest certain restricted profit interests.459 To be SFA. Data Boiler. 459 2013 rule § ll.10(d)(6)(ii). Under the 2013 rule, the exclusion from the definition of ownership interest is limited to restricted profit interests held by an entity, employee, or former employee in a covered fund for which the entity or employee serves as investment manager, investment adviser, commodity trading advisor, or other service provider. As noted in the preamble to the 2013 rule, the term ‘‘restricted profit interest’’ was used to avoid any confusion from using the term ‘‘carried interest,’’ which is used in other contexts. The proposed rule would focus on the treatment of restricted profit interests for purposes of calculating PO 00000 457 See 458 See Frm 00041 Fmt 4701 Sfmt 4700 46461 excluded from the definition of ownership interest, the restricted profit interest must also meet various other conditions, including that any amounts invested in the covered fund—including amounts paid by the entity, an employee of the entity, or former employee of the entity—are within the applicable limits under § ll.12 of the 2013 rule.460 Under § ll.12 of the 2013 rule, different calculation methodologies apply for purposes of calculating compliance with the per fund limit, the aggregate fund limit, and the covered fund deduction.461 For purposes of calculating a banking entity’s compliance with the aggregate fund limit and the covered fund deduction, the banking entity must include any amounts paid by the banking entity or an employee in connection with obtaining a restricted profit interest in the covered fund.462 The agencies did not receive comments on the proposed change in the treatment of restricted profit interests. Several commenters recommended that the agencies eliminate the per fund limit, the aggregate fund limit, and the covered fund deduction with respect to any ownership interest held by a banking entity in any covered fund, if that interest is held pursuant to underwriting and market making activities.463 With respect to the proposed change in the treatment of restricted profit interests, the agencies continue to believe that it is appropriate for a banking entity to count amounts invested by the banking entity (or its affiliates) to acquire restricted profit interests in a fund organized and offered by the banking entity for purposes of the aggregate fund limit and covered fund deduction. However, the agencies believe attribution of employee and director ownership of restricted profit interests to a banking entity may not be necessary in the circumstance when a banking entity does not finance, directly compliance with the aggregate fund limit and covered fund deduction but would not address in any way the treatment of such profit interests under other laws, including under Federal income tax law. See 79 FR 5706, n.2091. 460 2013 rule § ll.10(d)(6)(ii)(C). 461 2013 rule § ll.12(b)(1)(iv). As noted in the preamble to the 2013 rule, the attribution to a banking entity of ownership interests acquired by an employee or director using financing provided by the banking entity ensures that funding provided by the banking entity to acquire ownership interests in the fund, whether provided directly or indirectly, is counted against the per fund limit and aggregate fund limit. See 79 FR 5733. 462 2013 rule § ll.10(d)(6)(C); §§ ll.12(c)(1), (d). See also 12 U.S.C. 1851(d)(1)(G). 463 BPI; FSF; IIB; and SIFMA. E:\FR\FM\31JYR4.SGM 31JYR4 46462 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations or indirectly, the employee’s or director’s acquisition of a restricted profit interest in a covered fund organized or offered by the banking entity. The final rule amends the implementing regulations to limit the attribution of an employee’s or director’s restricted profit interest in a covered fund organized or offered by the banking entity to only those circumstances in which the banking entity has directly or indirectly financed the acquisition of the restricted profit interest. The agencies expect that this amendment will simplify a banking entity’s compliance with the aggregate fund limit and covered fund deduction provisions of the rule, and more fully recognize that employees and directors may use their own resources, not provided by the banking entity, to invest in ownership interests or restricted profit interests in a covered fund they advise (for example, to align their personal financial interests with those of other investors in the covered fund). The final rule does not adopt the recommendation from commenters that the agencies should eliminate the per fund limit, aggregate fund limit, or covered fund deduction requirements. The 2019 amendments adopted several changes to simplify the covered fund compliance requirements for banking entities that engage in market making or underwriting with respect to a thirdparty covered fund. Specifically, the 2019 amendments eliminated the aggregate fund limit and capital deduction requirements for the value of ownership interests in third-party funds acquired or retained in connection with permissible market making or underwriting activities (i.e., covered funds that the banking entity does not advise or organize and offer pursuant to § ll.11(a) or (b) of the implementing regulations). In discussing this change in the preamble to the 2019 amendments, the agencies noted that the amendments to the treatment of ownership interests in third-party funds were intended to better align the compliance requirements for underwriting and market making involving covered funds with the risks that those activities entail.464 The compliance challenges associated with underwriting and market making in ownership interests in covered funds is particularly acute with respect to thirdparty covered funds. As discussed in the preamble to the 2019 amendments, ‘‘a banking entity can more readily determine whether a fund is a covered fund if the banking entity advises or 464 See 84 FR 62017. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 organizes and offers the fund.’’ 465 While section 13 of the BHC Act provides the agencies greater flexibility to adopt changes in the treatment of ownership interests in third-party funds, it prescribes specific requirements that apply to funds that the banking entity advises, or organizes and offers. Specifically, section 13 provides that a banking entity must not acquire or retain an ownership interest in a fund organized and offered by the banking entity except for a de minimis investment subject to and in compliance with paragraph (d)(4) of section 13 of the BHC Act.466 Therefore, the final rule does not adopt the change recommended by commenters to modify the treatment of ownership interests in related covered funds that are held by a banking entity in connection with market making and underwriting activities. F. Parallel Investments The 2020 proposal included a new rule of construction in § ll.12(b) clarifying that banking entities are not required to treat investments alongside covered funds as investments in covered funds if certain conditions are met.467 As explained in the 2020 proposal, this rule of construction was meant to provide clarity in light of a discrepancy between the preamble to the 2013 rule and the text of the implementing regulations. The implementing regulations require that a banking entity hold no more than three percent of the total ownership interests of a covered fund that the banking entity organizes and offers pursuant to § ll.11.468 Section ll.12(b)(1)(i) of the implementing regulations requires that, for purposes of this ownership limitation, ‘‘the amount and value of a banking entity’s permitted investment in any single covered fund shall include any ownership interest held under § ll.12 directly by the banking entity, including any affiliate of the banking entity.’’ 469 Section ll.12(b) also includes several other rules of construction that address circumstances under which an investment in a covered fund would be attributed to a banking entity. The 2011 notice of proposed rulemaking included a proposed provision that would have required attribution of certain direct investments by a banking entity alongside, or 465 Id. U.S.C. 1851(d)(1)(G)(iii). 85 FR 12149. 468 See id. at 12148; implementing regulations § ll.12. 469 See implementing regulations § ll.12(b)(1)(i). PO 00000 466 12 467 See Frm 00042 Fmt 4701 Sfmt 4700 otherwise in parallel with, a covered fund.470 The agencies declined to adopt this provision in the 2013 rule after considering the language of the statute as well as commenters’ views on that provision.471 The 2013 rule restricts a banking entity’s investment in a covered fund organized and offered pursuant to § ll.11 to three percent of the total number or value of the outstanding ownership interests of the fund. That regulatory requirement is consistent with section 13(d)(4) of the BHC Act, which limits the size of investments by a banking entity in a hedge fund or private equity fund.472 Neither section 13(d)(4) of the BHC Act nor the text of the implementing regulations requires a banking entity to treat an otherwise permissible investment the banking entity makes alongside a covered fund as an investment in the covered fund. The text of the 2013 rule does not impose any quantitative limits on any investments by banking entities made alongside, or otherwise in parallel with, covered funds.473 However, in the preamble to the 2013 rule, the agencies discussed the potential for evasion of the per fund limit and aggregate fund limit and stated that ‘‘if a banking entity makes investments side by side in substantially the same positions as the covered fund, then the value of such investments shall be included for purposes of determining the value of the banking entity’s investment in the covered fund.’’ 474 The agencies also stated that ‘‘a banking entity that sponsors the covered fund should not itself make any additional side by side co-investment with the covered fund in a privately negotiated investment unless the value of such co-investment is less than 3% of the value of the total amount co-invested by other investors in such investment.’’ 475 The 2020 proposal included a new rule of construction to address investments made by banking entities alongside covered funds. This proposed rule of construction was intended to clarify in the rule text that banking 470 Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 76 FR 68846, 68951–52 (Nov. 7, 2011). 471 In declining to adopt this parallel investment provision, the agencies noted that banking entities rely on a number of investment authorities and structures to make investments and meet the needs of their clients. 79 FR 5734. 472 12 U.S.C. 1851(d)(4). 473 Any investment by the banking entity would need to comply with the proprietary trading restrictions in Subpart B of the implementing regulations. 474 79 FR 5734. 475 See id. E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations entities are not required to treat a direct investment by a banking entity alongside a covered fund as an investment in the covered fund if certain conditions are met. Specifically, proposed § ll.12(b)(5) provided that: (1) A banking entity shall not be required to include in the calculation of the investment limits under § ll.12(a)(2) any investment the banking entity makes alongside a covered fund as long as the investment is made in compliance with applicable laws and regulations, including applicable safety and soundness standards. (2) A banking entity shall not be restricted under § ll.12 in the amount of any investment the banking entity makes alongside a covered fund as long as the investment is made in compliance with applicable laws and regulations, including applicable safety and soundness standards.476 In the preamble to the 2020 proposal, the agencies recognized that banking entities rely on a number of investment authorities and structures to make investments and meet the needs of their clients and shareholders.477 The agencies indicated that the proposed rule of construction would provide clarity to banking entities so that they may make such investments for the benefit of their clients and shareholders, provided that those investments comply with applicable laws and regulations.478 The preamble to the 2020 proposal went on to note several restrictions that may apply to a banking entity’s investment alongside a covered fund. For example, a banking entity may not engage in prohibited proprietary trading alongside a covered fund. Likewise, a banking entity must have authority to make any investment alongside a covered fund under applicable banking and other laws and regulations and must ensure that the investment complies with applicable safety and soundness standards. For example, national banks are restricted in their ability to make direct equity investments under 12 U.S.C. 24 (Seventh) and 12 CFR part 1. In addition, a banking entity that invests alongside a covered fund that the banking entity organizes and offers under the asset management exemption in § ll.11 would need to comply with all the conditions of that exemption, which, among other things, prohibits the banking entity from guaranteeing, assuming, or otherwise insuring the obligations or performance of the covered fund. Thus, a banking entity 476 See 85 FR 12149. See also 79 FR 5734. 478 85 FR 12149. 477 Id. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 would not be permitted to make a direct investment alongside a covered fund that the banking entity organizes and offers for the purpose of artificially maintaining or increasing the value of the fund’s positions. Likewise, the banking entity would also need to ensure that any direct investment alongside an organized and offered covered fund does not cause the sponsoring banking entity’s permitted organizing and offering activities to violate the prudential backstops under § ll.15.479 Most commenters that addressed the proposed rule of construction supported adopting the proposed revision.480 Commenters stated that the rule of construction was consistent with section 13 of the BHC Act, would not increase the types of risks that section 13 of the BHC Act was meant to address, and would not raise concerns about evading section 13 of the BHC Act.481 Commenters noted that banking entities would need to hold their investments in a manner consistent with relevant authorities and the associated risk management and other prudential and regulatory limits and controls, including stringent capital requirements, for these types of investments.482 Some commenters also requested that the agencies permit employees and directors of a banking entity that sponsors a covered fund to invest directly in that covered fund, regardless of whether the employees or directors provide services to the covered fund on behalf of their banking entity employer.483 The agencies received one comment opposing the proposed rule of construction.484 This commenter characterized the proposed rule of construction as permitting proprietary trading at arm’s length but without a limit on the ownership interest that a banking entity may hold and stated that parallel investments should be subject to the limitations that would apply to direct investments in covered funds.485 After carefully considering the comments received, the agencies are adopting the rule of construction in 479 See id. In particular, to the extent the investment would result in a material conflict of interest between the banking entity and its clients, for example because the banking entity may exit the position at a different time or on different terms than the covered fund, the banking entity would be required to provide timely and effective disclosure in accordance with § ll.15(b) prior to making the investments. Id. 480 See FSF; SIFMA; BPI; IIB; Goldman Sachs; PNC; and ABA. 481 See FSF; SIFMA; and BPI. 482 See FSF; SIFMA; and BPI. 483 See ABA and PNC. 484 See Data Boiler. 485 See id. PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 46463 § ll.12(b)(5), as proposed.486 As described above and in the 2020 proposal, this rule of construction is consistent with the text of section 13 of the BHC Act, which does not prohibit a banking entity from making otherwise permissible investments directly when doing so alongside a covered fund. This rule of construction will also reduce compliance burden by clarifying that a banking entity is not required under § ll.12 of the final rule to attribute to the banking entity direct investments made alongside a covered fund for purposes of the de minimis investment limitation. In response to the commenter who opposed the rule of construction,487 the agencies note that the rule of construction is consistent with section 13 of the BHC Act and each investment by a banking entity must comply with laws and regulations, including any applicable safety and soundness standards. As discussed in the preamble to the 2020 proposal, the rule of construction will not prohibit a banking entity from having investment policies, arrangements or agreements to invest alongside a covered fund in all or substantially all of the investments made by the covered fund or to fund all or any portion of the investment opportunities made available by the covered fund to other investors. Accordingly, a banking entity could market a covered fund it organizes and offers pursuant to § ll.11 on the basis of the banking entity’s expectation that it would invest in parallel with the covered fund in some or all of the same investments, or the expectation that the banking entity would fund one or more co-investment opportunities made available by the covered fund. However, as discussed in the preamble to the 2020 proposal, the agencies would expect that any such investment policies, arrangements or agreements would ensure that the banking entity has the ability to evaluate each investment on a case-by-case basis to confirm that the banking entity does not make any investment unless the investment complies with applicable laws and 486 Final rule § ll.12(b)(5). These kinds of investments could be, for example, parallel investments or co-investments. For these purposes, ‘‘parallel investments’’ generally refers to a series of investments that are made side-by-side with a covered fund, and ‘‘co-investments’’ generally refers to a specific investment opportunity that is made available to third-parties when the general partner or investment manager for the covered fund determines that the covered fund does not have sufficient capital available to make the entire investment in the target portfolio company or determines that it would not be suitable for the covered fund to take the entire available investment. 487 See Data Boiler. E:\FR\FM\31JYR4.SGM 31JYR4 46464 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations regulations, including any applicable safety and soundness standards. The agencies believe that this would further ensure that the banking entity is not exposed to the types of risks that section 13 of the BHC Act was intended to address. As discussed earlier and in the preamble to the 2020 proposal, the agencies recognize that the 2011 proposed rule would have required a banking entity to apply the per fund limit and aggregate fund limit to a direct investment alongside a covered fund when, among other things, a banking entity is contractually obligated to make such investment alongside a covered fund. The agencies continue to believe that such a prohibition is not necessary given the agencies’ expectation that a banking entity would retain the ability to evaluate each investment on a caseby-case basis to confirm that the banking entity does not make any investment unless the investment complies with applicable laws and regulations, including any applicable safety and soundness standards. The 2013 rule imposes certain attribution rules and eligibility requirements for investments by directors and employees of a banking entity in covered funds organized and offered by the banking entity. Specifically, § ll.12(b)(1)(iv) of the 2013 rule requires attribution of 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 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. Section ll.11(a)(7) prohibits investments by any director or employee of the banking entity (or an affiliate thereof) in the covered fund, other than any director or employee 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 makes the investment. As discussed in the preamble to the 2020 proposal, the agencies recognize that directors and employees of banking entities may participate in investments alongside a covered fund, for example on an ad hoc basis or as part of a compensation arrangement. Consistent with the agencies’ rule of construction regarding direct investments by banking entities alongside a covered fund, the agencies would expect that any direct investments (whether a series of parallel VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 investments or a co-investment) by a director or employee of a banking entity (or an affiliate thereof) made alongside a covered fund in compliance with applicable laws and regulations would not be treated as an investment by the director or employee in the covered fund. Accordingly, such a direct investment would not be attributed to the banking entity as an investment in the covered fund, regardless of whether the banking entity arranged the transaction on behalf of the director or employee or provided financing for the investment.488 Similarly, the requirements under § ll.11(a)(7) limiting the directors and employees that are eligible to invest in a covered fund organized and offered by the banking entity to those that are directly engaged in providing specified services to the covered fund would not apply to any such direct investment.489 With respect to investments in a covered fund, the agencies decline to permit an employee or director of a banking entity that organizes and offers a covered fund to make investments in that covered fund if the director or employee does not provide services to the covered fund on behalf of the banking entity, as requested by some commenters.490 The restriction on these types of director and employee investments is required by the statute.491 G. Technical Amendments The agencies proposed five sets of clarifying technical edits to the implementing regulations. Specifically, the agencies proposed to (1) amend § ll.12(b)(1)(ii) to add a comma after the words ‘‘SEC-regulated business development companies’’ in both places where that phrase is used; (2) amend § ll.12(b)(4)(i) to replace the phrase ‘‘ownership interest of the master fund’’ with the phrase ‘‘ownership interest in the master fund’’; (3) amend § ll.12(b)(4)(ii) to replace the phrase 488 See 2013 rule § ll.12(b)(1)(iv) (requiring attribution of an investment by a director or employee in a covered fund organized and offered by the banking entity, where the banking entity, directly or indirectly, extends financing for the purpose of enabling the director or employee to acquire the ownership interest in the covered fund and the financing is used to acquire such ownership interest in the covered fund) (emphasis added). 489 See 2013 rule § ll.11(a)(7) (prohibiting investments by any director or employee of the banking entity (or an affiliate thereof) in a covered fund organized and offered by the banking entity, other than any director or employee 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 makes the investment) (emphasis added). 490 See ABA and PNC. 491 See 12 U.S.C. 1851(d)(1)(G)(vii). PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 ‘‘ownership interest of the fund’’ with the phrase ‘‘ownership interest in the fund;’’ (4) amend §§ ll.10(c)(3)(i) and ll.10(c)(10)(i) to replace the word ‘‘comprised’’ with the word ‘‘composed;’’ and (5) amend § ll.10(c)(8)(iv)(A) to replace the word ‘‘of’’ in the phrase ‘‘contractual rights of other assets’’ with the word ‘‘or.’’ The agencies did not receive comment on these provisions and are adopting the technical amendments as proposed. V. Administrative Law Matters A. Use of Plain Language Section 722 of the Gramm-LeachBliley Act 492 requires the Federal banking agencies to use plain language in all proposed and final rules published after January 1, 2000. The Federal banking agencies 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 creates new recordkeeping requirements and revises certain disclosure 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 492 Public Law 106–102, section 722, 113 Stat. 1338, 1471 (1999). E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations Reporting FDIC will take burden for banking entities that are not under a holding company. Abstract Section 13 of 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 and asset management activities. Current Actions The final rule contains requirements subject to the PRA, and the changes relative to the implementing regulations are discussed herein. The new recordkeeping requirements are found in section ll.10(c)(18)(ii)(C)(1) and the modified disclosure requirements are found in section ll.11(a)(8)(i). The modified information collection requirements 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. Recordkeeping Requirements Section ll.10(c)(18)(ii)(C)(1) requires a banking entity relying on the exclusion from the covered fund definition for customer facilitation vehicles to maintain documentation outlining how the banking entity intends to facilitate the customer’s exposure to a transaction, investment strategy, or service. The agencies estimate that the new recordkeeping requirement will be incurred once a year with an average hour per response of 10 hours. Disclosure Requirements Section ll.11(a)(8)(i), which requires banking entities that organize and offer covered funds to make certain disclosures to investors in such funds, is being expanded to also apply to banking entities relying on exclusions for credit funds, venture capital funds, family wealth management vehicles, or customer facilitation vehicles. The agencies estimate that the current average hours per response of 0.1 will increase to 0.5. Revision, With Extension, of the Following Information Collections Estimated average hours per response: VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 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)—40 hours (Initial setup 80 hours). Section ll.10(c)(18)(ii)(C)(1)—10 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)—0.5 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. Revisions estimated annual burden: 302 hours. Estimated annual burden hours: 20,410 hours (3,681 hour for initial setup and 16,729 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 PO 00000 Frm 00045 Fmt 4701 Sfmt 4700 46465 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 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. Revisions estimated annual burden: 7,880 hours. Estimated annual burden hours: 36,112 hours (4,381 hour for initial setup and 31,731 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: 10. E:\FR\FM\31JYR4.SGM 31JYR4 46466 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations Revisions estimated annual burden: 175 hours. Estimated annual burden hours: 3,288 hours (1,759 hours for initial set-up and 1,529 hours for ongoing). C. Regulatory Flexibility Act Analysis The Regulatory Flexibility Act (RFA) 493 requires an agency to either provide a regulatory flexibility analysis with a final rule or certify that the final 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.494 Except as otherwise specified below, the size standard to be considered a small business for banking entities subject to the final rule is $600 million or less in consolidated assets.495 Board The Board has considered the potential impact of the final rule on small entities in accordance with section 603 of the RFA. Based on the Board’s analysis, and for the reasons stated below, the Board certifies that the final rule will not have a significant economic impact on a substantial of number of small entities. The Board invited comment on all aspects of its analysis related to the requirements of the RFA in connection with the 2020 proposal. In particular, the Board requested that commenters describe the nature of any impact on small entities and provide empirical data to illustrate and support the extent of the impact. The Board did not receive any comments related to this issue. As discussed in the SUPPLEMENTARY INFORMATION, the agencies are adopting revisions to the regulations implementing section 13 of the BHC Act in order to improve and streamline the regulations by modifying and clarifying requirements related to the covered fund provisions.496 Certain of the exclusions from the covered fund definition included in the final rule contain recordkeeping and disclosure requirements that would apply to banking entities relying on the 493 5 U.S.C. 601 et seq. SBA, Table of Small Business Size Standards Matched to North American Industry Classification System Codes, available at https:// www.sba.gov/document/support--table-sizestandards. 495 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). 496 The agencies are explicitly authorized under section 13(b)(2) of the BHC Act to adopt rules implementing section 13. 12 U.S.C. 1851(b)(2). 494 U.S. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 exclusion. For example, the exclusion for customer facilitation vehicles requires a banking entity relying on the exclusion to maintain documentation outlining how the banking entity intends to facilitate the customer’s exposure to a transaction, investment strategy, or service. The final rule is expected to reduce regulatory burden on banking entities, and the Board does not expect these recordkeeping requirements to result in a significant economic impact. The Board’s rule generally applies to state-chartered banks that are members of the Federal Reserve System, bank holding companies, and foreign banking organizations and nonbank financial companies supervised by the Board (collectively, ‘‘Board-regulated entities’’). However, section 203 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA),497 which was enacted on May 24, 2018, amended section 13 of the BHC Act by narrowing the definition of banking entity to exclude certain community banks.498 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 its implementing regulations 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 its implementing regulations, the Board does not expect the total number of such entities to be substantial. Accordingly, the Board’s final rule is not expected to have a significant economic impact on a substantial number of small entities. OCC The Regulatory Flexibility Act (RFA), 5 U.S.C. 601 et seq., 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 Small Business Administration (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 final rule would not have a significant economic impact on Law 115–174 (May 24, 2018). 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 five percent or less of total consolidated assets. PO 00000 497 Public 498 Under Frm 00046 Fmt 4701 Sfmt 4700 a substantial number of small entities. The OCC currently supervises approximately 745 small entities.499 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 BHC Act if their trading assets and trading liabilities do not exceed five percent of their total consolidated assets. In addition, section 13 of the BHC Act generally excludes certain institutions that function only in a trust or fiduciary capacity from the definition of ‘‘banking entity. As a result, no OCC-supervised small entities are subject to section 13 of the BHC Act. 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 OCCsupervised small entities. FDIC The RFA generally requires that, in connection with a final rulemaking, an agency prepare and make available for public comment a final regulatory flexibility analysis describing the impact of the final rule on small entities.500 However, a regulatory flexibility analysis is not required if the agency certifies that the final 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 that are independently owned and operated or owned by a holding company with less than or equal to $600 million in total assets.501 Generally, the FDIC considers 499 The OCC bases its estimate of the number of small entities on 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 as a small entity. The OCC uses December 31, 2019, 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 SBA’s Table of Size Standards. 500 5 U.S.C. 601 et seq. 501 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 E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations a significant effect to be a quantified effect in excess of five 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. For the reasons described below and under section 605(b) of the RFA, the FDIC certifies that this final rule will not have a significant economic impact on a substantial number of small entities. As of December 31, 2019, the FDIC supervised 3,344 depository institutions,502 of which 2,581 were considered small entities for the purposes of RFA.503 The Economic Growth, Regulatory Relief, and Consumer Protection Act excluded entities from the requirements of section 13 of the BHC Act that do not have and are not controlled by a company that has total assets of more than $10 billion or trading assets and liabilities comprising more than five percent of total consolidated assets.504 Only one small, FDIC-supervised institution is subject to section 13 of the BHC Act, because its trading assets and liabilities exceed five percent of total consolidated assets.505 Section 13 of 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. As previously discussed, the final rule modifies existing definitions and exclusions and introduces new exclusions to the implementing regulations. The final rule permits covered entities to engage in additional activities with respect to covered funds, including acquiring or retaining an ownership interest in, sponsoring, or having certain relationships with covered funds, subject to certain restrictions. This final rule excludes certain types of investment funds from the definition of a ‘‘covered fund’’ for the purposes of section 13 of the BHC Act. Investments in funds that are affected by this final rule could be reported as deductions from capital on Call Report schedule RC–R Part 1 Lines 11 or 13 if the investments qualify as ‘‘investments in the capital of an unconsolidated determine whether the covered entity is ‘‘small’’ for the purposes of RFA. 502 FDIC-supervised institutions are set forth in 12 U.S.C. 1813(q)(2). 503 FDIC Call Report data, December 31, 2019. 504 Public Law 115–174, May 24, 2018. https:// www.congress.gov/bill/115th-congress/senate-bill/ 2155. 505 FDIC Call Report data, December 2019. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 financial institution’’ or as additional deductions on Lines 17 or 24 of schedule RC–R otherwise.506 The one affected small, FDIC-supervised institution did not report any such deductions over the past five years.507 Based on this supporting information, the FDIC certifies that this final rule will not have a significant economic impact on a substantial number of small entities. SEC In the 2020 proposal, the SEC certified that, pursuant to 5 U.S.C. 605(b), the 2020 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 amendments clarify and simplify compliance with the implementing regulations, refine the extraterritorial application of the section 13 of the BHC Act, and permit additional fund activities that do not present the risks that section 13 was intended to address. The amendments will generally apply to banking entities, including certain SEC-registered entities. These entities include bank-affiliated SEC-registered investment advisers, broker-dealers, and security-based swap dealers. Based on information in filings submitted by these entities, the SEC believes that there are no banking entity registered investment advisers or broker-dealers that are small entities for purposes of the RFA. For this reason, the SEC certifies that the amendments will not have a significant economic impact on a substantial number of small entities. CFTC Pursuant to 5 U.S.C. 605(b), the CFTC hereby certifies that the 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 final rule clarifies and simplifies compliance with the implementing regulations, refines the extraterritorial application of section 13 of the BHC Act, and permits additional fund activities that do not present the risks that section 13 was intended to 506 See ‘‘Supervisory Guidance on the Capital Treatment of Certain Investments in Covered Funds.’’ FDIC FIL–50–2015: November 6, 2015. https://www.fdic.gov/news/news/financial/2015/ fil15050a.pdf. 507 FDIC Call Report data, March 2015–December 2019. PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 46467 address. To reduce the extraterritorial impact of the implementing regulations, the final rule exempts the activities of certain funds that are organized outside of the United States and offered to foreign investors from certain restrictions of the implementing regulations. The final rule also revises several existing exclusions from the covered fund provisions, to provide clarity and simplify compliance with the requirements of the implementing regulations. The final rule adopts several new exclusions from the covered fund definition in order to more closely align the regulation with the purpose of the statute. Last, the final rule adopts revisions to the provisions that govern the relationship between a banking entity and a fund and the definition of ownership interest. The final rule 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.508 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.509 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.510 In the context of the 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 implementing regulations, and generally those that are registered have larger businesses. 508 The final rule 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 final rule. See 79 FR 5808, 5813 (Jan. 31, 2014) (CFTC version of 2013 final rule). 509 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); Registration of Swap Dealers and Major Swap Participants, 77 FR 2613, 2620 (Jan. 19, 2012) (swap dealers and major swap participants). 510 See Policy Statement and Establishment of Definitions of ‘‘Small Entities’’ for Purposes of the Regulatory Flexibility Act, 47 FR 18618, 18620 (Apr. 30, 1982). E:\FR\FM\31JYR4.SGM 31JYR4 46468 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations Similarly, the final rule applies to only those commodity trading advisors that are affiliated with banks, which the CFTC expects are larger businesses. The CFTC requested that commenters address in particular whether any of these commodity trading advisors, or other CFTC registrants covered by the proposed revisions, 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 that there are not a substantial number of registered, banking entity-affiliated commodity trading advisors 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 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. D. Riegle Community Development and Regulatory Improvement Act Section 302(a) of the Riegle Community Development and Regulatory Improvement Act of 1994 (RCDRIA) 511 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. 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.512 Therefore, the effective date for the Federal banking agencies is October 511 12 512 12 U.S.C. 4802(a). U.S.C. 4802(b). VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 1, 2020, the first day of the calendar quarter.513 E. OCC Unfunded Mandates Reform Act The OCC has analyzed the final rule under the factors in the Unfunded Mandates Reform Act of 1995 (UMRA). Under this analysis, the OCC considered whether the final 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 annually for inflation). The UMRA does not apply to regulations that incorporate requirements specifically set forth in law. The final rule does not impose new mandates. 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 i. Background As discussed above, section 13 of the Bank Holding Company (BHC) Act generally prohibits banking entities 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 (1) any insured depository institution (as defined by statute), (2) any company that controls an insured depository institution, (3) any company that is treated as a bank holding company for purposes of section 8 of the International Banking Act of 1978, and (4) any affiliate or subsidiary of such an entity.514 In addition, the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA),515 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 513 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, October 1, 2020, will be more than 30 days after publication in the Federal Register. 514 See 12 U.S.C. 1851(h)(1). 515 See supra note 504. PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 more than 5% of total consolidated assets.516 Certain SEC-regulated entities, such as broker-dealers, security-based swap dealers (SBSDs), and registered investment advisers (RIAs) affiliated with an insured depository institution, fall under the definition of ‘‘banking entity’’ and are subject to the prohibitions of section 13 of the BHC Act.517 The SEC’s 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 focuses primarily on the potential effects of the rule amendments being adopted here (the ‘‘final rule’’) on (1) SEC registrants, in their capacity as such, (2) the functioning and efficiency of the securities markets, (3) investor protection, and (4) capital formation. SEC registrants that may be affected by the final rule include SEC-registered broker-dealers, SBSDs, and RIAs. Thus, the analysis below does not consider the direct effects of the final rule on brokerdealers, SBSDs, and registered investment advisers that are not banking entities, or banking entities that are not SEC registrants. In addition, potential spillover effects on these and other entities are reflected in the SEC’s analysis of effects on efficiency, 516 These and other aspects of the regulatory baseline against which the SEC is assessing the economic effects of the final rule being adopted here on SEC-regulated 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. See Revisions to Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds, 84 FR 35008 (July 22, 2019). In November 2019, the agencies adopted the 2019 amendments, which tailored certain proprietary trading and covered fund restrictions of the 2013 rule. See supra note 8. 517 Throughout this economic analysis, the terms ‘‘banking entity’’ and ‘‘entity’’ generally refer only to banking entities for which the SEC is the primary financial regulatory agency. 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), 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, 84 FR 43872 (Aug. 22, 2019) (‘‘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. E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations competition, investor protection, and capital formation in securities markets. This economic analysis also discusses the impact of the final rule on private funds,518 to the degree that it may flow through to SEC registrants, such as RIAs, SEC-registered broker-dealers and SBSDs, and securities markets and investors. 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.519 The regulatory regime created by the 2013 rule may have enhanced regulatory oversight and compliance with the substantive prohibitions of section 13 of the BHC Act, but could also have impacted capital formation and liquidity, as well as the provision by banking entities of a variety of financial services for customers. Section 13 of the BHC Act also provides a number of statutory exemptions to the general prohibitions on proprietary trading and covered funds activities. For example, the statute exempts certain covered funds 518 There is significant overlap between the definitions of ‘‘private fund’’ and ‘‘covered fund.’’ For purposes of this economic analysis, ‘‘private fund’’ means an issuer that would be an investment company, as defined in section 3 of the Investment Company Act (15 U.S.C. 80a–3(a)), but for section 3(c)(1) or section 3(c)(7) of that Act (15 U.S.C. 80– 3(c)(1) or (7)). See also 15 U.S.C. 80b–2(a)(29). Section 13(h)(2) of the BHC Act defines ‘‘hedge fund’’ and ‘‘private equity fund’’ to mean an issuer that would be an investment company, but for section 3(c)(1) or 3(c)(7) of the Investment Company Act, or ‘‘such similar funds’’ as the agencies determine by rule (see 12 U.S.C. 1851(h)(2)). In the 2013 rule, the agencies combined the definitions of ‘‘hedge fund’’ and ‘‘private equity fund’’ into a single term ‘‘covered fund’’ and defined this term to include any issuer that would be an investment company as defined in the Investment Company Act but for section 3(c)(1) or 3(c)(7) of that Act with a number of express exclusions and additions as determined by the agencies. Implementing regulations § ll.10(b) and (c). 519 See, e.g., 79 FR 5536, 5541, 5574, 5659, 5666. An extensive body of research has examined moral hazard arising out of federal deposit insurance, implicit bailout guarantees, and systemic risk issues. See, e.g., Andrew G. Atkeson et al., Government Guarantees and the Valuation of American Banks, 33 NBER Macroeconomics Ann. 81 (2018). See also Javier Bianchi, Efficient Bailouts? 106 Amer. Econ. Rev. 3607 (2016); Bryan Kelly, Hanno Lustig, & Stijn Van Nieuwerburgh, Too-Systematic-to-Fail: What Option Markets Imply about Sector-Wide Government Guarantees, 106 Amer. Econ. Rev. 1278 (2016); Deniz Anginer, Asli Demirguc-Kunt, & Min Zhu, How Does Deposit Insurance Affect Bank Risk? Evidence from the Recent Crisis, 48 J. Banking & Fin. 312 (2014); Andrea Beltratti & Rene M. Stulz, The Credit Crisis Around the Globe: Why Did Some Banks Perform Better?, 105 J. Fin. Econ. 1 (2012); Pietro Veronesi & Luigi Zingales, Paulson’s Gift, 97 J. Fin. Econ. 339 (2010). 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). VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 activities, such as organizing and offering covered funds.520 The 2013 rule implemented these exemptions.521 Banking entities engaged in activities and investments covered by section 13 of the BHC Act and the implementing regulations are required to establish a compliance program reasonably designed to ensure and monitor compliance with the implementing regulations.522 In the 2020 proposal, the SEC solicited comment on all aspects of the costs and benefits associated with the proposed amendments for SEC registrants, including 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. ii. Broad Economic Effects Certain aspects of the implementing regulations may have resulted in a complex and costly compliance regime that is unduly restrictive and burdensome on some affected banking entities. Distinguishing between permissible and prohibited activities may be complex and costly, resulting in uncertain determinations for some entities. Moreover, the implementing regulations may include in their scope some groups of market participants that do not necessarily engage in the activities or pose the risks that section 13 of the BHC Act intended to address. For example, definition of the term ‘‘covered fund’’ may include entities that do not engage in the activities contemplated by section 13 of the BHC Act or may include entities that do not pose the risks that section 13 is intended to mitigate. The final rule includes amendments that (1) reduce the scope of entities that may be treated as covered funds (e.g., credit funds, venture capital funds, family wealth management vehicles, and customer facilitation vehicles), (2) modify existing covered fund exclusions under the implementing regulations (e.g., foreign public funds, public welfare funds, and small business investment companies), and (3) affect the types of permitted activities between 12 U.S.C. 1851(d)(1)(G). 2013 rule §§ ll.4, ll.5, ll.6, ll.11, and ll.13. 522 See 2013 rule § ll.20. See also 2019 amendments, 84 FR 62021–25, which, among other things, modified these requirements for banking entities with limited trading assets and liabilities. This SEC Economic Analysis follows earlier sections by referring to the regulations implementing section 13 of the BHC Act, as amended through June 1, 2020 as the ‘‘implementing regulations.’’ See supra note 8. PO 00000 520 See 521 See Frm 00049 Fmt 4701 Sfmt 4700 46469 certain banking entities and certain covered funds (e.g., restrictions on relationships between banking entities and covered funds, definition of ‘‘ownership interest,’’ and treatment of loan securitizations). The final rule also reduces the burden on affected banking entities by codifying an existing policy statement by the Federal banking agencies that addresses the potential issues related to a foreign banking entity controlling a qualifying foreign excluded fund and adopting a rule of construction to provide clarity regarding a banking entity’s permissible investments alongside a covered fund. Broadly, to the extent that the final rule directly changes the scope of permissible covered fund activities, and indirectly reduces costs to banking entities and covered funds by reducing uncertainty regarding the scope of permissible activities, the final rule may enhance the beneficial economic effects of the implementing regulations.523 The SEC’s economic analysis continues to recognize that the overall risk exposure of banking entities generally reflects a combination of activities, including proprietary trading, market making, traditional banking, asset management, investment activities, and the extent to which banking entities engage in hedging and other risk-mitigating activities. The overall risk exposure is also a function of the magnitude, structure, and manner in which banking entities engage in such activities, both within such activities individually and across all of these activities collectively. As discussed elsewhere,524 the SEC recognizes the complex baseline effects of section 13 of the BHC Act, as amended by sections 203 and 204 of EGRRCPA, and the implementing regulations (including those made with respect to sections 203 and 204 of EGRRCPA) on overall levels and structure of banking entity risk exposures. The final rule may promote the ability of the capital markets to intermediate between suppliers and users of capital through, for example, increased ability and willingness of banking entities and investors in ‘‘covered funds’’ to facilitate capital formation through sponsorship and participation in certain types of funds and to transact with certain groups of counterparties.525 For 523 See, e.g., 2019 amendments, 84 FR 62037–92. id. 525 See, e.g., U.S. Dep’t of the Treasury, A Financial System That Creates Economic Opportunities: Banks and Credit Unions (June 2017), at 77, available at https://www.treasury.gov/ press-center/press-releases/Documents/ A%20Financial%20System.pdf. 524 See E:\FR\FM\31JYR4.SGM 31JYR4 46470 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations example, exclusions from the ‘‘covered fund’’ definition of specific types of entities may benefit banking entities by providing clarity and removing certain constraints around potentially profitable business opportunities and by reducing compliance costs, and may benefit excluded funds and their banking entity sponsors and advisers by increasing the spectrum of available counterparties and improving the quality or cost of financial services available to customers. The final rule, however, may also facilitate risk mitigation as well as risktaking activities of banking entities. The final rule also may change aspects of the relationships among banking entities and certain other groups of market participants, including potentially introducing new conflicts of interest, and increasing or reducing the potential effects of conflicts of interest. To the degree that some banking entities react to the final rule by restructuring activities involving covered funds to take advantage of the exclusions contained in the final rule, there may be shifts in the structure and levels of activities of banking entities that would, in turn, decrease or increase risk exposure. Recognizing these various potential effects, each of the exclusions includes a number of conditions aimed at facilitating banking entity compliance while also allowing for customer oriented financial services provided on arms-length, market terms, and preventing evasion of the requirements of section 13. In evaluating these various potential effects, it is important to acknowledge that the exclusions made available by the final rule, such as for credit funds and qualifying venture capital funds, allow banking entities to engage indirectly through fund structures in the same activities in which they are currently permitted to engage directly (e.g., extensions of credit or direct ownership stakes). Thus, the type of exposure permitted by engaging in those activities directly, and indirectly through covered funds, is the same and the banking entities may use fund structures to diversify or otherwise mitigate their risk exposure. Other exclusions permit banking entities to provide traditional banking and asset management services to customers through a legal entity structure, with conditions (e.g., limitation on ownership by the banking entity and prohibition on ‘‘bail outs’’) intended to ensure that the risks that section 13 of the BHC Act was intended to address are mitigated. Finally, nothing in the final rule removes or modifies prudential capital, margin, and liquidity VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 requirements that are applicable to banking entities and that facilitate the safety and soundness of banking entities and the financial stability of the United States. The final rule may also impact competition, allocative efficiency, and capital formation. To the extent that the implementing regulations have constrained banking entities in their covered fund activities, including providing traditional banking and asset management services to customers through a legal entity structure, the exclusions from the definition of ‘‘covered fund’’ made available by the final rule may increase competition between banking entities and other entities providing services to and otherwise transacting with those types of funds and other entities. Such competition may reduce costs or increase the quality of certain financial services provided to such funds and their counterparties. Finally, the final rule’s costs, benefits, and effects on efficiency, competition, and capital formation will be influenced by a variety of factors, including the prevailing macroeconomic conditions, the financial condition of firms seeking to raise capital and of funds seeking to transact with banking entities, competition between bank and nonbank providers of capital, and many others. Moreover, these effects are likely to vary widely among banking entities and funds. The SEC recognizes that the economic effects of the final rule may be dampened or magnified in different phases of the macroeconomic cycle, depend on monetary and fiscal policy developments and other government actions, and may vary across different types of banking entities. The SEC also considered the implications of the final rule for investors. Broadly, the final rule should increase the number of funds and other entities that will be excluded from the covered fund definition. This is likely to result in an increase in offerings of such funds or an increase in the number of banking entities providing services to customers through entities such as customer facilitation vehicles and family wealth management vehicles. If the final rule increases the ability of investors to access public and private markets through funds and other entities, the final rule may result in the relaxing of constraints on investors’ portfolio optimization and, thus, enhance the efficiency of portfolio allocations. The ability of additional investors to access these markets through funds and other entities may, in addition to providing those investors with greater choice, benefit the issuers PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 of the securities held by those funds and other entities by potentially increasing demand for those securities. Increased demand typically results in increased liquidity which can benefit investors because it may enable them to enter or exit their positions in fund instruments, products, and portfolios in a more timely manner and at a more attractive price. Moreover, investors who seek access to public capital markets investments or other investments through foreign public funds may benefit to the extent the final rule results in banking entities offering more foreign public funds or offering these funds at a lower cost. Further, investors that prefer to implement a trading or investing strategy through a legal entity structure may benefit from the final rule, which allows banking entities to implement or facilitate such a trading or investing strategy while providing other banking and asset management services to the investor.526 At the same time, it is possible that, as a result of banking entities sponsoring or investing in more funds that are excluded from the definition of covered fund by the final rule, general market risk could increase and that risk could adversely affect markets generally, including through the impact on financial stability. However, due to the mitigation effects of the various conditions of the exclusions from the definition of covered fund contained in the final rule as well as expectations regarding the relative size and mix of the investments in the aggregate, the SEC believes this risk to be small. For example, the final rule permits a banking entity to act as a sponsor, investment adviser, or commodity trading advisor to certain excluded funds (e.g., credit funds and qualifying venture capital funds) only to the extent the banking entity ensures that the activities of the funds are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly. iii. Analytical Approach The SEC’s economic analysis is informed by research 527 on the effects of section 13 of the BHC Act and the 2013 rule, comments received by the agencies from a variety of interested parties, and experience administering the implementing regulations. Throughout this economic analysis, the SEC discusses how different market 526 See supra Section IV.B.1. (Foreign Public Funds). 527 See 2019 amendments, 84 FR 62044–54. E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations participants 528 may respond to various aspects of the final rule. This analysis also considers the potential effects of the final rule on activities by banking entities that involve risk, their willingness and ability to engage in client-facilitation activities, and competition, market quality, and capital formation. The final rule tailors, removes, or alters the scope of various covered fund requirements in the implementing regulations. Since section 13 of the BHC Act and the implementing regulations impose 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,529 it is difficult to attribute the observed effects to a specific provision or subset 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.530 Because of the extended timeline of implementation of section 13 of the BHC Act and the overlap of the period during which the 2013 rule was in effect with other postcrisis changes affecting the same group or certain sub-groups of SEC registrants, the SEC cannot rely on quantitative methods that might otherwise provide insight into 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 are substantially limited by the fact that they do not provide insight into security issuance and transaction activity that does not occur (or occurs in a sector of the market for which data is not readily available) as a result of the implementing regulations. Accordingly, it is difficult to quantify the primary 528 As discussed above, supra Section V.F.1.i. (Background), the SEC’s economic analysis is focused on the potential effects of the final rule on (1) SEC registrants, (2) the functioning and efficiency of the securities markets, (3) investor protection, and (4) capital formation. Thus, the below analysis does not consider the direct effects of the final rule on broker-dealers, SBSDs, or 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. See infra Section V.F.2.i. (Affected Participants). 529 See, e.g., 2013 rule at 5541. 530 With respect to the 2019 amendments, supra note 8, analysis of the effects is difficult because of the relatively short time that has passed since they became effective. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 security issuance and secondary market liquidity that would have been observed since the financial crisis absent various provisions of section 13 of the BHC Act and the implementing regulations. 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: (1) In recent years, on both an absolute and relative basis, bank dealers generally committed less capital to intermediation activities while nonbank dealers generally committed more, although not always in the same manner or on the same terms as bank dealers; (2) 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 nonbank entities that provide intraday liquidity, but generally not overnight liquidity, including in some sectors of the market through the use of electronic trading algorithms and high speed access to data and trading venues; and (3) the introduction of alternative credit markets, including non-bank direct lending markets, may have contributed to liquidity fragmentation across markets while potentially increasing access to capital.531 Where possible, the SEC has attempted to quantify the costs and benefits it expects 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 degree to which the implementing regulations may be impeding activity of banking entities with respect to certain investment vehicles, are inherently difficult to quantify. Moreover, some of the intended benefits of the implementing regulations’ definitions and prohibitions that the agencies are amending include the potential for more resilient markets during a financial crisis or during periods of severe market stress. These intended benefits are less readily observable under periods of strong economic conditions, periods of significant government credit 531 See U.S. Sec. & Exch. Comm’n, Access to Capital and Market Liquidity (Aug. 2017), available at https://www.sec.gov/files/access-to-capital-andmarket-liquidity-study-dera-2017.pdf. PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 46471 accommodation, and when markets have significant liquidity and are less volatile. Even following an economic shock, identification of these intended benefits requires a sufficient amount of data covering a relevant sample period. Moreover, identifying these benefits following an economic shock could prove difficult if the effects of past regulation are confounded by other interventions aimed at mitigating the impact of the shock on financial markets, including regulation, credit accommodation, and fiscal stimulus. Finally, it is difficult to quantify the net economic effects of any individual amendment because of overlapping implementation periods of various postcrisis regulations. Further, it is difficult to quantify the net economic effects of any individual amendment because of the fact that many market participants changed their behavior in anticipation of future changes in regulation. 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 on how market participants may choose to restructure their relationships with various types of entities in response to the final rule; the amount of capital formation in covered funds that does not occur because of current covered fund provisions, including those concerning the definition of covered fund, restrictions on relationships with covered funds, the definition of ownership interest, and the exclusion for loan securitizations; the volume of loans, guarantees, securities lending, and derivatives activity dealers may wish to engage in with related covered funds; as well as the extent of risk reduction associated with the covered fund provision of the 2013 rule. Where the SEC cannot quantify the relevant economic effects, they are discussed in qualitative terms. 2. Economic Baseline In the context of this economic analysis, the economic costs and benefits, and the impact of the final rule on efficiency, competition, and capital formation, are considered relative to a baseline that includes the implementing regulations (including the 2013 rule and the 2019 amendments), legislative amendments in EGRRCPA, and current practices aimed at compliance with these regulations. i. Regulation The SEC is assessing the economic impact of the final rule against a baseline that includes the legal and regulatory framework as it exists at the E:\FR\FM\31JYR4.SGM 31JYR4 46472 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations time of this release. Thus, the regulatory baseline for the SEC’s economic analysis includes section 13 of the BHC Act as amended by EGRRCPA, and the 2013 rule. Further, the baseline accounts for the fact that since the adoption of the 2013 rule, the agencies have adopted the 2019 amendments, which, among other things, relate to the ability of banking entities to engage in certain activities, including underwriting, market-making, and risk-mitigating hedging, with respect to ownership interests in covered funds, as well as amendments conforming the 2013 rule to sections 203 and 204 of EGRRCPA. In addition, the agencies’ staffs have provided FAQ responses related to the regulatory obligations of banking entities, including SEC-regulated entities that are also banking entities under the 2013 rule, which likely influenced these entities’ decisions about how to comply with the 2013 rule and may influence these entities’ decisions about how to comply with the 2019 amendments.532 The Federal banking agencies also issued the policy statement in 2017 with respect to foreign excluded funds, and has since extended the policy statement to 2021.533 Although the 2013 rule also included restrictions on proprietary trading and compliance requirements (as modified by the 2019 amendments), the most relevant portion of the 2013 rule for establishing an economic baseline is that involving covered fund restrictions.534 The features of the regulatory framework under the 2013 rule most relevant to the baseline include the definition of the term ‘‘covered fund’’; restrictions on a banking entity’s relationships with covered funds; and restrictions on parallel investment, co-investment, and investments in the fund by banking entity employees. Scope of the Covered Fund Definition The definition of ‘‘covered fund’’ impacts the scope of the substantive prohibitions on banking entities acquiring or retaining an ownership interest in, sponsoring, and having certain relationships with, covered funds. The implementing regulations define covered funds, in part, as issuers that would be investment companies but for section 3(c)(1) or 3(c)(7) of the Investment Company Act and then excludes specific types of entities from the definition. The definition also 532 See supra note 14. 533 See supra Section VI.A. (Qualifying Foreign Excluded Funds) and notes 26 and 28 (discussion of ‘‘the policy statement’’). 534 See 84 FR 61974. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 includes certain commodity pools as well as certain foreign funds. Funds that rely on the exclusions in sections 3(c)(1) or 3(c)(7) of the Investment Company Act are covered funds unless an exclusion from the covered fund definition is available. Funds that rely on any exclusion or exemption from the definition of ‘‘investment company’’ under the Investment Company Act, other than the exclusion contained in section 3(c)(1) or 3(c)(7), such as real estate and mortgage funds that rely on the exclusion in section 3(c)(5)(C), are not covered funds under the implementing regulations. The covered fund provisions of the implementing regulations may reduce the ability and incentives of banking entities to bail out affiliated funds to mitigate reputational risk, limit conflicts of interest with clients, customers, and counterparties, and reduce the ability of banking entities to engage in proprietary trading indirectly through funds. The broad definition of covered funds encompasses many different types of vehicles, and the implementing regulations exclude some of them from the definition of a covered fund.535 The excluded fund types relevant to the baseline are funds that are regulated by the SEC under the Investment Company Act: Registered investment companies (RICs) and business development companies (BDCs). Seeding vehicles for these funds are also excluded from the covered fund definition during their seeding period.536 Restrictions on Relationships Between Banking Entities and Covered Funds Under the baseline, banking entities are limited in the types of transactions in which they are able to engage with covered funds with which they have certain relationships. Banking entities that serve, directly or indirectly, as the investment manager, adviser, or sponsor to a covered fund are prohibited from engaging in a ‘‘covered transaction,’’ as defined in section 23A of the Federal Reserve Act, with the covered fund or with any other covered fund that is controlled by such covered fund.537 Similarly, a banking entity that organizes and offers a covered fund pursuant to § ll.11 or that continues to hold an ownership interest in a covered fund in accordance with § ll.11(b) is prohibited from engaging in such a ‘‘covered transaction.’’ This prohibits all ‘‘covered transactions’’ that 535 The exclusions from the covered fund definition are set forth in § ll.10(c) of the implementing regulations. 536 See implementing regulations §§ ll.10(c)(12)(i) and ll.10(c)(12)(iii). 537 See implementing regulations § ll.14(a). PO 00000 Frm 00052 Fmt 4701 Sfmt 4700 cause the banking entity to have credit exposure to the affiliated covered fund, including short-term extensions of credit and various other transactions required for a banking entity to provide an affiliated covered fund payment, clearing, and settlement services. Definition of ‘‘Banking Entity’’ For foreign banking entities,538 certain funds organized under foreign law and offered to foreign investors (‘‘foreign excluded funds’’) are not ‘‘covered funds’’ under the implementing regulations, but may be subject to the implementing regulations as ‘‘banking entities’’ under certain circumstances. Through the policy statement, the Federal banking agencies (in consultation with the staffs of the SEC and the CFTC) have provided temporary relief, that is currently scheduled to expire on July 21, 2021, for qualifying foreign excluded funds that may otherwise be subject to the implementing regulations as banking entities.539 Definition of ‘‘Ownership Interest’’ The implementing regulations prohibit a banking entity, as principal, from directly or indirectly acquiring or retaining an ‘‘ownership interest’’ in a covered fund.540 The implementing regulations define an ‘‘ownership interest’’ in a covered fund to mean any equity, partnership, or other similar interest. Under the implementing regulations, ‘‘other similar interest’’ is defined as 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, 538 For purposes of this analysis, ‘‘foreign banking entity’’ has the same meaning as used in the policy statement, supra note 27, i.e., 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. 539 See supra note 26 and 28. For purposes of the policy statement, a ‘‘qualifying foreign excluded fund’’ means, with respect to a foreign banking entity, an entity that (1) is organized or established outside the United States and the ownership interests of which are offered and sold solely outside the United States; (2) would be a covered fund were the entity organized or established in the United States, or is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments; (3) would not otherwise be a banking entity except by virtue of the foreign banking entity’s acquisition or retention of an ownership interest in, or sponsorship of, the entity; (4) is established and operated as part of a bona fide asset management business; and (5) is not operated in a manner that enables the foreign banking entity to evade the requirements of section 13 or implementing regulations. 540 Implementing regulations § ll.10(a). E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations 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 above.541 The implementing regulations permit a banking entity to acquire and retain an ownership interest in a covered fund that the banking entity organizes and offers pursuant to § ll.11, but limits such ownership interests to three percent of the total number or value of the outstanding ownership interests of such fund (the per-fund limit).542 Loan Securitizations As discussed above, section 13 of the BHC Act provides a rule of construction that explicitly allows the sale and securitization of loans as otherwise regulations § ll.10(d)(6)(i). regulations §§ ll.12(a)(1)(ii) and ll.12(a)(2)(ii)(A). The implementing regulations also require that the aggregate value of all ownership interests of a banking entity and its affiliates in all covered funds acquired or retained under § ll.12 may not exceed three percent of the tier 1 capital of the banking entity. Implementing regulations § ll.12(a)(2)(iii) (the aggregate funds limit). 541 Implementing 542 Implementing VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 permitted by law.543 Accordingly, the implementing regulations exclude from the covered fund definition entities that issue asset-backed securities if they meet specified conditions, including that they hold only loans, certain rights and assets, and a small set of other financial instruments (permissible assets).544 In addition, the baseline includes the FAQs issued by agencies’ staff in June 2014 regarding the servicing asset provision of the loan securitization exclusion.545 Public Welfare and SBIC Exclusions Under the implementing regulations, issuers in the business of making investments that are 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),546 are excluded from the covered fund definition. Similarly, the implementing regulations exclude from the covered fund definition small business investment companies (SBICs) and issuers that have received notice from the Small Business Administration to proceed to qualify for a license as a SBIC and for which the notice or license has not been revoked.547 Attribution of Certain Investments to a Banking Entity As discussed above, the implementing regulations include a per-fund limit and aggregate fund limit on a banking entity’s ownership of covered funds that the banking entity organizes and offers.548 The preamble to the 2013 rule stated, ‘‘if a banking entity makes investments side by side in substantially the same positions as a covered fund, then the value of such investments shall be included for purposes of determining the value of the banking entity’s investment in the covered fund.’’ 549 The agencies also stated that a banking entity that sponsors a covered fund should not make any additional side-byside co-investment with the covered fund in a privately negotiated investment unless the value of such co543 13 U.S.C. 1851(g)(2). See also supra Section IV.B.2 (Loan Securitizations). 544 See implementing regulations § ll.10(c)(8). Loan is further defined as any loan, lease, extension of credit, or secured or unsecured receivable that is not a security or derivative. Implementing regulations rule § ll.2(t). 545 See supra Section IV.B.2 (Loan Securitizations, discussion of servicing assets). 546 See implementing regulations § ll.10(c)(11)(ii). 547 See implementing regulations § ll.10(c)(11)(i). 548 See implementing regulations § ll.12(a). See also supra Section IV.E.2. (Ownership Interest— Fund Limits and Covered Fund Deduction). 549 79 FR 5734. PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 46473 investment is less than 3% of the value of the total amount co-invested by other investors in such investment.550 The 2019 amendments eliminated the aggregate fund limit and capital deduction requirement under § ll.12(d) for the value of ownership interests held by banking entities in third-party covered funds (e.g., covered funds that those banking entities do not organize or offer), acquired or retained as a result of certain underwriting or market-making activities. However, the 2019 amendments did not change or amend the application of the per-fund limit or aggregate funds limit to coinvestments alongside a covered fund. For purposes of calculating the aggregate fund limit and the capital deduction requirement, the implementing regulations require attribution to a banking entity of restricted profit interests in a covered fund as ownership interests in the covered fund for which the banking entity serves as investment manager, investment adviser, commodity trading advisor, or other service provider.551 Under the implementing regulations, for purposes of calculating a banking entity’s compliance with the aggregate fund limit and the capital deduction requirement, a banking entity must include any amounts paid by the banking entity or an employee in connection with obtaining a restricted profit interest in the covered fund.552 ii. Affected Participants The SEC-regulated entities directly affected by the final rule include brokerdealers, security-based swap dealers, and investment advisers. The implementing regulations impose a range of restrictions and compliance obligations on banking entities with respect to their covered fund activities and investments. To the degree that the final rule reduces or otherwise alters the scope of private funds subject to covered fund restrictions, SECregistered banking entities, including broker-dealers, security-based swap dealers, and investment advisers may be affected. Broker-Dealers 553 Under the implementing regulations, some of the largest SEC-regulated 550 See id. regulations §§ ll.10(d)(6)(ii) and ll.12(c)(1), (d). See also 12 U.S.C. 1851(d)(1)(G). 552 Implementing regulations §§ ll.12(c)(1), (d). 553 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 551 Implementing E:\FR\FM\31JYR4.SGM Continued 31JYR4 46474 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations broker-dealers are banking entities. Table 1 reports the number, total assets, and holdings of broker-dealers affiliated with banks and broker-dealers that are not. While the 3,487 domestic brokerdealers that are not affiliated with banks greatly outnumber the 202 banking entity broker-dealers subject to the implementing regulations, banking entity broker-dealers dominate nonbanking entity broker-dealers in terms of total assets (72% of total broker-dealer assets) and aggregate holdings (66% of total broker-dealer holdings). TABLE 1—BROKER-DEALER COUNT, ASSETS, AND HOLDINGS BY AFFILIATION Broker-dealer affiliation Number Total assets, $mln 554 Holdings, $mln 555 Holdings (alternative), $mln 556 Affected bank broker-dealers 557 ..................................................................... Non-bank broker-dealers 558 ............................................................................ 202 3,487 3,240,045 1,258,510 777,192 404,754 607,086 255,380 Total .......................................................................................................... 3,689 4,498,556 1,181,946 862,466 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 with the SEC as security-based swap dealers and that as many as 16 may already be SECregistered broker-dealers.559 Given the analysis of DTCC Derivatives Repository Limited Trade Information Warehouse (TIW) transaction and positions data on single-name credit-default swaps and consistent with other recent SEC rulemakings, the SEC preliminarily believes that 41 entities that may register with the SEC as SBSDs are bank-affiliated firms, including those that are SEC-registered broker-dealers. Therefore, the SEC preliminarily estimates that, in addition to the bankaffiliated SBSDs that are already 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 National Information Center. Broker-dealer assets and holdings were obtained from FOCUS Report data for Q4 2019. 554 Broker-dealer total assets are based on FOCUS report data for ‘‘Total Assets.’’ 555 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. 556 This alternative measure excludes U.S. and Canadian government obligations and spot commodities. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 registered as broker-dealers and included in the discussion above, as many as 25 other bank-affiliated SBSDs may be affected by the final rule.560 Similarly, the SEC’s analysis of TIW data suggests that none of the entities that may register with the SEC as Major Security-Based Swap Participants are affected by the final rule. October 6, 2021 is the compliance date for the SEC’s registration rules for SBSDs, as well as several rules applicable to those entities, including segregation requirements and non-bank capital and margin requirements, recordkeeping and reporting requirements, business conduct standards, and risk mitigation techniques.561 Accordingly, the SEC recognizes that in anticipation of the compliance date for registration, firms may choose to restructure their securitybased swap trading activity into (or out of) an affiliated bank or an affiliated This section describes RIAs advising private funds that may be affected by the final rule. Using Form ADV data, Table 2 reports the number of RIAs advising private funds by fund type as defined in Form ADV.563 Private funds rely on either section 3(c)(1) or 3(c)(7) of the Investment Company Act and so meet the implementing regulations’ definition of ‘‘covered fund.’’ Table 3 557 This category includes all bank-affiliated broker-dealers except those exempted by section 203 of EGRRCPA. 558 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. 559 See Recordkeeping and Reporting Requirements for Security-Based Swap Dealers, Major Security-Based Swap Participants, and Broker-Dealers, 84 FR 68550, 68607 (Dec. 16, 2019). 560 See id. 561 See Capital, Margin, and Segregation Adopting Release, supra note 517, at 43954. See also Rule Amendments and Guidance Addressing CrossBorder Application of Certain Security-Based Swap Requirements, 85 FR 6270, 6345–49 (Feb. 4, 2020). 562 These estimates are calculated from Form ADV data as of December 31, 2019. An investment adviser is defined as a ‘‘private fund adviser’’ for the purposes of this economic analysis 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 ‘‘banking entity 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 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. Those banks are no longer subject to the requirements of the 2013 rule following enactment of the EGRRCPA. Thus, these figures may overestimate or underestimate the number of banking entity RIAs. 563 RIAs may also advise foreign public funds that are excluded from the covered fund definition in the implementing regulations, are the subject of the final rule discussed below, and are not reported on Form ADV. PO 00000 Frm 00054 Fmt 4701 Sfmt 4700 broker-dealer instead of registering as a standalone SBSD if bank or brokerdealer 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 overestimate or underestimate the number of SBSDs that are not broker-dealers and that may become SEC-registered entities affected by the final rule. Private Funds and Private Fund Advisers 562 E:\FR\FM\31JYR4.SGM 31JYR4 46475 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations reports the number and gross assets of private funds advised by RIAs and separately reports these statistics for banking entity RIAs. As can be seen from Table 2, the two largest categories of private funds advised by RIAs are hedge funds and private equity funds.564 Banking entity RIAs advise a total of 4,387 private funds with approximately $2.089 trillion in gross assets. From Form ADV data, banking entity RIAs’ gross private fund assets under management are concentrated in hedge funds and private equity funds. The SEC estimates on the basis of this data that banking entity RIAs advise 890 hedge funds with approximately $606 billion in gross assets and 1,518 private equity funds with approximately $466 billion in assets. TABLE 2—SEC-REGISTERED INVESTMENT ADVISERS ADVISING PRIVATE FUNDS BY FUND TYPE 565 Fund type Banking entity RIA All RIA Hedge Funds ........................................................................................................................................................... Private Equity Funds ............................................................................................................................................... Real Estate Funds ................................................................................................................................................... Securitized Asset Funds .......................................................................................................................................... Venture Capital Funds ............................................................................................................................................. Liquidity Funds ......................................................................................................................................................... Other Private Funds ................................................................................................................................................ 2,620 1,738 551 233 223 44 1,060 151 96 51 44 8 16 140 Total Private Fund Advisers ............................................................................................................................. 4,781 282 TABLE 3—THE NUMBER AND GROSS ASSETS OF PRIVATE FUNDS ADVISED BY SEC-REGISTERED INVESTMENT ADVISERS 566 Number of private funds Fund type Banking entity RIA All RIA Gross assets, $bln All RIA Banking entity RIA Hedge Funds ..................................................................................................................................... Private Equity Funds ......................................................................................................................... Real Estate Funds ............................................................................................................................ Securitized Asset Funds ................................................................................................................... Venture Capital Funds ...................................................................................................................... Liquidity Funds .................................................................................................................................. Other Private Funds .......................................................................................................................... 10,445 16,217 3,699 2,000 1,387 76 4,757 890 1,518 320 380 44 30 1,206 8,048 4,119 732 767 174 304 1,543 606 466 94 145 3 231 542 Total Private Funds .................................................................................................................... 38,581 4,387 15,685 2,089 In addition, the SEC’s economic analysis is informed by private fund 564 For purposes of Form ADV, ‘‘private equity fund’’ is defined as ‘‘any private fund that is not a hedge fund, liquidity fund, real estate fund, securitized asset fund, or venture capital fund and does not provide investors with redemption rights in the ordinary course.’’ See Form ADV: Instructions for Part 1A, Instruction 6. For purposes of Form ADV, ‘‘hedge fund’’ is defined as ‘‘any private fund (other than a securitized asset fund): (a) With respect to which one or more investment advisers (or related persons of investment advisers) may be paid a performance fee or allocation calculated by taking into account unrealized gains (other than a fee or allocation the calculation of which may take into account unrealized gains solely for the purpose of reducing such fee or allocation to reflect net unrealized losses); (b) that may borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or (c) that may sell securities or other assets short or enter into similar transactions (other than for the purpose of hedging currency exposure or managing duration). 565 This table includes only the advisers that list private funds on section 7.B.(1) of Form ADV. The number of advisers in the ‘‘Total Private Fund Advisers’’ row is not the sum of the rows that precede it since an adviser may advise multiple types of private funds. Each listed private fund type (e.g., real estate funds and liquidity funds) is VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 statistics submitted by certain RIAs of private funds through Form PF as summarized in quarterly ‘‘Private Fund Statistics.’’ 567 Registered Investment Companies and Business Development Companies The baseline also reflects the potential that a RIC or a BDC would be treated as a banking entity where the RIC or BDC’s sponsor is a banking entity that holds 25% or more of the RIC or BDC’s voting securities after a seeding period.568 On the basis of SEC filings and public data, defined in Form ADV, and those definitions are the same for purposes of the SEC’s Form PF. 566 Gross assets include uncalled capital commitments on Form ADV. The large decrease in Gross assets for Liquidity Funds from that reported in the proposing release is due, in part, to the removal of certain Form ADV data from one filer that contained an erroneous value for gross assets. 567 See U.S. Sec. and Exchange Comm’n, Div. of Inv. Mgmt. Analytics Office, Private Fund Statistics, Third Calendar Quarter 2019 (May 14, 2020), available at https://www.sec.gov/divisions/ investment/private-funds-statistics/private-fundsstatistics-2019-q3-accessible.pdf. Statistics for preceding quarters are available at https:// www.sec.gov/divisions/investment/private-fundsstatistics.shtml. 568 See, e.g., 2019 amendments, 84 FR 61979. PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 the SEC estimates that, as of December 2019, there were approximately 15,300 RICs 569 and 101 BDCs. Although RICs and BDCs are generally not themselves banking entities subject to the implementing regulations, they may be indirectly affected by the implementing regulations and the final rule, for example, if their sponsors or advisers are banking entities. For instance, bankaffiliated RIAs or their affiliates may reduce their level of investment in the RICs or BDCs they advise, or potentially close those funds, to eliminate the risk of those funds becoming banking entities themselves. Small Business Investment Companies Small business investment companies are generally ‘‘privately owned and managed investment funds, licensed and regulated by the Small Business Administration (SBA), that use their own capital plus funds borrowed with 569 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 16,800. E:\FR\FM\31JYR4.SGM 31JYR4 46476 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations an SBA guarantee to make equity and debt investments in qualifying small businesses.’’ 570 The final rule provides relief with respect to banking entity investments in SBICs during the winddown process by excluding from the definition of ‘‘covered fund’’ those SBICs.571 While the SEC does not have data to quantify the number of SBICs undergoing wind-down, trends in the number of SBIC licenses can be indicative of the turnover in the total number of SBIC licensees. For example, according to SBA data, there were 295 SBIC licensees as of March 31, 2020 572 and 299 SBIC licensees as of December 31, 2019.573 By contrast, as of September 30, 2017, there were 315 SBICs licensed by the SBA.574 The final rule includes an exclusion for rural business investment companies (RBICs) from the implementing regulations similar to that provided to SBICs.575 As the SEC has discussed elsewhere,576 an RBIC is defined in section 384A of the Consolidated Farm and Rural Development Act as a company that is approved by the Secretary of Agriculture and that has entered into a participation agreement 570 See U.S. Small Bus. Admin., SBIC Program Overview, available at https://www.sba.gov/ content/sbic-program-overview. For purposes of the Advisers Act, an SBIC is (other than an entity that has elected to be regulated or is regulated as a business development company pursuant to section 54 of the Investment Company Act of 1940): (A) A small business investment company that is licensed under the Small Business Investment Act of 1958, (B) an entity that has received from the Small Business Administration notice to proceed to qualify for a license as a small business investment company under the Small Business Investment Act of 1958, which notice or license has not been revoked, or (C) an applicant that is affiliated with 1 or more licensed small business investment companies described in subparagraph (A) and that has applied for another license under the Small Business Investment Act of 1958, which application remains pending. 15 U.S.C. 80b–3(b)(7). 571 Specifically, the final rule excludes from the definition of ‘‘covered fund’’ any SBIC that has voluntarily surrendered its license to operate as an SBIC in accordance with 13 CFR 107.1900 and does not make any new investments (with some exceptions) after such voluntary surrender. See § ll.10(c)(11)(i). 572 See U.S. Small Bus. Admin., SBIC Program Overview as of March 31, 2020, available at: https://www.sba.gov/sites/default/files/2020-05/ SBIC%20Quarterly%20Report%20as%20of% 20March_31_2020%20Amended%205.14.2020.pdf. 573 See U.S. Small Bus. Admin., SBIC Program Overview as of December 31, 2019, available at https://www.sba.gov/sites/default/files/2020-02/ SBIC%20Quarterly%20Report%20as%20of%20 December_31_2019.pdf. 574 See id. 575 Under the implementing regulations, an SBIC is excluded from the ‘‘covered fund’’ definition. See implementing regulations § ll.10(c)(11)(i). 576 See Exemptions from Investment Adviser Registration for Advisers to Certain Rural Business Investment Companies, 85 FR 13734 (Mar. 10, 2020) (‘‘RBIC Investment Adviser Adopting Release’’). VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 with the Secretary.577 Because SBICs and RBICs share the common purpose of promoting capital formation in their respective sectors, advisers to SBICs and RBICs are treated similarly under the Advisers Act in that they have the opportunity to take advantage of expanded exemptions from investment adviser registration.578 As of August 2019, there were 5 RBICs who were licensed by the USDA managing approximately $352 million in assets.579 The Tax Cuts and Jobs Act established the ‘‘opportunity zone’’ program to provide tax incentives for long-term investing in designated economically distressed communities.580 The program allows taxpayers to defer and reduce taxes on capital gains by reinvesting gains in ‘‘qualified opportunity funds’’ (QOFs) that are required to have at least 90 percent of their assets in designated low-income zones.581 In this regard, QOFs are similar to SBICs and public welfare companies. The final rule provides relief to QOFs from the implementing regulations that is similar to the relief provided to SBICs.582 SEC staff is not aware of an official source for data regarding QOFs that are available for investment, but some private firms collect and report such data. One such firm reports that, as of April 2020, there were 406 QOFs that report raising 577 See the RBIC Advisers Relief Act of 2018, Public Law 115–417, 132 Stat. 5438 (2019) (the ‘‘RBIC Advisers Relief Act’’). To be eligible to participate as an RBIC, the company must be a newly formed for-profit entity or a newly formed for-profit subsidiary of such an entity, have a management team with experience in community development financing or relevant venture capital financing, and invest in enterprises that will create wealth and job opportunities in rural areas, with an emphasis on smaller enterprises. See 7 U.S.C. 2009cc–3(a). 578 Following enactment of the RBIC Advisers Relief Act, supra note 577, advisers to solely RBICs and advisers to solely SBICs are exempt from investment adviser registration pursuant to Advisers Act sections 203(b)(8) and 203(b)(7), respectively. The venture capital fund adviser exemption deems RBICs and SBICs to be venture capital funds for purposes of the registration exemption 15 U.S.C. 80b–3(l). Accordingly, the exclusion for certain venture capital funds discussed below (see infra text accompanying notes 672 and 673) which require that a fund be a venture capital fund as defined in the SEC regulations implementing the registration exemption, could include RBICs and SBICs to the extent that they satisfy the other elements of the exclusion. 579 See RBIC Investment Adviser Adopting Release, supra note 576. 580 Tax Cuts and Jobs Act of 2017, Public Law 115–97, 131 Stat. 2054 (2017). 581 See U.S. Sec. and Exchange Comm’n & NASAA, Staff Statement on Opportunity Zones: Federal and State Securities Laws Considerations, available at https://www.sec.gov/2019_OpportunityZones_FINAL_508v2.pdf (‘‘Opportunity Zone Statement’’). 582 See supra note 575. PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 $10.09 billion in equity, and have a fundraising goal of $31.89 billion.583 3. Costs and Benefits Section 13 of the BHC Act generally prohibits banking entities from acquiring or retaining an ownership interest in, sponsoring, or having certain relationships with covered funds, subject to certain exemptions.584 The SEC’s economic analysis concerns the potential costs, benefits, and effects on efficiency, competition, and capital formation of the final rule for five groups of market participants. First, the final rule may impact SEC-registered investment advisers that are banking entities, including those that sponsor or advise covered funds and those that do not, as well as SEC-registered investment advisers that are not banking entities that sponsor or advise covered funds and compete with banking entity RIAs. Second, the final rule permits dealers greater flexibility in providing services to more types of funds since dealers can provide a broader array of services to funds that would be excluded from the covered fund definition. Third, banking entities that are broker-dealers or RIAs may enjoy reduced uncertainty and greater flexibility in making direct investments alongside covered funds. Fourth, the final rule may impact private funds and other vehicles, including those entities scoped in or out of the covered fund provisions of the implementing regulations, as well as private funds competing with such funds. One such impact may be seen to the extent that the final rule permits banking entities to provide a full range of traditional customer-facing banking and asset management services to certain entities, such as customer facilitation vehicles and family wealth management vehicles. Fifth, to the extent that the final rule impacts efficiency, competition, and capital formation in covered funds or underlying securities, investors in, and sponsors of, covered funds and underlying securities and issuers may be affected as well. As discussed below, the agencies carefully considered the competing effects that could potentially result from the final rule and alternatives. For example, the final rule could result in enhanced competition among, and capital formation driven by, entities that would be treated as covered funds under the implementing regulations. 583 As reported by Novogradac, a national professional services organization that collects and reports information on QOFs. See https:// www.novoco.com/resource-centers/opportunityzone-resource-center/opportunity-funds-listing. 584 See 12 U.S.C. 1851. E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations The final rule could also potentially increase (or decrease) financial and other risks posed by the ability to make investments in covered funds in addition to or in lieu of direct investments; however, the agencies have sought to mitigate the potential for increased risk and other concerns by imposing various conditions on the exclusions designed to address such risks. In addition, to the extent that the covered fund provisions of the implementing regulations limit fund formation, the final rule could provide a greater ability for banking entities to organize funds and attract capital from third party investors. This could increase revenues for banking entities while reducing long-term compliance costs; increase the availability of venture, credit, and other financing, including for small businesses and startups; and, as a result, increase capital formation. The SEC is not currently aware of any information or data that would allow a quantification of the extent to which the covered fund provisions of the implementing regulations are inhibiting capital formation via funds. Therefore, the bulk of the analysis below is necessarily qualitative. To the extent that the covered fund provisions of the implementing regulations limit alignment of interests between banking entities and their clients, customers, or counterparties, and to the extent the final rule alters the alignment of interests, the final rule could have a positive or negative effect on conflict of interest concerns. The final rule creates new recordkeeping requirements and revise certain disclosure requirements. Specifically, a banking entity may only rely on the exclusion for customer facilitation vehicles if the banking entity and its affiliates maintain documentation outlining how the banking entity intends to facilitate the customer’s exposure to a transaction, investment strategy or service provided by the banking entity. As discussed above in Section V.B. (Paperwork Reduction Act) 585 and discussed further below, these new recordkeeping burdens may impose an initial burden 585 For the purposes of the burden estimates in this release, we are assuming the cost of $423 per hour for an attorney, from SIFMA’s Management and Professional Earnings in the Securities Industry 2013 (available at https://www.sifma.org/resources/ research/management-and-professional-earningsin-the-securities-industry-2013/), modified to account for an 1800-hour work year and multiplied by 5.35 to account for bonuses, firm size, employee benefits, and overhead, and adjusted for inflation. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 of $1,078,650 586 and an ongoing annual burden of $1,078,650.587 In addition, under certain circumstances, a banking entity must make certain disclosures with respect to an excluded credit fund, venture capital fund, family wealth vehicle, or customer facilitation vehicle, as if the entity were a covered fund. As discussed above in Section V.B, these disclosure requirements may impose an initial burden of $53,933 588 and an ongoing burden of $1,402,245.589 The sections that follow discuss how each of the amendments in the final rule change the implementing regulations, and the anticipated costs and benefits of the amendments, subject to the caveat that not all anticipated costs and benefits can be meaningfully quantified.590 i. Amendments Related to Specific Types of Funds As discussed above, the final rule modifies a number of the provisions of the implementing regulations related to the treatment of certain types of funds (e.g., credit funds, family wealth management vehicles, small business investment companies, qualifying venture capital funds, customer facilitation vehicles, foreign excluded funds, foreign public funds, and loan securitizations).591 Broadly, such modifications reduce the number and types of funds that are within the scope of the implementing 586 In the 2019 amendments, amendments that sought, among other things, to provide greater clarity and certainty about what activities were prohibited by the 2013 rule—in particular, under the prohibition on proprietary trading—and to better tailor the compliance requirements to the risk of a banking entity’s activities, banking entity PRArelated burdens were apportioned to SEC-regulated entities on the basis of the average weight of brokerdealer assets in holding company assets. See 2019 amendments, 84 FR 62074. The SEC believes that such an approach would be inappropriate for the PRA-related burdens associated with the final rule because we do not have a comparable proxy for an investment adviser’s significance within the holding company. Since we do not have sufficient information to determine the extent to which the costs associated with any of the new recordkeeping and disclosure requirements would be borne by SEC registrants specifically, we report the entire burden estimated based on information in supra Section V.B (Paperwork Reduction Act). Initial recordkeeping burdens: (10 hours) × (255 entities) × (Attorney at $423 per hour) = $1,078,650. 587 Annual recordkeeping burdens: (10 hours) × (255 entities) × (Attorney at $423 per hour) = $1,078,650. 588 Initial recordkeeping burdens: (0.5 hours) × (255 entities) × (Attorney at $423 per hour) = $53,933. 589 Annual recordkeeping burdens: (0.5 hours) × (255 entities) × (26 disclosures per year) × (Attorney at $423 per hour) = $1,402,245. 590 See supra Section V.F.1.iii. (SEC Economic Analysis—Analytical Approach). 591 See supra Section IV. (Summary of the Final Rule). PO 00000 Frm 00057 Fmt 4701 Sfmt 4700 46477 regulations, impacting the economic effects of section 13 of the BHC Act and the implementing regulations.592 Form ADV data is not sufficiently granular to allow the SEC to estimate the number of funds and fund advisers affected by the exclusions from the covered fund definition added or modified by the final rule and other relief addressed by the final rule. However, Table 2 and Table 3 in the economic baseline quantify the number and asset size of private funds advised by banking entity RIAs by the type of private fund they advise, as those fund types are defined in Form ADV.593 Using Form ADV data, the SEC estimates that approximately 151 banking entity RIAs advise hedge funds and 96 banking entity RIAs advise private equity funds (as those terms are defined in Form ADV).594 As can be seen from Table 2 in the economic baseline, 44 banking entity RIAs advise securitized asset funds. Table 3 shows that banking entity RIAs advise 380 securitized asset funds with $145 billion in gross assets. Another 51 banking entity RIAs advise real estate funds, and banking entity RIAs advise 320 real estate funds with $94 billion in gross assets. Venture capital funds are advised by only 8 banking entity RIAs, and all 44 venture capital funds advised by banking entity RIAs have in aggregate approximately $3 billion in gross assets. As noted elsewhere, the covered fund provisions of the implementing regulations may limit the ability of banking entities to use covered funds to circumvent the proprietary trading prohibition, reduce bank incentives to bail out their covered funds, and mitigate conflicts of interest between banking entities and their clients, customers, or counterparties. As discussed in the 2020 proposal, the implementing regulations may limit the ability of banking entities to conduct traditional asset management activities and reduce the availability of capital by imposing significant costs on some banking entities without providing commensurate benefits.595 Moreover, the 2013 rule’s limitations on banking entities’ investment in covered funds may be more significant for certain covered funds that are typically small in size such as many venture capital funds, with potentially more negative spillover 592 See, e.g., 2019 amendments, 84 FR 62037–92. fund types include hedge funds, private equity funds, real estate funds, securitized asset funds, venture capital funds, liquidity, and other private funds. See supra note 564. 594 As noted in the economic baseline, a single RIA may advise multiple types of funds. See supra note 565. 595 See 85 FR 12164. 593 These E:\FR\FM\31JYR4.SGM 31JYR4 46478 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations effects on capital formation in the types of underlying securities in which these types of funds invest.596 The final rule could reduce the scope of funds that need to be analyzed for covered fund status or could simplify this analysis and enable banking entities to own, sponsor, and have relationships with the types of entities that the final rule excludes from the covered fund definition. Accordingly, the final rule may reduce costs of banking entity ownership in, sponsorship of, and transactions with certain funds; may promote greater capital formation in, and competition among such funds; and may improve access to capital for issuers of the underlying debt or equity that those funds may purchase. The final rule may also benefit banking entity dealers through higher profits or greater demand for derivatives, margin, payment, clearing, and settlement services. Reducing restrictions on banking entities by further tailoring the covered fund definition may encourage more launches of funds that are excluded from the definition, capital formation and, possibly, competition in those types of funds. If competition increases the quality of funds available to investors or reduces the fees funds charge, investors in funds may benefit. Moreover, to the degree that the final rule may increase the spectrum of funds available to investors, the final rule may relax constraints around investor portfolio optimization and increase the efficiency of capital allocation. The SEC received comments from a diverse set of commenters. Comments from banking entities and financial services industry trade groups were generally supportive of the proposal, although many recommended additional modifications.597 There were also several organizations and individuals that were generally opposed to the 2020 proposal.598 The sections that follow further discuss the economic costs, benefits, and effects on competition, efficiency, and capital formation with respect to specific types of funds and specific amendments in the final rule. Foreign Excluded Funds Under the baseline, foreign excluded funds are excluded from the covered fund definition, but could be considered banking entities if a foreign banking entity controls the foreign fund in 596 See id. supra Section IV. (Summary of the Final Rule) for discussion of comments and recommendations for each of the proposed amendments. 598 See id. 597 See VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 certain circumstances.599 As discussed above, the policy statement released by Federal banking agencies provides that the Federal banking agencies would not propose to take action (1) against a foreign banking entity based on attribution of the activities and investments of a qualifying foreign excluded fund to the foreign banking entity 600 or (2) 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 implementing regulations, as if the qualifying foreign excluded fund were a covered fund.601 As in the 2020 proposal, the final rule provides a permanent exemption from the proprietary trading and covered fund prohibitions for certain foreign excluded funds that is substantively similar to the relief currently provided to qualifying foreign excluded funds by the policy statement.602 Commenters were generally supportive of the proposal to exempt qualifying foreign excluded funds from certain requirements of the rule.603 Two commenters expressed opposition to the proposed exemption.604 The SEC recognizes that failing to exclude such funds from the definition of ‘‘banking entity’’ in the implementing regulations imposed proprietary trading restrictions, covered fund prohibitions, and compliance obligations on qualifying foreign excluded funds that may be more burdensome than the requirements that would apply under the implementing regulations to covered funds. The SEC believes that, absent the qualifying foreign excluded fund exemption and upon expiry of the policy statement, the implementing regulations may have significant adverse 599 See supra Section IV.A. (Qualifying Foreign Excluded Funds). 600 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. 601 See supra note 26. The policy statement was subsequently extended for a two-year period ending on July 21, 2021. See also supra Section IV.A. (Qualifying Foreign Excluded Funds) and note 28. 602 See final rule §§ ll.6(f) and ll.13(d). 603 SIFMA; BPI; BVI; AIC; ABA; EFAMA; SAF; IIB; JBA; CBA; and Credit Suisse. See also supra Section IV.A. (Qualifying Foreign Excluded Funds) for a discussion of individual comments. 604 See Occupy and Data Boiler. PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 effects on foreign banking entities’ ability to organize and offer certain private funds for foreign investments, disrupting foreign asset management activities. The SEC recognizes that the exemption of qualifying foreign excluded funds from the proprietary trading and covered fund prohibitions that apply to ‘‘banking entities’’ may result in increased activity by foreign banking entities in organizing and offering such funds, and that such activity may involve risk for those banking entities. At the same time, the SEC recognizes a statutory purpose of certain portions of section 13 of the BHC Act is to limit the extraterritorial impact on foreign banking entities.605 Accordingly, the final rule may benefit foreign banking entities and their foreign counterparties seeking to transact with and through such funds. The agencies received comments on the 2020 proposal that expressed concern that although qualifying foreign excluded funds would be exempted from the proprietary trading and covered funds restrictions of the implementing regulations, these funds would still be required to put in place compliance programs.606 However, since these qualifying foreign excluded funds are exempted from the proprietary trading requirements of § ll.3(a) and covered fund restrictions of § ll.10(a), the agencies believe that requiring compliance programs to be established for the qualifying foreign excluded fund itself would be overly burdensome and unnecessary. Therefore, under the final rule, in addition to the proposed exemptions from the proprietary trading and covered fund prohibitions, qualifying foreign excluded funds will also not be required to have compliance programs under § ll.20. However, any banking entity that owns or sponsors a qualifying foreign excluded fund will still be required to have in place the appropriate compliance programs as required by § ll.20. The exemption is also expected to promote capital formation in the United States. While qualifying foreign excluded funds have a limited nexus to the United States, such funds are permitted to invest in U.S. companies. Therefore, to the extent that these funds have any direct impact on capital formation and U.S. financial stability, the exemption would promote U.S. financial stability by providing additional capital and liquidity to U.S. capital markets without a concomitant increase in risk borne by U.S. banking entities. 605 See 606 See E:\FR\FM\31JYR4.SGM 85 FR 12123–26. IIB; JBA; CBA; EBF; and Credit Suisse. 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations The final rule may increase the incentive for some foreign banking entities seeking to organize and offer qualifying foreign excluded funds to reorganize their activities so that these funds’ activities qualify for the exemptions. The costs and feasibility of such reorganization will depend on the complexity and existing compliance structures for banking entities, the degree to which there is unmet demand for investment funds that may be organized as qualifying foreign excluded funds, and the profitability of such banking activities. Importantly, the principal risk of foreign banking entities’ activities related to foreign excluded funds generally resides outside the United States. As discussed above,607 because the exemption requires that the foreign banking entity’s acquisition of an ownership interest in or sponsorship of the fund meets the requirements in § ll.13(b) of the final rule, the exemption will help to ensure that the risks of the investments made by these foreign funds would be booked to foreign entities in foreign jurisdictions. The agencies believe that exempting the activities of qualifying foreign excluded funds promotes and protects the safety and soundness of banking entities and U.S. financial stability,608 and relatedly the SEC believes the exemption is unlikely to impact negatively SEC registrants. Foreign Public Funds The implementing regulations exclude from the covered fund definition any foreign public fund that satisfies three sets of conditions. First, the issuer must be organized or established outside of the United States, be authorized to offer and sell ownership interests to retail investors in the issuer’s home jurisdiction (the ‘‘home jurisdiction’’ requirement), and sell ownership interests predominantly through one or more public offerings outside of the United States. The agencies stated in the preamble to the 2013 rule that they generally expect that an offering is made predominantly outside of the United States if 85 percent or more of the fund’s interests are sold to investors that are not residents of the United States.609 Second, for funds that are sponsored by a U.S. banking entity, or by a banking entity controlled by a U.S. banking entity, the ownership interests in the issuer must be sold ‘‘predominantly’’ to persons other than the sponsoring banking entity, the issuer, their affiliates, directors of such entities, or employees of such entities (the sales limitation). The agencies stated in the preamble to the 2013 rule that, consistent with the agencies’ view concerning whether a foreign public fund has been sold predominantly outside of the United States, the agencies generally expect that a foreign public fund would satisfy this additional condition if 85 percent or more of the fund’s interests are sold to persons other than the sponsoring U.S. banking entity and the specified persons connected to that banking entity.610 Third, such public offerings must occur outside the United States, must comply with applicable jurisdictional requirements (the compliance obligation), may not restrict availability to investors having a minimum level of net worth or net investment assets, and must have publicly available offering disclosure documents filed or submitted with the relevant jurisdiction. The final rule makes several changes to the foreign public fund exclusion. First, the final rule removes the home jurisdiction requirement.611 Second, the final rule makes the exclusion available with respect to issuers authorized to offer and sell ownership interests through one or more public offerings, removing the requirement that the issuer sells ownership interests ‘‘predominantly’’ through such public offerings.612 Third, the agencies are also modifying the definition of ‘‘public offering’’ from the implementing regulations to add a new requirement that the distribution is subject to substantive disclosure and retail investor protection laws or regulations in one or more jurisdictions where ownership interests are sold.613 Fourth, the final rule applies the compliance obligation only in instances in which the banking entity serves as the investment manager, investment adviser, commodity trading advisor, commodity pool operator, or sponsor.614 Finally, the final rule narrows the sales limitation to the sponsoring banking entity, the issuer, affiliates, and directors and senior executive officers of such entities, and requires more than 75 percent of the fund’s interest to be sold to such entities and persons.615 As discussed in the 2020 proposal, the SEC has received comments indicating that the foreign public fund 610 Id. final rule § ll.10(c)(1)(i)(B). final rule § ll.10(c)(1)(i)(B). 613 See final rule § ll.10(c)(1)(iii)(A). 614 See final rule § ll.10(c)(1)(iii)(B). 615 See final rule § ll.10(c)(1)(ii). 611 See 607 See supra Section IV.A. (Qualifying Foreign Excluded Funds). 608 See id. 609 79 FR 5678. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 PO 00000 612 See Frm 00059 Fmt 4701 Sfmt 4700 46479 exclusion under the implementing regulations is impractical, overly narrow, and prescriptive, and results in competitive disparities between foreign public funds and RICs.616 The SEC also received comment that the home jurisdiction requirement under the implementing regulations is narrow and fails to recognize the prevalence of nonU.S. retail funds organized in one jurisdiction and authorized to sell interests in other jurisdictions.617 As adopted in the final rule, the elimination of the home jurisdiction requirement may benefit such foreign public funds and may facilitate greater capital formation through such funds, with the potential to create more capital allocation choices for investors. To the degree that the implementing regulations have disadvantaged foreign public funds relative to otherwise comparable RICs, the elimination of the home jurisdiction requirement may dampen such competitive disparities. As also discussed in the 2020 proposal, the SEC has received comment that the requirement that ownership interests be sold ‘‘predominantly’’ through one or more public offerings outside of the United States has been burdensome and poses significant compliance burdens.618 For example, banking entities may not fully observe and predict both historical and potential future distributions of funds that are sponsored by third parties, listed on exchanges, or sold through third-party intermediaries or distributors.619 In response to the 2020 proposal, commenters supported the elimination of the home jurisdiction requirement and the requirement that the fund be sold predominantly through one or more public offerings.620 To the degree that some banking entities restrict their activities because they are unable to quantify the volumes of distributions through foreign public offerings relative to, for instance, foreign private placements, the final rule may enable greater activity by banking entities relating to foreign public funds. Similar to the above discussion, this aspect of the final rule also treats foreign public funds in a manner more similar to RICs (which are not required to 616 See 85 FR 12166. funds could be organized in a particular jurisdiction for reasons including tax treatment, investment strategy, or flexibility to distribute into multiple markets (for instance, in the European Union), even though such funds are authorized to sell interests in other jurisdictions. See also id. 618 See 85 FR 12166. 619 See id. 620 IIB; SIFMA; BPI; ABA; EBF; EFAMA; FSF; ICI; BVI; and CBA. See also supra Section IV.B.1. (Foreign Public Funds). 617 Such E:\FR\FM\31JYR4.SGM 31JYR4 46480 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations monitor or assess distributions), with corresponding competitive effects. Commenters on the 2020 proposal also supported the proposed change to the ‘‘public offering’’ definition to include a requirement that the distribution be subject to substantive disclosure and retail investor protection laws or regulations.621 The final rule adopts that change, as proposed. Accordingly, the final rule tailors the scope of disclosure and compliance obligations for those jurisdictions where ownership interests are sold in recognition of the prevalence of foreign retail fund sales across jurisdictions. Similarly, the final rule limits the compliance obligation to settings in which the banking entity serves as the investment manager, investment adviser, commodity trading advisor, commodity pool operator, or sponsor— settings that may involve greater conflicts of interest between banking entities and fund investors than when the banking entity is only an investor in the fund. The final rule also replaces the employee sales limitation with a limitation on sales to senior executive officers.622 As discussed in the 2020 proposal, the SEC has received comment that banking entities may face significant costs and logistical and interpretive challenges monitoring investments by their employees, including those who transact in fund shares through unaffiliated brokers or through independent exchange trading.623 The SEC has also received comment that the employee sales limitation serves no discernible antievasion purpose.624 In addition, commenters noted that employee ownership interest can be a meaningful mechanism of promoting incentive alignment.625 The final rule replaces the employee sales limitation with a corresponding sales limitation with respect only to senior executive officers. This change may reduce these reported compliance challenges and burdens while preserving, in part, the original anti-evasion purpose of the limitations on employee ownership. The SEC received comments to the 2020 proposal that recommended the agencies modify their expectation of the level of ownership of a foreign public fund that would satisfy the requirement that a fund be ‘‘predominantly’’ sold to persons other than its U.S. banking 621 IIB; EFAMA; FSF; ICI; and BVI. rule § ll.10(c)(1)(ii)(D). 623 See 85 FR 12166. 624 See id. 625 See id. 622 Final VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 entity sponsor and associated parties,626 which the preamble to the 2013 rule stated was 85 percent or more (which would permit the U.S. banking entity sponsor and associated parties to own the remaining 15 percent). These commenters asserted that the relevant ownership threshold for U.S. registered investment companies is 25 percent, and that, for foreign public funds, the threshold should be the same. The agencies agree that the permitted ownership level of a foreign public fund by a U.S. banking entity sponsor and associated parties should be aligned with the functionally equivalent threshold for banking entity investments in U.S. registered investment companies, which is 24.9 percent.627 Accordingly, the agencies have amended this provision in the final rule to require that more than 75 percent of a foreign public fund’s interests must be sold to persons other than the U.S. banking entity sponsor and associated parties.628 Commenters on the 2020 proposal generally supported the proposed changes to the foreign public funds exclusion; 629 however, as discussed in this section and above, the agencies are making certain targeted adjustments in response to comments received.630 One commenter stated that the proposed changes were less than ideal for maximum control but acceptable from a practical implementation standpoint to balance compliance costs and benefits.631 As discussed above, the SEC believes that the foreign public fund provisions of the final rule may facilitate greater capital formation through such funds, with the potential to create more capital allocation choices for investors. In 626 BPI; FSF; ICI; and CCMC. See also supra Section IV.B.1. (Foreign Public Funds). 627 Although the implementing regulations do not explicitly prohibit a banking entity from acquiring 25 percent or more of a U.S. registered investment company, a U.S. registered investment company would become a banking entity if it is affiliated with another banking entity (other than as described in § ll.12(b)(1)(ii) of the implementing regulations). See 79 FR 5732 (‘‘[F]or purposes of section 13 of the BHC Act and the final rule, a registered investment company . . . will not be considered to be an affiliate of the banking entity if the banking entity owns, controls, or holds with the power to vote less than 25 percent of the voting shares of the company or fund, and provides investment advisory, commodity trading advisory, administrative, and other services to the company or fund only in a manner that complies with other limitations under applicable regulation, order, or other authority.’’). 628 See supra note 69. 629 IIB; SIFMA; BPI; ABA; EBF; EFAMA; FSF; ICI; BVI; CBA; CCMR; Data Boiler; GS; IAA; JBA; SAF; and CCMC. 630 See supra Section IV.B.1. (Foreign Public Funds). 631 See Data Boiler. PO 00000 Frm 00060 Fmt 4701 Sfmt 4700 particular, to the degree that some banking entities restrict their activities relating to foreign public funds because they are unable to quantify the distributions through public offerings or determine the holdings of their employees, the final rule may enable greater activity by banking entities relating to foreign public funds. The final rule also limits the compliance obligation to settings in which the banking entity serves as the investment manager, investment adviser, commodity trading advisor, commodity pool operator, or sponsor—settings that may involve greater conflicts of interest between banking entities and fund investors than when the banking entity is only an investor in the fund. The agencies could have adopted a variety of alternatives offering more or less relief with respect to foreign public funds. For example, the agencies could have eliminated altogether the limit on sales to affiliated entities, directors and employees, which would have provided an even greater alignment of treatment between foreign public funds and RICs.632 Alternatives providing greater relief with respect to foreign public funds may have facilitated greater banking entity activity and intermediation of such funds on the one hand, but they may also have strengthened the competitive positioning of foreign public funds relative to U.S. registered funds. Moreover, providing greater relief with respect to foreign public funds may have allowed banking entities greater flexibility in the formation and operation of foreign public funds, but may also have increased the risk that banking entities would be able to use foreign public funds to engage in activities that the restrictions on covered funds were intended to prohibit, thereby reducing the magnitude of the expected economic benefits of section 13 of the BHC Act and the implementing regulations. Similarly, relative to the final rule, alternatives providing less relief with respect to foreign public funds may have strengthened the competitive positioning of U.S. RICs relative to foreign public funds and posed lower compliance or evasion risks, but may also have reduced the benefits of the relief for capital formation in foreign public funds and their investors. Loan Securitizations The 2013 rule excludes from the definition of covered fund any loan securitization that issues asset-backed securities, holds only loans, certain 632 See E:\FR\FM\31JYR4.SGM 2020 proposal at 12166. 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations rights and assets that arise from the structure of the loan securitization or from the loans supporting a loan securitization, and a small set of other financial instruments (permissible assets), and meets other criteria.633 As discussed in the 2020 proposal, the SEC received comment that, as a result of the 2013 rule, some banking entities may have divested or restructured their interests in loan securitizations due to the narrowly-drawn conditions of the exclusion, and that a limited holding of non-loan assets may enable banking entities to provide traditional securitization products and services demanded by customers, clients, and counterparties.634 The implementing regulations permit loan securitizations to hold rights or other assets (servicing assets) that arise from the structure of the loan securitization or from the loans supporting a loan securitization.635 In response to questions regarding the scope of the provisions permitting servicing assets and a separate provision limiting the types of permitted securities, the staffs of the agencies released the Loan Securitization Servicing FAQ.636 The final rule codifies the staff-level approach to the loan securitization exclusion in the Loan Securitization Servicing FAQ.637 To the degree that market participants may have restructured their activities consistent with the Loan Securitization Servicing FAQ, an effect of the final rule may be to reduce uncertainty. However, the economic effects of the codification of the Loan Securitization Servicing FAQ with respect to enabling greater capital formation through loan securitizations on the one hand, and increasing potential risks related to such activities on the other, may be limited. In the preamble to the 2013 rule, the agencies declined to permit loan securitizations to hold a certain amount of non-loan assets.638 Several commenters on the 2018 proposal disagreed with the agencies’ views and supported expanding the range of permissible assets in an excluded loan securitization.639 The 2020 proposal would have allowed a loan securitization vehicle to hold up to five 633 See 2013 rule § ll.10(c)(8). Loan is further defined as any loan, lease, extension of credit, or secured or unsecured receivable that is not a security or derivative. See also 2013 rule § ll.2(t). 634 See 85 FR 12173. 635 Implementing regulations §§ ll.2(s); ll.10(c)(8)(i)(D), (v). 636 See supra note 14 (links to the staff-level FAQs) and 78 and referencing paragraph (discussion of Loan Securitization Servicing FAQ). 637 § ll.10(c)(8)(i)(B). 638 2013 rule at 5687–88. 639 See 85 FR 12129. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 percent of the fund’s total assets in any non-loan assets. Commenters were generally supportive of allowing loan securitizations to hold a limited amount of non-loan assets.640 These commenters indicated that the requirements under the implementing regulations for the loan securitization exclusion have been too restrictive, excessively limited use of the exclusion, and prevented issuers from responding to investor demand. Further, commenters suggested that a limited bucket of non-loan assets would not fundamentally alter the characteristics and risks of securitizations or otherwise increase risks in banking entities or the financial system.641 In the final rule, the agencies are revising the loan securitization exclusion to permit a loan securitization to hold a limited amount of debt securities.642 To minimize the potential for banking entities to use this exclusion to engage in impermissible activities or take on excessive risk, the final rule permits a loan securitization to hold debt securities (excluding asset-backed securities and convertible securities), as opposed to any non-loan asset, as the 2020 proposal would have allowed.643 The SEC believes that non-loan assets with materially different risk characteristics from loans could change the character and complexity of an issuer and raise the type of concerns that section 13 of the BHC Act was intended to address. Moreover, as described further below, limiting the assets to those with risk characteristics that are similar to loans may allow for a simpler and more transparent calculation of the five percent limit than would have been necessary if loan securitizations could invest in any nonloan asset, which will facilitate banking entities’ compliance with the exclusion. Alternatively, the agencies could have expanded the range of permissible assets in an excluded loan securitization to include any non-loan asset with or without limitations (e.g., the holding of asset-backed securities could have been permitted). Permitting loan securitizations to hold small amounts of non-loan assets may have enabled loan securitizations to respond to investor demand and may have reduced compliance costs associated with 640 See, e.g., SIFMA; CCMC; ABA; Credit Suisse; MFA; Goldman Sachs; LSTA; BPI; and SFA. 641 See, e.g., LSTA and Goldman Sachs. 642 Final rule § ll.10(c)(8)(i)(E). 643 The implementing regulations also allow an excluded loan securitization to hold certain interest rate and foreign exchange derivatives for risk management purposes. The final rule makes no change to this provision. PO 00000 Frm 00061 Fmt 4701 Sfmt 4700 46481 ensuring that a loan securitization holds only assets permitted under the exclusion. However, permitting excluded loan securitizations to hold a broader range of non-loan assets could have increased the risk that the character and complexity of excluded loan securitizations would have changed in a manner that raised the type of concerns that section 13 of the BHC Act was intended to address. However, the SEC recognizes that the loan securitization industry may have evolved since the issuance of the 2013 rule. As a result, the SEC believes that, even if the scope of non-loan assets permitted to be held were expanded beyond debt securities, loan securitizations may continue to have excluded non-loan assets. Further, permitting loan securitizations to hold a small amount of debt securities will not affect the applicable prudential requirements aimed at the safety and soundness of banking entities. Banking entities currently take on a variety of risks arising out of a broad range of permissible activities, including the core traditional banking activity related to the extension of credit and direct and indirect extension of credit by banking entities flows through to the real economy in the form of greater access to capital. In the 2020 proposal, the agencies also requested comment on the methodology for calculating the limit on non-loan assets. Several commenters suggested using as a method for calculating the limit on non-loan assets: The par value of assets on the day they are acquired.644 These commenters suggested that relying on par value is accepted practice in the loan securitization industry and would obviate concerns related to tracking amortization or prepayment of loans in a securitization portfolio.645 Another commenter indicated that the limit should be calculated as the lower of the purchase price and par value of the nonqualifying assets over the issuer’s aggregate capital commitments plus its subscription based credit facility.646 In response to these comments, the agencies are clarifying the methodology for calculating the five percent limit on non-loan assets.647 As suggested by several commenters, the final rule specifies that the limit on debt securities must be calculated at the most recent 644 SIFMA; BPI; ABA; and LSTA. and BPI. 646 Goldman Sachs. 647 Final rule § ll.10(c)(8)(i)(E). 645 SIFMA E:\FR\FM\31JYR4.SGM 31JYR4 46482 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations time of acquisition of such assets.648 Specifically, the aggregate value of debt securities may not exceed five percent of the aggregate value of loans, cash and cash equivalents, and debt securities, where the value of the loans, cash and cash equivalents, and debt securities is calculated using par value at the most recent time any such debt security is purchased.649 The agencies have determined a calculation methodology that is intended to reduce compliance costs while ensuring that the investment pool of a loan securitization is composed of loans. The agencies have chosen the most recent time any such debt security is acquired as the moment of calculation to simplify the manner in which the five percent limit applies. This would permit an issuer that, at some point in its life, held debt securities in excess of five percent of its assets to continue to qualify for the exclusion if it came into compliance with the five percent limit prior to the next acquisition of a debt security that is subject to the five percent limit. The SEC believes that this approach balances the cost of calculation with the benefits of addressing the potential for evasion. The SEC believes that the alternative of a continuous monitoring obligation (i.e., requiring an excluded loan securitization to ensure that it held debt securities below or at the five percent limit at all times, regardless of any change in value of the securitization’s assets) would have imposed significant burdens on banking entities and could have caused an issuer to be disqualified from the loan securitization exclusion based on market events not under its control. In the final rule, this calculation is based only on the value of the loans and debt securities held under §§ ll.10(c)(8)(i)(A) and (E) and the cash and cash equivalents held under § ll.10(c)(8)(iii)(A) rather than the aggregate value of all of the issuing entity’s assets. The purpose of the five percent limit is to ensure the investment pool of a loan securitization is composed of loans. Therefore, the calculation takes into account the assets that should make up the issuing entity’s investment pool and excludes the value of other rights or incidental assets, as well as derivatives held for risk management. This further simplifies the calculation methodology by excluding assets that may be more complex to value and that are ancillary to the loan 648 This limit applies to the debt securities that a loan securitization may hold pursuant to final rule § ll.10(c)(8)(i)(E). 649 Id. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 securitization’s investment activities. This straightforward calculation methodology will ensure that the loan securitization exclusion remains easy to use and will facilitate banking entities’ compliance with the exclusion. The agencies recognize that a loan securitization’s transaction agreements may require that some categories of loans, cash equivalents, or debt securities be valued at fair market value for certain purposes. To accommodate such situations, the exclusion provides that the value of any loan, cash equivalent, or permissible debt security may be based on its fair market value if (1) the issuing entity is required to use the fair market value of such loan or debt security for purposes of calculating compliance with concentration limitations or other similar calculations under its transaction agreements and (2) the issuing entity’s valuation methodology values similarly situated assets, for example non-performing loans, consistently. This provision is intended to provide issuers with the flexibility to leverage existing calculation methodologies while preventing issuers from using inconsistent methodologies in a manner to evade the requirements of the exclusion. Credit Funds Under the baseline, funds that raise capital to engage in loan originations or extensions of credit or purchase and hold debt instruments that a banking entity would be permitted to acquire directly may be ‘‘covered funds’’ under the implementing regulations. As a result, prior to the final rule, banking entities faced limitations on sponsoring or investing in credit funds that engage in traditional banking activities— activities that banking entities are able to engage in directly outside of the fund structure. The SEC received several comments to the 2018 proposal supporting an exclusion for credit funds. For example, some commenters suggested that a fund or partnership structure enables banking entities to engage in permissible activities more efficiently.650 Specifically, one commenter indicated that credit funds facilitate investments by third parties, leading to the creation of a broader and deeper pool of capital, which may allow for more diversification in banking entities’ lending portfolios, the pooling of expertise of groups of market participants, and otherwise reduce the risk for banking entities and the financial system.651 In addition, some PO 00000 650 See 651 See 85 FR 12167. id. Frm 00062 Fmt 4701 Sfmt 4700 commenters stated that to the degree that credit funds require precommitments of capital, they may dampen cyclical fluctuations in loan originations and may facilitate ongoing extensions of credit during times of market stress.652 The agencies included in the 2020 proposal a specific exclusion for credit funds. Under the 2020 proposal, a credit fund would have been an issuer whose assets consist solely of: Loans, debt instruments, related rights and other assets that are related or incidental to acquiring, holding, servicing, or selling loans, or debt instruments; and certain interest rate or foreign exchange derivatives.653 The proposed exclusion would have been subject to certain additional requirements to reduce evasion concerns and ensure that banking entities invest in, sponsor, or advise credit funds in a safe and sound manner. For example, the proposed exclusion would have imposed (1) certain activity requirements on the credit fund, including a prohibition on proprietary trading; 654 (2) disclosure and safety and soundness requirements on banking entities that sponsor or serve as an advisor for a credit fund; 655 (3) safety and soundness requirements on all banking entities that invest in or have certain relationships with a credit fund; 656 and (4) restrictions on the banking entity’s investment in, and relationship with, a credit fund.657 The proposed exclusion also would have permitted a credit fund to receive and hold a limited amount of equity securities (or rights to acquire equity securities) that were received on customary terms in connection with the credit fund’s loans or debt instruments.658 Commenters on the 2020 proposal were generally supportive of adopting an exclusion for credit funds.659 After consideration of the comments, the agencies are adopting the credit fund exclusion largely as proposed. The final rule creates a separate exclusion from the covered fund definition for credit funds that meet certain conditions, including several conditions that are similar to certain conditions of the loan securitization exclusion, but that reflect 652 See id. proposal § ll.10(c)(15)(i). 654 2020 proposal § ll.10(c)(15)(ii). 655 2020 proposal § ll.10(c)(15)(iii). 656 2020 proposal § ll.10(c)(15)(iv). 657 2020 proposal § ll.10(c)(15)(v). 658 2020 proposal § ll.10(c)(15)(i)(C)(1)(iii). 659 See, e.g., CCMC; AIC; SIFMA; FSF; ABA; Arnold & Porter; and Goldman Sachs. See also supra Section IV.C.1.ii. (Credit Funds—Comments) for a more detailed discussion of comments received. 653 2020 E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations the structure and operation of credit funds. The final rule permits banking entities to extend credit through a fund structure but also contains provisions to prevent a banking entity from taking the types of risks that the covered fund provisions of section 13 were meant to address. First, the credit fund exclusion specifies the types of activities in which these funds may engage. Excluded credit funds can transact in or hold only loans, debt instruments that would be permissible for the banking entity relying on the exception to hold directly, certain rights or assets that are related or incidental to the loans or debt instruments, and certain interest rate and foreign exchange derivatives. The final rule requires that the credit fund not engage in activities that would constitute proprietary trading. Finally, the restrictions on guarantees and other limitations should eliminate the ability and incentive for either the banking entity sponsoring a credit fund or any affiliate to provide additional support beyond the ownership interest retained by the sponsor. Credit funds are likely to carry similar returns and risks as direct extensions of credit and loan origination outside of the fund structure, including the possibility of losses or gains related to changes in interest rates, borrower default or delinquent payments, fluctuations in foreign currencies, and overall market conditions. While the presence of a fund structure may introduce certain common risks associated with pooled investments, e.g., those related to governance of the fund and those related to relying on third-party investors providing capital to the fund, the SEC believes those risks to banking entities to be limited. Moreover, fund structures also entail certain common risk mitigating features (such as diversification across a larger number of borrowers) as well as significant cost efficiencies for banking entities. The SEC believes that the credit fund exclusion may allow banking entities to engage, indirectly, in more loan origination and traditional extension of credit relative to the current baseline. To the degree that banking entities are currently constrained in their ability to engage in extensions of credit through credit funds because of the implementing regulations, the exclusion may increase the volume of intermediation of credit by banking entities and make intermediation more efficient and less costly. In addition, permitting banking entities to extend financing to businesses through credit funds could allow banking entities to VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 compete more effectively with nonbanking entities that are not subject to the same prudential regulation or supervision as banking entities subject to section 13 of the BHC Act and thereby likely result in an increase in lending activity in banking entitysponsored credit funds without negatively affecting capital formation or the availability of financing. In this respect, the final rule could result in greater competition between bank and non-bank provision of credit with both expected lower costs that typically result from increased competition and a larger volume of permissible banking and financial activities to occur in the regulated banking system. In addition, since cost reductions and increased efficiencies are commonly passed along to customers, the exclusion may also benefit banking entities’ borrowers and facilitate the extension of credit in the real economy. The SEC continues to recognize that banking entities already engage in a variety of permissible activities involving risk, including extensions of credit, underwriting, and marketmaking. To the degree that credit funds may enable greater formation of capital by banking entities through various debt instruments, this may influence the risks and returns of banking entities individually and of banking entities as a whole. However, the SEC recognizes that the activities of credit funds largely replicate permissible and traditional activities of banking entities and undertaking similar activities largely results in the same risk exposures. Moreover, banking entities subject to the implementing regulations may also be subject to multiple prudential, capital, margin, and liquidity requirements that facilitate the safety and soundness of banking entities and promote the financial stability of the United States. These requirements would necessarily limit the risk that banks could take on by lending through a credit fund structure in a similar manner that would apply if the banking entity were to undertake similar lending activities directly. In addition, the final rule includes a set of conditions on the credit fund exclusion, including limitations on banking entities’ guarantees, assumption or other insurance of the obligations or performance of the fund,660 and compliance with applicable safety and soundness standards.661 Several provisions of the exclusion are similar to and modeled on conditions in the existing loan PO 00000 securitization exclusion to ease compliance burdens. For example, any derivatives held by the credit fund must relate to loans, permissible debt instruments, or other rights or assets held and reduce the interest rate and/or foreign exchange risks related to these holdings.662 In addition, any related rights or other assets held that are securities must be cash equivalents, securities received in lieu of debts previously contracted with respect to loans or debt instruments held or, unique to the credit fund exclusion, equity securities (or rights to acquire equity securities) received on customary terms in connection with the credit fund’s loans or debt instruments.663 Establishing an exclusion for credit funds based on the framework provided by the loan securitization exclusion will allow banking entities to provide traditional extensions of credit regardless of the specific form, whether directly via a loan made by a banking entity, or indirectly through an investment in or relationship with a credit fund that transacts primarily in loans and certain debt instruments. In the 2020 proposal, the agencies requested comment on whether to impose a limit on the amount of equity securities (or rights to acquire equity securities) that may be held by an excluded credit fund.664 After a review of the comments and further deliberation, the agencies are not adopting a quantitative limit on the amount of equity securities (or rights to acquire equity securities) that may be held by an excluded credit fund. Any such equity securities or rights are limited by the requirements that they be (1) received on customary terms in connection with the fund’s loans or debt instruments and (2) related or incidental to acquiring, holding, servicing, or selling those loans or debt instruments. The agencies generally expect that the equity securities or rights satisfying those criteria in connection with an investment in loans or debt instruments of a borrower (or affiliated borrowers) would not exceed five percent of the value of the fund’s total investment in the borrower (or affiliated borrowers) at the time the investment is made. The agencies could have imposed a quantitative limit on the amount of equity securities (or rights to acquire equity securities) held by the fund. However, the value of those equity securities or other rights may change over time for a variety of reasons, including as a result of market rule § ll.10(c)(15)(i)(D). rule § ll.10(c)(15)(i)(C). 664 85 FR 12133. 662 Final rule § ll.10(c)(15)(iv)(A). 661 Final rule § ll.10(c)(15)(v)(B). 660 Final Frm 00063 Fmt 4701 Sfmt 4700 46483 663 Final E:\FR\FM\31JYR4.SGM 31JYR4 46484 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations conditions and business performance, as well as more fundamental changes in the business and the credit fund’s corresponding management of the investment (e.g., exchanges of debt instruments for equity in connection with mergers and restructurings or a disposition of all portion of the credit investment without a corresponding disposition of the equity securities or rights due to differences in market conditions or other factors). Accordingly, the agencies can foresee various circumstances where the relative value of such equity securities or rights in a borrower (or affiliated borrowers) would over the life of the investment exceed five percent on a basis consistent with the requirements. Therefore, a quantitative limit on the amount of equity securities held by the fund could have imposed compliance, opportunity, and performance costs on a fund without a substantial reduction in risk to the fund. Nonetheless, the agencies expect that the fund’s exposure to equity securities (or other rights), individually and collectively and when viewed over time, would be managed on a basis consistent with the fund’s overall purpose. The credit fund exclusion prevents a banking entity from relying on the exclusion unless any debt instruments and equity securities (or rights to acquire an equity security) held by the credit fund and received on customary terms in connection with the credit fund’s loans or debt instruments are permissible for the banking entity to acquire and hold directly. A banking entity that acts as sponsor, investment adviser or commodity trading advisor of a credit fund must ensure that the activities of the credit fund are consistent with certain safety and soundness standards.665 In addition, a banking entity’s investment in, and relationship with, a credit fund must be conducted in compliance with, and subject to, applicable banking laws and regulations, including applicable safety and soundness standards.666 Combined with the prohibition on proprietary trading by a credit fund,667 these limitations are expected to prevent evasion of section 13 of the BHC Act. The final rule does not separately permit credit funds to hold derivatives under the provision allowing related rights and other assets. The preamble to the 2020 proposal made clear that ‘‘any derivatives held by the credit fund must relate to loans, permissible debt instruments, or other rights or assets held, and reduce the interest rate and/ or foreign exchange risks related to these holdings.’’ 668 The agencies suggested then and currently believe that allowing a credit fund to hold derivatives not related to interest rate or foreign exchange hedging would not be necessary to facilitate the indirect extensions of credit by banking entities that are the goal of the exclusion and may pose the very risks that section 13 of the BHC Act was intended to reach. To help ensure that the credit fund exclusion does not inadvertently allow the holding of certain derivatives unrelated to hedging interest rate and/ or foreign exchange risks, the final rule explicitly excludes derivatives from permissible related rights and other assets.669 Importantly, extensions of credit and loan origination by banking entities, whether directly or indirectly, are influenced by a wide variety of factors, including the prevailing macroeconomic conditions, the creditworthiness of borrowers and potential borrowers, competition between bank and nonbank credit providers, and many others. Moreover, the efficiencies of credit funds relative to direct extensions of credit described above are likely to vary considerably among banking entities and funds. The SEC recognizes that the potential effects described above of the credit fund exclusion may be dampened or magnified in different phases of the macroeconomic cycle and across various types of banking entities. Investors in a credit fund that a banking entity sponsors or for which the banking entity serves as an investment adviser or commodity trading advisor may have expectations related to the performance of the credit fund that raise bailout concerns. To ensure that these investors are adequately informed of the banking entity’s role in the credit fund, the final rule requires a banking entity that acts as a sponsor, investment adviser, or commodity trading advisor to an excluded credit fund to provide prospective and actual investors the disclosures specified in § ll.11(a)(8) of the implementing regulations as if the credit fund were a covered fund.670 In addition, a banking entity that acts as a sponsor, investment adviser, or commodity trading advisor must ensure that the activities of the credit fund are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking rule §§ ll.10(c)(15)(iv)(B), (iii)(B). rule §§ ll.10(c)(15)(v)(B). 667 Final rule § ll.10(c)(15)(ii)(A). 665 Final 668 See 666 Final 669 Final VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 85 FR 12132. rule § ll.10(c)(15)(i)(C)(2). 670 Final rule § ll.10(c)(15)(iii)(A). PO 00000 Frm 00064 Fmt 4701 Sfmt 4700 entity engaged in the activities directly.671 As an alternative, the agencies could have adopted a credit fund exclusion that restricted permissible assets to only loans or debt instruments and not equity. The SEC recognizes that many banking entities are permitted to take as consideration for a loan to a borrower a warrant or option issued by the borrower that may result in an equity holding. The SEC recognizes that if banking entities are to be allowed to provide credit through a fund structure that they would otherwise be allowed to provide outside of a fund structure, an allowance for equity holdings is necessary. However, allowing a credit fund to hold an unlimited amount of equity in connection with an extension of credit could turn the exclusion for credit funds into an exclusion for the type of funds that section 13 of the BHC Act was intended to address. Accordingly, the agencies indicate above that they generally expect that the equity securities or other rights acquired by a credit fund would not exceed five percent of the value of the fund’s total investment in a borrower at the time the investment is made. Venture Capital Funds As discussed above, the agencies are adopting amendments in the final rule to exclude certain venture capital funds from the definition of ‘‘covered fund,’’ which allow banking entities to acquire or retain an ownership interest in, or sponsor, those venture capital funds to the extent the banking entity is otherwise permitted to engage in such activities under applicable law.672 The exclusion is available with respect to qualifying venture capital funds, which includes an issuer that meets the definition of ‘‘venture capital fund’’ in 17 CFR 275.203(l)–1 and that meets several additional criteria.673 A qualifying venture capital fund is an issuer that, among other criteria, is a venture capital fund as defined in 17 CFR 275.203(l)–1.674 In the preamble to the regulations adopting this definition of venture capital fund, the SEC explained that the definition’s criteria distinguish venture capital funds from other types of funds, including private rule § ll.10(c)(15)(iii)(B). rule § ll.10(c)(16). 673 See supra Section IV.C.2. (Venture Capital Funds). 674 See id. for a discussion of the SEC’s definition of ‘‘venture capital fund’’ in 17 CFR 275.203(l)–1. Following enactment of the RBIC Advisers Relief Act, supra note 577, the SEC’s definition of ‘‘venture capital fund’’ includes any RBIC and any SBIC. See 15 U.S.C. 80b–3(l). 671 Final 672 Final E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations equity funds and hedge funds.675 Moreover, the SEC explained that these criteria reflect the Congressional understanding that venture capital funds are less connected with the public markets and therefore may have less potential for systemic risk.676 The SEC further explained that the restriction on the amount of borrowing, debt obligations, guarantees or other incurrence of leverage are appropriate to differentiate venture capital funds from other types of private funds that may engage in trading strategies that use financial leverage and may contribute to systemic risk.677 The SEC believes that its definition includes criteria reflecting the characteristics of venture capital funds that may pose less potential risk to a banking entity sponsoring or investing in venture capital funds and to the financial system—specifically, the smaller role of leverage financing and a lesser degree of interconnectedness with public markets. As discussed in the 2020 proposal, the SEC has received comments supporting an exclusion for venture capital funds and stating that venture capital funds do not commonly engage in short-term, high-risk activities, and that, by their nature, venture capital funds make long-term investments in private firms.678 Moreover, the SEC received comment that venture capital funds promote economic growth and competitiveness of the United States more effectively than investments in expressly permissible vehicles, such as small business investment companies.679 The SEC has also received comment that, by virtue of their investment strategy, long-term 675 See, e.g., Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers, 76 FR 39645, 39652 (July 6, 2011). 676 See id. at 39648 (‘‘[T]he proposed definition of venture capital fund was designed to . . . address concerns expressed by Congress regarding the potential for systemic risk.’’); and at 39656 (‘‘Congressional testimony asserted that these funds may be less connected with the public markets and may involve less potential for systemic risk. This appears to be a key consideration by Congress that led to the enactment of the venture capital exemption. As we discussed in the Proposing Release, the rule we proposed sought to incorporate this Congressional understanding of the nature of investments of a venture capital fund, and these principles guided our consideration of the proposed venture capital fund definition.’’). 677 See id. at 39661–62. See also id. at 39657 (‘‘We proposed these elements of the qualifying portfolio company definition because of the focus on leverage in the Dodd-Frank Act as a potential contributor to systemic risk as discussed by the Senate Committee report, and the testimony before Congress that stressed the lack of leverage in venture capital investing.’’). 678 See 85 FR 12168. 679 See id. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 investment horizon, and intermediation between companies in need of capital and institutional investors seeking to deploy capital in efficient ways, venture capital funds may play a significant role in capital formation, economic growth, and efficient market function.680 In response to the 2020 proposal, the agencies received comments supporting the proposed definition of ‘‘qualifying venture capital fund.’’ 681 At the same time, two commenters expressed opposition to the 2020 proposal.682 The final rule largely adopts the exclusion as proposed.683 As adopted, the exclusion for qualifying venture capital funds is available to an issuer that is a venture capital fund as defined in 17 CFR 275.203(l)–1 and does not engage in any activity that would constitute proprietary trading, under § ll.3(b)(1)(i), as if it were a banking entity.684 With respect to any banking entity that acts as sponsor, investment adviser, or commodity trading advisor to the issuer, the banking entity is required (1) to provide in writing to any prospective and actual investor the disclosures required under § ll.11(a)(8), as if the issuer were a covered fund, (2) to ensure that the activities of the issuer are consistent with the safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly, and (3) to comply with the restrictions in § ll.14 (except the banking entity may acquire and retain any ownership interest in the issuer), as if the issuer were a covered fund.685 As in the 2020 proposal, a banking entity that relies on the exclusion may not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the issuer.686 Finally, the banking entity’s ownership interest in or relationship with a qualifying venture capital fund must comply with the limitations imposed in § ll.15 of the implementing regulations (regarding, among other subjects, material conflicts of interest and high-risk investments), as if the issuer were a covered fund; and id. supra note 244. 682 See supra note 270. 683 The one change from the proposal is moving the requirement that the banking entity must comply with §§ ll.14 to ll.10(c)(16)(ii). This change clarifies that this requirement applies to a banking entity that acts as sponsor, investment adviser, or commodity trading advisor to the qualifying venture capital fund and does not apply to a banking entity that merely invests in a qualifying venture capital fund. 684 Final rule § ll.10(c)(16)(i). 685 Final rule § ll.10(c)(16)(ii). 686 Final rule § ll.10(c)(16)(iii). PO 00000 680 See 681 See Frm 00065 Fmt 4701 Sfmt 4700 46485 must be conducted in compliance with and subject to, applicable banking laws and regulations, including applicable safety and soundness standards.687 The qualifying venture capital fund exclusion being adopted may provide banking entities with greater flexibility in their investments in private firms generally and in private firms with a broader range of financing sources, in each case to the extent that those investments are made through a fund structure. In addition, it is widely noted that the availability of venture capital and other financing from funds is not uniform throughout the United States and is generally available on a competitive basis for companies with a significant presence in certain geographic regions (e.g., the New York metropolitan area, the Boston metropolitan area, and ‘‘Silicon Valley’’ and surrounding areas).688 This view was shared by several commenters on the 2020 proposal, who indicated that an exclusion for venture capital funds would benefit underserved regions where venture capital funding is not readily available currently.689 In this respect, the qualifying venture capital fund exclusion could allow banking entities with a presence in and knowledge of the areas where venture capital and other types of financing are less readily available to businesses to provide this type of financing in those areas, further promoting capital formation. The SEC remains cognizant of the fact that the overall level and structure of activities of banking entities that involve risk stems from a variety of permissible sources, including traditional capital provision, underwriting, and market-making. To the degree that qualifying venture capital funds may enable greater formation of capital by banking entities, this may influence the risks and returns of such funds individually and of banking entities as a whole. However, the exclusion has a number of conditions, including a prohibition on direct or indirect guarantees by the banking entity, disclosures to investors, and compliance with applicable safety and soundness standards. The SEC recognizes that venture capital funds commonly invest in rule § ll.10(c)(16)(iv). e.g., Richard Florida, Venture Capital Remains Highly Concentrated in Just a Few Cities, CITYLAB (Oct. 3, 2017), available at https:// www.citylab.com/life/2017/10/venture-capitalconcentration/539775/; PRICEWATERHOUSECOOPERS & CB INSIGHTS, MoneyTree Report (Q3 2019), available at https:// www.pwc.com/us/en/moneytree-report/assets/ moneytree-report-q3-2019.pdf. 689 See FSF; SIFMA; CCMC; and NVCA. 687 Final 688 See, E:\FR\FM\31JYR4.SGM 31JYR4 46486 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations illiquid private firms with few sources of market price information, with corresponding risks and returns. To the degree that the exclusion for qualifying venture capital funds facilitates banking entity activities related to venture capital funds, this exclusion could increase the volume and alter the structure of banking entities’ activities, affecting the risks associated with those activities. At the same time, as discussed elsewhere,690 many other traditional and permissible activities of banking entities involve risk, and the provision of capital to private firms is an important function of banking entities within the financial system and securities markets that benefits the real economy. As an alternative, the agencies considered an additional restriction for which they are requested specific comment as part of the 2020 proposal. Under this additional restriction, and notwithstanding 17 CFR 275.203(1)– 1(a)(2), the venture capital fund exclusion would be limited to funds that do not invest in companies that, at the time of the investment, have more than a limited dollar amount of total annual revenue. The agencies considered several alternative thresholds that could have been appropriate in this regard to further differentiate qualifying venture capital funds from other types of private funds. The potential benefit of including a revenue or other similar test is that it could have been more difficult for banking entities to use the exclusion to make investments through the fund that the agencies may not have intended to be permissible. However, any such antievasion benefits of this alternative could have been offset by the extent to which anti-evasion concerns are already addressed by the other conditions of the exclusion. In addition, such a revenue test or other similar test could have facilitated the indirect investment by banking entities in smaller companies that may have been particularly risky or would have required qualifying venture capital funds to pass up investment opportunities that would otherwise be considered typical venture capital-type investments. Such an additional restriction as contemplated in the alternative would have made it more difficult for banking entities to sponsor and invest in qualifying venture capital funds by limiting the pool of possible investments in which those funds could invest. This difficulty may have been particularly pronounced for banking entities that would use the qualifying 690 See venture capital fund exclusion to make investments in third-party funds, which may not have been willing to restrict— and could have been prohibited from restricting under other applicable laws—the fund’s investments in companies that met any such revenue or other similar test. As a result, such an additional condition could have diminished the benefits discussed above, both by limiting the utility of the exclusion for banking entities to make permissible investments and potentially reducing the availability of financing for businesses, including small businesses and start-ups in areas outside of certain major metropolitan areas. Small Business Investment Companies The implementing regulations exclude from the covered fund definition small business investment companies. The implementing regulations include within the scope of the exclusion SBICs and issuers that have received notice to proceed to qualify for a license as an SBIC and which have not received a revocation of the notice or license. The final rule expands the exclusion to incorporate SBICs that have voluntarily surrendered their licenses to operate and do not make new investments (other than investments in cash equivalents) after such voluntary surrender.691 Clarifying that SBICs that have voluntarily surrendered their licenses and are winding-down remain excluded from the covered fund definition reduces regulatory uncertainty for banking entities. Under the implementing regulations, because it is unclear whether an SBIC that has voluntarily surrendered its license is still excluded from the definition of ‘‘covered fund,’’ banking entities must make a determination whether or not the SBIC that is winding-down is a covered fund. If the banking entity determines that when the SBIC that is winding-down and has voluntarily surrendered its license no longer qualifies for the exclusion from the covered fund definition, then the implementing regulations apply and the banking entity’s existing investment in, and relationship with, the SBIC is prohibited. This potential result may discourage banking entities from making investments in SBICs. The 2020 proposal discussed comments the SEC had received indicating that the 2013 rule had limited banking entity activities in SBICs that may spur economic growth, and that banking entities faced significant regulatory burdens that are not 2019 amendments, 84 FR 62037–92. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 691 Final PO 00000 rule § ll.10(c)(11)(i). Frm 00066 Fmt 4701 Sfmt 4700 commensurate with the risk of the underlying activities.692 Another commenter indicated that, in the ordinary course of business, SBIC fund managers often relinquish or voluntarily surrender a license during the winddown of the fund while liquidating assets in the dissolution process (since the license is no longer necessary or an efficient use of partnership funds).693 The agencies proposed revising the exclusion for SBICs to clarify how the exclusion would apply to SBICs that voluntarily surrender their licenses during wind-down phases.694 Specifically, the agencies proposed revising the exclusion for SBICs to apply explicitly to an issuer that has voluntarily surrendered its license to operate as an SBIC and does not make new investments (other than investments in cash equivalents) after such voluntary surrender.695 Most commenters that directly addressed the 2020 proposal’s revisions concerning SBICs supported the proposed revisions, stating that the proposed revisions would provide greater certainty to banking entities wishing to invest in SBICs and would increase investment in small businesses.696 The final rule adopts the 2020 proposal’s revisions concerning SBICs without modification. SBICs are an important mechanism for capital allocation by banking entities and one important channel of capital raising for issuers. The final rule clarifies that banking entities are able to continue to participate in SBIC-related activities during the dissolution of such funds, as long as certain conditions are met. To the degree that banking entities have been reluctant to invest in SBICs to avoid the risk of an SBIC being treated as a covered fund during SBIC dissolution, the final rule may increase the willingness of some banking entities to participate in SBICs. The final rule requires that SBICs that have voluntarily surrendered their license may not make new investments during the wind-down process. This aspect of the final rule seeks to address the possibility of banking entities becoming exposed to greater risk as part of their participation in SBICs during their wind-down process, even though such exposure may not be common in an SBIC’s ordinary course of business. In any case, both the risks and the returns arising out of a banking entity’s investment in a SBIC at all stages of its lifecycle are 692 See 85 FR 12169. id. 694 See 85 FR 12131. 695 See id. 696 See SIFMA; BPI; ABA; PNC; and SBIA. 693 See E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations likely to flow through to the banking entity’s shareholders. Moreover, banking entities participating in SBICs remain subject to applicable safety and soundness regulations and requirements. Public Welfare Funds The implementing regulations exclude from the definition of ‘‘covered fund’’ issuers that make investments that are 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) (public welfare investment exclusion).697 As discussed in the 2020 proposal, the SEC has received comment that the implementing regulations’ exclusion for public welfare funds may not capture community development investments made through investment vehicles and comment supporting an exclusion of investments that qualify for Community Reinvestment Act (CRA) credit, including direct and indirect investments in a community development fund, SBIC, or similar fund.698 The 2020 proposal posed a number of questions related to the scope of the public welfare investment exclusion. For example, the 2020 proposal asked whether investments that would receive consideration as qualified investments under the regulations implementing the CRA should be excluded from the definition of covered fund, either by incorporating these investments into the public welfare investment exclusion or by establishing a new exclusion for CRA-qualifying investments.699 In addition, the 2020 proposal requested comment on whether RBICs are typically excluded from the definition of ‘‘covered fund’’ because of the public welfare investment exclusion or another exclusion and on whether the agencies should expressly exclude RBICs from the definition of covered fund.700 Finally, the 2020 proposal requested comment on whether many or all QOFs would meet the terms of the public welfare investment exclusion and on whether the agencies should expressly exclude QOFs from the definition of covered fund.701 The final rule revises the public welfare investment exclusion of the 697 Implementing regulations § ll.10(c)(11)(ii)(A). 698 See 85 FR 12169. 699 See id. 700 See id. 701 See id. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 implementing regulations to incorporate issuers explicitly, the business of which is to make investments that qualify for consideration under the regulations implementing the CRA.702 To the degree that some banking entities have faced uncertainty about their ability to make CRA-qualified investments and qualify for the exclusion, the explicit exclusion for such funds may increase the willingness of banking entities to intermediate such community development investments. At the same time, to the degree that banking entities have financed community development projects eligible for the CRA through other fund structures and have relied on corresponding exemptions, the economic effects of the explicit exclusion for CRA-qualified investments may be limited to the difference in compliance burdens between the new explicit exclusion and any existing covered fund exclusions. Commenters on the 2020 proposal generally favored explicitly excluding RBICs from the definition of ‘‘covered fund,’’ either by adopting a new exclusion, or by further clarifying the scope of the public welfare investment exclusion.703 The final rule provides a separate specific exclusion for RBICs, similar to the separate, specific exclusion for SBICs.704 As discussed elsewhere,705 RBICs are intended to promote economic development and the creation of wealth and job opportunities in rural areas and among individuals living in such areas,706 and their purpose is similar to the purpose of SBICs and public welfare companies.707 Because SBICs and RBICs share the common purpose of promoting capital formation in their respective sectors, advisers to SBICs and RBICs are treated similarly under the Advisers Act (in that they have the opportunity to take advantage of exemptions from investment adviser registration).708 The final rule’s specific exclusion for RBICs should expand the economic effects of the SBIC exclusion discussed above and may facilitate capital formation by Final rule § ll.10(c)(11)(ii)(A). SIFMA; FSF; and SBIA. 704 See supra note 575. 705 See supra note 576. 706 See U.S. Dep’t of Agriculture, Rural Business Investment Program Overview, available at http:// www.rd.usda.gov/programs-services/rural-businessinvestment-program. 707 SBICs are intended to increase access to capital for growth stage businesses. See U.S. Small Bus. Admin., SBIC Program Overview, available at https://www.sba.gov/partners/sbics. 708 See supra note 578. The private fund adviser exemption excludes the assets of RBICs and SBICs from counting towards the $150 million threshold. 15 U.S.C. 80b–3(m). PO 00000 702 See 703 See Frm 00067 Fmt 4701 Sfmt 4700 46487 banking entities in growth stage businesses. The SEC understands that RBICs may already have been excluded from the definition of covered fund under the implementing regulations.709 For example, RBICs may qualify for the public welfare exclusion under the implementing regulations or may not be a covered fund by virtue of relying on an exclusion from the definition of ‘‘investment company’’ under the Investment Company Act other than section 3(c)(1) or 3(c)(7). An express exclusion for RBICs nevertheless should reduce compliance costs for banking entities, which may otherwise have been required to conduct a case-by-case analysis of each RBIC to determine whether it qualifies for an exclusion or exemption under the implementing regulations. In response to a request for comment in the 2020 proposal, commenters generally favored explicitly excluding QOFs from the definition of ‘‘covered fund.’’ 710 The final rule provides a specific exclusion for QOFs similar to that provided to RBICs.711 As discussed above, the QOF program allows taxpayers to defer and reduce taxes on capital gains by reinvesting gains in QOFs that are required to have at least 90 percent of their assets in designated low-income zones. In this regard, QOFs are similar to SBICs and public welfare companies. The QOF exclusion should expand the economic effects of the SBIC exclusion and public welfare exclusion discussed above, and may facilitate capital formation by banking entities. QOFs already may have been excluded from the definition of covered fund under the implementing regulations. For example, QOFs may qualify for the public welfare exclusion under the implementing regulations or may not be covered funds by virtue of relying on an exclusion from the definition of ‘‘investment company’’ under the Investment Company Act other than section 3(c)(1) or 3(c)(7), such as section 3(c)(5)(C).712 In addition, depending on the facts and circumstances, an issuer that holds securities issued by a QOF may not meet the definition of ‘‘investment company’’ under section 3(a)(1) of the Investment Company Act, may be excluded under Rule 3a–1 thereunder, or may qualify for the exclusion under 709 In addition, RBICs may be excluded from the definition of ‘‘covered fund’’ under the qualifying venture capital fund exclusion in the final rule. See supra note 578. 710 See SIFMA; FSF; and ABA. 711 Final rule § ll.10(c)(11)(iv). 712 See Opportunity Zone Statement, supra note 581. E:\FR\FM\31JYR4.SGM 31JYR4 46488 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations section 3(c)(6) of the Investment Company Act.713 The express exclusion for QOFs, similar to the express exclusion for RBICs, should reduce compliance costs for banking entities, which may otherwise be required to conduct a case-by-case analysis of each QOF to determine whether it qualifies for an exclusion or exemption under the implementing regulations. Family Wealth Management Vehicles As discussed in the 2020 proposal, family wealth management vehicles commonly engage in asset management activities, as well as estate planning and other related activities.714 The SEC understands that some banking entities may have been constrained in providing traditional banking and asset management services, including, for example, investment advice, brokerage execution, financing, clearing, and settlement services, to family wealth management vehicles due to the implementing regulations.715 In addition, the SEC understands that certain family wealth management vehicles that are structured as trusts may prefer to appoint banking entities as trustees acting in a fiduciary capacity.716 In the 2020 proposal, the agencies requested comment on whether to exclude family wealth management vehicles from the definition of ‘‘covered fund.’’ 717 Several commenters supported this exclusion, stating generally that it would reduce uncertainty for banking entities about the permissibility of providing traditional banking, investment management, and trust and estate planning services to family wealth management vehicle clients.718 As discussed above, the agencies are adopting an exclusion from the definition of ‘‘covered fund’’ for any entity that acts as a ‘‘family wealth management vehicle.’’ By specifically excluding family wealth management vehicles, the final rule may benefit such banking entities and their family customers by permitting the banking entities to offer services to and engage in transactions with family wealth management vehicle customers. Importantly, the final rule may benefit family wealth management vehicles and their investment advisers by increasing the number of banking entity counterparties willing to provide 713 See id. 85 FR 12170. 715 See id. 716 See id. 717 See 85 FR 12170. 718 See, e.g., Goldman Sachs; FSF; CCMR; IAA; ABA; BPI; PNC; and SIFMA. 714 See VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 traditional client-oriented financial and asset management services. Thus, the final rule may enhance competition among banking and non-banking entities providing financial services to family wealth management vehicles and may lead to more efficient capital allocation of family wealth management vehicles’ funds. To the degree banking entities pass compliance costs on to customers, family wealth vehicles may experience costs savings from the final rule as well. Some commenters on the 2020 proposal opposed the exclusion for family wealth management vehicles. One commenter stated that rather than providing an exclusion for family wealth management vehicles through an agency rulemaking, the agencies should instead provide no-action relief to such vehicles on a case-by-case basis.719 The SEC believes that such an approach would be unnecessarily burdensome and difficult to administer. The compliance costs of such an approach could impact the willingness of banking entities to provide traditional clientoriented financial and asset management services to their family customers. This approach would also unnecessarily deviate from the agencies’ treatment of other excluded entities under the implementing regulations and hinder transparency and consistency. The SEC recognizes that some banking entities may respond to the exclusion by seeking to structure other entities as family wealth management vehicles. However, as discussed in detail above, the exclusion is only available under a number of conditions.720 Specifically, if the entity is a trust, the grantor(s) of the entity must all be family customers; if the entity is not a trust, a majority of the voting interests in the entity must be owned (directly or indirectly) by family customers, a majority of the interests in the entity must be owned by family customers, and the entity must be owned only by family customers and up to five closely related persons of the family customers.721 Moreover, up to an aggregate 0.5 percent of the family wealth management vehicle’s outstanding ownership interests may be acquired or retained by one or more entities that are not family customers or closely related persons for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or Data Boiler. supra Section IV.C.3. (Family Wealth Management Vehicles). 721 See final rule § ll.10(c)(17)(i). PO 00000 719 See 720 See Frm 00068 Fmt 4701 Sfmt 4700 similar concerns.722 In addition, banking entities may rely on this exclusion only if they: (1) Provide bona fide trust, fiduciary, investment advisory, or commodity trading advisory services to the entity; 723 (2) do not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such entity; 724 (3) comply with the disclosure obligations under § ll.11(a)(8), as if such entity were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the entity; 725 (4) comply with the requirements of §§ ll.14(b) and ll.15, as if such entity were a covered fund; 726 and (5) except for riskless principal transactions as defined in § ll.10(d)(11), comply with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the entity were an affiliate thereof.727 The definition of ‘‘family customer’’ includes any ‘‘family client’’ as defined in Rule 202(a)(11)(G)–1(d)(4) of the Investment Advisers Act of 1940, and any natural person who is a father-inlaw, mother-in-law, brother-in-law, sister-in-law, son-in-law or daughter-inlaw of a family client, or a spouse or a spousal equivalent of any of the foregoing.728 The SEC believes that the conditions for the exclusion and the definition of ‘‘family customer’’ will result in family wealth management vehicles being used as vehicles for providing customer-oriented financial services on arms-length, market terms, which the SEC believes will reduce the risk that banking entities’ involvement in these vehicles will give rise to the types of risks that the covered funds provisions are meant to mitigate. In the 2020 proposal, the agencies proposed to permit up to three closely related persons to hold ownership interests in a family wealth management vehicle. Several commenters supported allowing a finite number of closely related persons to hold ownership interests, but suggested that the proposed limit of three did not reflect the typical manner in which family final rule § ll.10(c)(17)(i)(C). final rule § ll.10(c)(17)(ii)(A). 724 See final rule § ll.10(c)(17)(ii)(B). 725 The disclosure content may be modified to prevent the disclosure from being misleading, and the manner of disclosure may be modified to accommodate the specific circumstances of the entity. See final rule § ll.10(c)(17)(ii)(C). 726 See final rule § ll.10(c)(17)(ii)(E). 727 See final rule § ll.10(c)(17)(ii)(F). 728 See final rule § ll.10(c)(17)(iii)(B). 722 See 723 See E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations wealth management vehicles are constituted and would unnecessarily constrain the availability of the exclusion.729 The final rule allows for five closely related persons to hold ownership interests in a family wealth management vehicle. The agencies understand that many family wealth management vehicles currently include more than three closely related persons.730 The agencies believe that the final rule will more closely align the exclusion with the current composition of family wealth management vehicles, thereby increasing the utility of the exclusion without allowing such a large number of non-family customer owners to suggest the entity is in reality a hedge fund or private equity fund. In the 2020 proposal, a banking entity could rely on the family wealth management vehicle exclusion only if the banking entity and its affiliates did not acquire or retain, as principal, an ownership interest in the entity, other than up to 0.5 percent of the entity’s outstanding ownership interests. In addition, such de minimis interest could be held only for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns.731 Some commenters requested that unaffiliated third parties—such as third-party trustees or similar service providers—be permitted to hold the de minimis interest.732 As adopted, the final rule allows up to an aggregate 0.5 percent of the vehicle’s outstanding ownership interests to be acquired or retained by third parties (that is, entities other than family customers or closely related persons). The SEC believes that permitting de minimis ownership by these third parties reflects a common structure of family wealth management vehicles. The SEC recognizes that without this modification, family wealth management vehicles may be forced to engage in less effective and/or efficient means of structuring and organization because the exclusion could limit the vehicle’s access to some customary service providers that have traditionally taken small ownership interests for structuring purposes. To the extent that a family customer prefers a particular person or entity to act as a service provider, allowing third-party service providers to acquire the de minimis ownership interest may enable the family customer to choose to establish a 729 See, e.g., BPI; SIFMA; ABA; and PNC. e.g., BPI; ABA; and PNC. 731 See 85 FR 12139. 732 See, e.g., SIFMA and BPI. 730 See, VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 family wealth management vehicle. Whether the de minimis amount is held by a banking entity or some other third party is not likely to raise any concerns that are not sufficiently addressed by the aggregate ownership limit and the narrow circumstances in which such de minimis ownership interest may be held. At the same time, when circumstances require that a de minimis ownership interest be held (e.g., for establishing corporate separateness), if the de minimis ownership interest is held by a third party and not a banking entity, then no banking entity will be exposed to any risk associated with holding the interest, however minimal that risk may be. In the 2020 proposal, banking entities could rely on the family wealth management vehicle exclusion only if the banking entity complied with the disclosure obligations under § ll.11(a)(8), as if such vehicle were a covered fund. Commenters on the 2020 proposal requested that the agencies clarify that the disclosures could be modified (1) to reflect the specific circumstances of the banking entity’s relationship with, and the particular structure of, its family wealth management vehicle clients; and (2) to allow the banking entity to satisfy the written disclosure requirement by means other than including such disclosures in the governing document(s) of the family wealth management vehicle(s). The final rule provides such clarity and change the disclosure requirement to permit banking entities and their affiliates (1) to modify the content of such disclosures to prevent them from being misleading and (2) to modify the manner of disclosure to accommodate the specific circumstances of the vehicle. The SEC believes that these disclosures will provide important information to the customers for whom these vehicles will be established. Because the final rule permits modification of the disclosures for certain reasons, the SEC expects that the disclosures provided to any particular family customer will be more accurate and better tailored to the particular circumstances of the family wealth management vehicle than the disclosures might have been under the 2020 proposal. These disclosures may result in the family customers being better able to understand the information included in these disclosures and being better able to weigh that information in determining whether to establish a family wealth management vehicle. To the extent that these tailored disclosures assist family customers in determining whether or PO 00000 Frm 00069 Fmt 4701 Sfmt 4700 46489 how to structure a family wealth management vehicle, they may assist family customers in deciding how best to receive services from or otherwise interact with banking entities. The SEC expects that these benefits will justify any costs incurred by banking entities in tailoring the disclosures of § ll.11(a)(8) or in providing them to customers (either by including them in existing documents or preparing a new disclosure document). The agencies are adopting, with modifications, the condition requiring a banking entity relying on the exclusion for family wealth management vehicles to comply with the requirements of 12 CFR 223.15(a), as if such banking entity were a member bank and the vehicle were an affiliate thereof.733 This condition prohibits banking entity purchases of low-quality assets from these vehicles and is intended to prevent banking entities from ‘‘bailing out’’ family wealth management vehicles. Several commenters on the 2020 proposal stated that the agencies should clarify that the exclusion permits banking entities to engage in riskless principal transactions to purchase assets—including low quality assets for purposes of section 223.15 of Regulation W—from family wealth management vehicles.734 According to these commenters, allowing a banking entity to engage in such riskless principal transactions would facilitate the family customer’s sale of assets,735 while posing minimal market or credit risk to the banking entity because the banking entity would purchase and sell the same asset contemporaneously.736 Furthermore, commenters stated that absent clarity on the permissiveness of riskless principal transactions, a family wealth management vehicle would be forced to obtain the services of a third party service provider to sell low quality assets, which in turn would increase the vehicle’s costs and operational complexity without providing a meaningful benefit to furthering the aims of section 13 of the BHC or the implementing regulations.737 The SEC believes that permitting a banking entity to engage in riskless principal transactions that involve the purchase of low-quality assets from a 733 See final rule § ll.10(c)(17)(ii)(F). 12 CFR 223.15(a) provides that a member bank may not purchase a low-quality asset from an affiliate unless, pursuant to an independent credit evaluation, the member bank had committed itself to purchase the asset before the time the asset was acquired by the affiliate. 12 CFR 223.15(a). 734 See, e.g., BPI and SIFMA. 735 See, e.g., SIFMA. 736 See, e.g., SIFMA and BPI. 737 See, e.g., SIFMA. E:\FR\FM\31JYR4.SGM 31JYR4 46490 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations family wealth management vehicle is unlikely to pose a substantive risk of evading section 13 of the BHC Act. Accordingly, in a change from the 2020 proposal and in response to the concerns raised by commenters, the condition will explicitly exclude from the requirements of 12 CFR 223.15(a) transactions that meet the definition of riskless principal transactions as defined in § ll.10(d)(11). The SEC expects that, together, the adopted criteria for the family wealth management vehicle exclusion will prevent a banking entity from being able to bail out such vehicles in periods of financial stress or otherwise expose the banking entity to the types of risks that the covered fund provisions of section 13 were intended to address. Alternative forms of relief with respect to family wealth management vehicles—for example, alternatives that define ‘‘family customers’’ more broadly or narrowly, or that remove some of the conditions for the exclusion—would have increased or reduced the availability of the exclusion relative to the final rule. Alternatively, the agencies could have amended the limitations on relationships with a covered fund to permit banking entity transactions with family wealth management vehicles that would otherwise be considered covered transactions (e.g., ordinary extensions of credit) without subjecting them to 12 CFR 223.15(a) or section 23B of the Federal Reserve Act, as if such banking entity were a member bank and such family wealth management vehicle were an affiliate thereof. Broader (narrower) alternative forms of relief may have increased (decreased) the magnitude of the economic benefits for capital formation, allocative efficiency, and the ability of banking entities to provide traditional customer oriented services to family wealth management vehicles. At the same time, such broader relief may have increased the risk that some banking entities would have responded to such relief by attempting to evade the intent of the rule, increasing the volume of their activities with family wealth management vehicles. Such risks of the alternatives, as compared to the exclusion contained in the final rule, may have been mitigated by the fact that banking entities would have remained subject to the full scope of broker-dealer and prudential capital, margin, and other rules aimed at facilitating safety and soundness. Nonetheless, by providing relief that is narrower than the broader alternative, the final rule should reduce those possible risks even further. Moreover, as discussed above, VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 the SEC believes that traditional banking and asset management services involving family wealth management vehicles in general do not involve the types of risks that section 13 of the BHC Act was designed to address.738 Accordingly, any narrower relief than that provided by the final rule with respect to family wealth management vehicles may have constrained the economic benefits of the final rule (including with respect to capital formation and allocative efficiency) unnecessarily. Customer Facilitation Vehicles As discussed in the 2020 proposal, the SEC has received comments that, because of the implementing regulations’ covered fund restrictions, some banking entities have been unable to engage in traditional banking and asset management services with respect to vehicles provided for customers, even though banking entities are otherwise able to provide such exposures and services to customers directly (outside of the fund structure).739 The SEC has also received comment that some clients, particularly clients in markets such as Brazil, Germany, Hong Kong, and Japan, prefer to transact with or through such vehicles rather than banking entities directly because of a variety of legal, counterparty risk management, and accounting factors.740 Moreover, the SEC is aware that limitations of the implementing regulations on the activities of such vehicles may have disrupted client relationships, reducing the efficiency of customer-facing financial services, and raising compliance costs of banking entities.741 The final rule establishes an exclusion from the definition of ‘‘covered fund’’ for any issuer that acts as a ‘‘customer facilitation vehicle.’’ The customer facilitation vehicle exclusion will, as proposed, be available for any issuer that is formed by or at the request of a customer of the banking entity for the purpose of providing such customer (which may include one or more affiliates of such customer) with exposure to a transaction, investment strategy, or other service provided by the banking entity.742 A banking entity may only rely on the exclusion with respect to an issuer provided that: (1) All of the ownership interests of the issuer are owned by the 738 See supra Section IV.C.3. (Customer Facilitation Vehicles). 739 See 85 FR 12171. 740 See id. 741 See id. 742 See final rule § ll.10(c)(18)(i). PO 00000 Frm 00070 Fmt 4701 Sfmt 4700 customer (which may include one or more of its affiliates) for whom the issuer was created; 743 and (2) the banking entity and its affiliates: (i) Maintain documentation outlining how the banking entity intends to facilitate the customer’s exposure to such transaction, investment strategy, or service; (ii) do not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such issuer; (iii) comply with the disclosure obligations under § ll.11(a)(8), as if such issuer were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the issuer; (iv) do not acquire or retain, as principal, an ownership interest in the issuer, other than up to an aggregate 0.5 percent of the issuer’s outstanding ownership interests for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns; (v) comply with the requirements of §§ ll.14(b) and ll.15, as if such issuer were a covered fund; and (vi) except for riskless principal transactions as defined in § ll.10(d)(11), comply with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the entity were an affiliate thereof. The exclusion in the final rule should reduce or eliminate the costs imposed by the implementing regulations that limit the services that banking entities can provide to customer facilitation vehicles, which in turn may limit the activities of these vehicles. These costs include those associated with the disruption of client relationships and the reduction in the efficiency of customer-facing financial services. The final rule should reduce these baseline costs and inefficiencies by allowing banking entities to provide customeroriented financial services through vehicles, the purpose of which is to provide such customers with exposure to a transaction, investment strategy, or other service. As a result, banking entities may become better able to engage in the full range of customer facilitation activities through special 743 Notwithstanding this condition, up to an aggregate 0.5 percent of the issuer’s outstanding ownership interests may be acquired or retained by one or more entities that are not customers if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns. See § ll.10(c)(18)(ii)(B). E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations purpose vehicles and fund structures, which could benefit banking entities, their customers, and securities markets more broadly. Most commenters on the 2020 proposal that addressed this exclusion were supportive,744 stating that it would provide banking entities with greater flexibility to meet client needs and objectives.745 Some commenters found the exclusion’s conditions to be reasonable and sufficient.746 However, two commenters recommended that the agencies impose additional limitations on the exclusion.747 One of these commenters argued that the exclusion would permit, and possibly encourage, banking entities to increase their risk exposures through the use of customer facilitation vehicles, and the agencies should minimize such risk exposures and promote risk monitoring and management.748 In the 2020 proposal, banking entities could rely on the customer facilitation vehicle exclusion only if the banking entity complied with the disclosure obligations under § ll.11(a)(8), as if such vehicle were a covered fund. Commenters on the 2020 proposal requested that the agencies provide clarification in the context of family wealth management vehicles that the content of the disclosure may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the issuer. As with family wealth management vehicles, the final rule includes a modification to the proposed exclusion clarifying that the content of the disclosure may be modified to accommodate the specific circumstances of the issuer.749 The SEC believes that these disclosures will provide important information to the customers for whom these vehicles will be used to provide services—whether they are family customers under the family wealth management vehicle exclusion or other customers under this exclusion. As discussed above with respect to family wealth management vehicles, the SEC believes that the clarification in the final rule regarding permissible modifications of the disclosures required by § ll.11(a)(8) will provide benefits that will justify 744 See, e.g., SIFMA; BPI; ABA; Credit Suisse; FSF; Goldman Sachs; and IAA. 745 See, e.g., SIFMA; BPI; ABA; and Goldman Sachs. 746 See, e.g., SIFMA; FSF; and SAF. 747 See Better Markets and Data Boiler. 748 See Better Markets. 749 See final rule § ll.10(c)(18)(ii)(C)(3). VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 any costs from tailoring and providing the disclosures. In the 2020 proposal, as with family wealth management vehicles, a banking entity could rely on the customer facilitation vehicle exclusion only if the banking entity and its affiliates did not acquire or retain, as principal, an ownership interest in the entity, other than up to 0.5 percent of the entity’s outstanding ownership interests. In addition, such de minimis interest could be held only for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns.750 As with family wealth management vehicles, commenters suggested that the agencies specifically allow any party that is unaffiliated with the customer, rather than only the banking entity and its affiliates, to own this de minimis interest.751 As adopted, the final rule allows up to an aggregate 0.5 percent of the vehicle’s outstanding ownership interests to be acquired or retained by third parties (that is, entities other than the customer) if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns.752 The SEC recognize that without this modification, customer facilitation vehicles may be forced to engage in less effective and/or efficient means of structuring and organization because the exclusion could limit the vehicle’s access to some customary service providers that have traditionally taken or may otherwise take small ownership interests for structuring purposes. To the extent that a customer prefers a particular person or entity to act as a service provider, allowing third-party service providers to acquire the de minimis ownership interest may make the customer more willing to establish a customer facilitation vehicle. Whether the de minimis amount is held by a banking entity or some other third party is not likely to raise any concerns that are not sufficiently addressed by the aggregate ownership limit and the narrow circumstances in which the de minimis ownership interest may be held. The SEC recognizes that the provision of financial services related to customer facilitation vehicles may involve market risk, and the exclusion in the final rule may enable banking entities to provide a greater array of financial services to, 750 See 85 FR 12139. SIFMA; BPI; and FSF. 752 See final rule § ll.10(c)(18)(ii)(B). 751 See PO 00000 Frm 00071 Fmt 4701 Sfmt 4700 46491 and otherwise transact with, such vehicles. The SEC believes that such risks may be mitigated by at least two of the conditions of the exclusion. First, similar to the family wealth management vehicle discussed above, other than the de minimis ownership interest, a banking entity and its affiliates may not acquire or retain, as principal, any ownership in interest in the issuer.753 Second, a banking entity and its affiliates may not directly or indirectly guarantee, assume, or otherwise insure the obligations or performance of the vehicle.754 These conditions, among the other conditions of the exclusion, may mitigate risks that may be borne by individual banking entities and by banking entities as a whole as a result of the exclusion, and may facilitate banking entities’ ongoing compliance with section 13 of the BHC Act and the final rule. Moreover, the SEC continues to believe that the provision of customer-oriented financial services by banking entities may benefit customers, counterparties, and securities markets. The final rule creates new recordkeeping requirements for a banking entity that relies on the exclusion for customer facilitation vehicles.755 Specifically, the banking entity and its affiliates must maintain documentation outlining how the banking entity intends to facilitate the customer’s exposure to a transaction, investment strategy or service offered by the banking entity. As discussed in Section V.B 756 and above, these recordkeeping burdens may impose a total initial burden of $1,078,650 757 and a total ongoing annual burden of 1,0798,650.758 The agencies are adopting, with modifications, the condition requiring a banking entity relying on the exclusion for customer facilitation vehicles to comply with the requirements of 12 CFR 223.15(a), as if such banking entity were a member bank and the vehicle were an affiliate thereof.759 The purpose of the proposed requirement that a customer facilitation vehicle must comply with 12 CFR 223.15(a) was the same for both the family wealth management vehicle and the customer facilitation vehicle rule § ll.10(c)(18)(ii)(B)(4). rule § ll.10(c)(18)(ii)(B)(2). 755 Final rule § ll.10(c)(18)(ii)(B)(1). 756 See supra note 585. 757 See supra note 586. 758 See supra note 587. 759 See final rule § ll.10(c)(18)(ii)(C)(6). 12 CFR 223.15(a) provides that a member bank may not purchase a low-quality asset from an affiliate unless, pursuant to an independent credit evaluation, the member bank had committed itself to purchase the asset before the time the asset was acquired by the affiliate. 12 CFR 223.15(a). 753 Final 754 Final E:\FR\FM\31JYR4.SGM 31JYR4 46492 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations exclusions—to help ensure that the exclusions do not allow banking entities to ‘‘bail out’’ either vehicle.760 For the same reasons discussed above with respect to family wealth management vehicles, the agencies have modified the requirement to exclude from the requirements of 12 CFR 223.15(a) any transactions that meet the definition of riskless principal transactions as defined in § ll.10(d)(11). As with the discussion of family wealth management vehicles above, the SEC believes that the ability of a banking entity to engage in riskless principal transactions with a customer facilitation vehicle will lower costs for the vehicle by allowing it to avoid finding a third party to intermediate trades for low quality assets. At the same time, allowing these riskless principal transactions should not pose the type of risk to the banking entity that section 13 of the BHC Act was intended to prevent. The SEC expects that the conditions for the customer facilitation vehicle exclusion will prevent a banking entity from being able to bail out such vehicles in periods of financial stress or otherwise expose the banking entity to the types of risks that the covered fund provisions of section 13 were intended to address. The agencies considered alternative forms of relief with respect to customer facilitation vehicles. For example, the agencies could have adopted a higher third party ownership limit (of, for example, 5% or 10%). Alternatively, the agencies could have adopted a 0.5% ownership interest limit, but without specifying a list of purposes for which such interest may be held, leading to banking entities accumulating greater ownership interests in such vehicles. As another example, the agencies could have adopted an exclusion for customer facilitation vehicles without subjecting the banking entity relying on the exclusion to 12 CFR 223.15(a) or section 23B of the Federal Reserve Act, as if such banking entity were a member bank and such customer facilitation vehicles were an affiliate thereof. Such alternatives would have removed or loosened the conditions of the exclusion, which may have increased the risk that customer facilitation vehicles could be used for evasion purposes or could have exposed banking entities to additional risk, but could also have further reduced compliance burdens and provided greater flexibility to banking entities and their customers. 760 See ii. Limitations on Relationships Between Banking Entities and Covered Funds As discussed above, under the implementing regulations, banking entities that either: (1) Serve, directly or indirectly, as a sponsor, investment adviser, commodity trading advisor, or investment manager to a covered fund; (2) organize and offer a covered fund under § ll.11; or (3) hold an ownership interest under § ll.11(b) have been unable to engage in any covered transactions with such funds.761 This prohibition may have limited the services that such banking entities and their affiliates have been able to provide to certain entities that are covered funds under the implementing regulations. For example, as noted above, banking entities have been significantly limited in their ability to both organize and offer a covered fund, as well as to provide custody or other services to the fund. The final rule permits a banking entity to engage in certain covered transactions with a related covered fund that would be exempt from the quantitative limits, collateral requirements, and low-quality asset prohibition under section 23A of the Federal Reserve Act, including certain transactions that would be exempt pursuant to section 223.42 of the Board’s Regulation W.762 In addition, the final rule authorizes banking entities to engage in certain transactions, such as extensions of intraday credit for purchases of assets from covered funds in connection with payment, clearing, and settlement services.763 Finally, in a modification from the 2020 proposal, the final rule expressly permits banking entities to enter into certain riskless principal transactions with a related covered fund, including in circumstances where the covered fund is not a ‘‘securities affiliate.’’ 764 As discussed in the 2020 proposal, the SEC received comment suggesting that section 13(f)(1) of the BHC Act should be interpreted to include the exemptions provided under section 23A of the Federal Reserve Act, and that banking entities should be permitted to engage in a limited amount of covered transactions with related covered funds.765 The SEC recognizes that outsourcing such activities to third parties may have adversely affected customer relationships, increasing costs and decreasing operational efficiency 85 FR 12140. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 PO 00000 761 See 12 U.S.C. 1851(f)(1). final rule § ll.14(a)(2)(iii). 763 See final rule § ll.14(a)(2)(v). 764 See final rule § ll.14(a)(2)(iv). 765 See 85 FR 12144. 762 See Frm 00072 Fmt 4701 Sfmt 4700 for banking entities and covered funds. The final rule provides banking entities greater flexibility to provide these and other services directly to covered funds. If being able to provide custody, clearing, and other services to related covered funds reduces the costs of these services and risks of operational failure of fund custodians, then fund advisers and, indirectly, fund investors, may benefit from the final rule. Many direct benefits are likely to accrue to banking entity advisers to covered funds that have been relying on third-party service providers as a result of the requirements of the implementing regulations. The final rule includes a standalone provision that permits banking entities to enter into riskless principal transactions with a related covered fund, including in circumstances where the covered fund is not a ‘‘securities affiliate.’’ The 2020 proposal would have permitted a banking entity to enter into a riskless principal transaction with a covered fund provided it met the criteria in Regulation W. The SEC believes that providing a standalone exception will provide clarity and certainty to banking entities about the extent to which they are able to enter into riskless principal transactions with related covered funds. In addition, by permitting more riskless principal transactions than would have been the case under the 2020 proposal (i.e., those that do not or may not meet the criteria of Regulation W), the final rule may facilitate banking entities entering into more of these transactions than they would have, reducing the likelihood that the covered fund would incur additional costs in buying or selling securities.766 As described above, in a riskless principal transaction, the riskless principal (the banking entity) buys and sells the same security contemporaneously, and the asset risk passes promptly from the affiliate (the related covered fund) through the riskless principal to a third party. Accordingly, the SEC does not believe that an increase in riskless principal transactions overall will increase the risks borne by any particular banking entity or banking entities in general. The final rule increases banking entities’ ability to engage in custody, clearing, and other transactions with related covered funds and will benefit banking entities that have been unable 766 As discussed above, the final rule includes a definition of riskless principal transaction that is similar to the definition adopted in Regulation W. To the extent these definitions are sufficiently similar, the SEC expects that compliance costs will be low for banking entities seeking to enter into riskless principal transactions with related covered funds. E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations to engage in otherwise profitable or efficient activities with related covered funds. Moreover, this may enhance operational efficiency and reduce operational risks and costs incurred by covered funds, which have been unable to rely on banking entities with which they have certain relationships for custody, clearing, and other transactions. As discussed above, reducing operational risk as well as the interconnectedness between financial firms that would result from such services being provided by the banking entities and their affiliates, would promote the financial stability of the U.S. financial system.767 In the 2020 proposal, the SEC discussed a prior comment that opposed incorporating the Federal Reserve Act section 23A exemptions or quantitative limits.768 To the extent that the final rule may increase transactions between banking entities and related covered funds, banking entities could incur risks associated with these transactions. However, as discussed above, the final rule imposes a number of conditions aimed at reducing overall risks to banking entities, the ability of banking entities to lever up related covered funds, and the incentive of banking entities to bail out related covered funds, while enhancing their ability to provide ordinary-course banking, custody, and asset management services, and to facilitate capital formation in covered funds. The agencies could have adopted broader or narrower forms of relief. For example, in addition to the relief under the final rule, the agencies could have permitted banking entities to engage in additional covered transactions in connection with payment, clearing, and settlement services beyond extensions of credit and purchases of assets. Further, under the final rule, each extension of credit must be repaid, sold, or terminated by the end of five business days.769 As another alternative, the agencies could have allowed extensions of credit in connection with payment transactions, clearing, or settlement services for periods that are longer than five business days. However, the five business day criteria is consistent with the federal banking agencies’ capital rule and generally requires banking entities to rely on transactions with normal settlement periods, which have lower risk of delayed settlement or failure, when providing short-term extensions of credit.770 In addition, the agencies could have imposed quantitative limits on the newly permitted covered transactions tied to bank capital or fund size. Relative to the final rule, alternatives providing greater relief with respect to covered transactions with covered funds could have magnified the cost savings and operational risk benefits described above, but may also have increased risk to banking entities or the incentives for banking entities to bail out related covered funds. Similarly, narrower alternative forms of relief may have dampened the economic effects of the final rule discussed above. iii. Definition of Ownership Interest As discussed above, the implementing regulations define ‘‘ownership interest’’ in a covered fund to mean any equity, partnership, or ‘‘other similar interest.’’ This definition focuses on the attributes of the interest and whether it provides a banking entity with voting rights or economic exposure to the profits and losses of the covered fund, rather than its form. ‘‘Other similar interest’’ is defined, in part, as an interest that: ‘‘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).’’ 771 As discussed in the 2020 proposal, the SEC has received comment that the implementing regulations’ definition of ownership interest has captured instruments that do not have equity-like features and constrained banking entity investments in debt securitizations and client facilitation services.772 For example, one commenter indicated that analyzing the ownership interest definition in the context of securitizations had resulted in added time and costs of executing transactions, as well as impeded securitization transactions.773 Moreover, the commenter indicated that the ‘‘other similar interest’’ prong of the definition precluded some banking entities from investing in collateralized loan obligation (CLO) senior debt instruments, which affects lending to CLOs, and that banking entities with pre-existing CLO exposures have had to waive credit-enhancing remedies to avoid triggering the ownership interest supra note 435. implementing regulations § ll.10(d)(6)(i)(A). See also supra Section IV.E.1. (Ownership Interest). 772 See 85 FR 12173. 773 See id. 767 See supra Section IV.D. (Limitations on Relationships with a Covered Fund). 768 See 85 FR 12172. 769 See final rule § ll.14(a)(2)(iv)(B). VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 PO 00000 restrictions.774 In addition, the SEC received comment that the ownership interest definition in the implementing regulations may have required an extensive legal analysis and documentation review and that, as a result, some banking entities may have defaulted to treating interests without controlling positions or equity-like features as ownership interests.775 The final rule modifies the definition of ownership interest in several ways. First, the final rule moves the existing exclusion from the definition of ‘‘other similar interest’’ in § ll.10(d)(6)(A) (‘‘for the rights of a creditor to exercise remedies upon the occurrence of an event of default or an acceleration event’’) from the parenthetical to its own provision.776 The final rule also creates a new exclusion, for ‘‘the right to participate in the removal of an investment manager for ’’cause’’ or participate in the selection of a replacement manager upon an investment manager’s resignation or removal.’’ 777 Commenters on the 2020 proposal asserted that creditors’ rights are also provided to debt holders in circumstances other than an event of default or acceleration. These commenters therefore recommended the proposed exclusion be expanded to include additional for cause events that are independent of an event of default or acceleration, such as the insolvency of the investment manager or breach of the investment management or collateral management agreement.778 The final rule reflects those comments and provide clarity about the types of creditor rights that may attach to an interest without that interest being deemed an ownership interest. In particular, under § ll.10(d)(6)(A)(2), the definition of ownership interest does not include rights of an interest that allows a creditor to participate in the removal of an investment manager for ‘‘cause.’’ The final rule defines ‘‘cause’’ for removal to mean one or more of the following events: (1) The bankruptcy, insolvency, conservatorship or receivership of the investment manager; (2) The breach by the investment manager of any material provision of the covered fund’s transaction agreements applicable to the investment manager; (3) The breach by the investment manager of material representations or warranties; 770 See 771 See Frm 00073 Fmt 4701 Sfmt 4700 46493 774 See id. id. 776 See final rule § ll.10(d)(6)(i)(A)(1). 777 See final rule § ll.10(d)(6)(i)(A)(2). 778 See SIFMA. 775 See E:\FR\FM\31JYR4.SGM 31JYR4 46494 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations (4) The occurrence of an act that constitutes fraud or criminal activity in the performance of the investment manager’s obligations under the covered fund’s transaction agreements; (5) The indictment of the investment manager for a criminal offense, or the indictment of any officer, member, partner or other principal of the investment manager for a criminal offense materially related to his or her investment management activities; (6) A change in control with respect to the investment manager; (7) The loss, separation or incapacitation of an individual critical to the operation of the investment manager or primarily responsible for the management of the covered fund’s assets; or (8) Other similar events that constitute ‘‘cause’’ for removal of an investment manager, provided that such events are not solely related to the performance of the covered fund or to the investment manager’s exercise of investment discretion under the covered fund’s transaction agreements. The final rule also modifies the definition of ownership interest to add to the list of interests that are excluded from the definition of ownership interest. Specifically, the final rule provides a safe harbor excluding any senior loan or senior debt interest that has specific characteristics.779 Those characteristics are: (1) Under the terms of the interest, the holders do not have the right to receive a share of the income, gains, or profits of the covered fund, but are entitled to receive only certain interest and fees, and repayment of a fixed principal amount on or before a maturity date in a contractuallydetermined manner (which may include prepayment premiums intended solely to reflect, and compensate holders of the interest for, forgone income resulting from an early prepayment); (2) the entitlement to payments is absolute and cannot be reduced because of the losses arising from the covered fund’s underlying assets; and (3) the holders of the interest are not entitled to receive the underlying assets of the covered fund after all other interests have been redeemed 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).780 The final rule should simplify the analysis banking entities must perform to determine whether they have an ownership interest under section 13 of the BHC Act and the final rule. final rule § ll.10(d)(6)(ii)(B). id. See also, supra Section IV.E.1. (Ownership Interest). 779 See Moreover, to the degree that banking entities may have responded to the ownership interest definition in the implementing regulations by reducing their investments in certain debt instruments, the final rule may result in greater banking entity investments in covered funds and a greater ability of covered funds to allocate capital to the underlying assets. The SEC recognizes that such debt instrument investments carry risk,781 and that the risks and returns of such investments flow through to banking entities’ shareholders. While the final rule’s ownership interest definition may permit banking entities to increase exposures to certain debt instruments, three key considerations may mitigate the risks associated with such activities. First, the final rule does not change any of the applicable prudential capital, margin, or liquidity requirements intended to ensure safety and soundness of banking entities. Second, to the degree that the ownership interest definition has actually discouraged banking entities from obtaining credit enhancements to avoid triggering the ownership interest restrictions, the final rule may result in banking entities receiving credit enhancements that reduce the risk of the debt instrument or loan and are therefore stronger than what banking entities may have received in the absence of the final rule. Finally, the final rule includes a number of conditions and restrictions aimed at reducing the risk to banking entities while facilitating traditional lending activity. The agencies could have adopted broader relief by limiting the particular forms of a banking entity’s interest (e.g., equity or partnership shares) that would qualify as an ownership interest or by limiting the definition of ownership interest to ‘‘voting securities’’ as defined by the Board’s Regulation Y. By providing broader relief relative to the final rule, such an alternative may have produced greater reductions in uncertainty and compliance burdens, and a greater willingness of banking entities to become involved in certain debt transactions. However, such greater involvement in certain debt transactions may also have given rise to greater risks being borne by banking entities. The final rule is intended to provide sufficient safeguards and limitations to prevent banking entities from acquiring interests in covered funds that run counter to the intentions of the implementing regulations and limit a banking entity’s exposure to the economic risks of covered funds and 780 See VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 781 See PO 00000 Occupy. Frm 00074 Fmt 4701 Sfmt 4700 their underlying assets, while reducing compliance uncertainty and increasing the willingness of banking entities to participate in covered funds. iv. Parallel Investments As discussed above, the preamble to the 2013 rule stated that if a banking entity makes investments side by side in substantially the same positions as a covered fund, then the value of such investments would be included for the purposes of determining the value of the banking entity’s investment in the covered fund.782 The agencies also stated that a banking entity that sponsors a covered fund should not make any additional side-by-side coinvestment with the covered fund in a privately negotiated investment unless the value of such co-investment is less than three percent of the value of the total amount co-invested by other investors in such investment.783 As discussed in the 2020 proposal, the SEC has received comment that argued the implementing regulations should not impose a limit on parallel investments and noted that such a restriction is not reflected in the text of the 2013 rule.784 The final rule includes a rule of construction that (1) a banking entity will not be required to include in the calculation of the investment limits under § ll.12(a)(2) any investment the banking entity makes alongside a covered fund, as long as the investment is made in compliance with applicable laws and regulations, and (2) a banking entity shall not be restricted in the amount of any investment the banking entity makes alongside a covered fund as long as the investment is made in compliance with applicable laws and regulations, including applicable safety and soundness standards.785 The SEC recognizes that this rule of construction may increase the incentive for banking entities to make parallel investments alongside a covered fund that is organized and offered by the banking entity for the purposes of artificially maintaining or increasing the value of the fund’s positions. Supporting a fund with a direct investment in such a manner would increase these banking entities’ exposures to the covered fund’s assets and, as discussed above, could be inconsistent with the final rule’s restriction on a banking entity guaranteeing, assuming, or otherwise 782 See supra Section IV.F. (Parallel Investments) and references therein. 783 See id. 784 See 85 FR 12174. 785 See final rule § ll.12(b)(5)(i). E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations insuring the obligations or performance of such covered fund.786 Further, as stated above, the agencies would expect that any investments made alongside a covered fund by a director or employee of a banking entity or its affiliate, if made in compliance with applicable laws and regulations, would not be treated as an investment by the director or employee in the covered fund. Accordingly, such an investment would not be attributed to the banking entity as an investment in the covered fund, regardless of whether the banking entity arranged the transaction on behalf of the director or employee or provided financing for the investment. The SEC recognizes that the rule of construction may remove a restriction on investments made alongside a covered fund that may have interfered with banking entities’ ability to make otherwise permissible investments directly on their balance sheets.787 In particular, the rule of construction may allow banking entities to make parallel investments alongside their covered funds without including the value of those parallel investments within the ownership limits imposed on a banking entity. Similarly, the rule of construction may provide clarity to banking entities such that they will not be prevented from making investments alongside their covered funds, as long as those investments are otherwise permissible under applicable laws and regulations.788 In addition to removing impediments for banking entities’ otherwise permissible investments, the rule of construction in the final rule may enable banking entities to make investments alongside a covered fund that will credibly signal the banking entity’s view of the quality of the investment(s) to investors in the fund, and may also help align the incentives of banking entities, and their directors and employees, with those of the covered funds and their investors. 4. Efficiency, Competition, and Capital Formation As discussed above, the final rule excludes certain groups of private funds and other entities from the scope of the covered fund definition and modifies other covered fund restrictions applicable to banking entities subject to the final rule. Moreover, the final rule reduces compliance obligations of banking entities subject to the final rule. The SEC believes that the final rule may 789 For example, the final rule could result in additional venture capital being available in geographic areas where it has been relatively less available. See supra Section V.F.3.i. (Venture Capital Funds). 786 Id. 787 See 788 See supra note 784. id. VerDate Sep<11>2014 20:59 Jul 30, 2020 impact competition, capital formation, and allocative efficiency. The final rule may have three groups of competitive effects. First, the final rule may make it easier for bank affiliated broker-dealers, SBSDs, and RIAs to compete with bank unaffiliated broker-dealers, SBSDs, and RIAs in their activities with certain groups of private funds and other entities. Second, the final rule may reduce competitive disparities between banking entities subject to the final rule and affected by the final rule, and banking entities that are not. Third, certain aspects of the final rule (such as those related to foreign excluded funds and foreign public funds) may reduce competitive disparities between U.S. banking entities and foreign banking entities in their covered fund activities. Because competition may reduce costs or increase quality, and because some affected banking entities may face economies of scale or scope in the provision of services to certain private funds, these competitive effects may flow through to customers, clients, and investors in the form of reduced transaction costs and greater quality of private fund and other offerings and related financial services. The final rule may also impact capital formation. For example, by reducing the scope of application of covered fund restrictions in the final rule, the final rule relaxes restrictions related to banking entity underwriting and market-making of certain private funds. Moreover, the final rule modifies certain restrictions related to banking entity relationships with certain covered funds. Further, as discussed above, the final rule enables banking entities to engage indirectly (through a fund structure) in certain of the same activities that they are currently able to engage in directly (extending credit or direct ownership stakes). To the degree that the implementing regulations impede or otherwise constrain banking entity activities in such funds, the final rule may result in a greater number of such private funds being launched by banking entities, increasing capital formation via private funds. The effects of the final rule on capital formation are likely to flow through to investors (in the form of greater availability or variety or private funds available for investors) as well as an increase in the supply of capital available to firms seeking to raise capital or obtain financing from private funds.789 Jkt 250001 PO 00000 Frm 00075 Fmt 4701 Sfmt 4700 46495 The possible effects of the final rule on allocative efficiency are related to the final rule’s likely impact on capital formation. Specifically, as discussed above, the SEC believes that the final rule may result in a greater number and variety of private funds launched by banking entities. To the degree that banking entities may be able to provide superior private funds due to their expertise or economies of scale or scope, and to the degree that fund structures may be more efficient than direct investments (due to, e.g., superior risk sharing and pooling of expertise across fund investors), the final rule may enhance the ability of market participants, investors, and issuers to allocate their capital efficiently. The SEC recognizes that the final rule may increase the ability of banking entities to engage in certain types of activities involving risk, and that increases in risk exposures of large groups of banking entities may negatively impact capital formation, securities markets, and the real economy, particularly during times of adverse economic conditions. Moreover, losses on investment portfolios may discourage capital market participation by various groups of investors. Three important considerations may mitigate these potential risks. First, as discussed throughout this economic analysis, banking entities already engage in a variety of permissible activities involving risk, including extensions of credit, underwriting, and marketmaking, and the activities of many types of private funds that are excluded under the final rule largely replicate permissible and traditional activities of banking entities. Second, banking entities subject to the final rule may also be subject to multiple prudential capital, margin, and liquidity requirements that facilitate the safety and soundness of banking entities and promote financial stability. Third, the additional exclusions from the definition of covered fund each include a number of conditions aimed at preventing evasion of section 13 of the BHC Act and the final rule, promoting safety and soundness, and/or allowing for customer oriented financial services provided on arms-length, market terms. Under the final rule, a banking entity is not prohibited from acquiring or retaining an ownership interest in, or acting as sponsor to, a covered fund if the banking entity organizes or offers the covered fund and satisfies other requirements. One such requirement is that the banking entity provide specified disclosures to prospective and actual E:\FR\FM\31JYR4.SGM 31JYR4 46496 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations investors in the covered fund.790 Under the final rule, banking entities must provide the disclosures specified by § ll.11(a)(8) to satisfy the exclusions for family wealth management vehicles and customer facilitation vehicles and to satisfy the exclusions for credit funds and venture capital funds if the banking entity is a sponsor, investment adviser, or commodity trading advisor of the fund. To the extent that the final rule leads banking entities to establish or provide services to more of these vehicles, the volume of information available to market participants could increase. Specifically, if banking entities respond to the final rule by establishing or providing services to more of these vehicles because they are excluded from the definition of ‘‘covered fund,’’ then the amount of such disclosures would increase accordingly. Importantly, the magnitude of all of the above effects on competition, capital formation, and allocative efficiency will be influenced by a large number of factors, such as prevailing macroeconomic conditions, the financial condition of firms seeking to raise capital, and of funds seeking to transact with banking entities, market saturation, and search for higher yields by investors during low interest rate environments. Moreover, the relative efficiency between fund structures and the direct provision of capital is likely to vary widely among banking entities and funds. The SEC recognizes that such economic effects may be dampened or magnified in different phases of the macroeconomic cycle and across various types of banking entities. G. Congressional Review Act For the OCC, Board, FDIC, SEC, and CFTC, the Office of Information and Regulatory Affairs, pursuant to the Congressional Review Act, has designated this rule as a ‘‘major rule’’ as defined by 5 U.S.C. 804(2). List of Subjects companies, Investments, Penalties, Reporting and recordkeeping requirements, Securities, State nonmember banks, State savings associations, Trusts and trustees. 12 CFR Part 351 Banks, Banking, Capital, Compensation, Conflicts of interest, Credit, Derivatives, Government securities, Insurance, Insurance companies, Investments, Penalties, Reporting and recordkeeping requirements, Risk, Risk retention, 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: ■ 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. 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. 12 CFR Part 248 Administrative practice and procedure, Banks, banking, Conflict of interests, Credit, Foreign banking, Government securities, Holding companies, Insurance, Insurance § 44.6 Other permitted proprietary trading activities. 790 Implementing VerDate Sep<11>2014 regulations § ll.11(a)(8). 20:59 Jul 30, 2020 Jkt 250001 Subpart B—Proprietary Trading 2. Amend § 44.6 by adding paragraph (f) to read as follows: ■ * * * * * (f) Permitted trading activities of qualifying foreign excluded funds. The prohibition contained in § 44.3(a) does not apply to the purchase or sale of a financial instrument by a qualifying PO 00000 Frm 00076 Fmt 4701 Sfmt 4700 foreign excluded fund. For purposes of this paragraph (f), a qualifying foreign excluded fund means a banking entity that: (1) Is organized or established outside the United States, and the ownership interests of which are offered and sold solely outside the United States; (2)(i) Would be a covered fund if the entity were organized or established in the United States, or (ii) Is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments; (3) Would not otherwise be a banking entity except by virtue of the acquisition or retention of an ownership interest in, sponsorship of, or relationship with the entity, by another banking entity that meets the following: (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; and (ii) The banking entity’s acquisition or retention of an ownership interest in or sponsorship of the fund meets the requirements for permitted covered fund activities and investments solely outside the United States, as provided in § 44.13(b); (4) Is established and operated as part of a bona fide asset management business; and (5) Is not operated in a manner that enables the banking entity that sponsors or controls the qualifying foreign excluded fund, or any of its affiliates, to evade the requirements of section 13 of the BHC Act or this part. Subpart C—Covered Funds Activities and Investments 3. Amend § 44.10 by: a. Revising paragraph (c)(1); b. Revising paragraph (c)(3)(i); c. Revising paragraph (c)(8); d. Revising the heading of paragraph (c)(10) and revising paragraph (c)(10)(i); ■ e. Revising paragraph (c)(11); ■ f. Adding paragraphs (c)(15), (16), (17), and (18); ■ g. Revising paragraph (d)(6); and ■ h. Adding paragraph (d)(11). The revisions and additions read as follows: ■ ■ ■ ■ ■ § 44.10 Prohibition on acquiring or retaining an ownership interest in and having certain relationships with a covered fund. * * * * * (c) * * * (1) Foreign public funds. (i) Subject to paragraphs (c)(1)(ii) and (iii) of this section, an issuer that: E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations (A) Is organized or established outside of the United States; and (B) Is authorized to offer and sell ownership interests, and such interests are offered and sold, through one or more public offerings. (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 more than 75 percent of the ownership interests in the issuer are sold 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 senior executive officers as defined in § 225.71(c) of the Board’s Regulation Y (12 CFR 225.71(c)) of such entities. (iii) For purposes of paragraph (c)(1)(i)(B) of this section, the term ‘‘public offering’’ means a distribution (as defined in § 44.4(a)(3)) of securities in any jurisdiction outside the United States to investors, including retail investors, provided that: (A) The distribution is subject to substantive disclosure and retail investor protection laws or regulations; (B) With respect to an issuer for which the banking entity serves as the investment manager, investment adviser, commodity trading advisor, commodity pool operator, or sponsor, the distribution complies with all applicable requirements in the jurisdiction in which such distribution is being made; (C) The distribution does not restrict availability to investors having a minimum level of net worth or net investment assets; and (D) The issuer has filed or submitted, with the appropriate regulatory authority in such jurisdiction, offering disclosure documents that are publicly available. * * * * * (3) * * * (i) Is composed of no more than 10 unaffiliated co-venturers; * * * * * (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 composed solely of: (A) Loans as defined in § 44.2(t); (B) Rights or other assets designed to assure the servicing or timely VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 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 that is a security (other than special units of beneficial interest and collateral certificates meeting the requirements of paragraph (c)(8)(v) of this section) 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; (D) Special units of beneficial interest and collateral certificates that meet the requirements of paragraph (c)(8)(v) of this section; and (E) Debt securities, other than assetbacked securities and convertible securities, provided that: (1) The aggregate value of such debt securities does not exceed five percent of the aggregate value of loans held under paragraph (c)(8)(i)(A) of this section, cash and cash equivalents held under paragraph (c)(8)(iii)(A) of this section, and debt securities held under this paragraph (c)(8)(i)(E); and (2) The aggregate value of the loans, cash and cash equivalents, and debt securities for purposes of this paragraph is calculated at par value at the most recent time any such debt security is acquired, except that the issuing entity may instead determine the value of any such loan, cash equivalent, or debt security based on its fair market value if: (i) The issuing entity is required to use the fair market value of such assets for purposes of calculating compliance with concentration limitations or other similar calculations under its transaction agreements, and (ii) The issuing entity’s valuation methodology values similarly situated assets consistently. (ii) Impermissible assets. For purposes of this paragraph (c)(8), except as permitted under paragraph (c)(8)(i)(E) 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 paragraphs (c)(8)(iii), (iv), or (v) 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, other than debt securities permitted under paragraph PO 00000 Frm 00077 Fmt 4701 Sfmt 4700 46497 (c)(8)(i)(E) of this section, if those securities are: (A) Cash equivalents—which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the securitization’s expected or potential need for funds and whose currency corresponds to either the underlying loans or the asset-backed securities—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 derivatives directly relate to the loans, the asset-backed securities, the contractual rights or other assets described in paragraph (c)(8)(i)(B) of this section, or the debt securities described in paragraph (c)(8)(i)(E) of this section; and (B) The derivatives reduce the interest rate and/or foreign exchange risks related to the loans, the asset-backed securities, the contractual rights or other assets described in paragraph (c)(8)(i)(B) of this section, or the debt securities described in paragraph (c)(8)(i)(E) 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 E:\FR\FM\31JYR4.SGM 31JYR4 46498 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations issuing entity are established under the direction of the same entity that initiated the loan securitization. * * * * * (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 composed solely of assets that meet the conditions in paragraph (c)(8)(i) of this section. * * * * * (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 that has voluntarily surrendered its license to operate as a small business investment company in accordance with 13 CFR 107.1900 and does not make any new investments (other than investments in cash equivalents, which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to the issuer’s assets) after such voluntary surrender; (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) and including investments that qualify for consideration under the regulations implementing the Community Reinvestment Act (12 U.S.C. 2901 et seq.); 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; (iii) That has elected to be regulated or is regulated as a rural business investment company, as described in 15 U.S.C. 80b–3(b)(8)(A) or (B), or that has terminated its participation as a rural business investment company in accordance with 7 CFR 4290.1900 and does not make any new investments VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 (other than investments in cash equivalents, which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to the issuer’s assets) after such termination; or (iv) That is a qualified opportunity fund, as defined in 26 U.S.C. 1400Z– 2(d). * * * * * (15) Credit funds. Subject to paragraphs (c)(15)(iii), (iv), and (v) of this section, an issuer that satisfies the asset and activity requirements of paragraphs (c)(15)(i) and (ii) of this section. (i) Asset requirements. The issuer’s assets must be composed solely of: (A) Loans as defined in § 44.2(t); (B) Debt instruments, subject to paragraph (c)(15)(iv) of this section; (C) Rights and other assets that are related or incidental to acquiring, holding, servicing, or selling such loans or debt instruments, provided that: (1) Each right or asset held under this paragraph (c)(15)(i)(C) that is a security is either: (i) A cash equivalent (which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to either the underlying loans or the debt instruments); (ii) A security received in lieu of debts previously contracted with respect to such loans or debt instruments; or (iii) An equity security (or right to acquire an equity security) received on customary terms in connection with such loans or debt instruments; and (2) Rights or other assets held under this paragraph (c)(15)(i)(C) of this section may not include commodity forward contracts or any derivative; and (D) Interest rate or foreign exchange derivatives, if: (1) The written terms of the derivative directly relate to the loans, debt instruments, or other rights or assets described in paragraph (c)(15)(i)(C) of this section; and (2) The derivative reduces the interest rate and/or foreign exchange risks related to the loans, debt instruments, or other rights or assets described in paragraph (c)(15)(i)(C) of this section. (ii) Activity requirements. To be eligible for the exclusion of paragraph (c)(15) of this section, an issuer must: (A) Not engage in any activity that would constitute proprietary trading under § 44.3(b)(l)(i), as if the issuer were a banking entity; and PO 00000 Frm 00078 Fmt 4701 Sfmt 4700 (B) Not issue asset-backed securities. (iii) Requirements for a sponsor, investment adviser, or commodity trading advisor. A banking entity that acts as a sponsor, investment adviser, or commodity trading advisor to an issuer that meets the conditions in paragraphs (c)(15)(i) and (ii) of this section may not rely on this exclusion unless the banking entity: (A) Provides in writing to any prospective and actual investor in the issuer the disclosures required under § 44.11(a)(8) of this subpart, as if the issuer were a covered fund; (B) Ensures that the activities of the issuer are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly; and (C) Complies with the limitations imposed in § 44.14, as if the issuer were a covered fund, except the banking entity may acquire and retain any ownership interest in the issuer. (iv) Additional Banking Entity Requirements. A banking entity may not rely on this exclusion with respect to an issuer that meets the conditions in paragraphs (c)(15)(i) and (ii) of this section unless: (A) The banking entity does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the issuer or of any entity to which such issuer extends credit or in which such issuer invests; and (B) Any assets the issuer holds pursuant to paragraphs (c)(15)(i)(B) or (i)(C)(1)(iii) of this section would be permissible for the banking entity to acquire and hold directly under applicable federal banking laws and regulations. (v) Investment and Relationship Limits. A banking entity’s investment in, and relationship with, the issuer must: (A) Comply with the limitations imposed in § 44.15, as if the issuer were a covered fund; and (B) Be conducted in compliance with, and subject to, applicable banking laws and regulations, including applicable safety and soundness standards. (16) Qualifying venture capital funds. (i) Subject to paragraphs (c)(16)(ii) through (iv) of this section, an issuer that: (A) Is a venture capital fund as defined in 17 CFR 275.203(l)–1; and (B) Does not engage in any activity that would constitute proprietary trading under § 44.3(b)(1)(i), as if the issuer were a banking entity. (ii) A banking entity that acts as a sponsor, investment adviser, or commodity trading advisor to an issuer E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations that meets the conditions in paragraph (c)(16)(i) of this section may not rely on this exclusion unless the banking entity: (A) Provides in writing to any prospective and actual investor in the issuer the disclosures required under § 44.11(a)(8), as if the issuer were a covered fund; (B) Ensures that the activities of the issuer are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly; and (C) Complies with the restrictions in § 44.14 as if the issuer were a covered fund (except the banking entity may acquire and retain any ownership interest in the issuer). (iii) The banking entity must not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the issuer. (iv) A banking entity’s ownership interest in or relationship with the issuer must: (A) Comply with the limitations imposed in § 44.15, as if the issuer were a covered fund; and (B) Be conducted in compliance with, and subject to, applicable banking laws and regulations, including applicable safety and soundness standards. (17) Family wealth management vehicles. (i) Subject to paragraph (c)(17)(ii) of this section, any entity that 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, and: (A) If the entity is a trust, the grantor(s) of the entity are all family customers; and (B) If the entity is not a trust: (1) A majority of the voting interests in the entity are owned (directly or indirectly) by family customers; (2) A majority of the interests in the entity are owned (directly or indirectly) by family customers; (3) The entity is owned only by family customers and up to 5 closely related persons of the family customers; and (C) Notwithstanding paragraph (c)(17)(i)(A) and (B) of this section, up to an aggregate 0.5 percent of the entity’s outstanding ownership interests may be acquired or retained by one or more entities that are not family customers or closely related persons if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 (ii) A banking entity may rely on the exclusion in paragraph (c)(17)(i) of this section with respect to an entity provided that the banking entity (or an affiliate): (A) Provides bona fide trust, fiduciary, investment advisory, or commodity trading advisory services to the entity; (B) Does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such entity; (C) Complies with the disclosure obligations under § 44.11(a)(8), as if such entity were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the entity; (D) Does not acquire or retain, as principal, an ownership interest in the entity, other than as described in paragraph (c)(17)(i)(C) of this section; (E) Complies with the requirements of §§ 44.14(b) and 44.15, as if such entity were a covered fund; and (F) Except for riskless principal transactions as defined in paragraph (d)(11) of this section, complies with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the entity were an affiliate thereof. (iii) For purposes of paragraph (c)(17) of this section, the following definitions apply: (A) Closely related person means a natural person (including the estate and estate planning vehicles of such person) who has longstanding business or personal relationships with any family customer. (B) Family customer means: (1) A family client, as defined in Rule 202(a)(11)(G)–1(d)(4) of the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)–1(d)(4)); or (2) Any natural person who is a father-in-law, mother-in-law, brother-inlaw, sister-in-law, son-in-law or daughter-in-law of a family client, or a spouse or a spousal equivalent of any of the foregoing. (18) Customer facilitation vehicles. (i) Subject to paragraph (c)(18)(ii) of this section, an issuer that is formed by or at the request of a customer of the banking entity for the purpose of providing such customer (which may include one or more affiliates of such customer) with exposure to a transaction, investment strategy, or other service provided by the banking entity. (ii) A banking entity may rely on the exclusion in paragraph (c)(18)(i) of this PO 00000 Frm 00079 Fmt 4701 Sfmt 4700 46499 section with respect to an issuer provided that: (A) All of the ownership interests of the issuer are owned by the customer (which may include one or more of its affiliates) for whom the issuer was created; (B) Notwithstanding paragraph (c)(18)(ii)(A) of this section, up to an aggregate 0.5 percent of the issuer’s outstanding ownership interests may be acquired or retained by one or more entities that are not customers if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns; and (C) The banking entity and its affiliates: (1) Maintain documentation outlining how the banking entity intends to facilitate the customer’s exposure to such transaction, investment strategy, or service; (2) Do not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such issuer; (3) Comply with the disclosure obligations under § 44.11(a)(8), as if such issuer were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the issuer; (4) Do not acquire or retain, as principal, an ownership interest in the issuer, other than as described in paragraph (c)(18)(ii)(B) of this section; (5) Comply with the requirements of §§ 44.14(b) and 44.15, as if such issuer were a covered fund; and (6) Except for riskless principal transactions as defined in paragraph (d)(11) of this section, comply with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the issuer were an affiliate thereof. * * * * * (d) * * * (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: (1) The rights of a creditor to exercise remedies upon the occurrence of an E:\FR\FM\31JYR4.SGM 31JYR4 46500 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations event of default or an acceleration event; and (2) The right to participate in the removal of an investment manager for ‘‘cause’’ or participate in the selection of a replacement manager upon an investment manager’s resignation or removal. For purposes of this paragraph (d)(6)(i)(A)(2), ‘‘cause’’ for removal of an investment manager means one or more of the following events: (i) The bankruptcy, insolvency, conservatorship or receivership of the investment manager; (ii) The breach by the investment manager of any material provision of the covered fund’s transaction agreements applicable to the investment manager; (iii) The breach by the investment manager of material representations or warranties; (iv) The occurrence of an act that constitutes fraud or criminal activity in the performance of the investment manager’s obligations under the covered fund’s transaction agreements; (v) The indictment of the investment manager for a criminal offense, or the indictment of any officer, member, partner or other principal of the investment manager for a criminal offense materially related to his or her investment management activities; (vi) A change in control with respect to the investment manager; (vii) The loss, separation or incapacitation of an individual critical to the operation of the investment manager or primarily responsible for the management of the covered fund’s assets; or (viii) Other similar events that constitute ‘‘cause’’ for removal of an investment manager, provided that such events are not solely related to the performance of the covered fund or the investment manager’s exercise of investment discretion under the covered fund’s transaction agreements; (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); VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 (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: (A) 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: (1) 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; (2) 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; (3) Any amounts invested in the covered fund, including any amounts paid by the entity in connection with obtaining the restricted profit interest, are within the limits of § 44.12 of this subpart; and (4) 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 PO 00000 Frm 00080 Fmt 4701 Sfmt 4700 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. (B) Any senior loan or senior debt interest that has the following characteristics: (1) Under the terms of the interest the holders of such interest do not have the right to receive a share of the income, gains, or profits of the covered fund, but are entitled to receive only: (i) Interest at a stated interest rate, as well as commitment fees or other fees, which are not determined by reference to the performance of the underlying assets of the covered fund; and (ii) Repayment of a fixed principal amount, on or before a maturity date, in a contractually-determined manner (which may include prepayment premiums intended solely to reflect, and compensate holders of the interest for, forgone income resulting from an early prepayment); (2) The entitlement to payments under the terms of the interest are absolute and could not be reduced based on losses arising from the underlying assets of the covered fund, such as allocation of losses, writedowns or charge-offs of the outstanding principal balance, or reductions in the amount of interest due and payable on the interest; and (3) The holders of the interest are not entitled to receive the underlying assets of the covered fund after all other interests have been redeemed 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). * * * * * (11) Riskless principal transaction. Riskless principal transaction means a transaction in which a banking entity, after receiving an order from a customer to buy (or sell) a security, purchases (or sells) the security in the secondary market for its own account to offset a contemporaneous sale to (or purchase from) the customer. ■ 4. Amend § 44.12 by: ■ a. Revising paragraph (b)(1)(ii); ■ b. Revising paragraph (b)(4); ■ c. Adding paragraph (b)(5); ■ d. Revising paragraph (c)(1); and ■ e. Revising paragraphs (d) and (e). The revisions and addition read as follows: E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations § 44.12 fund. Permitted investment in a covered * * * * * (b) * * * (1) * * * (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) will not be considered to be an affiliate of the banking entity so long as: (A) The banking entity, together with its affiliates, 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) The banking entity, or an affiliate of the banking entity, 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. * * * * * (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 in 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 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 in 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. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 (5) Parallel Investments and CoInvestments. (i) A banking entity shall not be required to include in the calculation of the investment limits under paragraph (a)(2) of this section any investment the banking entity makes alongside a covered fund as long as the investment is made in compliance with applicable laws and regulations, including applicable safety and soundness standards. (ii) A banking entity shall not be restricted under this section in the amount of any investment the banking entity makes alongside a covered fund as long as the investment is made in compliance with applicable laws and regulations, including applicable safety and soundness standards. (c) * * * (1)(i) 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 in connection with obtaining a restricted profit interest under § 44.10(d)(6)(ii)), on a historical cost basis; (ii) Treatment of employee and director restricted profit interests financed by the banking entity. For purposes of paragraph (c)(1)(i) of this section, an investment by a director or employee of a banking entity who acquires a restricted profit 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 restricted profit interest in the fund and the financing is used to acquire such ownership interest in the covered fund. * * * * * (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)(i) 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 in connection with obtaining a restricted profit interest under § 44.10(d)(6)(ii) of subpart C of this part), on a historical cost basis, plus any earnings received; and PO 00000 Frm 00081 Fmt 4701 Sfmt 4700 46501 (ii) 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 in connection with obtaining a restricted profit interest under § 44.10(d)(6)(ii) of subpart C of this part), if the banking entity accounts for the profits (or losses) of the fund investment in its financial statements. (2) Treatment of employee and director restricted profit interests financed by the banking entity. For purposes of paragraph (d)(1) of this section, an investment by a director or employee of a banking entity who acquires a restricted profit 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 restricted profit interest in the fund and the financing is used to acquire such ownership interest in the covered fund. (e) Extension of time to divest an ownership interest. (1) Extension period. 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. (2) Application requirements. 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)(3) 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. (3) 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 E:\FR\FM\31JYR4.SGM 31JYR4 46502 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations 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. (4) 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. (5) 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. ■ 5. Amend § 44.13 by adding paragraph (d) to read as follows: § 44.13 Other permitted covered fund activities and investments. * * * * * (d) Permitted covered fund activities and investments of qualifying foreign excluded funds. (1) The prohibition contained in § 44.10(a) does not apply to a qualifying foreign excluded fund. (2) For purposes of this paragraph (d), a qualifying foreign excluded fund means a banking entity that: (i) Is organized or established outside the United States, and the ownership VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 interests of which are offered and sold solely outside the United States; (ii)(A) Would be a covered fund if the entity were organized or established in the United States, or (B) Is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments; (iii) Would not otherwise be a banking entity except by virtue of the acquisition or retention of an ownership interest in, sponsorship of, or relationship with the entity, by another banking entity that meets the following: (A) 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; and (B) The banking entity’s acquisition of an ownership interest in or sponsorship of the fund by the foreign banking entity meets the requirements for permitted covered fund activities and investments solely outside the United States, as provided in § 44.13(b); (iv) Is established and operated as part of a bona fide asset management business; and (v) Is not operated in a manner that enables the banking entity that sponsors or controls the qualifying foreign excluded fund, or any of its affiliates, to evade the requirements of section 13 of the BHC Act or this part. ■ 6. Amend § 44.14 by: ■ a. Revising paragraph (a)(2)(i); ■ b. Revising paragraph (a)(2)(ii)(C); ■ c. Adding paragraphs (a)(2)(iii), (iv), (v), and (3); and ■ d. Revising paragraph (c). The revisions and additions read as follows: § 44.14 Limitations on relationships with a covered fund. (a) * * * (2) * * * (i) Acquire and retain any ownership interest in a covered fund in accordance with the requirements of §§ 44.11, 44.12, or 44.13; (ii) * * * (C) The Board has not determined that such transaction is inconsistent with the safe and sound operation and condition of the banking entity; and (iii) Enter into a transaction with a covered fund that would be an exempt covered transaction under 12 U.S.C. 371c(d) or § 223.42 of the Board’s Regulation W (12 CFR 223.42) subject to the limitations specified under 12 U.S.C. 371c(d) or § 223.42 of the Board’s Regulation W (12 CFR 223.42), as applicable, PO 00000 Frm 00082 Fmt 4701 Sfmt 4700 (iv) Enter into a riskless principal transaction with a covered fund; and (v) Extend credit to or purchase assets from a covered fund, provided: (A) Each extension of credit or purchase of assets is in the ordinary course of business in connection with payment transactions; settlement services; or futures, derivatives, and securities clearing; (B) Each extension of credit is repaid, sold, or terminated by the end of five business days; and (C) The banking entity making each extension of credit meets the requirements of § 223.42(l)(1)(i) and (ii) of the Board’s Regulation W (12 CFR 223.42(l)(1)(i) and(ii)), as if the extension of credit was an intraday extension of credit, regardless of the duration of the extension of credit. (3) Any transaction or activity permitted under paragraphs (a)(2)(iii), (iv) or (v) of this section must comply with the limitations in § 44.15. * * * * * (c) Restrictions on other permitted transactions. Any transaction permitted under paragraphs (a)(2)(ii), (iii), or (iv) 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 under section 23B. Subpart D—Compliance Program Requirements; Violations 7. Amend § 44.20 by: a. Revising paragraph (a); b. Revising the heading of paragraph (d) and revising paragraph (d)(1); and ■ c. Revising the introductory text of paragraph (e). The revisions and addition read as follows: ■ ■ ■ § 44.20 Program for compliance; reporting. (a) Program requirement. Each banking entity (other than a banking entity with limited trading assets and liabilities or a qualifying foreign excluded fund under section 44.6(f) or 44.13(d)) 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. * * * * * (d) Reporting requirements under appendix A to this part. (1) A banking E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations entity (other than a qualifying foreign excluded fund under section 44.6(f) or 44.13(d)) engaged in proprietary trading activity permitted under subpart B shall comply with the reporting requirements described in appendix A to this part, if: * * * * * (e) Additional documentation for covered funds. A banking entity with significant trading assets and liabilities (other than a qualifying foreign excluded fund under section 44.6(f) or 44.13(d)) shall maintain records that include: * * * * * 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 II of title 12, Code of Federal Regulations as follows: PART 248—PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND RELATIONSHIPS WITH COVERED FUNDS (Regulation VV) 8. 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 B—Proprietary Trading 9. Amend § 248.6 by adding paragraph (f) to read as follows: ■ § 248.6 Other permitted proprietary trading activities. * * * * * (f) Permitted trading activities of qualifying foreign excluded funds. The prohibition contained in § 248.3(a) does not apply to the purchase or sale of a financial instrument by a qualifying foreign excluded fund. For purposes of this paragraph (f), a qualifying foreign excluded fund means a banking entity that: (1) Is organized or established outside the United States, and the ownership interests of which are offered and sold solely outside the United States; (2)(i) Would be a covered fund if the entity were organized or established in the United States, or (ii) Is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments; (3) Would not otherwise be a banking entity except by virtue of the acquisition or retention of an ownership interest in, VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 sponsorship of, or relationship with the entity, by another banking entity that meets the following: (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; and (ii) The banking entity’s acquisition or retention of an ownership interest in or sponsorship of the fund meets the requirements for permitted covered fund activities and investments solely outside the United States, as provided in § 248.13(b); (4) Is established and operated as part of a bona fide asset management business; and (5) Is not operated in a manner that enables the banking entity that sponsors or controls the qualifying foreign excluded fund, or any of its affiliates, to evade the requirements of section 13 of the BHC Act or this part. Subpart C—Covered Funds Activities and Investments 10. Amend § 248.10 by: a. Revising paragraph (c)(1); b. Revising paragraph (c)(3)(i); c. Revising paragraph (c)(8); d. Revising the heading of paragraph (c)(10) and revising paragraph (c)(10)(i); ■ e. Revising paragraph (c)(11); ■ f. Adding paragraphs (c)(15), (16), (17), and (18); ■ g. Revising paragraph (d)(6); and ■ h. Adding paragraph (d)(11). The revisions and additions read as follows: ■ ■ ■ ■ ■ § 248.10 Prohibition on acquiring or retaining an ownership interest in and having certain relationships with a covered fund. * * * * * (c) * * * (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; and (B) Is authorized to offer and sell ownership interests, and such interests are offered and sold, through one or more public offerings. (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 more than 75 percent of the ownership interests in the issuer are sold to persons other than: PO 00000 Frm 00083 Fmt 4701 Sfmt 4700 46503 (A) Such sponsoring banking entity; (B) Such issuer; (C) Affiliates of such sponsoring banking entity or such issuer; and (D) Directors and senior executive officers as defined in § 225.71(c) of the Board’s Regulation Y (12 CFR 225.71(c)) of such entities. (iii) For purposes of paragraph (c)(1)(i)(B) of this section, the term ‘‘public offering’’ means a distribution (as defined in § 248.4(a)(3)) of securities in any jurisdiction outside the United States to investors, including retail investors, provided that: (A) The distribution is subject to substantive disclosure and retail investor protection laws or regulations; (B) With respect to an issuer for which the banking entity serves as the investment manager, investment adviser, commodity trading advisor, commodity pool operator, or sponsor, the distribution complies with all applicable requirements in the jurisdiction in which such distribution is being made; (C) The distribution does not restrict availability to investors having a minimum level of net worth or net investment assets; and (D) The issuer has filed or submitted, with the appropriate regulatory authority in such jurisdiction, offering disclosure documents that are publicly available. * * * * * (3) * * * (i) Is composed of no more than 10 unaffiliated co-venturers; * * * * * (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 composed solely of: (A) Loans as defined in § 248.2(t); (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 that is a security (other than special units of beneficial interest and collateral certificates meeting the requirements of paragraph (c)(8)(v) of this section) 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; (D) Special units of beneficial interest and collateral certificates that meet the requirements of paragraph (c)(8)(v) of this section; and E:\FR\FM\31JYR4.SGM 31JYR4 46504 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations (E) Debt securities, other than assetbacked securities and convertible securities, provided that: (1) The aggregate value of such debt securities does not exceed five percent of the aggregate value of loans held under paragraph (c)(8)(i)(A) of this section, cash and cash equivalents held under paragraph (c)(8)(iii)(A) of this section, and debt securities held under this paragraph (c)(8)(i)(E); and (2) The aggregate value of the loans, cash and cash equivalents, and debt securities for purposes of this paragraph is calculated at par value at the most recent time any such debt security is acquired, except that the issuing entity may instead determine the value of any such loan, cash equivalent, or debt security based on its fair market value if: (i) The issuing entity is required to use the fair market value of such assets for purposes of calculating compliance with concentration limitations or other similar calculations under its transaction agreements, and (ii) The issuing entity’s valuation methodology values similarly situated assets consistently. (ii) Impermissible assets. For purposes of this paragraph (c)(8), except as permitted under paragraph (c)(8)(i)(E) 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 paragraphs (c)(8)(iii), (iv), or (v) 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, other than debt securities permitted under paragraph (c)(8)(i)(E) of this section, if those securities are: (A) Cash equivalents—which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the securitization’s expected or potential need for funds and whose currency corresponds to either the underlying loans or the asset-backed securities—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 VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 exchange derivatives that satisfy all of the following conditions: (A) The written terms of the derivatives directly relate to the loans, the asset-backed securities, the contractual rights or other assets described in paragraph (c)(8)(i)(B) of this section, or the debt securities described in paragraph (c)(8)(i)(E) of this section; and (B) The derivatives reduce the interest rate and/or foreign exchange risks related to the loans, the asset-backed securities, the contractual rights or other assets described in paragraph (c)(8)(i)(B) of this section, or the debt securities described in paragraph (c)(8)(i)(E) 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. * * * * * (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 composed solely of assets that meet the conditions in paragraph (c)(8)(i) of this section. * * * * * (11) SBICs and public welfare investment funds. An issuer: (i) That is a small business investment company, as defined in section 103(3) of PO 00000 Frm 00084 Fmt 4701 Sfmt 4700 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 that has voluntarily surrendered its license to operate as a small business investment company in accordance with 13 CFR 107.1900 and does not make any new investments (other than investments in cash equivalents, which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to the issuer’s assets) after such voluntary surrender; (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) and including investments that qualify for consideration under the regulations implementing the Community Reinvestment Act (12 U.S.C. 2901 et seq.); 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; (iii) That has elected to be regulated or is regulated as a rural business investment company, as described in 15 U.S.C. 80b-3(b)(8)(A) or (B), or that has terminated its participation as a rural business investment company in accordance with 7 CFR 4290.1900 and does not make any new investments (other than investments in cash equivalents, which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to the issuer’s assets) after such termination; or (iv) That is a qualified opportunity fund, as defined in 26 U.S.C. 1400Z– 2(d). * * * * * (15) Credit funds. Subject to paragraphs (c)(15)(iii), (iv), and (v) of this section, an issuer that satisfies the asset and activity requirements of paragraphs (c)(15)(i) and (ii) of this section. E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations (i) Asset requirements. The issuer’s assets must be composed solely of: (A) Loans as defined in § 248.2(t); (B) Debt instruments, subject to paragraph (c)(15)(iv) of this section; (C) Rights and other assets that are related or incidental to acquiring, holding, servicing, or selling such loans or debt instruments, provided that: (1) Each right or asset held under this paragraph (c)(15)(i)(C) that is a security is either: (i) A cash equivalent (which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to either the underlying loans or the debt instruments); (ii) A security received in lieu of debts previously contracted with respect to such loans or debt instruments; or (iii) An equity security (or right to acquire an equity security) received on customary terms in connection with such loans or debt instruments; and (2) Rights or other assets held under this paragraph (c)(15)(i)(C) of this section may not include commodity forward contracts or any derivative; and (D) Interest rate or foreign exchange derivatives, if: (1) The written terms of the derivative directly relate to the loans, debt instruments, or other rights or assets described in paragraph (c)(15)(i)(C) of this section; and (2) The derivative reduces the interest rate and/or foreign exchange risks related to the loans, debt instruments, or other rights or assets described in paragraph (c)(15)(i)(C) of this section. (ii) Activity requirements. To be eligible for the exclusion of paragraph (c)(15) of this section, an issuer must: (A) Not engage in any activity that would constitute proprietary trading under § 248.3(b)(l)(i), as if the issuer were a banking entity; and (B) Not issue asset-backed securities. (iii) Requirements for a sponsor, investment adviser, or commodity trading advisor. A banking entity that acts as a sponsor, investment adviser, or commodity trading advisor to an issuer that meets the conditions in paragraphs (c)(15)(i) and (ii) of this section may not rely on this exclusion unless the banking entity: (A) Provides in writing to any prospective and actual investor in the issuer the disclosures required under § 248.11(a)(8) of this subpart, as if the issuer were a covered fund; (B) Ensures that the activities of the issuer are consistent with safety and soundness standards that are substantially similar to those that would VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 apply if the banking entity engaged in the activities directly; and (C) Complies with the limitations imposed in § 248.14, as if the issuer were a covered fund, except the banking entity may acquire and retain any ownership interest in the issuer. (iv) Additional Banking Entity Requirements. A banking entity may not rely on this exclusion with respect to an issuer that meets the conditions in paragraphs (c)(15)(i) and (ii) of this section unless: (A) The banking entity does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the issuer or of any entity to which such issuer extends credit or in which such issuer invests; and (B) Any assets the issuer holds pursuant to paragraphs (c)(15)(i)(B) or (i)(C)(1)(iii) of this section would be permissible for the banking entity to acquire and hold directly under applicable federal banking laws and regulations. (v) Investment and Relationship Limits. A banking entity’s investment in, and relationship with, the issuer must: (A) Comply with the limitations imposed in § 248.15, as if the issuer were a covered fund; and (B) Be conducted in compliance with, and subject to, applicable banking laws and regulations, including applicable safety and soundness standards. (16) Qualifying venture capital funds. (i) Subject to paragraphs (c)(16)(ii) through (iv) of this section, an issuer that: (A) Is a venture capital fund as defined in 17 CFR 275.203(l)–1; and (B) Does not engage in any activity that would constitute proprietary trading under § 248.3(b)(1)(i), as if the issuer were a banking entity. (ii) A banking entity that acts as a sponsor, investment adviser, or commodity trading advisor to an issuer that meets the conditions in paragraph (c)(16)(i) of this section may not rely on this exclusion unless the banking entity: (A) Provides in writing to any prospective and actual investor in the issuer the disclosures required under § 248.11(a)(8), as if the issuer were a covered fund; (B) Ensures that the activities of the issuer are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly; and (C) Complies with the restrictions in § 248.14 as if the issuer were a covered fund (except the banking entity may acquire and retain any ownership interest in the issuer). PO 00000 Frm 00085 Fmt 4701 Sfmt 4700 46505 (iii) The banking entity must not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the issuer. (iv) A banking entity’s ownership interest in or relationship with the issuer must: (A) Comply with the limitations imposed in § 248.15, as if the issuer were a covered fund; and (B) Be conducted in compliance with, and subject to, applicable banking laws and regulations, including applicable safety and soundness standards. (17) Family wealth management vehicles. (i) Subject to paragraph (c)(17)(ii) of this section, any entity that 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, and: (A) If the entity is a trust, the grantor(s) of the entity are all family customers; and (B) If the entity is not a trust: (1) A majority of the voting interests in the entity are owned (directly or indirectly) by family customers; (2) A majority of the interests in the entity are owned (directly or indirectly) by family customers; (3) The entity is owned only by family customers and up to 5 closely related persons of the family customers; and (C) Notwithstanding paragraph (c)(17)(i)(A) and (B) of this section, up to an aggregate 0.5 percent of the entity’s outstanding ownership interests may be acquired or retained by one or more entities that are not family customers or closely related persons if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns. (ii) A banking entity may rely on the exclusion in paragraph (c)(17)(i) of this section with respect to an entity provided that the banking entity (or an affiliate): (A) Provides bona fide trust, fiduciary, investment advisory, or commodity trading advisory services to the entity; (B) Does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such entity; (C) Complies with the disclosure obligations under § 248.11(a)(8), as if such entity were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to E:\FR\FM\31JYR4.SGM 31JYR4 46506 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations accommodate the specific circumstances of the entity; (D) Does not acquire or retain, as principal, an ownership interest in the entity, other than as described in paragraph (c)(17)(i)(C) of this section; (E) Complies with the requirements of §§ 248.14(b) and 248.15, as if such entity were a covered fund; and (F) Except for riskless principal transactions as defined in paragraph (d)(11) of this section, complies with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the entity were an affiliate thereof. (iii) For purposes of paragraph (c)(17) of this section, the following definitions apply: (A) Closely related person means a natural person (including the estate and estate planning vehicles of such person) who has longstanding business or personal relationships with any family customer. (B) Family customer means: (1) A family client, as defined in Rule 202(a)(11)(G)–1(d)(4) of the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)–1(d)(4)); or (2) Any natural person who is a father-in-law, mother-in-law, brother-inlaw, sister-in-law, son-in-law or daughter-in-law of a family client, or a spouse or a spousal equivalent of any of the foregoing. (18) Customer facilitation vehicles. (i) Subject to paragraph (c)(18)(ii) of this section, an issuer that is formed by or at the request of a customer of the banking entity for the purpose of providing such customer (which may include one or more affiliates of such customer) with exposure to a transaction, investment strategy, or other service provided by the banking entity. (ii) A banking entity may rely on the exclusion in paragraph (c)(18)(i) of this section with respect to an issuer provided that: (A) All of the ownership interests of the issuer are owned by the customer (which may include one or more of its affiliates) for whom the issuer was created; (B) Notwithstanding paragraph (c)(18)(ii)(A) of this section, up to an aggregate 0.5 percent of the issuer’s outstanding ownership interests may be acquired or retained by one or more entities that are not customers if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns; and VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 (C) The banking entity and its affiliates: (1) Maintain documentation outlining how the banking entity intends to facilitate the customer’s exposure to such transaction, investment strategy, or service; (2) Do not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such issuer; (3) Comply with the disclosure obligations under § 248.11(a)(8), as if such issuer were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the issuer; (4) Do not acquire or retain, as principal, an ownership interest in the issuer, other than as described in paragraph (c)(18)(ii)(B) of this section; (5) Comply with the requirements of §§ 248.14(b) and 248.15, as if such issuer were a covered fund; and (6) Except for riskless principal transactions as defined in paragraph (d)(11) of this section, comply with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the issuer were an affiliate thereof. * * * * * (d) * * * (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: (1) The rights of a creditor to exercise remedies upon the occurrence of an event of default or an acceleration event; and (2) The right to participate in the removal of an investment manager for ‘‘cause’’ or participate in the selection of a replacement manager upon an investment manager’s resignation or removal. For purposes of this paragraph (d)(6)(i)(A)(2), ‘‘cause’’ for removal of an investment manager means one or more of the following events: (i) The bankruptcy, insolvency, conservatorship or receivership of the investment manager; (ii) The breach by the investment manager of any material provision of the covered fund’s transaction agreements applicable to the investment manager; PO 00000 Frm 00086 Fmt 4701 Sfmt 4700 (iii) The breach by the investment manager of material representations or warranties; (iv) The occurrence of an act that constitutes fraud or criminal activity in the performance of the investment manager’s obligations under the covered fund’s transaction agreements; (v) The indictment of the investment manager for a criminal offense, or the indictment of any officer, member, partner or other principal of the investment manager for a criminal offense materially related to his or her investment management activities; (vi) A change in control with respect to the investment manager; (vii) The loss, separation or incapacitation of an individual critical to the operation of the investment manager or primarily responsible for the management of the covered fund’s assets; or (viii) Other similar events that constitute ‘‘cause’’ for removal of an investment manager, provided that such events are not solely related to the performance of the covered fund or the investment manager’s exercise of investment discretion under the covered fund’s transaction agreements; (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 E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations in paragraphs (d)(6)(i)(A) through (F) of this section. (ii) Ownership interest does not include: (A) 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: (1) 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; (2) 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; (3) Any amounts invested in the covered fund, including any amounts paid by the entity in connection with obtaining the restricted profit interest, are within the limits of § 248.12 of this subpart; and (4) 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. (B) Any senior loan or senior debt interest that has the following characteristics: (1) Under the terms of the interest the holders of such interest do not have the right to receive a share of the income, gains, or profits of the covered fund, but are entitled to receive only: VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 (i) Interest at a stated interest rate, as well as commitment fees or other fees, which are not determined by reference to the performance of the underlying assets of the covered fund; and (ii) Repayment of a fixed principal amount, on or before a maturity date, in a contractually-determined manner (which may include prepayment premiums intended solely to reflect, and compensate holders of the interest for, forgone income resulting from an early prepayment); (2) The entitlement to payments under the terms of the interest are absolute and could not be reduced based on losses arising from the underlying assets of the covered fund, such as allocation of losses, writedowns or charge-offs of the outstanding principal balance, or reductions in the amount of interest due and payable on the interest; and (3) The holders of the interest are not entitled to receive the underlying assets of the covered fund after all other interests have been redeemed 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). * * * * * (11) Riskless principal transaction. Riskless principal transaction means a transaction in which a banking entity, after receiving an order from a customer to buy (or sell) a security, purchases (or sells) the security in the secondary market for its own account to offset a contemporaneous sale to (or purchase from) the customer. ■ 11. Amend § 248.12 by: ■ a. Revising paragraph (b)(1)(ii); ■ b. Revising paragraph (b)(4); ■ c. Adding paragraph (b)(5); ■ d. Revising paragraph (c)(1); and ■ e. Revising paragraphs (d) and (e). The revisions and addition read as follows: § 248.12 Permitted investment in a covered fund. * * * * * (b) * * * (1) * * * (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) will not be considered to be an affiliate of the banking entity so long as: (A) The banking entity, together with its affiliates, does not own, control, or hold with the power to vote 25 percent PO 00000 Frm 00087 Fmt 4701 Sfmt 4700 46507 or more of the voting shares of the company or fund; and (B) The banking entity, or an affiliate of the banking entity, 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. * * * * * (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 in 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 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 in 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. (5) Parallel Investments and CoInvestments. (i) A banking entity shall not be required to include in the calculation of the investment limits under paragraph (a)(2) of this section any investment the banking entity makes alongside a covered fund as long as the investment is made in compliance with applicable laws and regulations, including applicable safety and soundness standards. (ii) A banking entity shall not be restricted under this section in the amount of any investment the banking entity makes alongside a covered fund as long as the investment is made in compliance with applicable laws and regulations, including applicable safety and soundness standards. E:\FR\FM\31JYR4.SGM 31JYR4 46508 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations (c) * * * (1)(i) 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 in connection with obtaining a restricted profit interest under § 248.10(d)(6)(ii)), on a historical cost basis; (ii) Treatment of employee and director restricted profit interests financed by the banking entity. For purposes of paragraph (c)(1)(i) of this section, an investment by a director or employee of a banking entity who acquires a restricted profit 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 restricted profit interest in the fund and the financing is used to acquire such ownership interest in the covered fund. * * * * * (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)(i) 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 in connection with obtaining a restricted profit interest under § 248.10(d)(6)(ii) of subpart C of this part), on a historical cost basis, plus any earnings received; and (ii) 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 in connection with obtaining a restricted profit interest under § 248.10(d)(6)(ii) of subpart C of this part), if the banking entity accounts for the profits (or losses) of the fund investment in its financial statements. (2) Treatment of employee and director restricted profit interests financed by the banking entity. For purposes of paragraph (d)(1) of this section, an investment by a director or employee of a banking entity who acquires a restricted profit interest in his or her personal capacity in a covered VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 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 restricted profit interest in the fund and the financing is used to acquire such ownership interest in the covered fund. (e) Extension of time to divest an ownership interest. (1) Extension period. 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. (2) Application requirements. 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)(3) 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. (3) 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, PO 00000 Frm 00088 Fmt 4701 Sfmt 4700 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. (4) 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. (5) 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. ■ 12. Amend § 248.13 by adding paragraph (d) to read as follows: § 248.13 Other permitted covered fund activities and investments. * * * * * (d) Permitted covered fund activities and investments of qualifying foreign excluded funds. (1) The prohibition contained in § 248.10(a) does not apply to a qualifying foreign excluded fund. (2) For purposes of this paragraph (d), a qualifying foreign excluded fund means a banking entity that: (i) Is organized or established outside the United States, and the ownership interests of which are offered and sold solely outside the United States; (ii)(A) Would be a covered fund if the entity were organized or established in the United States, or (B) Is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments; (iii) Would not otherwise be a banking entity except by virtue of the acquisition or retention of an ownership interest in, sponsorship of, or relationship with the entity, by another banking entity that meets the following: (A) The banking entity is not organized, or directly or indirectly controlled by a banking entity that is E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations organized, under the laws of the United States or of any State; and (B) The banking entity’s acquisition of an ownership interest in or sponsorship of the fund by the foreign banking entity meets the requirements for permitted covered fund activities and investments solely outside the United States, as provided in § 248.13(b); (iv) Is established and operated as part of a bona fide asset management business; and (v) Is not operated in a manner that enables the banking entity that sponsors or controls the qualifying foreign excluded fund, or any of its affiliates, to evade the requirements of section 13 of the BHC Act or this part. ■ 13. Amend § 248.14 by: ■ a. Revising paragraph (a)(2)(i); ■ b. Revising paragraph (a)(2)(ii)(C); ■ c. Adding paragraphs (a)(2)(iii), (iv), (v), and (3); and ■ d. Revising paragraph (c). The revisions and additions read as follows: § 248.14 Limitations on relationships with a covered fund. (a) * * * (2) * * * (i) Acquire and retain any ownership interest in a covered fund in accordance with the requirements of §§ 248.11, 248.12, or 248.13; (ii) * * * (C) The Board has not determined that such transaction is inconsistent with the safe and sound operation and condition of the banking entity; and (iii) Enter into a transaction with a covered fund that would be an exempt covered transaction under 12 U.S.C. 371c(d) or § 223.42 of the Board’s Regulation W (12 CFR 223.42) subject to the limitations specified under 12 U.S.C. 371c(d) or § 223.42 of the Board’s Regulation W (12 CFR 223.42), as applicable, (iv) Enter into a riskless principal transaction with a covered fund; and (v) Extend credit to or purchase assets from a covered fund, provided: (A) Each extension of credit or purchase of assets is in the ordinary course of business in connection with payment transactions; settlement services; or futures, derivatives, and securities clearing; (B) Each extension of credit is repaid, sold, or terminated by the end of five business days; and (C) The banking entity making each extension of credit meets the requirements of § 223.42(l)(1)(i) and (ii) of the Board’s Regulation W (12 CFR 223.42(l)(1)(i) and(ii)), as if the extension of credit was an intraday extension of credit, regardless of the duration of the extension of credit. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 (3) Any transaction or activity permitted under paragraphs (a)(2)(iii), (iv) or (v) must comply with the limitations in § 248.15. * * * * * (c) Restrictions on other permitted transactions. Any transaction permitted under paragraphs (a)(2)(ii), (iii), or (iv) 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 under section 23B. Subpart D—Compliance Program Requirements; Violations 14. Amend § 248.20 by: a. Revising paragraph (a); ■ b. Revising the heading of paragraph (d) and revising paragraph (d)(1) ; and ■ c. Revising the introductory text of paragraph (e). The revisions and addition 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 or a qualifying foreign excluded fund under §§ 248.6(f) or 248.13(d)) 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. * * * * * (d) Reporting requirements under appendix A to this part. (1) A banking entity (other than a qualifying foreign excluded fund under section 248.6(f) or 248.13(d)) engaged in proprietary trading activity permitted under subpart B shall comply with the reporting requirements described in appendix A to this part, if: * * * * * (e) Additional documentation for covered funds. A banking entity with significant trading assets and liabilities (other than a qualifying foreign excluded fund under section 248.6(f) or 248.13(d)) shall maintain records that include: * * * * * PO 00000 Frm 00089 Fmt 4701 Sfmt 4700 46509 FEDERAL DEPOSIT INSURANCE CORPORATION 12 CFR Chapter III Authority and Issuance For the reasons set forth 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 15. 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 B—Proprietary Trading 16. Amend § 351.6 by adding paragraph (f) to read as follows: ■ § 351.6 Other permitted proprietary trading activities. * * * * * (f) Permitted trading activities of qualifying foreign excluded funds. The prohibition contained in § 351.3(a) does not apply to the purchase or sale of a financial instrument by a qualifying foreign excluded fund. For purposes of this paragraph (f), a qualifying foreign excluded fund means a banking entity that: (1) Is organized or established outside the United States, and the ownership interests of which are offered and sold solely outside the United States; (2)(i) Would be a covered fund if the entity were organized or established in the United States, or (ii) Is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments; (3) Would not otherwise be a banking entity except by virtue of the acquisition or retention of an ownership interest in, sponsorship of, or relationship with the entity, by another banking entity that meets the following: (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; and (ii) The banking entity’s acquisition or retention of an ownership interest in or sponsorship of the fund meets the requirements for permitted covered fund activities and investments solely outside the United States, as provided in § 351.13(b); E:\FR\FM\31JYR4.SGM 31JYR4 46510 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations (4) Is established and operated as part of a bona fide asset management business; and (5) Is not operated in a manner that enables the banking entity that sponsors or controls the qualifying foreign excluded fund, or any of its affiliates, to evade the requirements of section 13 of the BHC Act or this part. Subpart C—Covered Funds Activities and Investments 17. Amend § 351.10 by: a. Revising paragraph (c)(1); b. Revising paragraph (c)(3)(i); c. Revising paragraph (c)(8); d. Revising the heading of paragraph (c)(10) and revising paragraph (c)(10)(i); ■ e. Revising paragraph (c)(11); ■ f. Adding paragraphs (c)(15), (16), (17), and (18); ■ g. Revising paragraph (d)(6); and ■ h. Adding paragraph (d)(11). The revisions and additions read as follows: ■ ■ ■ ■ ■ § 351.10 Prohibition on acquiring or retaining an ownership interest in and having certain relationships with a covered fund. * * * * * (c) * * * (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; and (B) Is authorized to offer and sell ownership interests, and such interests are offered and sold, through one or more public offerings. (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 more than 75 percent of the ownership interests in the issuer are sold 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 senior executive officers as defined in § 225.71(c) of the Board’s Regulation Y (12 CFR 225.71(c)) of such entities. (iii) For purposes of paragraph (c)(1)(i)(B) of this section, the term public offering means a distribution (as defined in § 351.4(a)(3)) of securities in any jurisdiction outside the United States to investors, including retail investors, provided that: VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 (A) The distribution is subject to substantive disclosure and retail investor protection laws or regulations; (B) With respect to an issuer for which the banking entity serves as the investment manager, investment adviser, commodity trading advisor, commodity pool operator, or sponsor, the distribution complies with all applicable requirements in the jurisdiction in which such distribution is being made; (C) The distribution does not restrict availability to investors having a minimum level of net worth or net investment assets; and (D) The issuer has filed or submitted, with the appropriate regulatory authority in such jurisdiction, offering disclosure documents that are publicly available. * * * * * (3) * * * (i) Is composed of no more than 10 unaffiliated co-venturers; * * * * * (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 composed solely of: (A) Loans as defined in § 351.2(t); (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 that is a security (other than special units of beneficial interest and collateral certificates meeting the requirements of paragraph (c)(8)(v) of this section) 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; (D) Special units of beneficial interest and collateral certificates that meet the requirements of paragraph (c)(8)(v) of this section; and (E) Debt securities, other than assetbacked securities and convertible securities, provided that: (1) The aggregate value of such debt securities does not exceed five percent of the aggregate value of loans held under paragraph (c)(8)(i)(A) of this section, cash and cash equivalents held under paragraph (c)(8)(iii)(A) of this section, and debt securities held under this paragraph (c)(8)(i)(E); and (2) The aggregate value of the loans, cash and cash equivalents, and debt securities for purposes of this paragraph is calculated at par value at the most PO 00000 Frm 00090 Fmt 4701 Sfmt 4700 recent time any such debt security is acquired, except that the issuing entity may instead determine the value of any such loan, cash equivalent, or debt security based on its fair market value if: (i) The issuing entity is required to use the fair market value of such assets for purposes of calculating compliance with concentration limitations or other similar calculations under its transaction agreements, and (ii) The issuing entity’s valuation methodology values similarly situated assets consistently. (ii) Impermissible assets. For purposes of this paragraph (c)(8), except as permitted under paragraph (c)(8)(i)(E) 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 paragraphs (c)(8)(iii), (iv), or (v) 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, other than debt securities permitted under paragraph (c)(8)(i)(E) of this section, if those securities are: (A) Cash equivalents—which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the securitization’s expected or potential need for funds and whose currency corresponds to either the underlying loans or the asset-backed securities—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 derivatives directly relate to the loans, the asset-backed securities, the contractual rights or other assets described in paragraph (c)(8)(i)(B) of this section, or the debt securities described in paragraph (c)(8)(i)(E) of this section; and (B) The derivatives reduce the interest rate and/or foreign exchange risks related to the loans, the asset-backed securities, the contractual rights or other assets described in paragraph (c)(8)(i)(B) E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations of this section, or the debt securities described in paragraph (c)(8)(i)(E) 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. * * * * * (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 composed solely of assets that meet the conditions in paragraph (c)(8)(i) of this section. * * * * * (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 that has voluntarily surrendered its license to operate as a small business investment company in accordance with 13 CFR 107.1900 and does not make any new investments (other than investments in cash equivalents, which, for the purposes of this paragraph, means high quality, highly liquid investments VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to the issuer’s assets) after such voluntary surrender; (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) and including investments that qualify for consideration under the regulations implementing the Community Reinvestment Act (12 U.S.C. 2901 et seq.); 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; (iii) That has elected to be regulated or is regulated as a rural business investment company, as described in 15 U.S.C. 80b–3(b)(8)(A) or (B), or that has terminated its participation as a rural business investment company in accordance with 7 CFR 4290.1900 and does not make any new investments (other than investments in cash equivalents, which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to the issuer’s assets) after such termination; or (iv) That is a qualified opportunity fund, as defined in 26 U.S.C. 1400Z– 2(d). * * * * * (15) Credit funds. Subject to paragraphs (c)(15)(iii), (iv), and (v) of this section, an issuer that satisfies the asset and activity requirements of paragraphs (c)(15)(i) and (ii) of this section. (i) Asset requirements. The issuer’s assets must be composed solely of: (A) Loans as defined in § 351.2(t); (B) Debt instruments, subject to paragraph (c)(15)(iv) of this section; (C) Rights and other assets that are related or incidental to acquiring, holding, servicing, or selling such loans or debt instruments, provided that: (1) Each right or asset held under this paragraph (c)(15)(i)(C) that is a security is either: (i) A cash equivalent (which, for the purposes of this paragraph, means high quality, highly liquid investments PO 00000 Frm 00091 Fmt 4701 Sfmt 4700 46511 whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to either the underlying loans or the debt instruments); (ii) A security received in lieu of debts previously contracted with respect to such loans or debt instruments; or (iii) An equity security (or right to acquire an equity security) received on customary terms in connection with such loans or debt instruments; and (2) Rights or other assets held under this paragraph (c)(15)(i)(C) of this section may not include commodity forward contracts or any derivative; and (D) Interest rate or foreign exchange derivatives, if: (1) The written terms of the derivative directly relate to the loans, debt instruments, or other rights or assets described in paragraph (c)(15)(i)(C) of this section; and (2) The derivative reduces the interest rate and/or foreign exchange risks related to the loans, debt instruments, or other rights or assets described in paragraph (c)(15)(i)(C) of this section. (ii) Activity requirements. To be eligible for the exclusion of paragraph (c)(15) of this section, an issuer must: (A) Not engage in any activity that would constitute proprietary trading under § 351.3(b)(l)(i), as if the issuer were a banking entity; and (B) Not issue asset-backed securities. (iii) Requirements for a sponsor, investment adviser, or commodity trading advisor. A banking entity that acts as a sponsor, investment adviser, or commodity trading advisor to an issuer that meets the conditions in paragraphs (c)(15)(i) and (ii) of this section may not rely on this exclusion unless the banking entity: (A) Provides in writing to any prospective and actual investor in the issuer the disclosures required under § 351.11(a)(8) of this subpart, as if the issuer were a covered fund; (B) Ensures that the activities of the issuer are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly; and (C) Complies with the limitations imposed in § 351.14, as if the issuer were a covered fund, except the banking entity may acquire and retain any ownership interest in the issuer. (iv) Additional Banking Entity Requirements. A banking entity may not rely on this exclusion with respect to an issuer that meets the conditions in paragraphs (c)(15)(i) and (ii) of this section unless: (A) The banking entity does not, directly or indirectly, guarantee, E:\FR\FM\31JYR4.SGM 31JYR4 46512 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations assume, or otherwise insure the obligations or performance of the issuer or of any entity to which such issuer extends credit or in which such issuer invests; and (B) Any assets the issuer holds pursuant to paragraphs (c)(15)(i)(B) or (i)(C)(1)(iii) of this section would be permissible for the banking entity to acquire and hold directly under applicable federal banking laws and regulations. (v) Investment and Relationship Limits. A banking entity’s investment in, and relationship with, the issuer must: (A) Comply with the limitations imposed in § 351.15, as if the issuer were a covered fund; and (B) Be conducted in compliance with, and subject to, applicable banking laws and regulations, including applicable safety and soundness standards. (16) Qualifying venture capital funds. (i) Subject to paragraphs (c)(16)(ii) through (iv) of this section, an issuer that: (A) Is a venture capital fund as defined in 17 CFR 275.203(l)–1; and (B) Does not engage in any activity that would constitute proprietary trading under § 351.3(b)(1)(i), as if the issuer were a banking entity. (ii) A banking entity that acts as a sponsor, investment adviser, or commodity trading advisor to an issuer that meets the conditions in paragraph (c)(16)(i) of this section may not rely on this exclusion unless the banking entity: (A) Provides in writing to any prospective and actual investor in the issuer the disclosures required under § 351.11(a)(8), as if the issuer were a covered fund; (B) Ensures that the activities of the issuer are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly; and (C) Complies with the restrictions in § 351.14 as if the issuer were a covered fund (except the banking entity may acquire and retain any ownership interest in the issuer). (iii) The banking entity must not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the issuer. (iv) A banking entity’s ownership interest in or relationship with the issuer must: (A) Comply with the limitations imposed in § 351.15, as if the issuer were a covered fund; and (B) Be conducted in compliance with, and subject to, applicable banking laws and regulations, including applicable safety and soundness standards. (17) Family wealth management vehicles. (i) Subject to paragraph VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 (c)(17)(ii) of this section, any entity that 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, and: (A) If the entity is a trust, the grantor(s) of the entity are all family customers; and (B) If the entity is not a trust: (1) A majority of the voting interests in the entity are owned (directly or indirectly) by family customers; (2) A majority of the interests in the entity are owned (directly or indirectly) by family customers; (3) The entity is owned only by family customers and up to 5 closely related persons of the family customers; and (C) Notwithstanding paragraph (c)(17)(i)(A) and (B) of this section, up to an aggregate 0.5 percent of the entity’s outstanding ownership interests may be acquired or retained by one or more entities that are not family customers or closely related persons if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns. (ii) A banking entity may rely on the exclusion in paragraph (c)(17)(i) of this section with respect to an entity provided that the banking entity (or an affiliate): (A) Provides bona fide trust, fiduciary, investment advisory, or commodity trading advisory services to the entity; (B) Does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such entity; (C) Complies with the disclosure obligations under § 351.11(a)(8), as if such entity were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the entity; (D) Does not acquire or retain, as principal, an ownership interest in the entity, other than as described in paragraph (c)(17)(i)(C) of this section; (E) Complies with the requirements of §§ 351.14(b) and 351.15, as if such entity were a covered fund; and (F) Except for riskless principal transactions as defined in paragraph (d)(11) of this section, complies with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the entity were an affiliate thereof. PO 00000 Frm 00092 Fmt 4701 Sfmt 4700 (iii) For purposes of paragraph (c)(17) of this section, the following definitions apply: (A) Closely related person means a natural person (including the estate and estate planning vehicles of such person) who has longstanding business or personal relationships with any family customer. (B) Family customer means: (1) A family client, as defined in Rule 202(a)(11)(G)–1(d)(4) of the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)–1(d)(4)); or (2) Any natural person who is a father-in-law, mother-in-law, brother-inlaw, sister-in-law, son-in-law or daughter-in-law of a family client, or a spouse or a spousal equivalent of any of the foregoing. (18) Customer facilitation vehicles. (i) Subject to paragraph (c)(18)(ii) of this section, an issuer that is formed by or at the request of a customer of the banking entity for the purpose of providing such customer (which may include one or more affiliates of such customer) with exposure to a transaction, investment strategy, or other service provided by the banking entity. (ii) A banking entity may rely on the exclusion in paragraph (c)(18)(i) of this section with respect to an issuer provided that: (A) All of the ownership interests of the issuer are owned by the customer (which may include one or more of its affiliates) for whom the issuer was created; (B) Notwithstanding paragraph (c)(18)(ii)(A) of this section, up to an aggregate 0.5 percent of the issuer’s outstanding ownership interests may be acquired or retained by one or more entities that are not customers if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns; and (C) The banking entity and its affiliates: (1) Maintain documentation outlining how the banking entity intends to facilitate the customer’s exposure to such transaction, investment strategy, or service; (2) Do not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such issuer; (3) Comply with the disclosure obligations under § 351.11(a)(8), as if such issuer were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations disclosure may be modified to accommodate the specific circumstances of the issuer; (4) Do not acquire or retain, as principal, an ownership interest in the issuer, other than as described in paragraph (c)(18)(ii)(B) of this section; (5) Comply with the requirements of §§ 351.14(b) and 351.15, as if such issuer were a covered fund; and (6) Except for riskless principal transactions as defined in paragraph (d)(11) of this section, comply with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the issuer were an affiliate thereof. * * * * * (d) * * * (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: (1) The rights of a creditor to exercise remedies upon the occurrence of an event of default or an acceleration event; and (2) The right to participate in the removal of an investment manager for ‘‘cause’’ or participate in the selection of a replacement manager upon an investment manager’s resignation or removal. For purposes of this paragraph (d)(6)(i)(A)(2), ‘‘cause’’ for removal of an investment manager means one or more of the following events: (i) The bankruptcy, insolvency, conservatorship or receivership of the investment manager; (ii) The breach by the investment manager of any material provision of the covered fund’s transaction agreements applicable to the investment manager; (iii) The breach by the investment manager of material representations or warranties; (iv) The occurrence of an act that constitutes fraud or criminal activity in the performance of the investment manager’s obligations under the covered fund’s transaction agreements; (v) The indictment of the investment manager for a criminal offense, or the indictment of any officer, member, partner or other principal of the investment manager for a criminal offense materially related to his or her investment management activities; (vi) A change in control with respect to the investment manager; (vii) The loss, separation or incapacitation of an individual critical VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 to the operation of the investment manager or primarily responsible for the management of the covered fund’s assets; or (viii) Other similar events that constitute ‘‘cause’’ for removal of an investment manager, provided that such events are not solely related to the performance of the covered fund or the investment manager’s exercise of investment discretion under the covered fund’s transaction agreements; (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: (A) 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: (1) 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 PO 00000 Frm 00093 Fmt 4701 Sfmt 4700 46513 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; (2) 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; (3) Any amounts invested in the covered fund, including any amounts paid by the entity in connection with obtaining the restricted profit interest, are within the limits of § 351.12 of this subpart; and (4) 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. (B) Any senior loan or senior debt interest that has the following characteristics: (1) Under the terms of the interest the holders of such interest do not have the right to receive a share of the income, gains, or profits of the covered fund, but are entitled to receive only: (i) Interest at a stated interest rate, as well as commitment fees or other fees, which are not determined by reference to the performance of the underlying assets of the covered fund; and (ii) Repayment of a fixed principal amount, on or before a maturity date, in a contractually-determined manner (which may include prepayment premiums intended solely to reflect, and compensate holders of the interest for, forgone income resulting from an early prepayment); (2) The entitlement to payments under the terms of the interest are absolute and could not be reduced based on losses arising from the underlying assets of the covered fund, such as allocation of losses, writedowns or charge-offs of the outstanding principal balance, or reductions in the E:\FR\FM\31JYR4.SGM 31JYR4 46514 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations amount of interest due and payable on the interest; and (3) The holders of the interest are not entitled to receive the underlying assets of the covered fund after all other interests have been redeemed 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). * * * * * (11) Riskless principal transaction. Riskless principal transaction means a transaction in which a banking entity, after receiving an order from a customer to buy (or sell) a security, purchases (or sells) the security in the secondary market for its own account to offset a contemporaneous sale to (or purchase from) the customer. ■ 18. Amend § 351.12 by: ■ a. Revising paragraph (b)(1)(ii); ■ b. Revising paragraph (b)(4); ■ c. Adding paragraph (b)(5); ■ d. Revising paragraph (c)(1); and ■ e. Revising paragraphs (d) and (e). The revisions and addition read as follows: § 351.12 Permitted investment in a covered fund. * * * * * (b) * * * (1) * * * (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) will not be considered to be an affiliate of the banking entity so long as: (A) The banking entity, together with its affiliates, 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) The banking entity, or an affiliate of the banking entity, 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. * * * * * (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, VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 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 in 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 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 in 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. (5) Parallel Investments and CoInvestments. (i) A banking entity shall not be required to include in the calculation of the investment limits under paragraph (a)(2) of this section any investment the banking entity makes alongside a covered fund as long as the investment is made in compliance with applicable laws and regulations, including applicable safety and soundness standards. (ii) A banking entity shall not be restricted under this section in the amount of any investment the banking entity makes alongside a covered fund as long as the investment is made in compliance with applicable laws and regulations, including applicable safety and soundness standards. (c) * * * (1)(i) 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 in connection with obtaining a restricted profit interest under § 351.10(d)(6)(ii)), on a historical cost basis; (ii) Treatment of employee and director restricted profit interests financed by the banking entity. For purposes of paragraph (c)(1)(i) of this section, an investment by a director or employee of a banking entity who acquires a restricted profit interest in his or her personal capacity in a covered PO 00000 Frm 00094 Fmt 4701 Sfmt 4700 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 restricted profit interest in the fund and the financing is used to acquire such ownership interest in the covered fund. * * * * * (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)(i) 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 in connection with obtaining a restricted profit interest under § 351.10(d)(6)(ii) of subpart C of this part), on a historical cost basis, plus any earnings received; and (ii) 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 in connection with obtaining a restricted profit interest under § 351.10(d)(6)(ii) of subpart C of this part), if the banking entity accounts for the profits (or losses) of the fund investment in its financial statements. (2) Treatment of employee and director restricted profit interests financed by the banking entity. For purposes of paragraph (d)(1) of this section, an investment by a director or employee of a banking entity who acquires a restricted profit 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 restricted profit interest in the fund and the financing is used to acquire such ownership interest in the covered fund. (e) Extension of time to divest an ownership interest. (1) Extension period. 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. (2) Application requirements. An application for extension must: E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations (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)(3) 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. (3) 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; (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. (4) 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 VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 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. (5) 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. ■ 19. Amend § 351.13 by adding paragraph (d) to read as follows: § 351.13 Other permitted covered fund activities and investments. * * * * * (d) Permitted covered fund activities and investments of qualifying foreign excluded funds. (1) The prohibition contained in § 351.10(a) does not apply to a qualifying foreign excluded fund. (2) For purposes of this paragraph (d), a qualifying foreign excluded fund means a banking entity that: (i) Is organized or established outside the United States, and the ownership interests of which are offered and sold solely outside the United States; (ii)(A) Would be a covered fund if the entity were organized or established in the United States, or (B) Is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments; (iii) Would not otherwise be a banking entity except by virtue of the acquisition or retention of an ownership interest in, sponsorship of, or relationship with the entity, by another banking entity that meets the following: (A) 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; and (B) The banking entity’s acquisition of an ownership interest in or sponsorship of the fund by the foreign banking entity meets the requirements for permitted covered fund activities and investments solely outside the United States, as provided in § 351.13(b); (iv) Is established and operated as part of a bona fide asset management business; and (v) Is not operated in a manner that enables the banking entity that sponsors or controls the qualifying foreign excluded fund, or any of its affiliates, to evade the requirements of section 13 of the BHC Act or this part. ■ 20. Amend § 351.14 by: ■ a. Revising paragraph (a)(2)(i); PO 00000 Frm 00095 Fmt 4701 Sfmt 4700 46515 b. Revising paragraph (a)(2)(ii)(C); c. Adding paragraphs (a)(2)(iii), (iv), (v), and (3); and ■ d. Revising paragraph (c). The revisions and additions read as follows: ■ ■ § 351.14 Limitations on relationships with a covered fund. (a) * * * (2) * * * (i) Acquire and retain any ownership interest in a covered fund in accordance with the requirements of §§ 351.11, 351.12, or 351.13; (ii) * * * (C) The Board has not determined that such transaction is inconsistent with the safe and sound operation and condition of the banking entity; and (iii) Enter into a transaction with a covered fund that would be an exempt covered transaction under 12 U.S.C. 371c(d) or § 223.42 of the Board’s Regulation W (12 CFR 223.42) subject to the limitations specified under 12 U.S.C. 371c(d) or § 223.42 of the Board’s Regulation W (12 CFR 223.42), as applicable, (iv) Enter into a riskless principal transaction with a covered fund; and (v) Extend credit to or purchase assets from a covered fund, provided: (A) Each extension of credit or purchase of assets is in the ordinary course of business in connection with payment transactions; settlement services; or futures, derivatives, and securities clearing; (B) Each extension of credit is repaid, sold, or terminated by the end of five business days; and (C) The banking entity making each extension of credit meets the requirements of § 223.42(l)(1)(i) and (ii) of the Board’s Regulation W (12 CFR 223.42(l)(1)(i) and(ii)), as if the extension of credit was an intraday extension of credit, regardless of the duration of the extension of credit. (3) Any transaction or activity permitted under paragraphs (a)(2)(iii), (iv) or (v) must comply with the limitations in § 351.15. * * * * * (c) Restrictions on other permitted transactions. Any transaction permitted under paragraphs (a)(2)(ii), (iii), or (iv) 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 under section 23B. Subpart D—Compliance Program Requirements; Violations ■ ■ 21. Amend § 351.20 by: a. Revising paragraph (a); E:\FR\FM\31JYR4.SGM 31JYR4 46516 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations b. Revising the heading of paragraph (d) and revising paragraph (d)(1); and ■ c. Revising the introductory text of paragraph (e). The revisions and addition read as follows: ■ (a) Program requirement. Each banking entity (other than a banking entity with limited trading assets and liabilities or a qualifying foreign excluded fund under section 351.6(f) or 351.13(d)) 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. * * * * * (d) Reporting requirements under appendix A to this part. (1) A banking entity (other than a qualifying foreign excluded fund under section 351.6(f) or 351.13(d)) engaged in proprietary trading activity permitted under subpart B shall comply with the reporting requirements described in appendix A to this part, if: * * * * * (e) Additional documentation for covered funds. A banking entity with significant trading assets and liabilities (other than a qualifying foreign excluded fund under section 351.6(f) or 351.13(d)) shall maintain records that include: * * * * * COMMODITY FUTURES TRADING COMMISSION 17 CFR Chapter I Authority and Issuance For the reasons set forth in the Common Preamble, the Commodity Futures Trading Commission amends part 75 to chapter I of title 17 of the Code of Federal Regulations as follows: 22. The authority citation for part 75 continues to read as follows: VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 § 75.6 Other permitted proprietary trading activities. * * * * (f) Permitted trading activities of qualifying foreign excluded funds. The prohibition contained in § 75.3(a) does not apply to the purchase or sale of a financial instrument by a qualifying foreign excluded fund. For purposes of this paragraph (f), a qualifying foreign excluded fund means a banking entity that: (1) Is organized or established outside the United States, and the ownership interests of which are offered and sold solely outside the United States; (2)(i) Would be a covered fund if the entity were organized or established in the United States, or (ii) Is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments; (3) Would not otherwise be a banking entity except by virtue of the acquisition or retention of an ownership interest in, sponsorship of, or relationship with the entity, by another banking entity that meets the following: (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; and (ii) The banking entity’s acquisition or retention of an ownership interest in or sponsorship of the fund meets the requirements for permitted covered fund activities and investments solely outside the United States, as provided in § 75.13(b); (4) Is established and operated as part of a bona fide asset management business; and (5) Is not operated in a manner that enables the banking entity that sponsors or controls the qualifying foreign excluded fund, or any of its affiliates, to evade the requirements of section 13 of the BHC Act or this part. Subpart C—Covered Funds Activities and Investments 24. Amend § 75.10 by: a. Revising paragraph (c)(1); b. Revising paragraph (c)(3)(i); c. Revising paragraph (c)(8); d. Revising the heading of paragraph (c)(10) and revising paragraph (c)(10)(i); ■ e. Revising paragraph (c)(11); ■ f. Adding paragraphs (c)(15), (16), (17), and (18); ■ ■ ■ ■ ■ PART 75—PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND RELATIONSHIPS WITH COVERED FUNDS Authority: 12 U.S.C. 1851. 23. Amend § 75.6 by adding paragraph (f) to read as follows: ■ * § 351.20 Program for compliance; reporting. ■ Subpart B—Proprietary Trading PO 00000 Frm 00096 Fmt 4701 Sfmt 4700 g. Revising paragraph (d)(6); and h. Adding paragraph (d)(11). The revisions and additions read as follows: ■ ■ § 75.10 Prohibition on acquiring or retaining an ownership interest in and having certain relationships with a covered fund. * * * * * (c) * * * (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; and (B) Is authorized to offer and sell ownership interests, and such interests are offered and sold, through one or more public offerings. (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 more than 75 percent of the ownership interests in the issuer are sold 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 senior executive officers as defined in § 225.71(c) of the Board’s Regulation Y (12 CFR 225.71(c)) of such entities. (iii) For purposes of paragraph (c)(1)(i)(B) 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 is subject to substantive disclosure and retail investor protection laws or regulations; (B) With respect to an issuer for which the banking entity serves as the investment manager, investment adviser, commodity trading advisor, commodity pool operator, or sponsor, the distribution complies with all applicable requirements in the jurisdiction in which such distribution is being made; (C) The distribution does not restrict availability to investors having a minimum level of net worth or net investment assets; and (D) The issuer has filed or submitted, with the appropriate regulatory authority in such jurisdiction, offering disclosure documents that are publicly available. * * * * * E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations (3) * * * (i) Is composed of no more than 10 unaffiliated co-venturers; * * * * * (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 composed solely of: (A) Loans as defined in § 75.2(t); (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 that is a security (other than special units of beneficial interest and collateral certificates meeting the requirements of paragraph (c)(8)(v) of this section) 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; (D) Special units of beneficial interest and collateral certificates that meet the requirements of paragraph (c)(8)(v) of this section; and (E) Debt securities, other than assetbacked securities and convertible securities, provided that: (1) The aggregate value of such debt securities does not exceed five percent of the aggregate value of loans held under paragraph (c)(8)(i)(A) of this section, cash and cash equivalents held under paragraph (c)(8)(iii)(A) of this section, and debt securities held under this paragraph (c)(8)(i)(E); and (2) The aggregate value of the loans, cash and cash equivalents, and debt securities for purposes of this paragraph is calculated at par value at the most recent time any such debt security is acquired, except that the issuing entity may instead determine the value of any such loan, cash equivalent, or debt security based on its fair market value if: (i) The issuing entity is required to use the fair market value of such assets for purposes of calculating compliance with concentration limitations or other similar calculations under its transaction agreements, and (ii) The issuing entity’s valuation methodology values similarly situated assets consistently. (ii) Impermissible assets. For purposes of this paragraph (c)(8), except as permitted under paragraph (c)(8)(i)(E) 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 VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 equity or debt security other than as permitted in paragraphs (c)(8)(iii), (iv), or (v) 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, other than debt securities permitted under paragraph (c)(8)(i)(E) of this section, if those securities are: (A) Cash equivalents—which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the securitization’s expected or potential need for funds and whose currency corresponds to either the underlying loans or the asset-backed securities—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 derivatives directly relate to the loans, the asset-backed securities, the contractual rights or other assets described in paragraph (c)(8)(i)(B) of this section, or the debt securities described in paragraph (c)(8)(i)(E) of this section; and (B) The derivatives reduce the interest rate and/or foreign exchange risks related to the loans, the asset-backed securities, the contractual rights or other assets described in paragraph (c)(8)(i)(B) of this section, or the debt securities described in paragraph (c)(8)(i)(E) 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 PO 00000 Frm 00097 Fmt 4701 Sfmt 4700 46517 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. * * * * * (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 composed solely of assets that meet the conditions in paragraph (c)(8)(i) of this section. * * * * * (11) * * * (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 that has voluntarily surrendered its license to operate as a small business investment company in accordance with 13 CFR 107.1900 and does not make any new investments (other than investments in cash equivalents, which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to the issuer’s assets) after such voluntary surrender; (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) and including investments that qualify for consideration under the regulations implementing the Community Reinvestment Act (12 U.S.C. 2901 et seq.); or (B) Qualified rehabilitation expenditures with respect to a qualified rehabilitated building or certified historic structure, as such terms are E:\FR\FM\31JYR4.SGM 31JYR4 46518 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations defined in section 47 of the Internal Revenue Code of 1986 or a similar State historic tax credit program; (iii) That has elected to be regulated or is regulated as a rural business investment company, as described in 15 U.S.C. 80b–3(b)(8)(A) or (B), or that has terminated its participation as a rural business investment company in accordance with 7 CFR 4290.1900 and does not make any new investments (other than investments in cash equivalents, which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to the issuer’s assets) after such termination; or (iv) That is a qualified opportunity fund, as defined in 26 U.S.C. 1400Z– 2(d). * * * * * (15) Credit funds. Subject to paragraphs (c)(15)(iii), (iv), and (v) of this section, an issuer that satisfies the asset and activity requirements of paragraphs (c)(15)(i) and (ii) of this section. (i) Asset requirements. The issuer’s assets must be composed solely of: (A) Loans as defined in § 75.2(t); (B) Debt instruments, subject to paragraph (c)(15)(iv) of this section; (C) Rights and other assets that are related or incidental to acquiring, holding, servicing, or selling such loans or debt instruments, provided that: (1) Each right or asset held under this paragraph (c)(15)(i)(C) that is a security is either: (i) A cash equivalent (which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to either the underlying loans or the debt instruments); (ii) A security received in lieu of debts previously contracted with respect to such loans or debt instruments; or (iii) An equity security (or right to acquire an equity security) received on customary terms in connection with such loans or debt instruments; and (2) Rights or other assets held under this paragraph (c)(15)(i)(C) of this section may not include commodity forward contracts or any derivative; and (D) Interest rate or foreign exchange derivatives, if: (1) The written terms of the derivative directly relate to the loans, debt instruments, or other rights or assets described in paragraph (c)(15)(i)(C) of this section; and (2) The derivative reduces the interest rate and/or foreign exchange risks VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 related to the loans, debt instruments, or other rights or assets described in paragraph (c)(15)(i)(C) of this section. (ii) Activity requirements. To be eligible for the exclusion of paragraph (c)(15) of this section, an issuer must: (A) Not engage in any activity that would constitute proprietary trading under § 75.3(b)(l)(i), as if the issuer were a banking entity; and (B) Not issue asset-backed securities. (iii) Requirements for a sponsor, investment adviser, or commodity trading advisor. A banking entity that acts as a sponsor, investment adviser, or commodity trading advisor to an issuer that meets the conditions in paragraphs (c)(15)(i) and (ii) of this section may not rely on this exclusion unless the banking entity: (A) Provides in writing to any prospective and actual investor in the issuer the disclosures required under § 75.11(a)(8) of this subpart, as if the issuer were a covered fund; (B) Ensures that the activities of the issuer are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly; and (C) Complies with the limitations imposed in § 75.14, as if the issuer were a covered fund, except the banking entity may acquire and retain any ownership interest in the issuer. (iv) Additional Banking Entity Requirements. A banking entity may not rely on this exclusion with respect to an issuer that meets the conditions in paragraphs (c)(15)(i) and (ii) of this section unless: (A) The banking entity does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the issuer or of any entity to which such issuer extends credit or in which such issuer invests; and (B) Any assets the issuer holds pursuant to paragraphs (c)(15)(i)(B) or (i)(C)(l)(iii) of this section would be permissible for the banking entity to acquire and hold directly under applicable federal banking laws and regulations. (v) Investment and Relationship Limits. A banking entity’s investment in, and relationship with, the issuer must: (A) Comply with the limitations imposed in § 75.15, as if the issuer were a covered fund; and (B) Be conducted in compliance with, and subject to, applicable banking laws and regulations, including applicable safety and soundness standards. (16) Qualifying venture capital funds. (i) Subject to paragraphs (c)(16)(ii) PO 00000 Frm 00098 Fmt 4701 Sfmt 4700 through (iv) of this section, an issuer that: (A) Is a venture capital fund as defined in 17 CFR 275.203(l)–1; and (B) Does not engage in any activity that would constitute proprietary trading under § 75.3(b)(1)(i), as if the issuer were a banking entity. (ii) A banking entity that acts as a sponsor, investment adviser, or commodity trading advisor to an issuer that meets the conditions in paragraph (c)(16)(i) of this section may not rely on this exclusion unless the banking entity: (A) Provides in writing to any prospective and actual investor in the issuer the disclosures required under § 75.11(a)(8), as if the issuer were a covered fund; (B) Ensures that the activities of the issuer are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly; and (C) Complies with the restrictions in § 75.14 as if the issuer were a covered fund (except the banking entity may acquire and retain any ownership interest in the issuer). (iii) The banking entity must not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the issuer. (iv) A banking entity’s ownership interest in or relationship with the issuer must: (A) Comply with the limitations imposed in § 75.15, as if the issuer were a covered fund; and (B) Be conducted in compliance with, and subject to, applicable banking laws and regulations, including applicable safety and soundness standards. (17) Family wealth management vehicles. (i) Subject to paragraph (c)(17)(ii) of this section, any entity that 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, and: (A) If the entity is a trust, the grantor(s) of the entity are all family customers; and (B) If the entity is not a trust: (1) A majority of the voting interests in the entity are owned (directly or indirectly) by family customers; (2) A majority of the interests in the entity are owned (directly or indirectly) by family customers; (3) The entity is owned only by family customers and up to 5 closely related persons of the family customers; and (C) Notwithstanding paragraph (c)(17)(i)(A) and (B) of this section, up to an aggregate 0.5 percent of the E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations entity’s outstanding ownership interests may be acquired or retained by one or more entities that are not family customers or closely related persons if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns. (ii) A banking entity may rely on the exclusion in paragraph (c)(17)(i) of this section with respect to an entity provided that the banking entity (or an affiliate): (A) Provides bona fide trust, fiduciary, investment advisory, or commodity trading advisory services to the entity; (B) Does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such entity; (C) Complies with the disclosure obligations under § 75.11(a)(8), as if such entity were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the entity; (D) Does not acquire or retain, as principal, an ownership interest in the entity, other than as described in paragraph (c)(17)(i)(C) of this section; (E) Complies with the requirements of §§ 75.14(b) and 75.15, as if such entity were a covered fund; and (F) Except for riskless principal transactions as defined in paragraph (d)(11) of this section, complies with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the entity were an affiliate thereof. (iii) For purposes of paragraph (c)(17) of this section, the following definitions apply: (A) Closely related person means a natural person (including the estate and estate planning vehicles of such person) who has longstanding business or personal relationships with any family customer. (B) Family customer means: (1) A family client, as defined in Rule 202(a)(11)(G)–1(d)(4) of the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)–1(d)(4)); or (2) Any natural person who is a father-in-law, mother-in-law, brother-inlaw, sister-in-law, son-in-law or daughter-in-law of a family client, or a spouse or a spousal equivalent of any of the foregoing. (18) Customer facilitation vehicles. (i) Subject to paragraph (c)(18)(ii) of this section, an issuer that is formed by or at the request of a customer of the VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 banking entity for the purpose of providing such customer (which may include one or more affiliates of such customer) with exposure to a transaction, investment strategy, or other service provided by the banking entity. (ii) A banking entity may rely on the exclusion in paragraph (c)(18)(i) of this section with respect to an issuer provided that: (A) All of the ownership interests of the issuer are owned by the customer (which may include one or more of its affiliates) for whom the issuer was created; (B) Notwithstanding paragraph (c)(18)(ii)(A) of this section, up to an aggregate 0.5 percent of the issuer’s outstanding ownership interests may be acquired or retained by one or more entities that are not customers if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns; and (C) The banking entity and its affiliates: (1) Maintain documentation outlining how the banking entity intends to facilitate the customer’s exposure to such transaction, investment strategy, or service; (2) Do not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such issuer; (3) Comply with the disclosure obligations under § 75.11(a)(8), as if such issuer were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the issuer; (4) Do not acquire or retain, as principal, an ownership interest in the issuer, other than as described in paragraph (c)(18)(ii)(B) of this section; (5) Comply with the requirements of §§ 75.14(b) and 75.15, as if such issuer were a covered fund; and (6) Except for riskless principal transactions as defined in paragraph (d)(11) of this section, comply with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the issuer were an affiliate thereof. * * * * * (d) * * * (6) Ownership interest. (i) Ownership interest means any equity, partnership, or other similar interest. An ‘‘other similar interest’’ means an interest that: PO 00000 Frm 00099 Fmt 4701 Sfmt 4700 46519 (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: (1) The rights of a creditor to exercise remedies upon the occurrence of an event of default or an acceleration event; and (2) The right to participate in the removal of an investment manager for ‘‘cause’’ or participate in the selection of a replacement manager upon an investment manager’s resignation or removal. For purposes of this paragraph (d)(6)(i)(A)(2), ‘‘cause’’ for removal of an investment manager means one or more of the following events: (i) The bankruptcy, insolvency, conservatorship or receivership of the investment manager; (ii) The breach by the investment manager of any material provision of the covered fund’s transaction agreements applicable to the investment manager; (iii) The breach by the investment manager of material representations or warranties; (iv) The occurrence of an act that constitutes fraud or criminal activity in the performance of the investment manager’s obligations under the covered fund’s transaction agreements; (v) The indictment of the investment manager for a criminal offense, or the indictment of any officer, member, partner or other principal of the investment manager for a criminal offense materially related to his or her investment management activities; (vi) A change in control with respect to the investment manager; (vii) The loss, separation or incapacitation of an individual critical to the operation of the investment manager or primarily responsible for the management of the covered fund’s assets; or (viii) Other similar events that constitute ‘‘cause’’ for removal of an investment manager, provided that such events are not solely related to the performance of the covered fund or the investment manager’s exercise of investment discretion under the covered fund’s transaction agreements; (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 E:\FR\FM\31JYR4.SGM 31JYR4 46520 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations 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: (A) 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: (1) 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; (2) 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; (3) Any amounts invested in the covered fund, including any amounts paid by the entity in connection with VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 obtaining the restricted profit interest, are within the limits of § 75.12 of this subpart; and (4) 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. (B) Any senior loan or senior debt interest that has the following characteristics: (1) Under the terms of the interest the holders of such interest do not have the right to receive a share of the income, gains, or profits of the covered fund, but are entitled to receive only: (i) Interest at a stated interest rate, as well as commitment fees or other fees, which are not determined by reference to the performance of the underlying assets of the covered fund; and (ii) Repayment of a fixed principal amount, on or before a maturity date, in a contractually-determined manner (which may include prepayment premiums intended solely to reflect, and compensate holders of the interest for, forgone income resulting from an early prepayment); (2) The entitlement to payments under the terms of the interest are absolute and could not be reduced based on losses arising from the underlying assets of the covered fund, such as allocation of losses, writedowns or charge-offs of the outstanding principal balance, or reductions in the amount of interest due and payable on the interest; and (3) The holders of the interest are not entitled to receive the underlying assets of the covered fund after all other interests have been redeemed 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). * * * * * (11) Riskless principal transaction. Riskless principal transaction means a transaction in which a banking entity, after receiving an order from a customer to buy (or sell) a security, purchases (or sells) the security in the secondary market for its own account to offset a contemporaneous sale to (or purchase from) the customer. ■ 26. Amend § 75.12 by: PO 00000 Frm 00100 Fmt 4701 Sfmt 4700 a. Revising paragraph (b)(1)(ii); b. Revising paragraph (b)(4); c. Adding paragraph (b)(5); d. Revising paragraph (c)(1); and e. Revising paragraphs (d) and (e). The revisions and addition read as follows: ■ ■ ■ ■ ■ § 75.12 fund. Permitted investment in a covered * * * * * (b) * * * (1) * * * (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: (A) The banking entity, together with its affiliates, 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) The banking entity, or an affiliate of the banking entity, 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. * * * * * (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 in 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, E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations as well as the banking entity’s pro-rata share of any ownership interest in 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. (5) Parallel Investments and CoInvestments. (i) A banking entity shall not be required to include in the calculation of the investment limits under paragraph (a)(2) of this section any investment the banking entity makes alongside a covered fund as long as the investment is made in compliance with applicable laws and regulations, including applicable safety and soundness standards. (ii) A banking entity shall not be restricted under this section in the amount of any investment the banking entity makes alongside a covered fund as long as the investment is made in compliance with applicable laws and regulations, including applicable safety and soundness standards. (c) * * * (1)(i) 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 in connection with obtaining a restricted profit interest under § 75.10(d)(6)(ii)), on a historical cost basis; (ii) Treatment of employee and director restricted profit interests financed by the banking entity. For purposes of paragraph (c)(1)(i) of this section, an investment by a director or employee of a banking entity who acquires a restricted profit 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 restricted profit interest in the fund and the financing is used to acquire such ownership interest in the covered fund. * * * * * (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)(i) The sum of all amounts paid or contributed by the banking entity in connection with acquiring or retaining VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 an ownership interest (together with any amounts paid by the entity in connection with obtaining a restricted profit interest under § 75.10(d)(6)(ii) of subpart C of this part), on a historical cost basis, plus any earnings received; and (ii) 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 in connection with obtaining a restricted profit interest under § 75.10(d)(6)(ii) of subpart C of this part), if the banking entity accounts for the profits (or losses) of the fund investment in its financial statements. (2) Treatment of employee and director restricted profit interests financed by the banking entity. For purposes of paragraph (d)(1) of this section, an investment by a director or employee of a banking entity who acquires a restricted profit 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 restricted profit interest in the fund and the financing is used to acquire such ownership interest in the covered fund. (e) Extension of time to divest an ownership interest. (1) Extension period. 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. (2) Application requirements. 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)(3) 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. (3) 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 PO 00000 Frm 00101 Fmt 4701 Sfmt 4700 46521 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. (4) 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. (5) 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. ■ 26. Amend § 75.13 by adding paragraph (d) to read as follows: § 75.13 Other permitted covered fund activities and investments. * * * * * (d) Permitted covered fund activities and investments of qualifying foreign excluded funds. (1) The prohibition E:\FR\FM\31JYR4.SGM 31JYR4 46522 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations contained in § 75.10(a) does not apply to a qualifying foreign excluded fund. (2) For purposes of this paragraph (d), a qualifying foreign excluded fund means a banking entity that: (i) Is organized or established outside the United States, and the ownership interests of which are offered and sold solely outside the United States; (ii)(A) Would be a covered fund if the entity were organized or established in the United States, or (B) Is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments; (iii) Would not otherwise be a banking entity except by virtue of the acquisition or retention of an ownership interest in, sponsorship of, or relationship with the entity, by another banking entity that meets the following: (A) 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; and (B) The banking entity’s acquisition of an ownership interest in or sponsorship of the fund by the foreign banking entity meets the requirements for permitted covered fund activities and investments solely outside the United States, as provided in § 75.13(b); (iv) Is established and operated as part of a bona fide asset management business; and (v) Is not operated in a manner that enables the banking entity that sponsors or controls the qualifying foreign excluded fund, or any of its affiliates, to evade the requirements of section 13 of the BHC Act or this part. ■ 27. Amend § 75.14 by: ■ a. Revising paragraph (a)(2)(i); ■ b. Revising paragraph (a)(2)(ii)(C); ■ c. Adding paragraphs (a)(2)(iii), (iv), (v), and (3); and ■ d. Revising paragraph (c). The revisions and additions read as follows: § 75.14 Limitations on relationships with a covered fund. (a) * * * (2) * * * (i) Acquire and retain any ownership interest in a covered fund in accordance with the requirements of §§ 75.11, 75.12, or 75.13; (ii) * * * (C) The Board has not determined that such transaction is inconsistent with the safe and sound operation and condition of the banking entity; and (iii) Enter into a transaction with a covered fund that would be an exempt VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 covered transaction under 12 U.S.C. 371c(d) or § 223.42 of the Board’s Regulation W (12 CFR 223.42) subject to the limitations specified under 12 U.S.C. 371c(d) or § 223.42 of the Board’s Regulation W (12 CFR 223.42), as applicable, (iv) Enter into a riskless principal transaction with a covered fund; and (v) Extend credit to or purchase assets from a covered fund, provided: (A) Each extension of credit or purchase of assets is in the ordinary course of business in connection with payment transactions; settlement services; or futures, derivatives, and securities clearing; (B) Each extension of credit is repaid, sold, or terminated by the end of five business days; and (C) The banking entity making each extension of credit meets the requirements of § 223.42(l)(1)(i) and (ii) of the Board’s Regulation W (12 CFR 223.42(l)(1)(i) and(ii)), as if the extension of credit was an intraday extension of credit, regardless of the duration of the extension of credit. (3) Any transaction or activity permitted under paragraphs (a)(2)(iii), (iv) or (v) must comply with the limitations in § 75.15. * * * * * (c) Restrictions on other permitted transactions. Any transaction permitted under paragraphs (a)(2)(ii), (iii), or (iv) 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 under section 23B. Subpart D—Compliance Program Requirements; Violations 28. Amend § 75.20 by: a. Revising paragraph (a); b. Revising the heading of paragraph (d) and revising paragraph (d)(1); and ■ c. Revising the introductory text of paragraph (e). The revisions and addition 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 or a qualifying foreign excluded fund under section 75.6(f) or 75.13(d)) 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 PO 00000 Frm 00102 Fmt 4701 Sfmt 4700 detail of the compliance program shall be appropriate for the types, size, scope, and complexity of activities and business structure of the banking entity. * * * * * (d) Reporting requirements under appendix A to this part. (1) A banking entity (other than a qualifying foreign excluded fund under section 75.6(f) or 75.13(d)) engaged in proprietary trading activity permitted under subpart B shall comply with the reporting requirements described in appendix A to this part, if: * * * * * (e) Additional documentation for covered funds. A banking entity with significant trading assets and liabilities (other than a qualifying foreign excluded fund under section 75.6(f) or 75.13(d)) shall maintain records that include: * * * * * 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 29. The authority citation for part 255 continues to read as follows: ■ Authority: 12 U.S.C. 1851. Subpart B—Proprietary Trading 30. Amend § 255.6 by adding paragraph (f) to read as follows: ■ § 255.6 Other permitted proprietary trading activities. * * * * * (f) Permitted trading activities of qualifying foreign excluded funds. The prohibition contained in § 255.3(a) does not apply to the purchase or sale of a financial instrument by a qualifying foreign excluded fund. For purposes of this paragraph (f), a qualifying foreign excluded fund means a banking entity that: (1) Is organized or established outside the United States, and the ownership interests of which are offered and sold solely outside the United States; (2)(i) Would be a covered fund if the entity were organized or established in the United States, or (ii) Is, or holds itself out as being, an entity or arrangement that raises money E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments; (3) Would not otherwise be a banking entity except by virtue of the acquisition or retention of an ownership interest in, sponsorship of, or relationship with the entity, by another banking entity that meets the following: (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; and (ii) The banking entity’s acquisition or retention of an ownership interest in or sponsorship of the fund meets the requirements for permitted covered fund activities and investments solely outside the United States, as provided in § 255.13(b); (4) Is established and operated as part of a bona fide asset management business; and (5) Is not operated in a manner that enables the banking entity that sponsors or controls the qualifying foreign excluded fund, or any of its affiliates, to evade the requirements of section 13 of the BHC Act or this part. Subpart C—Covered Funds Activities and Investments 31. Amend § 255.10 by: a. Revising paragraph (c)(1); b. Revising paragraph (c)(3)(i); c. Revising paragraph (c)(8); d. Revising the heading of paragraph (c)(10) and revising paragraph (c)(10)(i); ■ e. Revising paragraph (c)(11); ■ f. Adding paragraphs (c)(15), (16), (17), and (18); ■ g. Revising paragraph (d)(6); and ■ h. Adding paragraph (d)(11). The revisions and additions read as follows: ■ ■ ■ ■ ■ § 255.10 Prohibition on acquiring or retaining an ownership interest in and having certain relationships with a covered fund. * * * * * (c) * * * (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; and (B) Is authorized to offer and sell ownership interests, and such interests are offered and sold, through one or more public offerings. (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 VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 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 more than 75 percent of the ownership interests in the issuer are sold 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 senior executive officers as defined in § 225.71(c) of the Board’s Regulation Y (12 CFR 225.71(c)) of such entities. (iii) For purposes of paragraph (c)(1)(i)(B) of this section, the term ‘‘public offering’’ means a distribution (as defined in § 255.4(a)(3)) of securities in any jurisdiction outside the United States to investors, including retail investors, provided that: (A) The distribution is subject to substantive disclosure and retail investor protection laws or regulations; (B) With respect to an issuer for which the banking entity serves as the investment manager, investment adviser, commodity trading advisor, commodity pool operator, or sponsor, the distribution complies with all applicable requirements in the jurisdiction in which such distribution is being made; (C) The distribution does not restrict availability to investors having a minimum level of net worth or net investment assets; and (D) The issuer has filed or submitted, with the appropriate regulatory authority in such jurisdiction, offering disclosure documents that are publicly available. * * * * * (3) * * * (i) Is composed of no more than 10 unaffiliated co-venturers; * * * * * (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 composed solely of: (A) Loans as defined in § 255.2(t); (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 that is a security (other than special units of beneficial interest and collateral certificates meeting the requirements of paragraph (c)(8)(v) of this section) meets the requirements of paragraph (c)(8)(iii) of this section; PO 00000 Frm 00103 Fmt 4701 Sfmt 4700 46523 (C) Interest rate or foreign exchange derivatives that meet the requirements of paragraph (c)(8)(iv) of this section; (D) Special units of beneficial interest and collateral certificates that meet the requirements of paragraph (c)(8)(v) of this section; and (E) Debt securities, other than assetbacked securities and convertible securities, provided that: (1) The aggregate value of such debt securities does not exceed five percent of the aggregate value of loans held under paragraph (c)(8)(i)(A) of this section, cash and cash equivalents held under paragraph (c)(8)(iii)(A) of this section, and debt securities held under this paragraph (c)(8)(i)(E); and (2) The aggregate value of the loans, cash and cash equivalents, and debt securities for purposes of this paragraph is calculated at par value at the most recent time any such debt security is acquired, except that the issuing entity may instead determine the value of any such loan, cash equivalent, or debt security based on its fair market value if: (i) The issuing entity is required to use the fair market value of such assets for purposes of calculating compliance with concentration limitations or other similar calculations under its transaction agreements, and (ii) The issuing entity’s valuation methodology values similarly situated assets consistently. (ii) Impermissible assets. For purposes of this paragraph (c)(8), except as permitted under paragraph (c)(8)(i)(E) 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 paragraphs (c)(8)(iii), (iv), or (v) 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, other than debt securities permitted under paragraph (c)(8)(i)(E) of this section, if those securities are: (A) Cash equivalents—which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the securitization’s expected or potential need for funds and whose currency corresponds to either the underlying loans or the asset-backed securities—for purposes of the rights and assets in paragraph (c)(8)(i)(B) of this section; or E:\FR\FM\31JYR4.SGM 31JYR4 46524 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations (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 derivatives directly relate to the loans, the asset-backed securities, the contractual rights or other assets described in paragraph (c)(8)(i)(B) of this section, or the debt securities described in paragraph (c)(8)(i)(E) of this section; and (B) The derivatives reduce the interest rate and/or foreign exchange risks related to the loans, the asset-backed securities, the contractual rights or other assets described in paragraph (c)(8)(i)(B) of this section, or the debt securities described in paragraph (c)(8)(i)(E) 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. * * * * * (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 composed solely VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 of assets that meet the conditions in paragraph (c)(8)(i) of this section. * * * * * (11) * * * (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 that has voluntarily surrendered its license to operate as a small business investment company in accordance with 13 CFR 107.1900 and does not make any new investments (other than investments in cash equivalents, which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to the issuer’s assets) after such voluntary surrender; (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) and including investments that qualify for consideration under the regulations implementing the Community Reinvestment Act (12 U.S.C. 2901 et seq.); 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; (iii) That has elected to be regulated or is regulated as a rural business investment company, as described in 15 U.S.C. 80b–3(b)(8)(A) or (B), or that has terminated its participation as a rural business investment company in accordance with 7 CFR 4290.1900 and does not make any new investments (other than investments in cash equivalents, which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to the issuer’s assets) after such termination; or (iv) That is a qualified opportunity fund, as defined in 26 U.S.C. 1400Z– 2(d). * * * * * PO 00000 Frm 00104 Fmt 4701 Sfmt 4700 (15) Credit funds. Subject to paragraphs (c)(15)(iii), (iv), and (v) of this section, an issuer that satisfies the asset and activity requirements of paragraphs (c)(15)(i) and (ii) of this section. (i) Asset requirements. The issuer’s assets must be composed solely of: (A) Loans as defined in § 255.2(t); (B) Debt instruments, subject to paragraph (c)(15)(iv) of this section; (C) Rights and other assets that are related or incidental to acquiring, holding, servicing, or selling such loans or debt instruments, provided that: (1) Each right or asset held under this paragraph (c)(15)(i)(C) that is a security is either: (i) A cash equivalent (which, for the purposes of this paragraph, means high quality, highly liquid investments whose maturity corresponds to the issuer’s expected or potential need for funds and whose currency corresponds to either the underlying loans or the debt instruments); (ii) A security received in lieu of debts previously contracted with respect to such loans or debt instruments; or (iii) An equity security (or right to acquire an equity security) received on customary terms in connection with such loans or debt instruments; and (2) Rights or other assets held under this paragraph (c)(15)(i)(C) of this section may not include commodity forward contracts or any derivative; and (D) Interest rate or foreign exchange derivatives, if: (1) The written terms of the derivative directly relate to the loans, debt instruments, or other rights or assets described in paragraph (c)(15)(i)(C) of this section; and (2) The derivative reduces the interest rate and/or foreign exchange risks related to the loans, debt instruments, or other rights or assets described in paragraph (c)(15)(i)(C) of this section. (ii) Activity requirements. To be eligible for the exclusion of paragraph (c)(15) of this section, an issuer must: (A) Not engage in any activity that would constitute proprietary trading under § 255.3(b)(l)(i), as if the issuer were a banking entity; and (B) Not issue asset-backed securities. (iii) Requirements for a sponsor, investment adviser, or commodity trading advisor. A banking entity that acts as a sponsor, investment adviser, or commodity trading advisor to an issuer that meets the conditions in paragraphs (c)(15)(i) and (ii) of this section may not rely on this exclusion unless the banking entity: (A) Provides in writing to any prospective and actual investor in the issuer the disclosures required under E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations § 255.11(a)(8) of this subpart, as if the issuer were a covered fund; (B) Ensures that the activities of the issuer are consistent with safety and soundness standards that are substantially similar to those that would apply if the banking entity engaged in the activities directly; and (C) Complies with the limitations imposed in § 255.14, as if the issuer were a covered fund, except the banking entity may acquire and retain any ownership interest in the issuer. (iv) Additional Banking Entity Requirements. A banking entity may not rely on this exclusion with respect to an issuer that meets the conditions in paragraphs (c)(15)(i) and (ii) of this section unless: (A) The banking entity does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the issuer or of any entity to which such issuer extends credit or in which such issuer invests; and (B) Any assets the issuer holds pursuant to paragraphs (c)(15)(i)(B) or (i)(C)(1)(iii) of this section would be permissible for the banking entity to acquire and hold directly under applicable federal banking laws and regulations. (v) Investment and Relationship Limits. A banking entity’s investment in, and relationship with, the issuer must: (A) Comply with the limitations imposed in § 255.15, as if the issuer were a covered fund; and (B) Be conducted in compliance with, and subject to, applicable banking laws and regulations, including applicable safety and soundness standards. (16) Qualifying venture capital funds. (i) Subject to paragraphs (c)(16)(ii) through (iv) of this section, an issuer that: (A) Is a venture capital fund as defined in 17 CFR 275.203(l)–1; and (B) Does not engage in any activity that would constitute proprietary trading under § 255.3(b)(1)(i), as if the issuer were a banking entity. (ii) A banking entity that acts as a sponsor, investment adviser, or commodity trading advisor to an issuer that meets the conditions in paragraph (c)(16)(i) of this section may not rely on this exclusion unless the banking entity: (A) Provides in writing to any prospective and actual investor in the issuer the disclosures required under § 255.11(a)(8), as if the issuer were a covered fund; (B) Ensures that the activities of the issuer are consistent with safety and soundness standards that are substantially similar to those that would VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 apply if the banking entity engaged in the activities directly; and (C) Complies with the restrictions in § 255.14 as if the issuer were a covered fund (except the banking entity may acquire and retain any ownership interest in the issuer). (iii) The banking entity must not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the issuer. (iv) A banking entity’s ownership interest in or relationship with the issuer must: (A) Comply with the limitations imposed in § 255.15, as if the issuer were a covered fund; and (B) Be conducted in compliance with, and subject to, applicable banking laws and regulations, including applicable safety and soundness standards. (17) Family wealth management vehicles. (i) Subject to paragraph (c)(17)(ii) of this section, any entity that 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, and: (A) If the entity is a trust, the grantor(s) of the entity are all family customers; and (B) If the entity is not a trust: (1) A majority of the voting interests in the entity are owned (directly or indirectly) by family customers; (2) A majority of the interests in the entity are owned (directly or indirectly) by family customers; (3) The entity is owned only by family customers and up to 5 closely related persons of the family customers; and (C) Notwithstanding paragraph (c)(17)(i)(A) and (B) of this section, up to an aggregate 0.5 percent of the entity’s outstanding ownership interests may be acquired or retained by one or more entities that are not family customers or closely related persons if the ownership interest is acquired or retained by such parties for the purpose of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns. (ii) A banking entity may rely on the exclusion in paragraph (c)(17)(i) of this section with respect to an entity provided that the banking entity (or an affiliate): (A) Provides bona fide trust, fiduciary, investment advisory, or commodity trading advisory services to the entity; (B) Does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such entity; (C) Complies with the disclosure obligations under § 255.11(a)(8), as if PO 00000 Frm 00105 Fmt 4701 Sfmt 4700 46525 such entity were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the entity; (D) Does not acquire or retain, as principal, an ownership interest in the entity, other than as described in paragraph (c)(17)(i)(C) of this section; (E) Complies with the requirements of §§ 255.14(b) and 255.15, as if such entity were a covered fund; and (F) Except for riskless principal transactions as defined in paragraph (d)(11) of this section, complies with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the entity were an affiliate thereof. (iii) For purposes of paragraph (c)(17) of this section, the following definitions apply: (A) Closely related person means a natural person (including the estate and estate planning vehicles of such person) who has longstanding business or personal relationships with any family customer. (B) Family customer means: (1) A family client, as defined in Rule 202(a)(11)(G)–1(d)(4) of the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)–1(d)(4)); or (2) Any natural person who is a father-in-law, mother-in-law, brother-inlaw, sister-in-law, son-in-law or daughter-in-law of a family client, or a spouse or a spousal equivalent of any of the foregoing. (18) Customer facilitation vehicles. (i) Subject to paragraph (c)(18)(ii) of this section, an issuer that is formed by or at the request of a customer of the banking entity for the purpose of providing such customer (which may include one or more affiliates of such customer) with exposure to a transaction, investment strategy, or other service provided by the banking entity. (ii) A banking entity may rely on the exclusion in paragraph (c)(18)(i) of this section with respect to an issuer provided that: (A) All of the ownership interests of the issuer are owned by the customer (which may include one or more of its affiliates) for whom the issuer was created; (B) Notwithstanding paragraph (c)(18)(ii)(A) of this section, up to an aggregate 0.5 percent of the issuer’s outstanding ownership interests may be acquired or retained by one or more entities that are not customers if the ownership interest is acquired or retained by such parties for the purpose E:\FR\FM\31JYR4.SGM 31JYR4 46526 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations of and to the extent necessary for establishing corporate separateness or addressing bankruptcy, insolvency, or similar concerns; and (C) The banking entity and its affiliates: (1) Maintain documentation outlining how the banking entity intends to facilitate the customer’s exposure to such transaction, investment strategy, or service; (2) Do not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of such issuer; (3) Comply with the disclosure obligations under § 255.11(a)(8), as if such issuer were a covered fund, provided that the content may be modified to prevent the disclosure from being misleading and the manner of disclosure may be modified to accommodate the specific circumstances of the issuer; (4) Do not acquire or retain, as principal, an ownership interest in the issuer, other than as described in paragraph (c)(18)(ii)(B) of this section; (5) Comply with the requirements of §§ 255.14(b) and 255.15, as if such issuer were a covered fund; and (6) Except for riskless principal transactions as defined in paragraph (d)(11) of this section, comply with the requirements of 12 CFR 223.15(a), as if such banking entity and its affiliates were a member bank and the issuer were an affiliate thereof. * * * * * (d) * * * (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: (1) The rights of a creditor to exercise remedies upon the occurrence of an event of default or an acceleration event; and (2) The right to participate in the removal of an investment manager for ‘‘cause’’ or participate in the selection of a replacement manager upon an investment manager’s resignation or removal. For purposes of this paragraph (d)(6)(i)(A)(2), ‘‘cause’’ for removal of an investment manager means one or more of the following events: (i) The bankruptcy, insolvency, conservatorship or receivership of the investment manager; (ii) The breach by the investment manager of any material provision of the VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 covered fund’s transaction agreements applicable to the investment manager; (iii) The breach by the investment manager of material representations or warranties; (iv) The occurrence of an act that constitutes fraud or criminal activity in the performance of the investment manager’s obligations under the covered fund’s transaction agreements; (v) The indictment of the investment manager for a criminal offense, or the indictment of any officer, member, partner or other principal of the investment manager for a criminal offense materially related to his or her investment management activities; (vi) A change in control with respect to the investment manager; (vii) The loss, separation or incapacitation of an individual critical to the operation of the investment manager or primarily responsible for the management of the covered fund’s assets; or (viii) Other similar events that constitute ‘‘cause’’ for removal of an investment manager, provided that such events are not solely related to the performance of the covered fund or the investment manager’s exercise of investment discretion under the covered fund’s transaction agreements; (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 PO 00000 Frm 00106 Fmt 4701 Sfmt 4700 (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: (A) 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: (1) 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; (2) 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; (3) Any amounts invested in the covered fund, including any amounts paid by the entity in connection with obtaining the restricted profit interest, are within the limits of § 255.12 of this subpart; and (4) 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. (B) Any senior loan or senior debt interest that has the following characteristics: (1) Under the terms of the interest the holders of such interest do not have the right to receive a share of the income, E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations gains, or profits of the covered fund, but are entitled to receive only: (i) Interest at a stated interest rate, as well as commitment fees or other fees, which are not determined by reference to the performance of the underlying assets of the covered fund; and (ii) Repayment of a fixed principal amount, on or before a maturity date, in a contractually-determined manner (which may include prepayment premiums intended solely to reflect, and compensate holders of the interest for, forgone income resulting from an early prepayment); (2) The entitlement to payments under the terms of the interest are absolute and could not be reduced based on losses arising from the underlying assets of the covered fund, such as allocation of losses, writedowns or charge-offs of the outstanding principal balance, or reductions in the amount of interest due and payable on the interest; and (3) The holders of the interest are not entitled to receive the underlying assets of the covered fund after all other interests have been redeemed 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). * * * * * (11) Riskless principal transaction. Riskless principal transaction means a transaction in which a banking entity, after receiving an order from a customer to buy (or sell) a security, purchases (or sells) the security in the secondary market for its own account to offset a contemporaneous sale to (or purchase from) the customer. ■ 32. Amend § 255.12 by: ■ a. Revising paragraph (b)(1)(ii); ■ b. Revising paragraph (b)(4); ■ c. Adding paragraph (b)(5); ■ d. Revising paragraph (c)(1); and ■ e. Revising paragraphs (d) and (e). The revisions and addition read as follows: § 255.12 Permitted investment in a covered fund. * * * * * (b) * * * (1) * * * (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 § 255.10(c)(1) will not be considered to be an affiliate of the banking entity so long as: VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 (A) The banking entity, together with its affiliates, 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) The banking entity, or an affiliate of the banking entity, 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. * * * * * (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 in 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 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 in 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. (5) Parallel Investments and CoInvestments. (i) A banking entity shall not be required to include in the calculation of the investment limits under paragraph (a)(2) of this section any investment the banking entity makes alongside a covered fund as long as the investment is made in compliance with applicable laws and regulations, including applicable safety and soundness standards. (ii) A banking entity shall not be restricted under this section in the amount of any investment the banking entity makes alongside a covered fund as long as the investment is made in PO 00000 Frm 00107 Fmt 4701 Sfmt 4700 46527 compliance with applicable laws and regulations, including applicable safety and soundness standards. (c) * * * (1)(i) 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 in connection with obtaining a restricted profit interest under § 255.10(d)(6)(ii)), on a historical cost basis; (ii) Treatment of employee and director restricted profit interests financed by the banking entity. For purposes of paragraph (c)(1)(i) of this section, an investment by a director or employee of a banking entity who acquires a restricted profit 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 restricted profit interest in the fund and the financing is used to acquire such ownership interest in the covered fund. * * * * * (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)(i) 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 in connection with obtaining a restricted profit interest under § 255.10(d)(6)(ii) of subpart C of this part), on a historical cost basis, plus any earnings received; and (ii) 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 in connection with obtaining a restricted profit interest under § 255.10(d)(6)(ii) of subpart C of this part), if the banking entity accounts for the profits (or losses) of the fund investment in its financial statements. (2) Treatment of employee and director restricted profit interests financed by the banking entity. For purposes of paragraph (d)(1) of this section, an investment by a director or E:\FR\FM\31JYR4.SGM 31JYR4 46528 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations employee of a banking entity who acquires a restricted profit 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 restricted profit interest in the fund and the financing is used to acquire such ownership interest in the covered fund. (e) Extension of time to divest an ownership interest. (1) Extension period. 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. (2) Application requirements. 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)(3) 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. (3) 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 VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 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. (4) 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. (5) 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. ■ 33. Amend § 255.13 by adding paragraph (d) to read as follows: § 255.13 Other permitted covered fund activities and investments. * * * * * (d) Permitted covered fund activities and investments of qualifying foreign excluded funds. (1) The prohibition contained in § 255.10(a) does not apply to a qualifying foreign excluded fund. (2) For purposes of this paragraph (d), a qualifying foreign excluded fund means a banking entity that: (i) Is organized or established outside the United States, and the ownership interests of which are offered and sold solely outside the United States; (ii)(A) Would be a covered fund if the entity were organized or established in the United States, or (B) Is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments; (iii) Would not otherwise be a banking entity except by virtue of the acquisition or retention of an ownership interest in, sponsorship of, or relationship with the entity, by another banking entity that meets the following: PO 00000 Frm 00108 Fmt 4701 Sfmt 4700 (A) 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; and (B) The banking entity’s acquisition of an ownership interest in or sponsorship of the fund by the foreign banking entity meets the requirements for permitted covered fund activities and investments solely outside the United States, as provided in § 255.13(b); (iv) Is established and operated as part of a bona fide asset management business; and (v) Is not operated in a manner that enables the banking entity that sponsors or controls the qualifying foreign excluded fund, or any of its affiliates, to evade the requirements of section 13 of the BHC Act or this part. ■ 34. Amend § 255.14 by: ■ a. Revising paragraph (a)(2)(i); ■ b. Revising paragraph (a)(2)(ii)(C); ■ c. Adding paragraphs (a)(2)(iii), (iv), (v), and (3); and ■ d. Revising paragraph (c). The revisions and additions read as follows: § 255.14 Limitations on relationships with a covered fund. (a) * * * (2) * * * (i) Acquire and retain any ownership interest in a covered fund in accordance with the requirements of §§ 255.11, 255.12, or 255.13; (ii) * * * (C) The Board has not determined that such transaction is inconsistent with the safe and sound operation and condition of the banking entity; and (iii) Enter into a transaction with a covered fund that would be an exempt covered transaction under 12 U.S.C. 371c(d) or § 223.42 of the Board’s Regulation W (12 CFR 223.42) subject to the limitations specified under 12 U.S.C. 371c(d) or § 223.42 of the Board’s Regulation W (12 CFR 223.42), as applicable, (iv) Enter into a riskless principal transaction with a covered fund; and (v) Extend credit to or purchase assets from a covered fund, provided: (A) Each extension of credit or purchase of assets is in the ordinary course of business in connection with payment transactions; settlement services; or futures, derivatives, and securities clearing; (B) Each extension of credit is repaid, sold, or terminated by the end of five business days; and (C) The banking entity making each extension of credit meets the requirements of § 223.42(l)(1)(i) and (ii) of the Board’s Regulation W (12 CFR E:\FR\FM\31JYR4.SGM 31JYR4 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations 223.42(l)(1)(i) and(ii)), as if the extension of credit was an intraday extension of credit, regardless of the duration of the extension of credit. (3) Any transaction or activity permitted under paragraphs (a)(2)(iii), (iv) or (v) must comply with the limitations in § 255.15. * * * * * (c) Restrictions on other permitted transactions. Any transaction permitted under paragraphs (a)(2)(ii), (iii), or (iv) 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 under section 23B. Subpart D—Compliance Program Requirements; Violations 35. Amend § 255.20 by: ■ a. Revising paragraph (a); ■ b. Revising the heading of paragraph (d) and revising paragraph (d)(1); and ■ c. Revising the introductory text of paragraph (e). The revisions and addition read as follows: ■ § 255.20 Program for compliance; reporting. (a) Program requirement. Each banking entity (other than a banking entity with limited trading assets and liabilities or a qualifying foreign excluded fund under section 255.6(f) or 255.13(d)) 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. * * * * * (d) Reporting requirements under appendix A to this part. (1) A banking entity (other than a qualifying foreign excluded fund under section 255.6(f) or 255.13(d)) engaged in proprietary trading activity permitted under subpart B shall comply with the reporting requirements described in appendix A to this part, if: * * * * * (e) Additional documentation for covered funds. A banking entity with significant trading assets and liabilities (other than a qualifying foreign excluded fund under section 255.6(f) or VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 255.13(d)) shall maintain records that include: * * * * * Brian P. Brooks, Acting Comptroller of the Currency. By order of the Board of Governors of the Federal Reserve System. Ann E. Misback, Secretary of the Board. Federal Deposit Insurance Corporation. By order of the Board of Directors. Dated at Washington, DC, on or about June 25, 2020. James P. Sheesley, Acting Assistant Executive Secretary. Issued in Washington, DC, on June 25, 2020 by the Commission. Christopher Kirkpatrick, Secretary of the Commission. By the Securities and Exchange Commission. Vanessa A. Countryman, Secretary. Note: The following appendices will not appear in the Code of Federal Regulations. Appendices to Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds—CFTC Voting Summary and CFTC Commissioners’ Statements Appendix 1—CFTC Voting Summary On this matter, CFTC Chairman Tarbert and Commissioners Quintenz and Stump voted in the affirmative. CFTC 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. Appendix 2—Supporting Statement of CFTC Chairman Heath P. Tarbert As I have previously remarked, the Volcker Rule is ‘‘among the most well-intentioned but poorly designed regulations in the history of American finance.’’ 1 While today’s final rule does not fix the fundamental flaws of the Volcker Rule 2—only congressional action can do that—it at least represents a more accurate reading of the law Congress actually passed and brings us a step closer to a reasonable implementation of the rule.3 1 See Statement of Chairman Heath P. Tarbert in Support of Revisions to the Volcker Rule (Sept. 16, 2019), https://www.cftc.gov/PressRoom/ SpeechesTestimony/tarbertstatement091619. 2 See, e.g., Economic Growth, Regulatory Relief, and Consumer Protection Act, Public Law No: 115– 174 (May 24, 2018) (amending section 13 of the Bank Holding Company Act by narrowing the definition of ‘‘banking entity’’ in the Volcker Rule to exclude certain community banks). 3 See Statement of Chairman Heath P. Tarbert in Support of Further Revisions to the Volcker Rule (Jan. 30, 2020), https://www.cftc.gov/PressRoom/ SpeechesTestimony/tarbertstatement013020b. PO 00000 Frm 00109 Fmt 4701 Sfmt 4700 46529 Specifically, the Volcker Rule will now no longer be applied to investments Congress never intended to be included in the first place, such as credit funds, venture capital funds, customer facilitation vehicles, and family wealth management vehicles. The final rule also contains important modifications to several existing exclusions from the prohibition on activities related to private equity and hedge funds (the ‘‘covered funds’’ provisions)—for foreign public funds, loan securitizations, and small business investment companies. In these ways, the final rule begins to address the over-breadth of the covered funds definition and related requirements. I am therefore pleased to support adoption of the proposed revisions to the Volcker Rule’s covered funds provisions. While only a modest step forward, these refinements will nonetheless enhance the regulatory experience and provide clarity for market participants who have struggled to comply with the Volcker Rule. Appendix 3—Dissenting Statement of CFTC Commissioner Rostin Behnam I respectfully dissent as to the Commission’s decision to finalize additional revisions to the Volcker Rule. As we approach the ten year anniversary of the Dodd-Frank Act,1 and cautiously begin mapping a path out of the current pandemic, I believe it is a good time to reflect on the lessons learned from the 2008 financial crisis, the efficacy of our responses, and whether our objectives have changed, or just our perspective. One of the many critically important provisions of the Dodd-Frank Act is the Volcker Rule. The Volcker Rule, in simple terms, contains two basic prohibitions: (1) Banking entities may not engage in proprietary trading; and (2) banking entities cannot have an ownership interest in, sponsor, or have certain relationships with a covered fund. Last September, the Commission, along with other Federal agencies (the ‘‘Agencies’’),2 approved changes that significantly weakened the prohibition on propriety trading by narrowing the scope of financial instruments subject to the Volcker Rule.3 I did not support those changes.4 Today, the Commission, again in tandem with the Agencies, completes the dismantling that began in 2018,5 and votes to significantly weaken the prohibition on ownership of 1 Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111–203, 124 Stat. 1376 (2010). 2 The Office of the Comptroller of the Currency, Treasury; the Board of Governors of the Federal Reserve System; the Federal Deposit Insurance Corporation; and the Securities and Exchange Commission. 3 Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 84 FR 61974 (Nov. 14, 2019). 4 Id. at 62275. 5 See Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 83 FR 33432 (proposed July 17, 2018). E:\FR\FM\31JYR4.SGM 31JYR4 46530 Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules and Regulations covered funds. Again, I cannot support these changes. I voted against the 2018 proposal, and earlier this year, voted against the proposal that strikes the final blow today.6 In voting against the 2020 proposal, I quoted the late Paul Volcker’s letter to the Chairman of the Federal Reserve, which he penned last September, when the Agencies approved the changes breaking down the proprietary trading prohibition.7 Mr. Volcker warned that the amended 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.’’ 8 Mr. Volcker’s words apply equally well to the changes that the Commission finalizes today regarding covered funds—particularly the erosion of the existing protections regarding conflicts of interest. As the tenth anniversary of the Dodd-Frank Act sadly coincides with a different kind of crisis, I think it is critical to take a hard look at how far we have come in ten years, and how well markets have adapted to carefully crafted policy intended to create a more resilient financial system. Chipping away, particularly at a time of great uncertainty, risks a reversion to the past, when in fact, we should only be looking forward. Appendix 4—Dissenting Statement of CFTC Commissioner Dan M. Berkovitz The Volcker covered funds final release (‘‘Covered Funds Rule’’) adopts with only minor changes the rule amendments as proposed by the agencies in January of this year (‘‘the Proposal’’). I voted against 1 the Proposal because the agencies had only superficially considered the additional risks that banks would incur under the loosened regulations. Nothing in the Covered Funds Rule final release dispels this concern. Therefore I dissent from the final release. Congress enacted the original Volcker rule after the 2008 financial crisis to protect American taxpayers from again having to bailout banks that are insured by the FDIC or 6 Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 85 FR 12120, 12204 (proposed Feb. 28, 2020). 7 Id. 8 Jesse Hamilton and Yalman Onaran, ‘‘Volcker 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. 1 Dissenting Statement of Commissioner Dan M. Berkovitz Regarding Volcker Covered Funds Proposal (Jan. 30, 2020), available at: https:// www.cftc.gov/PressRoom/SpeechesTestimony/ berkovitzstatement013020. VerDate Sep<11>2014 20:59 Jul 30, 2020 Jkt 250001 have access to Federal Reserve Bank financial support. This goal was to be achieved by preventing the government-supported banks from undertaking risky proprietary trading activities and from owning hedge funds or private equity funds. The new Covered Funds Rule, together with the rollbacks in the Volcker proprietary trading regulations adopted in 2019,2 will undermine many of the risk-reducing benefits of the original Volcker rule. The original Volcker covered funds regulations were not perfect. The foreign public funds exception and the so called ‘‘super 23A’’ provisions governing activities banks can undertake with covered funds needed careful adjustments. However, the Covered Funds Rule goes much, much further. It creates broad new exclusions from the covered funds definition with inadequate analysis as to whether these activities were intended to be permitted under the statute or pose serious risk to the banks and the United States financial system. I addressed some of these new exclusions in more detail in my dissenting statement on the Proposal.3 Of these, the new ‘‘venture capital funds’’ exclusion perhaps best illustrates the extent to which the Covered Funds Rule undermines the very purpose of the Volcker rule. Venture capital serves an important function in our financial markets by providing needed capital to startup companies. But venture capital investing is very risky. One study found that about 75% of venture capital-backed firms in the United States did not return capital to investors.4 Another article on venture capital noted that ‘‘VC funds haven’t significantly outperformed the public markets since the late 1990s, and since 1997 less cash has been returned to VC investors than they have invested.’’ 5 This is exactly the type of risky private equity fund 6 investing by 2 Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds, 84 FR 61974 (Nov. 14, 2019). 3 Supra footnote 1. 4 Deborah Gage, The Venture Capital Secret: 3 out of 4 Start-Ups Fail, Wall Street Journal (Sept. 20, 2012) (citing research by Shikhar Ghosh, a senior lecturer at Harvard Business School), available at https://www.wsj.com/articles/SB100008723963904 43720204578004980476429190. 5 Diane Mulcahy, Six Myths About Venture Capitalists, Harvard Business Review (May 2013), available at https://hbr.org/2013/05/six-mythsabout-venture-capitalists. 6 Interestingly, while the Proposal acknowledged that venture capital funds are a subset of private equity funds for purposes of Volcker, in the preamble to the Covered Funds Rule, the agencies provide a tortured, speculative analysis of statutory construction trying to explain that Congress ‘‘may’’ have meant to exclude venture capital funds, PO 00000 Frm 00110 Fmt 4701 Sfmt 9990 government-supported banks that Congress intended the Volcker rule to curtail. In adopting the Covered Funds Rule, the agencies failed to analyze any data or other information that lays out the risks of venture capital investing. The agencies simply exclude venture capital funds from Volcker regulation. The Covered Funds Rule makes, at best, a weak case that venture capital investments promote and protect the safety and soundness of banking entities and the United States financial system by allowing banks to diversify investments. The weakness of that assertion is clear when one considers that allowing any investments in hedge funds and private equity funds would do the same, and yet that risk taking activity is precisely what Congress prohibited. The banking industry does not need to take on the additional risks permitted by the Covered Funds Rule to be successful. U.S. banks have performed well in recent years. Recent Global League Tables ranking global banks by amount of banking business activity shows that three or four U.S. banks are ranked among the top five banks in the world in almost every table, including the tables for foreign markets banking.7 While many factors impact banking success, the relative strength of U.S. banks internationally belies suggestions that the new laws and regulations adopted in the wake of the 2008 financial crisis are hurting the competitiveness of U.S. banks. We should recognize, rather than undermine, the success of U.S. banks since the 2008 financial crisis and adoption of the Dodd-Frank Act in 2010. To date, U.S. banks also have performed well during the Covid-19 pandemic. But our financial system continues to face many extraordinary risks from the effects of the pandemic. In the middle of this latest shock to our financial system, we should not be rushing out a final rule that permits greater risk taking by banks. Rather, we should take stock of the data available to us, and make carefully reasoned, incremental changes that are consistent with the Congressional intent for the Volcker rule. [FR Doc. 2020–15525 Filed 7–30–20; 8:45 am] BILLING CODE 4810–33–P despite no real evidence to that effect. To the contrary, three of the four statements from members of Congress in the legislative record cited in the Covered Funds Rule clearly show that they assumed that venture capital funds are private equity funds under the Volcker rule. See Covered Funds Rule, section IV.C.2.i. 7 See GlobalCapital.com, Global League Tables, available at https://www.globalcapital.com/data/allleague-tables. E:\FR\FM\31JYR4.SGM 31JYR4

Agencies

[Federal Register Volume 85, Number 148 (Friday, July 31, 2020)]
[Rules and Regulations]
[Pages 46422-46530]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-15525]



[[Page 46421]]

Vol. 85

Friday,

No. 148

July 31, 2020

Part IV





 Department of the Treasury





-----------------------------------------------------------------------





 Office of the Comptroller of the Currency





-----------------------------------------------------------------------





 Federal Reserve System





-----------------------------------------------------------------------





 Federal Deposit Insurance Corporation





-----------------------------------------------------------------------





 Commodity Futures Trading Commission





-----------------------------------------------------------------------





 Securities and Exchange Commission





-----------------------------------------------------------------------





12 CFR Parts 44, 248 and 351

17 CFR Parts 75 and 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. 85, No. 148 / Friday, July 31, 2020 / Rules 
and Regulations

[[Page 46422]]


-----------------------------------------------------------------------

DEPARTMENT OF TREASURY

Office of the Comptroller of the Currency

12 CFR Part 44

[Docket No. OCC-2020-0002]
RIN 1557-AE67

FEDERAL RESERVE SYSTEM

12 CFR Part 248

[Docket No. R-1694]
RIN 7100-AF70

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 351

RIN 3064-AF17

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 75

RIN 3038-AE93

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 255

[Release No. BHCA-9; File No. S7-02-20]
RIN 3235-AM70


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.

-----------------------------------------------------------------------

SUMMARY: The OCC, Board, FDIC, SEC, and CFTC (together, the agencies) 
are adopting amendments to the regulations implementing section 13 of 
the Bank Holding Company Act (BHC Act). Section 13 contains certain 
restrictions on the ability of a banking entity or 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 (covered funds). These final amendments are 
intended to improve and streamline the regulations implementing section 
13 of the BHC Act by modifying and clarifying requirements related to 
the covered fund provisions of the rules.

DATES: Effective date: The final rule is effective October 1, 2020.

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, Elizabeth MacDonald, Manager, (202) 475-6316, Cecily Boggs, 
Senior Financial Institution Policy Analyst, (202) 530-6209, Brendan 
Rowan, Senior Financial Institution Policy Analyst, (202) 475-6685, 
Christopher Powell, Senior Financial Institution Policy Analyst, (202) 
452-3442, Nathaniel Grant, Lead Financial Institution Policy Analyst, 
(202) 452-3105, 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], 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.
    CFTC: Cantrell Dumas, Special Counsel, (202) 418-5043, 
[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.
    SEC: Juliet M. Han, Senior Counsel, William Miller, Senior Counsel, 
Benjamin A. Tecmire, Senior Counsel, or Jennifer Songer, Branch Chief 
at (202) 551-6787 or [email protected], Investment Adviser Regulation 
Office, Division of Investment Management, and Katherine Hsu, Office 
Chief, or Benjamin Meeks, Special Counsel at (202) 551-3850, Office of 
Structured Finance, Division of Corporation Finance, U.S. Securities 
and Exchange Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
II. Notice of Proposed Rulemaking
III. Overview of the Final Rule
IV. Summary of the Final Rule
    A. Qualifying Foreign Excluded Funds
    B. Modifications to Existing Covered Fund Exclusions
    1. Foreign Public Funds
    2. Loan Securitizations
    3. Public Welfare and Small Business Funds
    C. Additional Covered Fund Exclusions
    1. Credit Funds
    2. Venture Capital Funds
    3. Family Wealth Management Vehicles
    4. Customer Facilitation Vehicles
    D. Limitations on Relationships With a Covered Fund
    E. Ownership Interest
    F. Parallel Investments
    G. Technical Amendments
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
    F. SEC Economic Analysis
    G. Congressional Review Act

I. Background

    Section 13 of the BHC Act,\1\ also known as the Volcker Rule, 
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 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.
---------------------------------------------------------------------------

     Underwriting and market making-related activities;
     Risk-mitigating hedging activities;
     Activities on behalf of customers;
     Activities for the general account of insurance companies; 
and
     Trading and covered fund activities and investments by 
non-U.S. banking entities solely outside the United States.\3\
---------------------------------------------------------------------------

    \3\ 12 U.S.C. 1851(d)(1).
---------------------------------------------------------------------------

    In addition, section 13 of the BHC Act contains an exemption that 
permits banking entities to organize and offer, including sponsor, 
covered funds, subject to certain restrictions, including

[[Page 46423]]

that banking entities do not rescue investors in those funds from loss, 
and are not themselves exposed to significant losses due to investments 
in or other relationships with these funds.\4\
---------------------------------------------------------------------------

    \4\ 12 U.S.C. 1851(d)(1)(G). Other restrictions and requirements 
include: (1) The banking entity provides bona fide trust, fiduciary, 
or investment advisory services; (2) the fund is organized and 
offered only to customers in connection with the provision of such 
services; (3) the banking entity does not have an ownership interest 
in the fund, except for a de minimis investment; (4) the banking 
entity complies with certain marketing restrictions related to the 
fund; (5) no director or employee of the banking entity has an 
ownership interest in the fund, with certain exceptions; and (6) the 
banking entity discloses to investors that it does not guarantee the 
performance of the fund. Id.
---------------------------------------------------------------------------

    Authority under section 13 of the BHC Act for developing and 
adopting regulations to implement the prohibitions, restrictions, and 
exemptions of section 13 is shared among the Board, the FDIC, the OCC, 
the SEC, and the CFTC (individually, an agency, and collectively, the 
agencies).\5\ The agencies originally issued a final rule implementing 
section 13 in December 2013 (the 2013 rule), and those provisions 
became effective on April 1, 2014.\6\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    The agencies published a notice of proposed rulemaking in July 2018 
(the 2018 proposal) that proposed several amendments to the 2013 
rule.\7\ These proposed revisions sought to provide greater clarity and 
certainty about what activities are prohibited under the 2013 rule--in 
particular, under the prohibition on proprietary trading--and to better 
tailor the compliance requirements based on the risk of a banking 
entity's trading activities. The agencies issued a final rule 
implementing amendments to the 2013 rule in November 2019 (the 2019 
amendments), and those provisions became effective in January 2020.\8\
---------------------------------------------------------------------------

    \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\ Prohibitions and Restrictions on Proprietary Trading and 
Certain Interests in, and Relationships With, Hedge Funds and 
Private Equity Funds, 84 FR 61974 (Nov. 14, 2019). The regulations 
implementing section 13 of the BHC Act, as amended through June 1, 
2020, are referred throughout as the ``implementing regulations.''
---------------------------------------------------------------------------

    As part of the 2018 proposal, the agencies proposed targeted 
changes to the provisions of the 2013 rule relating to acquiring or 
retaining an ownership interest in, sponsoring, or having certain 
relationships with a fund and sought comments on other aspects of the 
covered fund provisions beyond those changes for which specific rule 
text was proposed.\9\ The 2019 amendments finalized those changes to 
the covered fund provisions for which specific rule text was proposed 
in the 2018 proposal.\10\ The agencies indicated they would issue a 
separate proposal addressing and requesting comment on the covered fund 
provisions of the rule and other fund-related issues, and, in February 
2020, the agencies issued a separate notice of proposed rulemaking that 
specifically addressed those areas (the 2020 proposal).\11\
---------------------------------------------------------------------------

    \9\ 83 FR 33471-87.
    \10\ In response to the 2018 proposal, the agencies received 
numerous comments related to covered fund issues for which no 
specific rule text was proposed. However, in the preamble to the 
2019 amendments, the agencies generally deferred public 
consideration of such comments to a future proposed rulemaking. 84 
FR 62016.
    \11\ Prohibitions and Restrictions on Proprietary Trading and 
Certain Interests in, and Relationships With, Hedge Funds and 
Private Equity Funds, 85 FR 12120 (Feb. 28, 2020).
---------------------------------------------------------------------------

II. Notice of Proposed Rulemaking

    In the 2020 proposal, the agencies proposed revisions to a number 
of the provisions regarding covered fund investments and activities as 
well as to other provisions of the implementing regulations related to 
the treatment of funds. The proposed changes, which were based on 
comments received in response to the agencies' questions in the 2018 
proposal and the agencies' experience with the implementing 
regulations, were intended to reduce the extraterritorial impact of the 
implementing regulations, improve and streamline the covered fund 
provisions, and provide clarity to banking entities regarding the 
provision of financial services and the conduct of permissible 
activities in a manner that is consistent with the requirements of 
section 13 of the BHC Act.
    To better limit the extraterritorial impact of the implementing 
regulations, the 2020 proposal would have exempted the activities of 
certain funds that are organized outside of the United States and 
offered to foreign investors (qualifying foreign excluded funds) from 
the restrictions of the implementing regulations. Under the 2013 rule, 
in certain circumstances, some foreign funds that are not ``covered 
funds'' may be subject to the implementing regulations as ``banking 
entities,'' if they are controlled by a foreign banking entity, and 
thus could be subject to more onerous compliance obligations than are 
imposed on similarly-situated U.S. covered funds, even though the 
foreign funds have limited nexus to the United States. Accordingly, the 
2020 proposal would have codified an existing policy statement by the 
Federal banking agencies (the OCC, Board, and FDIC) that addresses the 
potential issues related to a foreign banking entity controlling 
qualifying foreign excluded funds.
    The 2020 proposal also would have made modifications to several 
existing exclusions from the covered fund provisions to provide clarity 
and simplify compliance with the requirements of the implementing 
regulations. First, the 2020 proposal would have revised certain 
restrictions in the foreign public funds exclusion to more closely 
align the provision with the exclusion for similarly-situated U.S. 
registered investment companies. Second, the 2020 proposal would have 
permitted loan securitizations excluded from the definition of covered 
fund to hold a small amount of non-loan assets, consistent with past 
industry practice, and would have codified existing staff-level 
guidance regarding this exclusion. In addition, the 2020 proposal would 
have revised the exclusion for small business investment companies to 
account for the life cycle of those companies and requested comment on 
whether to clarify the scope of the exclusion for public welfare and 
other investments to include rural business investment companies and 
qualified opportunity funds. Finally, the 2020 proposal would have 
addressed concerns about certain components of the preamble to the 2013 
rule related to calculating a banking entity's ownership interests in 
covered funds.
    The agencies also included in the 2020 proposal several new 
exclusions from the covered fund definition in order to more directly 
align the regulation with the purpose of the statute. For example, the 
agencies recognized that the implementing regulations have inhibited 
banking entities' ability to extend credit by restricting their 
relationships with credit funds, and the 2020 proposal would have 
created a new exclusion for such funds. Under the 2020 proposal, 
banking entities would have been able to invest in and have certain 
relationships with credit funds that extend the type of credit that a 
banking entity may provide directly, subject to certain safeguards. 
Relatedly, the 2020 proposal would have established an exclusion from 
the definition of covered fund for venture capital funds. This 
provision was intended to facilitate banking entities' abilities to 
engage in this important type of development and investment activity, 
which may facilitate capital formation and provide important financing 
for small

[[Page 46424]]

businesses, particularly in areas where such financing may not be 
readily available. In addition, the agencies believed that excluding 
such activities would be consistent with the purpose of the statute, as 
it would exclude fund activities that do not present the risks that 
section 13 of the BHC Act was intended to address.
    The 2020 proposal also would have allowed a banking entity to 
provide certain traditional financial services to its customers via a 
fund structure, subject to certain safeguards and limitations. First, 
the 2020 proposal would have excluded from the definition of covered 
fund an entity created and used to facilitate customer exposures to a 
transaction, investment strategy, or other service. Second, the 2020 
proposal would have excluded from the covered fund definition wealth 
management vehicles that manage the investment portfolio of a family 
and certain other closely related persons. Both of these provisions 
were intended to allow a banking entity to provide such services in the 
manner best suited to its customers.
    In addition, the 2020 proposal would have permitted a banking 
entity to engage in a limited set of covered transactions with a 
covered fund that the banking entity sponsors or advises or with which 
the banking entity has certain other relationships. The implementing 
regulations generally prohibit all covered transactions between a 
covered fund and its banking entity sponsor or investment adviser. The 
agencies, in the 2020 proposal, recognized that the existing 
restrictions have prevented banking entities from providing certain 
traditional banking services to covered funds, such as standard 
payment, clearing, and settlement services.
    Lastly, the 2020 proposal would have clarified certain aspects of 
the definition of ownership interest. Currently, due to the broad 
definition of ownership interest, some loans by banking entities to 
covered funds could be deemed ownership interests. The 2020 proposal 
included a safe harbor for bona fide senior loans or senior debt 
instruments to make clear that an ``ownership interest'' in a fund 
would not include such credit interests in the fund. In addition, the 
2020 proposal would have clarified the types of creditor rights that 
may attach to an interest without necessarily causing such an interest 
to fall within the scope of the definition of ownership interest. 
Finally, the 2020 proposal would have simplified compliance efforts by 
tailoring the calculation of a banking entity's compliance with the 
implementing regulations' aggregate fund limit and covered fund 
deduction and provided clarity to banking entities regarding their 
permissible investments made alongside covered funds.\12\
---------------------------------------------------------------------------

    \12\ Separately, the agencies proposed various technical edits 
to the implementing regulations. See infra Section IV.G (Technical 
Amendments).
---------------------------------------------------------------------------

    The agencies invited comment on all aspects of the 2020 proposal, 
including specific proposed revisions and questions posed by the 
agencies. The agencies received approximately 40 unique comments from 
banking entities and industry groups, public interest groups, and other 
organizations and individuals. In addition, the agencies received six 
letters related to the subject matter considered in the 2020 proposal 
prior to the formal comment period. The agencies are now finalizing the 
2020 proposal, with certain changes based on public comments, as 
described in detail below.\13\
---------------------------------------------------------------------------

    \13\ Comments are generally discussed in the relevant sections, 
infra. The agencies also received several miscellaneous comments. 
One commenter suggested revising Sec.  __.21 (Termination of 
activities or investments; penalties for violations) of the 
implementing regulations to provide for mandatory prison time for 
violations of the implementing regulations. Anonymous. The agencies 
believe that this comment is beyond the scope of the current 
rulemaking. Another commenter encouraged the agencies to exempt from 
the implementing regulations international banks with a small 
presence in the United States. Institute of International Bankers 
(IIB). The agencies believe that this comment is beyond the scope of 
the current rulemaking. A third commenter claimed that the 2020 
proposal improperly assumed that the implementing regulations have 
certain burdens and that it did not adequately assess the costs and 
benefits of the proposed revisions to the implementing regulations. 
Occupy the SEC (Occupy). Contrary to the commenter's suggestions, 
the Federal Register notice for the 2020 proposal contained 
extensive discussion of the costs and benefits of the 2020 proposal. 
See 85 FR 12151-76. This final rule contains similar analyses. See 
infra, Section IV (Administrative Law Matters). Several commenters 
expressed support for the comment letters submitted by other 
organizations. E.g., IIB; European Banking Federation (EBF); Goldman 
Sachs Group, Inc. (Goldman Sachs); and Canadian Bankers Association 
(CBA). Finally, one comment was not relevant. See Charity Colleen 
Crouse.
---------------------------------------------------------------------------

III. Overview of the Final Rule

    Similar to the 2020 proposal, the final rule clarifies and 
simplifies compliance with the implementing regulations, refines the 
extraterritorial application of section 13 of the BHC Act, and permits 
additional fund activities that do not present the risks that section 
13 was intended to address. The agencies received comments from a 
diverse set of commenters: Comments from banking entities and financial 
services industry trade groups were generally supportive of the 2020 
proposal and recommended additional modifications, while several 
organizations and individuals were generally opposed to the 2020 
proposal. As described further below, the agencies have adopted many of 
the proposed changes to the implementing regulations, with certain 
targeted adjustments.
    To reduce the extraterritorial impact of the implementing 
regulations, the final rule, similar to the 2020 proposal, exempts the 
activities of certain funds that are organized outside of the United 
States and offered to foreign investors (qualifying foreign excluded 
funds) from certain restrictions of the implementing regulations. 
Specifically, the final rule codifies an existing policy statement by 
the Federal banking agencies that addresses the potential issues 
related to a foreign banking entity controlling a qualifying foreign 
excluded fund. The final rule contains some modifications to the 
proposed exemption--the anti-evasion provision and compliance program 
requirements--to address comments that the proposed exemption would 
have unintentionally continued to subject qualifying foreign excluded 
funds to these requirements.
    The final rule also revises, as proposed, but with some 
modifications, several existing exclusions from the covered fund 
provisions, to provide clarity and simplify compliance with the 
requirements of the implementing regulations. First, the final rule 
revises certain restrictions in the foreign public funds exclusion to 
more closely align the provision with the exclusion for similarly 
situated U.S. registered investment companies. Second, the final rule 
permits loan securitizations excluded from the definition of covered 
fund to hold a small amount of debt securities, consistent with past 
industry practice, and codifies existing staff-level guidance regarding 
this exclusion. In addition, the final rule revises the exclusion for 
small business investment companies to account for the life cycle of 
those companies and clarifies the scope of the exclusion for public 
welfare and other investments to include rural business investment 
companies and qualified opportunity funds. Finally, the final rule 
clarifies the calculation of ownership interests in covered funds that 
are attributed to a banking entity.
    The final rule adopts--as proposed, with some modifications--
several new exclusions from the covered fund definition to more closely 
align the regulation with the purpose of the statute. First, the final 
rule establishes a new exclusion for funds that extend credit to permit 
the same credit-related activities that banking entities can engage in 
directly. In addition, the final rule creates an exclusion for venture 
capital funds to help ensure that banking entities can indirectly 
facilitate

[[Page 46425]]

this important type of development and investment activity to the same 
degree that banking entities can do so directly. Finally, the final 
rule adopts two exclusions for family wealth management and customer 
facilitation vehicles to provide banking entities flexibility to 
provide advisory and other traditional banking services to customers 
through a fund structure.
    In an effort to clarify and simplify compliance with the 
implementing regulations, the final rule adopts revisions to the 
provisions that govern the relationship between a banking entity and a 
fund and the definition of ownership interest. Specifically, the final 
rule permits established, codified categories of limited low-risk 
transactions between a banking entity and a related fund, including 
riskless principal transactions, and allows a banking entity to engage 
in certain transactions with a related fund in connection with payment, 
clearing, and settlement activities. In addition, the final rule would 
provide an express safe harbor for senior loans and senior debt and 
provide clarity about the types of creditor rights that would be 
considered within the scope of the definition of ownership interest. 
Finally, the agencies are adopting revisions, as proposed, to provide 
clarity regarding a banking entity's permissible investments in the 
same investments as a covered fund organized or offered by such banking 
entity.

Frequently Asked Questions

    The staffs of the agencies have addressed several questions 
concerning the implementing regulations through a series of staff 
Frequently Asked Questions (FAQs).\14\ In the 2020 proposal, the 
agencies indicated that the proposed rule would not modify or revoke 
any previously issued staff FAQs, unless otherwise specified.\15\ 
Several commenters recommended codifying specific FAQs and making 
explicit that other FAQs would continue to be in effect, 
unmodified.\16\ Consistent with the 2020 proposal and commenters' 
suggestions, the final rule does not modify or revoke any previously 
issued staff FAQs, unless otherwise specified.\17\
---------------------------------------------------------------------------

    \14\ 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-volcker-rule-section13.htm (SEC); https://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_28_VolckerRule/index.htm 
(CFTC).
    \15\ 85 FR 12122-23.
    \16\ E.g., Securities Industry and Financial Markets Association 
(SIFMA); Financial Services Forum (FSF); and IIB.
    \17\ 85 FR 12122-23.
---------------------------------------------------------------------------

Comment Period

    Since the issuance of the 2020 proposal, the COVID-19 global 
pandemic has substantially disrupted activity in the United States and 
in other countries. The effects of the COVID-19 disruptions have 
created many challenges for households and businesses, and the agencies 
received comments requesting that the agencies extend the comment 
period for the 2020 proposal or delay the rulemaking more 
generally.\18\ In contrast, one commenter expressed support for the 
rapid approval of the 2020 proposal, to provide banking entities 
regulatory relief during a period of financial stress.\19\ The agencies 
announced on April 2, 2020, that they would consider comments submitted 
before May 1, 2020.\20\ The agencies, however, do not believe that 
further delay of the rule is warranted, given the volume, depth, and 
diversity of comments submitted. The agencies believe, as well, that 
the final rule may provide clarity to banking entities that will enable 
banking entities to engage in financial services and other permissible 
activities in a manner that both is consistent with the requirements of 
section 13 of the BHC Act and will facilitate capital formation and 
economic activity.
---------------------------------------------------------------------------

    \18\ E.g., Better Markets, Inc. (Better Markets) and Kathy 
Bowman.
    \19\ American Bankers Association (ABA).
    \20\ https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200402a.htm.
---------------------------------------------------------------------------

Effective and Compliance Dates

    The Federal Register notice accompanying the finalization of the 
2019 amendments provided for a rolling compliance system.\21\ The 
effective date of the amendments was January 1, 2020, and firms are 
required to comply with the revisions by January 1, 2021. Until the 
mandatory compliance date, banking entities are required to comply with 
the 2013 rule, or alternatively, a banking entity may voluntarily 
comply, in whole or in part, with the 2019 amendments prior to the 
compliance date.
---------------------------------------------------------------------------

    \21\ 84 FR 61974.
---------------------------------------------------------------------------

    Several commenters on the 2020 proposal suggested that the agencies 
provide for voluntary early compliance with the final rule.\22\ One 
commenter also suggested establishing a transition period of at least 
one year.\23\
---------------------------------------------------------------------------

    \22\ E.g., SIFMA; FSF; Japanese Bankers Association (JBA); and 
ABA.
    \23\ JBA.
---------------------------------------------------------------------------

    The effective date for the final rule will be October 1, 2020, to 
accommodate the requirements of the Riegle Community Development and 
Regulatory Improvement Act.\24\ The agencies do not believe an extended 
compliance or transition period is necessary because the final rule 
largely tailors the regulations implementing section 13 of the BHC Act 
rather than increases compliance burdens.
---------------------------------------------------------------------------

    \24\ See infra, Section V.D (Riegle Community Development and 
Regulatory Improvement Act).
---------------------------------------------------------------------------

IV. Summary of the Final Rule

A. Qualifying Foreign Excluded Funds

    Since the adoption of the 2013 rule, a number of foreign banking 
entities, foreign government officials, and other market participants 
have expressed concerns regarding instances in which certain funds 
offered and sold outside of the United States are excluded from the 
covered fund definition but still could be considered banking entities 
in certain circumstances (foreign excluded funds).\25\ This situation 
may occur if a foreign banking entity controls the foreign fund. A 
foreign banking entity could be considered to control the fund based on 
common corporate governance structures abroad, such as where the fund's 
sponsor selects the majority of the fund's directors or trustees, or 
the foreign banking entity otherwise controls the fund for purposes of 
section 13 of the BHC Act. As a result, such a fund would be subject to 
the requirements of section 13 and the implementing regulations, 
including restrictions on proprietary trading, restrictions on 
investing in or sponsoring covered funds, and compliance obligations.
---------------------------------------------------------------------------

    \25\ The implementing regulations generally exclude covered 
funds from the definition of ``banking entity.'' 2013 rule Sec.  
__.2(c)(2)(i). However, because foreign excluded funds are not 
covered funds, they can become banking entities through affiliation 
with other banking entities.
---------------------------------------------------------------------------

    The Federal banking agencies released a policy statement on July 
21, 2017 (the policy statement), to address concerns about the possible 
unintended consequences and extraterritorial impact of section 13 and 
the implementing regulations for foreign excluded funds.\26\ The policy 
statement noted that the Federal banking agencies would not take action 
against a foreign banking entity \27\ based on attribution of

[[Page 46426]]

the activities and investments of a qualifying foreign excluded fund to 
a foreign banking entity, or against a qualifying foreign excluded fund 
as a banking entity, for a period of one year while staffs of the 
agencies considered alternative ways in which the implementing 
regulations could be amended, or other appropriate action could be 
taken, to address the issue. The policy statement has since been 
extended and is currently scheduled to expire on July 21, 2021.\28\
---------------------------------------------------------------------------

    \26\ Statement regarding Treatment of Certain Foreign Funds 
under the Rules Implementing Section 13 of the Bank Holding Company 
Act (July 21, 2017), available at https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20170721a1.pdf.
    \27\ ``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. Id.
    \28\ 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.
---------------------------------------------------------------------------

    For purposes of the policy statement, a ``qualifying foreign 
excluded fund'' means, with respect to a foreign banking entity, an 
entity that:
    (1) Is organized or established outside the United States and the 
ownership interests of which are offered and sold solely outside the 
United States;
    (2) Would be a covered fund were the entity organized or 
established in the United States, or is, or holds itself out as being, 
an entity or arrangement that raises money from investors primarily for 
the purpose of investing in financial instruments for resale or other 
disposition or otherwise trading in financial instruments;
    (3) Would not otherwise be a banking entity except by virtue of the 
foreign banking entity's acquisition or retention of an ownership 
interest in, or sponsorship of, the entity;
    (4) Is established and operated as part of a bona fide asset 
management business; and
    (5) Is not operated in a manner that enables the foreign banking 
entity to evade the requirements of section 13 or implementing 
regulations.
    To be eligible for this relief, the foreign banking entity's 
acquisition or retention of any ownership interest in, or sponsorship 
of, the qualifying foreign excluded fund must 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 implementing regulations, as if the qualifying 
foreign excluded fund were a covered fund. To provide greater clarity 
and certainty to banking entities and qualifying foreign excluded 
funds, and to limit the extraterritoriality of the rule, the 2020 
proposal included a permanent exemption from the section 13 
restrictions on proprietary trading and investing in or sponsoring 
covered funds for the activities of qualifying foreign excluded funds. 
The proposed exemption generally included the same eligibility criteria 
from the policy statement, although it included a modified version of 
the anti-evasion provision such that, in order to qualify, a fund could 
not be operated in a manner that enables ``any other banking entity'' 
(rather than ``the foreign banking entity'') to evade the requirements 
of section 13 or the implementing regulations.
    The agencies requested comment on all aspects of this exemption. 
Commenters were generally supportive of the 2020 proposal to exempt 
qualifying foreign excluded funds from certain requirements of the 
implementing regulations.\29\ Two commenters expressed opposition to 
the proposed exemption.\30\
---------------------------------------------------------------------------

    \29\ SIFMA; Bank Policy Institute (BPI); Bundesverband 
Investment und Asset Management e.V. (BVI); American Investment 
Council (AIC); ABA; European Fund and Asset Management Association 
(EFAMA); Shareholder Advocacy Forum (SAF); IIB; JBA; CBA; and Credit 
Suisse.
    \30\ Occupy and Data Boiler Technologies LLC (Data Boiler).
---------------------------------------------------------------------------

    Some commenters requested that qualifying foreign excluded funds be 
excluded from the definition of banking entity.\31\ One commenter 
expressed concern that the 2020 proposal would require qualifying 
foreign excluded funds to establish section 13 of the BHC Act 
compliance programs, imposing costs on qualifying foreign excluded 
funds.\32\ This commenter noted that there may be situations under 
section 13 of the BHC Act where a foreign banking entity controls a 
qualifying foreign excluded fund, but under foreign law does not have 
the necessary authority to require it to adopt a section 13 compliance 
program. As such, this commenter advocated for either excluding this 
type of fund from the definition of banking entity or exempting this 
type of fund from the compliance program requirements under the 
rule.\33\ One commenter expressed concern that a qualifying foreign 
excluded fund would still need to comply with various restrictions 
under section 13, including the provisions of Sec.  __.14 of the 
implementing regulations (i.e., Super 23A) and the compliance program 
requirements.\34\
---------------------------------------------------------------------------

    \31\ IIB; JBA; CBA; Credit Suisse; and EBF.
    \32\ JBA.
    \33\ JBA.
    \34\ Credit Suisse.
---------------------------------------------------------------------------

    Some commenters requested that the agencies change the anti-evasion 
provision of the qualifying foreign excluded funds definition so that 
it would only apply to the specific foreign banking entity, in a manner 
consistent with the policy statement.\35\ One of these commenters 
suggested, as an alternative, revising the provision so that it would 
only apply to ``any affiliated banking entities.'' \36\
---------------------------------------------------------------------------

    \35\ IIB; JBA; Credit Suisse; and EBF.
    \36\ Credit Suisse.
---------------------------------------------------------------------------

    One commenter requested an anti-evasion safe harbor and changes to 
allow a fund to be a qualifying foreign excluded fund when a non-U.S. 
banking entity serves as a management company to the fund and is 
approved to provide fund management in accordance with local law.\37\ 
This commenter also requested that the agencies limit the requirements 
in the proposed qualifying foreign excluded funds definition to only 
those set forth in Sec.  __.13(b) of the rule for covered fund 
activities conducted by foreign banking entities solely outside the 
United States, and treat as qualifying foreign excluded funds those 
funds for which the foreign banking entity cannot exercise voting 
rights.
---------------------------------------------------------------------------

    \37\ JBA.
---------------------------------------------------------------------------

    Pursuant to their authority under section 13(d)(1)(J) of the BHC 
Act, the agencies are adopting the exemption for the activities of 
qualifying foreign excluded funds substantially as proposed, but with 
modifications to the anti-evasion provision and compliance program 
requirements. Specifically, the agencies are exempting the activities 
of qualified foreign excluded funds from the restrictions on 
proprietary trading and investing in or sponsoring covered funds, if 
the acquisition or retention of the ownership interest in, or 
sponsorship of, the qualifying foreign excluded fund by the foreign 
banking entity meets the requirements for permitted covered fund 
activities and investments conducted solely outside the United States, 
as provided in Sec.  __.13(b) of the rule.\38\ Under the final rule, a 
qualifying foreign excluded fund has the same meaning as in the policy 
statement as described above and in the 2020 proposal, except for the 
modification to the anti-evasion provision, as described below.
---------------------------------------------------------------------------

    \38\ See final rule Sec.  __.13(b).
---------------------------------------------------------------------------

    Section 13(d)(1)(J) of the BHC Act gives the agencies rulemaking 
authority to exempt activities from the prohibitions of section 13, 
provided the agencies determine that the activity in question would 
promote and protect the safety and soundness of the banking entity and 
the financial stability of the

[[Page 46427]]

United States.\39\ For the reasons described below, the agencies have 
determined that exempting the activities of qualifying foreign excluded 
funds promotes and protects the safety and soundness of banking 
entities and U.S. financial stability.
---------------------------------------------------------------------------

    \39\ 12 U.S.C. 1851(d)(1)(J).
---------------------------------------------------------------------------

    This relief is expected to promote and protect the safety and 
soundness of such funds and their foreign banking entity sponsors by 
putting them on a level playing field with their foreign competitors 
that are not subject to the implementing regulations. If the activities 
of these foreign funds were subject to the restrictions applicable to 
banking entities, their asset management activities could be 
significantly disrupted, and their foreign banking entity sponsors may 
be at a competitive disadvantage to other foreign bank and non-bank 
market participants conducting asset management business outside of the 
United States. Exempting the activities of these foreign funds allows 
their foreign banking entity sponsors to continue to conduct their 
asset management business outside the United States as long as the 
foreign banking entity's acquisition of an ownership interest in or 
sponsorship of the fund meets the requirements in Sec.  __.13(b) of the 
implementing regulations. Thus, the exemption is expected to have the 
effect of promoting the safety and soundness of these foreign funds and 
their sponsors, while at the same time limiting the extraterritorial 
impact of the implementing regulations, consistent with the purposes of 
sections 13(d)(1)(H) and (I) of the BHC Act.
    The exemption is also expected to promote and protect U.S. 
financial stability. While qualifying foreign excluded funds have a 
very limited nexus to the U.S. financial system, the exemption would 
promote U.S. financial stability by providing additional capital and 
liquidity to U.S. capital markets without a concomitant increase in 
risk borne by U.S. entities. Because the exemption requires that the 
foreign banking entity's acquisition of an ownership interest in or 
sponsorship of the fund meets the requirements in Sec.  __.13(b) of the 
final rule, the exemption will help ensure that the risks of 
investments made by these foreign funds will be booked at foreign 
entities in foreign jurisdictions, thus promoting and protecting U.S. 
financial stability. Additionally, subjecting such funds to the 
requirements of the implementing regulations could precipitate 
disruptions in foreign capital markets, which could generate spillover 
effects in the U.S. financial system.
    In response to comments regarding the anti-evasion provision, the 
final rule specifies that the qualifying foreign excluded fund must not 
be operated in a manner that enables the banking entity that sponsors 
or controls the qualifying foreign excluded fund, or any other 
affiliated banking entity (other than a qualifying foreign excluded 
fund), to evade the requirements of section 13 of the BHC Act or the 
final rule. This change is meant to clarify the scope of the anti-
evasion provision and provide certainty for banking entities that 
sponsor or control the qualifying foreign excluded fund.
    Consistent with feedback from several commenters, the agencies also 
have modified compliance requirements with respect to qualifying 
foreign excluded funds. While, under the final rule, the activities of 
a qualifying foreign excluded fund are exempted from the proprietary 
trading restrictions of Sec.  __.3(a) and the covered fund restrictions 
of Sec.  __.10(a) of the final rule, the qualifying foreign excluded 
fund is still a banking entity. Absent any additional changes, the 
qualifying foreign excluded fund could become subject to the compliance 
requirements of Sec.  __.20. However, since these qualifying foreign 
excluded funds are exempted from the proprietary trading requirements 
of Sec.  __.3(a) and covered fund restrictions of Sec.  __.10(a) of the 
final rule, the agencies believe that requiring a compliance program 
for the fund itself is overly burdensome and unnecessary. The 
requirements in Sec.  __.20 are intended to ensure and monitor 
compliance with the proprietary trading and covered fund provisions, 
and there would be no benefit to applying these requirements to an 
entity that is exempt from those provisions. Therefore, under the final 
rule, qualifying foreign excluded funds are not required to have 
compliance programs or comply with the reporting and additional 
documentation requirements under Sec.  __.20. However, any banking 
entity that owns or sponsors a qualifying foreign excluded fund will 
still be required to have in place appropriate compliance programs for 
itself and its other subsidiaries and provide reports and additional 
documentation as required by Sec.  __.20.
    The final rule does not amend the definition of ``banking entity'' 
as requested by several commenters. Because ``banking entity'' is 
specifically defined in section 13 of the BHC Act, the agencies find it 
appropriate to address concerns related to foreign excluded funds 
through their exemptive rulemaking authority.
    The agencies are not making any change regarding the applicability 
of Sec.  __.14 of the implementing regulations, which imposes 
limitations on relationships with covered funds, with respect to 
qualifying foreign excluded funds. The agencies believe it is 
appropriate to retain the application of Sec.  __.14 to qualifying 
foreign excluded funds to limit risks that may be borne by banking 
entities located in the United States through transactions with such 
funds.\40\ Further, given the limited set of circumstances in which 
Sec.  __.14 would apply (i.e., a transaction between a foreign excluded 
fund and a covered fund that is sponsored or advised by the same 
banking entity), the agencies do not believe that it is overly 
burdensome for a banking entity that sponsors or controls a qualifying 
foreign excluded fund to ensure that it is not in violation of Sec.  
__.14.
---------------------------------------------------------------------------

    \40\ A U.S. banking entity's exposure to a fund that would be a 
qualifying foreign excluded fund with respect to a foreign banking 
entity may still be a covered fund with respect to a U.S. banking 
entity under Sec.  __.10(b)(1)(iii) of the implementing regulations. 
A U.S. banking entity's investment in and relationship with such a 
fund could therefore be subject to the entirety of the applicable 
prohibitions and restrictions of Subpart C of the implementing 
regulations.
---------------------------------------------------------------------------

B. Modifications To Existing Covered Fund Exclusions

    In the preamble to the 2013 rule, the agencies acknowledged that 
the covered fund definition was expansive.\41\ To effectively tailor 
the covered fund provisions to the types of entities that section 13 of 
the BHC Act was intended to cover, the 2013 rule excluded various types 
of entities from the covered fund definition.\42\ In response to 
comments received on the 2020 proposal, and based on experience 
implementing the rule, the agencies are modifying certain of the 
existing exclusions, as described below, to make them more 
appropriately structured to effectuate the intent of the statute and 
its implementing regulations.
---------------------------------------------------------------------------

    \41\ See 79 FR 5677.
    \42\ See id.
---------------------------------------------------------------------------

1. Foreign Public Funds

2013 Rule

    To provide consistent treatment for U.S. registered investment 
companies and their foreign equivalents, the implementing regulations 
exclude foreign public funds from the definition of covered fund.\43\ A 
foreign public fund

[[Page 46428]]

is generally defined under the 2013 rule as any issuer that is 
organized or established outside of the United States and the ownership 
interests of which are (1) authorized to be offered and sold to retail 
investors in the issuer's home jurisdiction and (2) sold predominantly 
through one or more public offerings outside of the United States.\44\ 
The agencies stated in the preamble to the 2013 rule that they 
generally expect that an offering is made predominantly outside of the 
United States if 85 percent or more of the fund's interests are sold to 
investors that are not residents of the United States.\45\ The 2013 
rule defines ``public offering'' for purposes of this exclusion to mean 
a ``distribution,'' as defined in Sec.  __.4(a)(3) of subpart B, of 
securities in any jurisdiction outside the United States to investors, 
including retail investors, provided that the distribution complies 
with all applicable requirements in the jurisdiction in which such 
distribution is being made; the distribution does not restrict 
availability to only investors with a minimum level of net worth or net 
investment assets; and the issuer has filed or submitted, with the 
appropriate regulatory authority in such jurisdiction, offering 
disclosure documents that are publicly available.\46\
---------------------------------------------------------------------------

    \43\ In adopting the foreign public fund exclusion, the 
agencies' view was that it was appropriate to exclude these funds 
from the ``covered fund'' definition because they are sufficiently 
similar to U.S. registered investment companies. 79 FR 5678.
    \44\ 2013 rule Sec.  __.10(c)(1); see also 79 FR 5678.
    \45\ 79 FR 5678.
    \46\ 2013 rule Sec.  __.10(c)(1)(iii).
---------------------------------------------------------------------------

    The 2013 rule places an additional condition on a U.S. banking 
entity's ability to rely on the foreign public fund exclusion with 
respect to any foreign fund it sponsors.\47\ The foreign public fund 
exclusion is only available to a U.S. banking entity with respect to a 
foreign fund sponsored by the U.S. banking entity if, in addition to 
the requirements discussed above, the fund's ownership interests are 
sold predominantly to persons other than the sponsoring banking entity, 
the issuer (or affiliates of the sponsoring banking entity or issuer), 
and employees and directors of such entities.\48\ The agencies stated 
in the preamble to the 2013 rule that, consistent with the agencies' 
view concerning whether a foreign public fund has been sold 
predominantly outside of the United States, the agencies generally 
expect that a foreign public fund would satisfy this additional 
condition if 85 percent or more of the fund's interests are sold to 
persons other than the sponsoring U.S. banking entity and the specified 
persons connected to that banking entity.\49\
---------------------------------------------------------------------------

    \47\ Although the discussion of this condition generally refers 
to U.S. banking entities for ease of reading, the condition also 
applies to foreign subsidiaries of a U.S. banking entity. See 2013 
rule Sec.  __.10(c)(1)(ii) (applying this limitation ``[w]ith 
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'').
    \48\ See 2013 rule Sec.  __.10(c)(1)(ii).
    \49\ 79 FR 5678.
---------------------------------------------------------------------------

2020 Proposal

    In the 2020 proposal, the agencies acknowledged that some of the 
conditions of the 2013 rule's foreign public fund exclusion may not be 
necessary to ensure consistent treatment of foreign public funds and 
U.S. registered investment companies. Moreover, some conditions may 
make it difficult for a non-U.S. fund to qualify for the exclusion or 
for a banking entity to validate whether a non-U.S. fund qualifies for 
the exclusion, resulting in certain non-U.S. funds that are similar to 
U.S. registered investment companies being treated as covered funds.
    To address these concerns, the 2020 proposal would have made 
certain modifications to the foreign public fund exclusion. First, the 
agencies proposed to replace the requirement that the fund be 
authorized to be offered and sold to retail investors in the issuer's 
home jurisdiction (the home jurisdiction requirement) and the 
requirement that the fund interests be sold predominantly through one 
or more public offerings outside of the United States, with a 
requirement that the fund is authorized to offer and sell ownership 
interests, and such interests are offered and sold, through one or more 
public offerings outside of the United States. This change would have 
permitted foreign funds to qualify for the exclusion if they are 
organized in one jurisdiction but only authorized to be sold to retail 
investors in another jurisdiction, as this is a fairly common way for 
foreign retail funds to be organized. Also, no longer requiring a fund 
to be sold predominantly through one or more public offerings was 
intended to reduce the difficulty that banking entities have described 
in determining and monitoring the distribution history and patterns of 
a third-party sponsored fund or a sponsored fund whose interests are 
sold through third-party distributors.
    The agencies also proposed modifying the definition of ``public 
offering'' from the implementing regulations to add a new requirement 
that the distribution be subject to substantive disclosure and retail 
investor protection laws or regulations, to help ensure that foreign 
funds qualifying for this exclusion are sufficiently similar to U.S. 
registered investment companies. Additionally, the 2020 proposal would 
have only applied the condition that the distribution comply with all 
applicable requirements in the jurisdiction where it is made to 
instances in which the banking entity acts as the investment manager, 
investment adviser, commodity trading advisor, commodity pool operator, 
or sponsor. This proposed change was intended to address the potential 
difficulty that a banking entity investing in a third-party sponsored 
fund may have in determining whether the distribution of such fund 
complied with all the requirements in the jurisdiction where it was 
made.
    To simplify the requirements of the exclusion and address concerns 
described by banking entities with the difficulty in tracking the sale 
of ownership interests to employees and their immediate family members, 
the 2020 proposal would have eliminated the limitation on selling 
ownership interests of the issuer to employees (other than senior 
executive officers) of the sponsoring banking entity or the issuer (or 
affiliates of the banking entity or issuer). This change was intended 
to help align the treatment of foreign public funds with that of U.S. 
registered investment companies, as the exclusion for U.S. registered 
investment companies has no such limitation. The 2020 proposal would 
have continued to limit the sale of ownership interests to directors or 
senior executive officers of the sponsoring banking entity or the 
issuer (or their affiliates), as the agencies believed that such a 
requirement would be simpler for a banking entity to track.
    Finally, the 2020 proposal requested comment on the appropriateness 
of the expectation stated in the preamble to the 2013 rule that, for a 
U.S. banking entity-sponsored foreign fund to satisfy the condition 
that it be ``predominantly'' sold to persons other than the sponsoring 
U.S. banking entity and certain persons connected to that banking 
entity, at least 85 percent of the ownership interests in the fund 
should be sold to such other persons.

Discussion of Comments and the Final Rule

    The agencies are adopting all of the proposed changes and are 
making certain adjustments in response to comments received, as 
discussed below.
    Commenters on the 2020 proposal generally supported the proposed 
changes to the foreign public funds

[[Page 46429]]

exclusion.\50\ Specifically, commenters supported the elimination of 
the home jurisdiction requirement and the requirement that the fund be 
sold predominantly through one or more public offerings.\51\ Commenters 
supported the proposed change to the ``public offering'' definition to 
include a requirement that a distribution be subject to substantive 
disclosure and retail investor protection laws or regulations,\52\ but 
did not recommend further specifying what substantive disclosure and 
investor protection requirements should apply because they generally 
viewed it as unnecessary and overly prescriptive.\53\ Commenters also 
supported eliminating the restriction on share ownership by employees 
(other than senior executives and directors) of the U.S. banking entity 
that sponsors the foreign public fund.\54\ In response to a specific 
question in the 2020 proposal, one commenter indicated that the 
proposed changes to the foreign public funds exclusion would not 
increase the risk of evasion of the requirements of section 13 and the 
implementing regulations, and thus no additional anti-evasion measures 
were necessary.\55\ Another commenter stated that the proposed changes 
were less than ideal but were acceptable after balancing compliance 
costs and benefits.\56\
---------------------------------------------------------------------------

    \50\ IIB; SIFMA; BPI; ABA; EBF; EFAMA; FSF; Investment Company 
Institute (ICI); BVI; CBA; Committee on Capital Markets Regulation 
(CCMR); Data Boiler; Goldman Sachs; Investment Adviser Association 
(IAA); JBA; SAF; and U.S. Chamber of Commerce Center for Capital 
Markets Competitiveness (CCMC).
    \51\ IIB; SIFMA; BPI; ABA; EBF; EFAMA; FSF; ICI; BVI; and CBA.
    \52\ IIB; EFAMA; FSF; ICI; and BVI.
    \53\ IIB; ICI; and CBA. One commenter supported this assertion 
by stating that 95 percent of the world's securities markets, 
including all major emerging markets, have substantive disclosure 
and retail investor protection rules that are guided by the 
International Organization of Securities Commissions' common 
principles for retail funds and the detailed policy work that 
informs those principles. ICI.
    \54\ FSF.
    \55\ SIFMA.
    \56\ Data Boiler.
---------------------------------------------------------------------------

    Commenters also recommended additional changes to further align the 
treatment of foreign public funds with that of U.S. registered 
investment companies or to prevent evasion of the rule.\57\ 
Specifically, some commenters recommended eliminating the requirement 
that a fund actually be sold through a public offering and, instead, 
only require that a fund be authorized to be sold through a public 
offering.\58\ These commenters generally viewed this requirement as 
burdensome and difficult to administer and noted that U.S. registered 
investment companies are not required to be sold in public 
distributions. The agencies do not consider the fact that there is no 
requirement for U.S. registered investment companies to be actually 
sold through public offerings as a sufficient rationale for removing 
this requirement from the foreign public fund exclusion. Requiring 
foreign public funds to be sold through one or more public offerings is 
intended to ensure that such funds are in fact public funds and thus 
sufficiently similar to U.S. registered investment companies. While 
there may be certain limited scenarios where a U.S. registered 
investment company is not sold to retail investors, the agencies 
believe that the vast majority of U.S. registered investment companies 
are sold to retail investors. Furthermore, U.S. registered investment 
companies are subject to robust registration, reporting, and other 
requirements that are familiar to the agencies, whereas foreign public 
funds are subject to a differing array of requirements depending on the 
jurisdiction where they are authorized to be sold. These other 
jurisdictions may have less developed requirements for retail funds, 
which may increase the likelihood of a fund seeking authorization for 
public distribution in certain foreign jurisdictions solely as a means 
of avoiding the covered fund prohibition. The agencies believe that 
eliminating this requirement would increase the risk of evasion by 
permitting foreign funds that may be authorized for sale to retail 
investors in a foreign jurisdiction--but are only sold through private 
offerings where no substantive disclosure or retail investor 
protections exist--to qualify for the exclusion. Such funds would not 
be comparable to U.S. registered investment companies and would not be 
the type of fund that foreign public fund exclusion was intended to 
address. Accordingly, the agencies are not adopting this suggested 
modification.
---------------------------------------------------------------------------

    \57\ One commenter recommended that the agencies create an 
exclusion from the ``proprietary trading'' definition for the 
activities of regulated funds, including foreign public funds, under 
certain circumstances. ICI. The agencies note that such a change is 
not within the scope of this rulemaking.
    \58\ IIB; SIFMA; and EBF.
---------------------------------------------------------------------------

    One trade association commenter suggested eliminating a provision 
in the ``public offering'' requirement that prohibits a distribution 
from being limited to investors with a minimum net worth or net 
investment assets because some of its members distribute funds, 
including mutual funds, in offerings that do not meet this requirement 
but that are nonetheless subject to substantive disclosure and retail 
investor protection requirements. Similar to the reasons for retaining 
the requirement that a foreign public fund actually be sold through one 
or more public offerings, the agencies believe that retaining this 
requirement is necessary to ensure that funds qualifying for this 
exclusion are sufficiently similar to U.S. registered investment 
companies. In fact, one of the identifying characteristics of a covered 
fund is that its offerings are limited to investors with minimum net 
worth or net investment assets.\59\ The agencies therefore believe that 
foreign funds that limit their offerings to investors with a minimum 
net worth or net investment assets are generally not sufficiently 
similar to U.S. registered investment companies, and thus the agencies 
are not adopting this suggested change to the ``public offering'' 
definition.
---------------------------------------------------------------------------

    \59\ Under the Investment Company Act, certain funds whose 
offerings are limited to investors with minimum net worth or net 
investment assets are exempt from registration as investment 
companies. See 15 U.S.C. 80a-3(c)(7). These funds are generally 
treated as covered funds under section 13 of the BHC Act and the 
implementing regulations. See 12 U.S.C. 1851(h)(2); implementing 
regulations Sec.  __.10(b)(1)(i).
---------------------------------------------------------------------------

    One commenter opposed the proposed elimination of the requirement 
in the ``public offering'' definition that a distribution comply with 
all applicable requirements in the jurisdiction in which such 
distribution is being made for a banking entity that does not serve as 
the fund's investment manager, investment adviser, commodity trading 
advisor, commodity pool operator, or sponsor.\60\ The final rule adopts 
this modification as proposed, because the agencies believe the other 
eligibility criteria for a fund to qualify under the foreign public 
fund exclusion are sufficient to appropriately identify these funds. In 
addition, the agencies recognize that it may be difficult or impossible 
for a banking entity that invests in a third-party fund to know whether 
the fund's distribution complied with all applicable requirements in 
the jurisdiction where it was distributed.
---------------------------------------------------------------------------

    \60\ Data Boiler.
---------------------------------------------------------------------------

    One commenter recommended that the agencies require 85 percent of a 
foreign public fund's ownership interests be sold to and owned by 
``bona fide'' retail investors in the fund's home jurisdiction.\61\ 
However, for the same reasons that the agencies are eliminating the 
home jurisdiction requirement and the requirement that a fund be sold 
predominantly through public offerings,

[[Page 46430]]

the agencies are not adopting this requirement.
---------------------------------------------------------------------------

    \61\ Oleh Zadorestskyy. This commenter also suggested that the 
agencies require proof that the investors were non-U.S. persons.
---------------------------------------------------------------------------

    Some commenters suggested that the agencies identify common foreign 
fund types that are presumed to qualify for the exclusion for foreign 
public funds for the purpose of improving efficiency and simplifying 
compliance with the rule.\62\ Other commenters recommended that issuers 
listed on an internationally-recognized exchange and available in 
retail-level denominations should automatically qualify for the 
exclusion for similar reasons.\63\ Although the agencies expect many 
such funds will qualify for the exclusion, the agencies decline to 
adopt either of these suggested changes, as both would require the 
agencies' review and on-going monitoring of foreign laws and 
regulations to ensure that the types of funds that would qualify under 
these provisions are sufficiently similar to U.S. registered investment 
companies and that their exclusion as foreign public funds would 
continue to be appropriate.
---------------------------------------------------------------------------

    \62\ IIB and EBF.
    \63\ IIB; SIFMA; BPI; ABA; FSF; and CBA.
---------------------------------------------------------------------------

    Some commenters recommended that the agencies entirely eliminate 
the restrictions on share ownership by parties affiliated with a U.S. 
banking entity sponsor of a foreign public fund.\64\ Other commenters 
suggested that, if the restrictions on share ownership by banking 
entities affiliated with the sponsor were retained, the restrictions on 
share ownership by senior executives and directors should be 
removed.\65\ The commenters generally viewed these requirements as 
unnecessary and burdensome to track and monitor. As discussed in the 
preamble to the 2013 rule, these requirements are intended to prevent 
evasion of section 13 of the BHC Act.\66\ Additionally, the agencies 
note that U.S. banking entity sponsors of foreign public funds would 
need to track the ownership of such funds by their affiliates and 
management officials even if the requirements were eliminated in order 
to determine whether they control such funds for BHC Act purposes.\67\ 
Thus, for a U.S. banking entity relying on this exclusion with respect 
to a fund that it sponsors, the agencies are retaining the requirement 
that the fund be sold predominantly to persons other than the U.S. 
banking entity sponsor, the fund, affiliates of such sponsoring banking 
entity or fund, and the directors and senior executive officers of such 
entities (collectively, ``U.S. banking entity sponsor and associated 
parties'').
---------------------------------------------------------------------------

    \64\ SIFMA and FSF.
    \65\ SIFMA; BPI; ICI; and CCMC.
    \66\ 79 FR 5678-79.
    \67\ See 12 CFR 225.2(e); 12 CFR 225.31(d)(2)(ii). If a foreign 
public fund is controlled by a banking entity for BHC Act purposes, 
such fund could also be being treated as a banking entity under 
section 13. See implementing regulations Sec.  __.2(c); FAQ 14.
---------------------------------------------------------------------------

    Relatedly, some commenters recommended that the agencies modify 
their expectation of the level of ownership of a foreign public fund 
that would satisfy the requirement that a fund be ``predominantly'' 
sold to persons other than its U.S. banking entity sponsor and 
associated parties,\68\ which, in the preamble to the 2013 rule, the 
agencies stated was 85 percent or more (which would permit the U.S. 
banking entity sponsor and associated parties to own the remaining 15 
percent). These commenters asserted that the relevant ownership 
threshold for U.S. registered investment companies is 25 percent, and 
that, for foreign public funds, the threshold should be the same. The 
agencies agree that the permitted ownership level of a foreign public 
fund by a U.S. banking entity sponsor and associated parties should be 
aligned with the functionally equivalent threshold for banking entity 
investments in U.S. registered investment companies, which is 24.9 
percent.\69\ Accordingly, the agencies have amended this provision in 
the final rule to require that more than 75 percent of the fund's 
interests be sold to persons other than the U.S. banking entity sponsor 
and associated parties.\70\
---------------------------------------------------------------------------

    \68\ BPI; FSF; ICI; and CCMC.
    \69\ Although the implementing regulations do not explicitly 
prohibit a banking entity from acquiring 25 percent or more of a 
U.S. registered investment company, a U.S. registered investment 
company would become a banking entity if it is affiliated with 
another banking entity (other than as described in Sec.  
__.12(b)(1)(ii) of the implementing regulations). See 79 FR 5732 
(``[F]or purposes of section 13 of the BHC Act and the final rule, a 
registered investment company . . . will not be considered to be an 
affiliate of the banking entity if the banking entity owns, 
controls, or holds with the power to vote less than 25 percent of 
the voting shares of the company or fund, and provides investment 
advisory, commodity trading advisory, administrative, and other 
services to the company or fund only in a manner that complies with 
other limitations under applicable regulation, order, or other 
authority.'').
    \70\ For a U.S. banking entity that sponsors a foreign public 
fund, crossing the 24.9 percent ownership threshold (other than 
during a permitted seeding period) would cause the fund to be a 
covered fund (if no other exclusion applied), in which case the 
banking entity would be in violation of the 3 percent per-fund 
investment limit. See implementing regulations Sec.  
__.12(a)(2)(ii)(A). The agencies believe that such a strict 
prohibition against a U.S. banking entity acquiring 25 percent or 
more of a foreign public fund that it sponsors is appropriate 
because of the elevated risk of evasion by the sponsoring banking 
entity, which may be able to control the investments made by the 
fund.
---------------------------------------------------------------------------

    One commenter recommended that, with respect to foreign public 
funds sponsored by U.S. affiliates of foreign banking entities, the 
agencies exclude the sponsoring U.S. banking entity's non-U.S. 
affiliates and their directors and employees from the restrictions on 
share ownership, provided that such non-U.S. affiliates are not 
controlled by a U.S. banking entity.\71\ This commenter asserted that 
there is no U.S. financial stability or safety and soundness benefit to 
applying this restriction to such non-U.S. affiliates and their 
directors and employees, as the risks of any such investments are borne 
solely outside the United States. However, with the change described 
above, which permits a U.S. banking entity sponsor and associated 
parties to hold less than 25 percent of a foreign public fund, the 
agencies do not believe that this change is necessary. Even if the 
requirement were modified as the commenter suggested, the banking 
entity and its affiliates would still be limited to owning less than 25 
percent of the fund without the fund becoming a banking entity.
---------------------------------------------------------------------------

    \71\ IIB.
---------------------------------------------------------------------------

    One commenter requested that the agencies modify Sec.  __.12(b)(1) 
of the implementing regulations, which governs attribution of ownership 
interests in covered funds to banking entities, to clarify that the 
banking entity ``or an affiliate'' can provide the advisory, 
administrative, or other services required in Sec.  __.12(b)(1)(ii)(B) 
for the non-attribution rule to apply. The commenter requested this 
clarification because Sec.  __.12(b)(1)(ii)(B) is cross-referenced by 
FAQ 14, which, as discussed above, states that a foreign public fund 
will not be treated as a banking entity if it complies with the test in 
Sec.  __.12(b)(1)(ii) (i.e., the banking entity holds less than 25 
percent of the voting shares in the foreign public fund and provides 
advisory, administrative, or other services to the fund). The agencies 
confirm that the requested interpretation is correct and, accordingly, 
have amended Sec.  __.12(b)(1)(ii) of the implementing regulations to 
clarify that the ownership limit applies to the banking entity and its 
affiliates, in the aggregate, and the requirement that the banking 
entity provide advisory or other services can be satisfied by the 
banking entity or its affiliates.
    One commenter noted that FAQ 16, which relates to the seeding 
period for foreign public funds, uses 3 years as an example of the 
duration of such a seeding period, and requested that the agencies 
confirm that a foreign public fund's seeding period can be longer than

[[Page 46431]]

3 years.\72\ Another commenter requested that the agencies codify the 
3-year seeding period in the implementing regulations.\73\ The agencies 
believe that, depending on the facts and circumstances of a particular 
foreign public fund, the appropriate duration of its seeding period may 
vary and, under certain facts and circumstances, may exceed three 
years. The agencies believe that this flexibility is appropriate and 
thus decline to further specify such a limit. Another commenter 
requested that the agencies codify the foreign public fund seeding 
FAQ,\74\ FAQ 14, and FAQ 16, both described above, in the implementing 
regulations.\75\ The agencies decline to codify these FAQs at this time 
but note that the final rule does not modify or revoke any previously 
issued staff FAQs, unless otherwise specified.
---------------------------------------------------------------------------

    \72\ IAA.
    \73\ CCMC.
    \74\ The foreign public fund seeding FAQ states that staffs of 
the agencies would not advise that a seeding vehicle that is 
operated pursuant to a written plan to become a foreign public fund 
and that meets certain conditions be treated as a covered fund 
during such seeding period.
    \75\ IIB.
---------------------------------------------------------------------------

    In the final rule, the agencies are adopting the amendments to the 
foreign public funds exclusion as proposed, with the additional 
modifications described above. The agencies believe the revised 
requirements will make the foreign public fund exclusion more effective 
by expanding its availability, providing clarity, and simplifying 
compliance with its requirements, while continuing to ensure that the 
funds that qualify are sufficiently similar to U.S. registered 
investment companies.
2. Loan Securitizations
    Section 13 of the BHC Act provides that ``[n]othing in this section 
shall be construed to limit or restrict the ability of a banking entity 
. . . to sell or securitize loans in a manner otherwise permitted by 
law.'' \76\ To effectuate this statutory mandate, the 2013 rule 
excluded from the definition of covered fund loan securitizations that 
issue asset-backed securities and hold only loans, certain rights and 
assets that arise from the structure of the loan securitization or from 
the loans supporting a loan securitization, and a small set of other 
financial instruments (permissible assets).\77\
---------------------------------------------------------------------------

    \76\ 12 U.S.C. 1851(g)(2).
    \77\ See 2013 rule Sec.  __.10(c)(8). Loan is further defined as 
any loan, lease, extension of credit, or secured or unsecured 
receivable that is not a security or derivative. Implementing 
regulations Sec.  __.2(t).
---------------------------------------------------------------------------

    Since the adoption of the 2013 rule, several banking entities and 
other participants in the loan securitization industry have commented 
that the limited set of permissible assets has inappropriately 
restricted their ability to use the loan securitization exclusion. In 
the 2018 proposal, the agencies asked several questions regarding the 
efficacy and scope of the exclusion and the Loan Securitization 
Servicing FAQ.\78\ Comments focused on permitting small amounts of non-
loan assets and clarifying the treatment of leases and related assets.
---------------------------------------------------------------------------

    \78\ 83 FR 33480-81.
---------------------------------------------------------------------------

    In response to these concerns, the 2020 proposal would have 
codified the Loan Securitization Servicing FAQ and permitted loan 
securitizations to hold a small amount of non-loan assets. The agencies 
requested comment on all aspects of the proposed changes to the loan 
securitization exclusion, and comments were generally supportive of the 
proposed revisions.\79\ Several commenters also suggested revisions to 
the 2020 proposal.\80\ Comments are discussed in detail below.\81\
---------------------------------------------------------------------------

    \79\ E.g., SIFMA; BPI; Managed Funds Association (MFA); PNC 
Financial Services Group, Inc. (PNC); Goldman Sachs; Loan 
Syndications and Trading Association (LSTA); and Structured Finance 
Association (SFA).
    \80\ E.g., SIFMA; CCMC; BPI; and IIB.
    \81\ One commenter suggested that some jurisdictions' risk 
retention rules may vary from the regulations implementing section 
15G of the Exchange Act (15 U.S.C. 78o-11), which requires a banking 
entity to retain and maintain a certain minimum interest in certain 
asset-backed securities. See IIB. This commenter recommended 
allowing banking entities to hold certain investments in compliance 
with certain foreign laws (e.g., European risk retention rules). The 
agencies understand that rules for risk retention vary across 
jurisdictions. However, the agencies believe that the requested 
action is outside the scope of the current rulemaking. In addition, 
another commenter requested that the agencies clarify the definition 
of asset-backed securities as used in the loan securitization 
exclusions. See Arnold & Porter Kaye Scholer LLP (Arnold & Porter). 
The agencies discuss the definition of asset-backed securities in 
Section IV.C.1.iii (Credit Funds), infra.
---------------------------------------------------------------------------

Servicing Assets
    The implementing regulations permit loan securitizations to hold 
rights or other assets (servicing assets) that arise from the structure 
of the loan securitization or from the loans supporting a loan 
securitization.\82\ Rights or other servicing assets are assets 
designed to facilitate the servicing of the underlying loans or the 
distribution of proceeds from those loans to holders of the asset-
backed securities.\83\ In response to confusion regarding the scope of 
the provisions permitting servicing assets and a separate provision 
limiting the types of permitted securities, the staffs of the agencies 
released the Loan Securitization Servicing FAQ. The FAQ clarified that 
a servicing asset may or may not be a security, but if the servicing 
asset is a security, it must be a permitted security under the rule.
---------------------------------------------------------------------------

    \82\ Sec. Sec.  __.2(t); __.10(c)(8)(i)(D); __.10(c)(8)(v).
    \83\ See, e.g., FASB Statement No. 156: Accounting for Servicing 
of Financial Assets, ] 61 (FAS 156).
---------------------------------------------------------------------------

    The 2020 proposal would have codified the Loan Securitization 
Servicing FAQ in the implementing regulations to clarify the scope of 
the servicing asset provision.\84\ Commenters generally supported the 
codification of the Loan Securitization Servicing FAQ, indicating that 
such a codification would promote transparency and ensure continued use 
of the loan securitization exclusion.\85\ For the above reasons, the 
final rule adopts the codification of the Loan Securitization Servicing 
FAQ as proposed.
---------------------------------------------------------------------------

    \84\ The 2020 proposal also clarified that special units of 
beneficial interest and collateral certificates meeting the 
requirements of paragraph (c)(8)(v) of the exclusion that are 
securities need not meet the requirements of paragraph (c)(8)(iii) 
of the exclusion. See 2020 proposal Sec.  __.10(c)(8)(i)(B). The 
agencies are adopting this revision, as proposed.
    \85\ E.g., SIFMA; PNC; and SFA. One commenter indicated that the 
current Loan Securitization Servicing FAQ was sufficient and that 
codifying the FAQ was not necessary; however, the commenter did not 
elaborate on or justify this position. Data Boiler.
---------------------------------------------------------------------------

Cash Equivalents
    The loan securitization exclusion permits issuers relying on the 
exclusion to hold certain types of contractual rights or assets related 
to the loans underlying the securitization, including cash equivalents. 
In response to questions about the scope of the cash equivalents 
provision, the Loan Securitization Servicing FAQ stated that ``cash 
equivalents'' means high quality, highly liquid investments whose 
maturity corresponds to the securitization's expected or potential need 
for funds and whose currency corresponds to either the underlying loans 
or the asset-backed securities.\86\ To promote transparency and 
clarity, the 2020 proposal would have codified this additional language 
in the Loan Securitization Servicing FAQ regarding the meaning of 
``cash equivalents.'' \87\ The agencies did not propose requiring 
``cash equivalents'' to be ``short term,'' because the agencies 
recognized that a loan securitization may need greater flexibility to 
match the maturity of high quality, highly liquid investments to its 
expected or potential need for funds. Commenters generally supported 
the codification of the definition of ``cash equivalents'' in the loan 
securitization

[[Page 46432]]

exclusion.\88\ The final rule adopts the codification of ``cash 
equivalents'' as proposed.
---------------------------------------------------------------------------

    \86\ See supra, n.14.
    \87\ 2020 proposed rule Sec.  __.10(c)(8)(iii)(A).
    \88\ E.g., LSTA; PNC; and SIFMA. One commenter expressed 
opposition to this codification but did not elaborate or justify 
this position. See Data Boiler.
---------------------------------------------------------------------------

Limited Holdings of Certain Debt Securities
    In the preamble to the 2013 rule, the agencies declined to permit 
loan securitizations to hold a certain amount of non-loan assets.\89\ 
The agencies supported a narrow scope of permissible assets in loan 
securitizations, suggesting that such an approach would be consistent 
with the purpose of section 13 of the BHC Act.\90\
---------------------------------------------------------------------------

    \89\ 79 FR 5687-88.
    \90\ 79 FR 5687.
---------------------------------------------------------------------------

    Several commenters on the 2018 proposal disagreed with the 
agencies' views and supported expanding the range of permissible assets 
in an excluded loan securitization. After considering the comments 
received on the 2018 proposal, the 2020 proposal would have allowed a 
loan securitization vehicle to hold up to five percent of the fund's 
total assets in non-loan assets. The agencies indicated that 
authorizing loan securitizations to hold small amounts of non-loan 
assets could, consistent with section 13 of the BHC Act, permit loan 
securitizations to respond to investor demand and reduce compliance 
costs associated with the securitization process without significantly 
increasing risk to banking entities and the financial system.\91\ The 
agencies requested comment on, among other things, the maximum amount 
of permitted non-loan assets, the methodology for calculating the cap 
on non-loan assets, and whether the agencies should limit the type of 
assets that could be held under the non-loan asset provision. 
Specifically, the agencies requested comment on whether the non-loan 
asset provision should be limited to debt securities or should exclude 
certain financial instruments such as derivatives and collateralized 
debt obligations.
---------------------------------------------------------------------------

    \91\ 85 FR 12128-29.
---------------------------------------------------------------------------

    Commenters were generally supportive of allowing loan 
securitizations to hold a limited amount of non-loan assets.\92\ These 
commenters indicated that the requirements for the current loan 
securitization exclusion are too restrictive and excessively limit use 
of the exclusion and prevent issuers from responding to investor 
demand, and suggested that a limited bucket of non-loan assets would 
not fundamentally alter the characteristics and risks of 
securitizations or otherwise increase risks in banking entities or the 
financial system.\93\
---------------------------------------------------------------------------

    \92\ E.g., SIFMA; CCMC; ABA; Credit Suisse; MFA; Goldman Sachs; 
LSTA; BPI; and SFA.
    \93\ E.g., LSTA and Goldman Sachs.
---------------------------------------------------------------------------

    Several commenters recommended against limiting the type of assets 
that could be held per the non-loan asset provision.\94\ For example, 
one commenter stated that allowing excluded loan securitizations to 
invest in any class of asset would allow those vehicles to achieve 
investment goals during periods of constrained loan supply, while 
another commenter indicated that such a restriction would be 
unnecessary given that the low limit on non-loan assets would constrain 
risks.\95\ In contrast, one commenter suggested limiting the type of 
permissible assets to securities with risk characteristics similar to 
loans.\96\
---------------------------------------------------------------------------

    \94\ E.g., MFA; LSTA; and SFA. One commenter also requested that 
the agencies make clear that the non-loan assets would not be 
subject to the other provisions of the loan securitization 
exclusion. LSTA.
    \95\ SFA and LSTA.
    \96\ JBA.
---------------------------------------------------------------------------

    Numerous commenters suggested raising the cap on non-loan assets 
from five percent of assets to ten percent of assets,\97\ while one 
commenter indicated that a five percent cap would be sufficient.\98\ 
Commenters that supported an elevated limit on non-loan assets 
generally argued that a ten percent limit would further reduce 
compliance burdens while not materially increasing risk.\99\
---------------------------------------------------------------------------

    \97\ SIFMA; CCMC; ABA; Credit Suisse; MFA; Goldman Sachs; LSTA; 
and SFA.
    \98\ PNC. Another commenter who generally supported the proposed 
modifications to the loan securitization exclusion did not urge the 
agencies to raise the cap on non-loan assets. See BPI.
    \99\ E.g., LSTA; SIFMA; and Goldman Sachs.
---------------------------------------------------------------------------

    Several commenters also suggested a method for calculating the cap 
on non-loan assets: The par value of assets on the day they are 
acquired.\100\ These commenters suggested that relying on par value is 
accepted practice in the loan securitization industry and would obviate 
concerns related to tracking amortization or prepayment of loans in a 
securitization portfolio.\101\ One of these commenters further 
specified that the limit should be calculated (1) according to the par 
value of the acquired assets on the date of investment over the 
securitization's total collateral pool and (2) only at the time of 
investment.\102\ Another commenter indicated that the cap should be 
calculated as the lower of the purchase price and par value of the non-
qualifying assets over the issuer's aggregate capital commitments plus 
its subscription based credit facility.\103\ A third commenter 
suggested having a separate valuation mechanism for equity securities, 
which the commenter suggested should be market value upon 
acquisition.\104\
---------------------------------------------------------------------------

    \100\ SIFMA; BPI; ABA; and LSTA.
    \101\ SIFMA and BPI.
    \102\ BPI.
    \103\ Goldman Sachs.
    \104\ SFA.
---------------------------------------------------------------------------

    Finally, two commenters opposed allowing excluded loan 
securitizations to hold non-loan assets and suggested that such a 
change would be contrary to the purpose of section 13 of the BHC Act or 
would result in loan securitizations with differing risk 
characteristics, potentially increasing monitoring costs on 
investors.\105\ In addition, a commenter claimed that the 2020 proposal 
to allow excluded loan securitizations to hold non-loan assets would be 
contrary to section 13 of the BHC Act.\106\ Specifically, this 
commenter suggested that the rule of construction in 12 U.S.C. 
1851(g)(2) only permits the securitization or sale of loans and that 
legislative history supports this reading of the statute.
---------------------------------------------------------------------------

    \105\ JBA and Data Boiler.
    \106\ Occupy.
---------------------------------------------------------------------------

    The agencies previously concluded and continue to believe they have 
legal authority to adopt the proposed allowance for a limited amount of 
non-loan assets.\107\ Section 13(g)(2) of the BHC Act states, 
``[n]othing in this section shall be construed to limit or restrict the 
ability of a banking entity or nonbank financial company supervised by 
the Board to sell or securitize loans in a manner otherwise permitted 
by law.'' \108\ This rule of construction is permissive--it allows the 
agencies to design the regulations implementing section 13 in a way 
that accommodates and does not unduly ``limit or restrict'' the ability 
of banking entities to sell or securitize loans. Contrary to the 
commenter's argument, this provision does not mandate that any loan 
securitization exclusion only relate to loans. As discussed in this 
section and the preamble to the 2020 proposal,\109\ the agencies 
believe that allowing excluded loan securitizations to hold limited 
amounts of non-loan assets would, in fact, promote the ability of

[[Page 46433]]

banking entities to sell or securitize loans.
---------------------------------------------------------------------------

    \107\ See 79 FR 5688-92 (stating, for example, that ``[t]he 
[a]gencies also do not believe that they lack the statutory 
authority to permit a loan securitization relying on the loan 
securitization exclusion to use derivative[s,] as suggested by 
[Occupy]'' and that, more broadly, the agencies have the authority 
to allow excluded loan securitizations to hold non-loan assets).
    \108\ 12 U.S.C. 1851(g)(2).
    \109\ 85 FR 12128-29.
---------------------------------------------------------------------------

    After considering the foregoing comments, the agencies are revising 
the loan securitization exclusion to permit a loan securitization to 
hold a limited amount of debt securities. Loan securitizations provide 
an important mechanism for banking entities to fund lending programs. 
Allowing loan securitizations to hold a small amount of debt securities 
in response to customer and market demand may increase a banking 
entity's capacity to provide financing and lending. To minimize the 
potential for banking entities to use this exclusion to engage in 
impermissible activities or take on excessive risk, the final rule 
permits a loan securitization to hold debt securities (excluding asset-
backed securities and convertible securities), as opposed to any non-
loan assets, as the 2020 proposal would have allowed.\110\
---------------------------------------------------------------------------

    \110\ Final rule Sec.  __.10(c)(8)(i)(E).
---------------------------------------------------------------------------

    Although several commenters supported allowing a loan 
securitization to hold any non-loan asset to provide flexibility and 
allow the issuer's investment manager to respond to changing market 
demands, the agencies believe that limiting the assets to debt 
securities is more consistent with the activities of an issuer focused 
on securitizing loans, rather than engaging in other activities. The 
agencies have determined, consistent with the views of another 
commenter, that non-loan assets with materially different risk 
characteristics from loans could change the character and complexity of 
an issuer and raise the type of concerns that section 13 of the BHC Act 
was intended to address. Moreover, as described further below, limiting 
the assets to those with risk characteristics that are similar to loans 
will allow for a simpler and more transparent calculation of the five 
percent limit, which will facilitate banking entities' compliance with 
the exclusion. For the same reasons, the final rule does not permit a 
loan securitization to hold asset-backed securities or convertible 
securities as part of its five percent allowance for debt securities. 
This helps to ensure that a loan securitization will not be exposed to 
complex financial instruments and will retain the general 
characteristic of a loan securitization issuer.
    Similarly, to reduce potential risk-taking and to ensure that the 
fund is composed almost entirely of loans with minimal non-loan assets, 
the final rule retains the 2020 proposal's five percent limit on non-
loan assets. Commenters differed on whether raising the limit on non-
loan assets was appropriate or necessary to ensure flexibility, and it 
is not clear what benefit would accrue to issuers who could hold debt 
securities of, for example, seven or ten percent versus five percent. 
The amount of non-loan assets held by a fund should not be so 
significant that it fundamentally changes the character of the fund 
from one that is engaged in securitizing loans to one that is engaged 
in investing in other types of assets.
    The agencies are also clarifying the methodology for calculating 
the five percent limit on non-convertible debt securities.\111\ The 
2020 proposal only provided that ``the aggregate value of any such 
other assets must not exceed five percent of the aggregate value of the 
issuing entity's assets'' and requested comment about how the agencies 
should calculate this limit.\112\ As suggested by several commenters, 
the final rule specifies that the limit on non-convertible debt 
securities must be calculated at the most recent time of acquisition of 
such assets. Specifically, the aggregate value of debt securities held 
under Sec.  __.10(c)(8)(i)(E) of the final rule may not exceed five 
percent of the aggregate value of loans held under Sec.  
__.10(c)(8)(i)(A), cash and cash equivalents held under Sec.  
__.10(c)(8)(iii)(A), and debt securities held under Sec.  
__.10(c)(8)(i)(E), where the value of the loans, cash and cash 
equivalents, and debt securities is calculated at par value at the time 
any such debt security is purchased.\113\
---------------------------------------------------------------------------

    \111\ Final rule Sec.  __.10(c)(8)(i)(E)(1)-(2).
    \112\ 2020 proposal Sec.  __.10(c)(8)(i)(E); 85 FR 12129.
    \113\ Final rule Sec.  __.10(c)(8)(i)(E)(1)-(2).
---------------------------------------------------------------------------

    The agencies have chosen the most recent time of acquisition of 
non-convertible debt securities as the moment of calculation to 
simplify the manner in which the 5 percent cap applies. This would 
permit an issuer that, at some point in its life, held debt securities 
in excess of five percent of its assets to qualify for the exclusion if 
it came into compliance with the five percent limit prior to a banking 
entity relying on the exclusion with respect to such issuer. The 
agencies believe that a continuous monitoring obligation could impose 
significant burdens on excluded issuers and could cause an issuer to be 
disqualified from the loan securitization exclusion based on market 
events not under its control. It is also unnecessary to require this 
calculation at other intervals because limiting permissible assets to 
those that have similar characteristics as loans addresses the 
potential for evasion of the five percent limit that could arise if the 
issuer held more volatile assets.\114\
---------------------------------------------------------------------------

    \114\ The agencies also have authority to address acts that 
function as an evasion of the requirements of the exclusion. See 
implementing regulations Sec.  __.21.
---------------------------------------------------------------------------

    In the final rule, this measurement is based only on the value of 
the loans and debt securities held under Sec. Sec.  __.10(c)(8)(i)(A) 
and (E) and the cash and cash equivalents held under Sec.  
__.10(c)(8)(iii)(A) rather than the aggregate value of all of the 
issuing entity's assets. The purpose of the five percent limit is to 
ensure the investment pool of a loan securitization is composed of 
loans. Therefore, the calculation takes into account the assets that 
should make up the issuing entity's investment pool and excludes the 
value of other rights or incidental assets, as well as derivatives held 
for risk management. This further simplifies the calculation 
methodology by excluding assets that may be more complex to value and 
that are ancillary to the loan securitization's investment activities. 
This straightforward calculation methodology will ensure that the loan 
securitization exclusion remains easy to use and will facilitate 
banking entities' compliance with the exclusion.
    The agencies recognize that a loan securitization's transaction 
agreements may require that some categories of loans, cash equivalents, 
or debt securities be valued at fair market value for certain purposes. 
To accommodate such situations, the exclusion provides that the value 
of any loan, cash equivalent, or permissible debt security may be based 
on its fair market value if (1) the issuing entity is required to use 
the fair market value of such loan or debt security for purposes of 
calculating compliance with concentration limitations or other similar 
calculations under its transaction agreements and (2) the issuing 
entity's valuation methodology values similarly situated assets, for 
example non-performing loans, consistently. This provision is intended 
to provide issuers with the flexibility to leverage existing 
calculation methodologies while preventing issuers from using 
inconsistent methodologies in a manner to evade the requirements of the 
exclusion.
Leases
    A commenter on the 2018 proposal suggested that the loan 
securitization exclusion be expanded to cover leases and related 
assets, including operating or capital leases.\115\ In response, in the 
2020 proposal the agencies stated that they were ``not proposing to 
separately

[[Page 46434]]

list leases within the loan securitization exclusion because leases are 
included in the definition of loan and thus are permitted assets for 
loan securitizations under the current exclusion.'' \116\ That same 
commenter made a comment on the 2020 proposal urging the agencies to 
reconsider explicitly including operating leases and leased properties 
in the loan securitization exclusion.\117\ This commenter asserted that 
unless the agencies specifically revise the definition of ``rights or 
other assets'' to explicitly include leased property, then 
securitization vehicles with operating leases that rely on the residual 
property value after expiration of the lease to support their asset-
backed securities would not be able to qualify under the loan 
securitization exemption, despite the 2013 rule's provisions for 
special units of beneficial interest and collateral certificates.
---------------------------------------------------------------------------

    \115\ See 85 FR 12128.
    \116\ Id.
    \117\ SFA.
---------------------------------------------------------------------------

    Consistent with the 2020 proposal, the agencies are not separately 
listing leases within the loan securitization exclusion because leases 
are included in the definition of loan and thus are permitted assets 
for loan securitizations under the current exclusion. The agencies are 
also not modifying the definition of ``rights or other assets'' to 
explicitly include leased property, as any residual value of such 
leased property upon expiration of an operating lease should meet the 
requirements to constitute an asset that is related or incidental to 
purchasing or otherwise acquiring and holding loans.
3. Public Welfare and Small Business Funds
i. Public Welfare Funds
    Section 13(d)(1)(E) of the BHC Act permits, among other things, a 
banking entity to make and retain investments that are designed 
primarily to promote the public welfare of the type permitted under 12 
U.S.C. 24(Eleventh).\118\ Consistent with the statute, the implementing 
regulations exclude from the definition of ``covered fund'' issuers 
that make investments that are 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) (the public welfare investment 
exclusion).\119\
---------------------------------------------------------------------------

    \118\ See 12 U.S.C. 1851(d)(1)(E).
    \119\ Implementing regulations Sec.  __.10(c)(11)(ii)(A).
---------------------------------------------------------------------------

    The 2020 proposal noted that the OCC's regulations implementing 12 
U.S.C. 24(Eleventh) provide that investments that receive consideration 
as qualified investments under the regulations implementing the 
Community Reinvestment Act (CRA) are public welfare investments for 
national banks.\120\ The 2020 proposal requested comment on whether any 
change should be made to clarify that all permissible public welfare 
investments, under any agency's regulation, are excluded from the 
covered fund restrictions.\121\ The 2020 proposal specifically asked 
whether investments that would receive consideration as qualified 
investments under the CRA should be excluded from the definition of 
covered fund, either by incorporating these investments into the public 
welfare investment exclusion or by establishing a new exclusion for 
CRA-qualifying investments.\122\
---------------------------------------------------------------------------

    \120\ See 85 FR 12130; 12 CFR 24.3.
    \121\ See 85 FR 12130 (noting that such a change could provide 
additional certainty regarding community development investments 
made through fund structures).
    \122\ See id.
---------------------------------------------------------------------------

    In addition, the 2020 proposal requested comment on whether Rural 
Business Investment Companies (RBICs) are typically excluded from the 
definition of ``covered fund'' because of the public welfare investment 
exclusion or another exclusion and on whether the agencies should 
expressly exclude RBICs from the definition of covered fund.\123\ RBICs 
are licensed under a program designed to promote economic development 
and job creation in rural communities by investing in companies 
involved in the production, processing, and supply of food and 
agriculture-related products.\124\
---------------------------------------------------------------------------

    \123\ See id.
    \124\ See id.
---------------------------------------------------------------------------

    The Tax Cuts and Jobs Act established the ``opportunity zone'' 
program to provide tax incentives for long-term investing in designated 
economically distressed communities.\125\ The program allows taxpayers 
to defer and reduce taxes on capital gains by reinvesting gains in 
``qualified opportunity funds'' (QOF) that are required to have at 
least 90 percent of their assets in designated low-income zones.\126\ 
The 2020 proposal requested comment on whether many or all QOFs would 
meet the terms of the public welfare investment exclusion and on 
whether the agencies should expressly exclude QOFs from the definition 
of covered fund.\127\
---------------------------------------------------------------------------

    \125\ See id.
    \126\ See id.
    \127\ See id.
---------------------------------------------------------------------------

    Commenters generally supported clarifying that funds that make 
investments that qualify for consideration under the CRA qualify for 
the public welfare investment exclusion.\128\ Commenters noted that 
this clarification would be consistent with the OCC's regulations 
concerning public welfare investments and the CRA, provide greater 
certainty, and avoid unnecessarily chilling public welfare investment 
activities.\129\ One commenter stated that some banking entities have 
been reluctant to invest in certain community development funds due to 
uncertainty as to whether these funds were covered funds.\130\ This 
commenter stated that explicitly excluding funds that qualify for 
consideration under the CRA from the definition of covered fund would 
eliminate this uncertainty and would help support the type of community 
development efforts that the public welfare investment exclusion was 
designed to promote.\131\ In addition, some commenters recommended 
excluding funds that qualify for the public welfare investment 
exclusion from the definition of ``banking entity.'' \132\
---------------------------------------------------------------------------

    \128\ See SIFMA; FSF; BPI; ABA; PNC; Community Development 
Venture Capital Alliance (CDVCA); IIB; and Data Boiler (stating that 
incorporating the CRA public welfare exemption may ease some 
challenges faced by communities during the current COVID pandemic, 
but all PWI should not be excluded).
    \129\ See SIFMA; FSF; and CDVCA.
    \130\ See CDVCA.
    \131\ See id.
    \132\ See SIFMA; BPI; ABA; and IIB.
---------------------------------------------------------------------------

    Commenters also generally favored explicitly excluding RBICs and 
QOFs from the definition of ``covered fund,'' either by adopting new 
exclusions, or by clarifying the scope of the public welfare investment 
exclusion.\133\ Commenters stated that explicitly excluding these funds 
from the definition of ``covered fund'' would be consistent with the 
statutory provision permitting public welfare investments. Commenters 
stated that RBICs and QOFs must make investments that are clearly 
designed primarily to promote the public welfare because they are 
required to invest primarily in ways that promote job creation in rural 
communities (which may have significant low- and moderate-income 
populations or be economically disadvantaged and in need of 
revitalization or stabilization) and in economically distressed 
communities, respectively.\134\ Commenters stated that

[[Page 46435]]

certain RBICs and QOFs qualify for the public welfare investment 
exclusion, but providing an express exclusion for these funds would 
reduce uncertainty and associated compliance burdens and would 
encourage banking entities to provide capital to projects that promote 
economic development in rural and low-income communities.\135\ One 
commenter stated that RBICs and QOFs engage in investments that are 
substantively similar or identical to those of public welfare 
investment funds that are already excluded from the definition of 
covered fund and of the type that Congress recognized that section 13 
of the BHC Act was not designed to prohibit.\136\ Another commenter 
stated that explicitly excluding RBICs would result in the provision of 
valuable expertise and services to RBICs and provide funding and 
assistance to small businesses and low- and moderate-income 
communities.\137\ One commenter expressed skepticism about providing a 
new exclusion for RBICs and QOFs but suggested that certain of these 
funds may currently qualify for the public welfare investment 
exclusion.\138\ Another commenter stated that it is not necessary to 
expressly exclude QOFs from the definition of covered fund, noting that 
these funds should be of the type primarily intended to promote the 
public welfare of low- and moderate-income areas and should therefore 
qualify for the current public welfare investment exclusion.\139\
---------------------------------------------------------------------------

    \133\ See SIFMA; FSF; ABA (addressing QOFs); and Small Business 
Investor Alliance (SBIA) (addressing RBICs).
    \134\ See SIFMA and FSF.
    \135\ See SIFMA and FSF.
    \136\ See SIFMA.
    \137\ See SBIA.
    \138\ See Data Boiler.
    \139\ See PNC.
---------------------------------------------------------------------------

    After carefully considering the comments received, the agencies are 
revising the public welfare investment exclusion to explicitly 
incorporate funds, the business of which is to make investments that 
qualify for consideration under the Federal banking agencies' 
regulations implementing the CRA.\140\ Explicitly excluding these types 
of investments from the definition of covered fund clarifies and gives 
full effect to the statutory exemption for public welfare 
investments.\141\ In addition, this clarification will reduce 
uncertainty and will facilitate public welfare investments by banking 
entities.
---------------------------------------------------------------------------

    \140\ Final rule Sec.  __.10(c)(11)(ii)(A).
    \141\ See 12 U.S.C. 1851(d)(1)(E). A banking entity must have 
independent authority to make a public welfare investment. For 
example, a banking entity that is a state member bank may make a 
public welfare investment to the extent permissible under 12 U.S.C. 
338a and 12 CFR 208.22.
---------------------------------------------------------------------------

    The agencies are also adopting explicit exclusions from the 
definition of covered fund for RBICs and QOFs in Sec.  __.10(c)(11) of 
the final rule. These types of funds were created by Congress to 
promote development in rural and low-income communities, and, due to 
their similarity to SBICs and public welfare investments, the agencies 
believe that section 13 of the BHC Act was not intended to restrict the 
types of funds that engage in those activities. RBICs are companies 
licensed under the Rural Business Investment Program, a program 
designed to promote economic development and the creation of wealth and 
job opportunities among individuals living in rural areas and to help 
meet the equity capital investment needs primarily of smaller 
enterprises located in such areas.\142\ Likewise, QOFs were developed 
as part of a program to promote long-term investing in designated 
economically distressed communities and are required to have at least 
90 percent of their assets in designated low-income zones.\143\ 
Congress created RBICs and QOFs to encourage investment in rural areas, 
small enterprises, and low-income areas. Providing an explicit 
exclusion for these funds in the implementing regulations gives effect 
to section 13 of the BHC Act's provision permitting public welfare 
investments and avoids chilling the activities of funds that were not 
the target of section 13 of the BHC Act.\144\ Although many of these 
funds may already qualify for the public welfare investment exclusion, 
the agencies are explicitly excluding these funds from the definition 
of covered fund to reduce uncertainty and compliance burden. Thus, 
under the final rule, a covered fund does not include an issuer that 
has elected to be regulated or is regulated as a RBIC, as described in 
15 U.S.C. 80b-3(b)(8)(A) or (B), or that has terminated its 
participation as a RBIC in accordance with 7 CFR 4290.1900 and does not 
make any new investments (other than investments in cash equivalents, 
which, for the purposes of this paragraph, means high quality, highly 
liquid investments whose maturity corresponds to the issuer's expected 
or potential need for funds and whose currency corresponds to the 
issuer's assets) after such termination.\145\ Likewise, under the final 
rule, a covered fund does not include an issuer that is a QOF, as 
defined in 26 U.S.C. 1400Z-2(d).\146\
---------------------------------------------------------------------------

    \142\ See, e.g., Rural Business Investment Company (RBIC) 
Program, 85 FR 16519, 16520 (Mar. 24, 2020).
    \143\ See 26 U.S.C. 1400Z-2(d).
    \144\ See 12 U.S.C. 1851(d)(1)(E); 156 Cong. Rec. S5896 (daily 
ed. July 15, 2010) (Statement of Sen. Merkley) (noting that Section 
13(d)(1)(E) permits investments ``of the type'' permitted under 12 
U.S.C. 24 (Eleventh), including ``a range of low-income community 
development and other projects,'' but ``is flexible enough to permit 
the [agencies] to include other similar low-risk investments with a 
public welfare purpose'').
    \145\ Final rule Sec.  __.10(c)(11)(iii). As with SBICs, 
discussed below, the final rule contemplates that an issuer that 
ceases to be a RBIC during wind-down may continue to qualify for the 
exclusion from the definition of ``covered fund'' for RBICs if the 
issuer satisfies certain conditions designed to prevent abuse.
    \146\ Final rule Sec.  __.10(c)(11)(iv). As with other types of 
issuers excluded from the covered fund definition, a banking entity 
must have independent authority to invest in a QOF.
---------------------------------------------------------------------------

    The final rule does not exclude funds that qualify for the public 
welfare investment exclusion from the definition of ``banking entity'' 
as requested by some commenters.\147\ The term ``banking entity'' is 
specifically defined in section 13 of the BHC Act.\148\ In addition, 
the agencies do not believe that applying the definition of banking 
entity places an undue burden on banking entities' public welfare 
investments. The agencies believe that banking entities are able to 
design their permissible public welfare investments so as not to cause 
the investment fund to become a banking entity. For public welfare 
investment funds that are banking entities, the agencies believe that 
the burden-reducing amendments adopted in this final rule and the 2019 
amendments should mitigate concerns about compliance burdens.
---------------------------------------------------------------------------

    \147\ See SIFMA and BPI.
    \148\ 12 U.S.C. 1851(h)(1).
---------------------------------------------------------------------------

ii. Small Business Investment Companies
    Consistent with section 13 of the BHC Act,\149\ the implementing 
regulations exclude from the definition of ``covered fund'' SBICs and 
issuers that have received notice from the Small Business 
Administration to proceed to qualify for a license as an SBIC, which 
notice or license has not been revoked.\150\ The agencies proposed 
revising the exclusion for SBICs to clarify how the exclusion would 
apply to SBICs that surrender their licenses during wind-down 
phases.\151\ Specifically, the agencies proposed revising the exclusion 
for SBICs to apply explicitly to an issuer that has voluntarily 
surrendered its license to operate as an SBIC in accordance with 13 CFR 
107.1900 and does not make new investments (other than investments in 
cash equivalents) after such voluntary

[[Page 46436]]

surrender.\152\ The agencies explained that applying the exclusion to 
an issuer that has surrendered its SBIC license is appropriate because 
of the statutory exemption for investments in SBICs and because banking 
entities may otherwise become discouraged from investing in SBICs due 
to concerns that an SBIC may become a covered fund during its wind-down 
phase.\153\ The agencies further noted that the proposed revisions 
included a number of requirements designed to ensure that the exclusion 
would not be abused.\154\ In particular, the exclusion would apply only 
to an issuer that voluntarily surrenders its license in accordance with 
13 CFR 107.1900 and that does not make any new investments (other than 
investments in cash equivalents).\155\
---------------------------------------------------------------------------

    \149\ See 12 U.S.C. 1851(d)(1)(E) (permitting investments in 
SBICs).
    \150\ See implementing regulations Sec.  __.10(c)(11)(i).
    \151\ See 85 FR 12131.
    \152\ See id.
    \153\ See id.; 12 U.S.C 1851(d)(1)(E).
    \154\ See 85 FR 12131.
    \155\ See id.
---------------------------------------------------------------------------

    Most commenters that directly addressed the 2020 proposal's 
revisions concerning SBICs supported the proposed revisions, stating 
that the proposed revisions would provide greater certainty to banking 
entities wishing to invest in SBICs and would increase investment in 
small businesses.\156\ One commenter stated that revising the exclusion 
for SBICs would prevent a banking entity from being forced to sell an 
interest in an SBIC that became a covered fund for reasons outside of 
the banking entity's control.\157\ Commenters further noted that the 
proposed revisions included sufficient safeguards against evasion and 
did not present safety or soundness concerns.\158\ One commenter 
recommended against revising the exclusion from the definition of 
covered fund for SBICs. This commenter expressed concern about frequent 
buying and selling of SBICs and noted that section 13 of the BHC Act 
and its implementing regulations do not prohibit a banking entity from 
lending to small businesses.\159\ The commenter further expressed 
concern that an SBIC that surrenders its license may be doing so 
because it has failed or no longer wishes to comply with the Small 
Business Administration's regulations.\160\
---------------------------------------------------------------------------

    \156\ See SIFMA; BPI; ABA; PNC; and SBIA.
    \157\ See SBIA.
    \158\ See SIFMA; BPI; and SBIA.
    \159\ See SIFMA; BPI; and SBIA.
    \160\ See Data Boiler.
---------------------------------------------------------------------------

    After carefully considering the comments received, the agencies are 
adopting the revisions to the exclusion from the definition of covered 
fund for SBICs, as proposed.\161\ The revisions will provide greater 
certainty to banking entities, give full effect to the provision of 
section 13 of the BHC Act that permits investments in SBICs, and 
support capital formation for small businesses. In response to one 
commenter's concerns regarding the exclusion for SBICs,\162\ the 
agencies note that a banking entity's investment in an SBIC must comply 
with all applicable laws and regulations, including the prohibition 
against proprietary trading under section 13 of the BHC Act and its 
implementing regulations. Furthermore, as noted above, the revised 
exclusion for SBICs includes safeguards designed to prevent abuse or 
evasion. In particular, the exclusion would only apply to an issuer 
that has voluntarily surrendered its license to operate as an SBIC in 
accordance with 13 CFR 107.1900 and that does not make new investments 
(other than investments in cash equivalents) after such voluntary 
surrender.
---------------------------------------------------------------------------

    \161\ See final rule Sec.  __10(c)(11)(i).
    \162\ See Data Boiler.
---------------------------------------------------------------------------

C. Additional Covered Fund Exclusions

    In addition to modifying certain existing exclusions, the agencies 
are creating four new exclusions from the definition of ``covered 
fund'' to better tailor the provision to the types of entities that 
section 13 was intended to cover. These exclusions are for credit 
funds, venture capital funds, family wealth management vehicles, and 
customer facilitation vehicles.
General Comments
    Many commenters were broadly supportive of the proposed new 
exclusions from the definition of ``covered fund.'' \163\ Some 
commenters recommended adopting additional exclusions for an array of 
fund types and situations, including for tender bond vehicles,\164\ 
ownership interests erroneously acquired or retained,\165\ certain real 
estate funds,\166\ and funds in their seeding period.\167\ The agencies 
are declining to adopt these suggested exclusions because the requested 
actions are outside the scope of the current rulemaking. In addition, 
one commenter urged the agencies to redefine the definition of 
``covered fund,'' to rely on a characteristics-based approach.\168\ The 
agencies decline to revise the definition of ``covered fund'' for the 
reasons articulated in the preamble to the 2013 rule.\169\
---------------------------------------------------------------------------

    \163\ E.g., SIFMA; JBA; Credit Suisse; and SAF.
    \164\ SIFMA.
    \165\ SIFMA and BPI.
    \166\ IAA.
    \167\ ABA.
    \168\ JBA.
    \169\ See 79 FR 5671.
---------------------------------------------------------------------------

1. Credit Funds
i. Background and 2020 Proposal
    In the preamble to the 2013 rule, the agencies declined to 
establish an exclusion from the definition of covered fund for funds 
that make loans, invest in debt, or otherwise extend the type of credit 
that banking entities may provide directly under applicable banking law 
(credit funds).\170\ The agencies cited concerns about whether credit 
funds could be distinguished from private equity funds and hedge funds 
and the possible evasion of the requirements of section 13 of the BHC 
Act through the availability of such an exclusion. In addition, the 
agencies suggested that some credit funds would be able to operate 
using other exclusions from the definition of covered fund in the 2013 
rule, such as the exclusion for joint ventures or the exclusion for 
loan securitizations.\171\
---------------------------------------------------------------------------

    \170\ See 79 FR 5705.
    \171\ Id.
---------------------------------------------------------------------------

    However, commenters on the 2018 proposal noted that many credit 
funds have not been able to utilize the joint venture and loan 
securitization exclusions. In response, the agencies included in the 
2020 proposal a specific exclusion for credit funds. Under the 2020 
proposal, a credit fund would have been an issuer whose assets consist 
solely of:
     Loans;
     Debt instruments;
     Related rights and other assets that are related or 
incidental to acquiring, holding, servicing, or selling loans, or debt 
instruments; and
     Certain interest rate or foreign exchange 
derivatives.\172\
---------------------------------------------------------------------------

    \172\ 2020 proposal Sec.  __.10(c)(15)(i).
---------------------------------------------------------------------------

    The proposed exclusion would have been subject to certain 
additional requirements to reduce evasion concerns and help ensure that 
banking entities invest in, sponsor, or advise credit funds in a safe 
and sound manner. For example, the proposed exclusion would have 
imposed (1) certain activity requirements on the credit fund, including 
a prohibition on proprietary trading; \173\ (2) disclosure and safety 
and soundness requirements on banking entities that sponsor or serve as 
an advisor for a credit fund; \174\ (3) safety and soundness 
requirements on all banking entities that invest in or have certain 
relationships with a credit

[[Page 46437]]

fund; \175\ and (4) restrictions on the banking entity's investment in, 
and relationship with, a credit fund.\176\ The proposed exclusion also 
would have permitted a credit fund to receive and hold a limited amount 
of equity securities (or rights to acquire equity securities) that were 
received on customary terms in connection with the credit fund's loans 
or debt instruments.\177\
---------------------------------------------------------------------------

    \173\ 2020 proposal Sec.  __.10(c)(15)(ii).
    \174\ 2020 proposal Sec.  __.10(c)(15)(iii).
    \175\ 2020 proposal Sec.  __.10(c)(15)(iv).
    \176\ 2020 proposal Sec.  __.10(c)(15)(v).
    \177\ 2020 proposal Sec.  __.10(c)(15)(i)(C)(1)(iii).
---------------------------------------------------------------------------

ii. Comments
    The agencies requested comment on all aspects of the proposed 
credit fund exclusion. In addition, the agencies solicited comment on 
specific provisions of the proposed exclusion, including the 
permissibility of certain assets and requirements related to the 
activities of the credit fund and the relationship between a banking 
entity and a credit fund.\178\
---------------------------------------------------------------------------

    \178\ See 85 FR 12133.
---------------------------------------------------------------------------

General
    Commenters were generally supportive of adopting an exclusion for 
credit funds, and several commenters suggested specific revisions to 
the proposed exclusion.\179\ Several commenters supportive of the 2020 
proposal urged the agencies not to adopt any further limitations on the 
proposed exclusion and indicated that the proposed exclusion would not 
increase the risk of evasion of the requirements of section 13 of the 
BHC Act.\180\ Two commenters expressed general opposition to or concern 
about the proposed credit fund exclusion.\181\
---------------------------------------------------------------------------

    \179\ E.g., CCMC; AIC; SIFMA; FSF; ABA; Arnold & Porter; and 
Goldman Sachs.
    \180\ E.g., SIFMA; Credit Suisse; Goldman Sachs; and Arnold & 
Porter.
    \181\ Better Markets and Data Boiler. One of these commenters 
suggested that banking entities should instead rely on the 
exclusions for joint ventures and loan securitizations. Data Boiler.
---------------------------------------------------------------------------

Asset Requirements
    Commenters were generally supportive of allowing a credit fund to 
invest broadly in loans and debt instruments, certain related assets, 
and certain derivatives.\182\ One commenter recommended against 
delineating between permissible and non-permissible types of loans and 
debt instruments, arguing that credit funds should be able to extend 
credit to the same degree as would be permitted for the banking entity 
to extend directly.\183\ Another commenter encouraged the agencies to 
clarify and expand the definition of debt instrument and derivatives, 
to include all tranches of debt, collateralized loan and collateralized 
debt obligations, and any derivatives related to hedging credit risk, 
such as credit default swaps and total return swaps.\184\ In addition, 
a commenter suggested clarifying that no specific credit standard 
applies to loans held by a credit fund.\185\ One commenter also urged 
the agencies to establish a safe harbor to the permissible asset 
restrictions for banking entities that rely, in good faith, on a 
representation by the credit fund that the credit fund only invests in 
permissible assets.\186\
---------------------------------------------------------------------------

    \182\ E.g., SIFMA; Arnold & Porter; and ABA. One commenter also 
noted that the permissible holding period for debt previously 
contracted varies depending on applicable regulations and suggested 
that the agencies specify the holding period for debt previously 
contracted assets owned by a credit fund and provide for an 
extension process. Arnold & Porter.
    \183\ SIFMA. The same commenter also urged the agencies to 
permit credit funds to hold commodity forward contracts, which the 
commenter argued may be an appropriate hedge for extensions of 
credit to agricultural businesses. SIFMA.
    \184\ Credit Suisse. See also Arnold & Porter (recommending 
expanding the types of permissible derivatives, to allow for more 
effective hedging and easier disposal of portfolio assets).
    \185\ ABA.
    \186\ Arnold & Porter.
---------------------------------------------------------------------------

    Two commenters recommended limiting permissible assets to only 
loans or debt instruments, and not equity.\187\ In contrast, a range of 
commenters argued that allowing a credit fund to receive certain 
assets, like equity, related to an extension of credit would promote 
the sale of loans and extensions of credit.\188\ Some of these 
commenters suggested that taking equity as partial consideration for 
extending credit is commonplace in the debt and loan markets and that 
such a provision could ensure that credit funds are able to facilitate 
loan and debt workouts and restructurings, a critical financial 
intermediation function.\189\ Most commenters supportive of the 2020 
proposal were generally opposed to a quantitative limit on the amount 
of equity securities (or rights to acquire an equity security) received 
on customary terms in connection with such loans or debt instruments 
that could be held by a credit fund, citing compliance costs and 
diminished flexibility,\190\ but some commenters indicated that a 
limitation of 20 or 25 percent of total assets could be acceptable if 
the agencies were to impose a limit.\191\
---------------------------------------------------------------------------

    \187\ Data Boiler and Better Markets. One of these commenters 
argued that the inclusion of non-loan instruments would be contrary 
to the purpose of section 13 of the BHC Act. Data Boiler. As 
indicated by the agencies in the preamble to the 2020 proposal, 
taking limited amounts of non-loan or debt assets as consideration 
for an extension of credit is common and is a permitted practice for 
insured depository institutions. Therefore, the agencies believe it 
would not be inconsistent with section 13 of the BHC Act to 
facilitate the sale of loans by establishing a credit fund exclusion 
that allows a credit fund to hold a limited amount of certain equity 
instruments related to extensions of credit. See also the discussion 
about permitting excluded loan securitizations to hold a small 
amount of non-loan assets, supra Section IV.B.2 (Loan 
Securitizations).
    \188\ E.g., SIFMA; Credit Suisse; ABA; and Arnold & Porter.
    \189\ E.g., SIFMA; Credit Suisse; and Arnold & Porter.
    \190\ SIFMA; FSF; CCMC; AIC; ABA; and Goldman Sachs.
    \191\ SIFMA and CCMC.
---------------------------------------------------------------------------

    Commenters supportive of allowing credit funds to hold certain 
related assets, such as equity, in connection with an extension of 
credit suggested that the provision would not raise significant safety 
and soundness or evasion concerns. For example, one commenter claimed 
that such a provision would not raise the risk of evasion, in part, 
because equity options received as consideration generally expire 
unexercised.\192\ Other commenters argued that the activity 
requirements of the exclusion would prevent a credit fund from becoming 
actively involved in the purchase and sale of equity instruments.\193\ 
Another commenter suggested that the agencies could impose a 
requirement that non-loan or non-debt assets be acquired on arms-length 
terms and adhere to bank safety and soundness standards.\194\
---------------------------------------------------------------------------

    \192\ Arnold & Porter.
    \193\ Goldman Sachs and FSF.
    \194\ ABA.
---------------------------------------------------------------------------

    Separately, several commenters recommended allowing excluded credit 
funds to hold any type of asset, up to a certain percentage of 
aggregate assets, either 20 or 25 percent of a credit fund's total 
assets.\195\ These commenters asserted that permitting a credit fund to 
own equity securities and other assets would help the fund more 
effectively provide credit, without altering the character of the 
credit fund, and would reduce compliance burdens associated with 
launching and operating a credit fund.\196\ In addition, these 
commenters claimed that a limited bucket for non-loan and non-debt 
assets would be consistent with the ability of banking entities and 
some business development companies to invest in equity.\197\
---------------------------------------------------------------------------

    \195\ SIFMA; FSF; Credit Suisse; ABA; and Goldman Sachs. One 
commenter also suggested a formula for determining the cap. Goldman 
Sachs.
    \196\ E.g., SIFMA and Goldman Sachs.
    \197\ Id.
---------------------------------------------------------------------------

Banking Entity and Issuer Requirements
    Generally, commenters either agreed that certain restrictions to 
ensure that a credit fund is actually engaged in prudently providing 
credit and credit

[[Page 46438]]

intermediation and is not operated for the purpose of evading the 
provisions of section 13 of the BHC Act were appropriate or did not 
object to the inclusion of these requirements.\198\ Several commenters, 
however, offered revisions to the activities, sponsor or advisor, 
banking entity, or investment and relationship limit requirements. For 
example, several commenters requested clarification on the prohibition 
on proprietary trading by an excluded credit fund contained in Sec.  
__.10(c)(15)(ii)(A) of the 2020 proposal. One commenter suggested that 
the definition of proprietary trading for a credit fund should depend 
on the definition used by the banking entity.\199\ Another commenter 
encouraged the agencies to incorporate the exclusions and exemptions 
from the prohibition on proprietary trading into the credit fund 
exclusion's prohibition on proprietary trading.\200\ A third commenter 
recommended making explicit that exercising rights for certain related 
assets, such as an equity warrant, is not proprietary trading.\201\
---------------------------------------------------------------------------

    \198\ E.g., SIFMA; Better Markets; FSF; and Goldman Sachs. One 
commenter also indicated that the disclosure requirement for banking 
entities that sponsor or advise funds is appropriate. Arnold & 
Porter.
    \199\ SIFMA. For example, the commenter suggested that a credit 
fund sponsored by a banking entity subject to the market risk rule 
should be permitted to use the definitions of proprietary trading 
and trading account in Sec.  __.3(b)(1)(ii).
    \200\ FSF.
    \201\ Arnold & Porter.
---------------------------------------------------------------------------

    Commenters also requested revisions to and clarification about the 
limits on a banking entity's investment in, and relationship with, a 
credit fund. One commenter argued that the imposition of Sec.  __.14 of 
the implementing regulations (which imposes limitations on the 
relationship between a banking entity and a fund it sponsors or 
advises) would be duplicative of (1) the requirement that the banking 
entity not, directly or indirectly, guarantee, assume, or otherwise 
insure the obligations or performance of the credit fund and (2) 
certain conflict of interest, high-risk, and safety and soundness 
restrictions.\202\ Another commenter claimed that there was little 
benefit to imposing the requirements of Sec.  __.14 (described above) 
and Sec.  __.15 (which imposes certain material conflicts of interest, 
high-risk investments, and safety and soundness and financial stability 
requirements on permitted covered fund activities) of the implementing 
regulations in the context of credit funds and suggested that the 
partial application of Sec.  __.14, in particular, could lead to 
unexpected and inappropriate outcomes, such as allowing a banking 
entity to invest in the equity of a credit fund, but not the debt 
instruments issued by that same credit fund.\203\ That same commenter 
also recommended eliminating Sec.  __.10(c)(15)(v)(B) of the 2020 
proposal--which would have required that the banking entity's 
investment in, and relationship with, the credit fund be conducted in 
compliance with, and subject to, applicable banking laws and 
regulations--because applicable banking laws and regulations apply 
regardless of the banking entity's use of the credit fund 
exclusion.\204\
---------------------------------------------------------------------------

    \202\ SIFMA.
    \203\ Arnold & Porter.
    \204\ Arnold & Porter.
---------------------------------------------------------------------------

    In addition, a commenter argued that banking entities that serve as 
investment advisers or commodity trading advisors to credit funds 
should not be subject to the disclosure and safety and soundness 
requirements of Sec.  __.10(c)(15)(iii) of the 2020 proposal since 
investment advisers and commodity trading advisors who do not otherwise 
sponsor or invest in a fund are generally not subject to section 13 of 
the BHC Act. The commenter argued that Sec.  __.10(c)(15)(iii) of the 
2020 proposal would impose differing requirements on a credit fund 
depending on whether the investment adviser or commodity trading 
advisor was an insured depository institution or a bank holding 
company. That commenter also claimed that the portfolio requirements in 
Sec.  __.10(c)(15)(iv)(B) of the 2020 proposal could require banking 
entities to establish complex compliance programs to assess credit fund 
compliance with state and foreign laws and that the agencies should 
limit the scope of the provision to only federal banking laws and 
regulations.\205\
---------------------------------------------------------------------------

    \205\ Id.
---------------------------------------------------------------------------

    Finally, one commenter contended that the application of certain 
requirements in the exclusion is contingent on the type of banking 
entity that invests in or sponsors a credit fund and urged the agencies 
to make explicit that only the identity of the sponsor of the credit 
fund, and not its affiliates or third-party investors, determines which 
portfolio quality and safety and soundness requirements apply to the 
credit fund.\206\ More generally, this commenter asked the agencies to 
make explicit in the preamble to the final rule that the actions of 
unaffiliated, third-party banking entities do not affect whether a 
banking entity may invest in a fund.\207\
---------------------------------------------------------------------------

    \206\ Id.
    \207\ Id.
---------------------------------------------------------------------------

Other Comments
    Commenters also submitted several miscellaneous comments about the 
proposed exclusion for credit funds. One commenter requested that the 
agencies clarify the definition of asset-backed securities as used in 
the proposed credit fund exclusion and the current loan securitization 
exclusion.\208\ That same commenter also urged the agencies to revise 
the proposed credit fund exclusion to allow banking entities with more 
stringent credit requirements, such as insured depository institutions, 
to invest in credit funds that hold distressed debt.\209\
---------------------------------------------------------------------------

    \208\ Id.
    \209\ Id.
---------------------------------------------------------------------------

    Finally, the 2020 proposal requested comment on whether to combine 
the proposed credit fund exclusion with the loan securitization 
exclusion. Commenters were generally opposed to combining the two 
exclusions, citing different classes of assets in which the two types 
of issuers invest and a fundamental difference in structure (loan 
securitizations issue asset-backed securities, while credit funds do 
not).\210\ In addition, one commenter argued that while combining the 
two exclusions would increase the simplicity of the rule, such an 
amalgamated exclusion could result in increased compliance burdens for 
issuers who are accustomed to the lack of credit requirements in the 
current loan securitization exclusion.\211\
---------------------------------------------------------------------------

    \210\ SIFMA; FSF; CCMC; Credit Suisse; and Data Boiler.
    \211\ Arnold & Porter.
---------------------------------------------------------------------------

iii. Final Exclusion
    After consideration of the comments, the agencies are adopting the 
credit fund exclusion as proposed, with certain modifications. The 
agencies believe that the credit fund exclusion in the final rule (1) 
addresses the application of the covered fund provisions to credit-
related activities that certain banking entities are permitted to 
engage in directly and (2) is consistent with Congress's intent that 
section 13 of the BHC Act limit banking entities' investment in and 
relationships with hedge funds and private equity funds, but not limit 
or restrict banking entities' ability to extend credit.\212\ The 
agencies also believe that the credit fund exclusion in the final rule, 
with the eligibility criteria described below, will address concerns 
the agencies expressed in the preamble to the 2013

[[Page 46439]]

rule about the ability to administer an exclusion for credit funds and 
the potential evasion of section 13 of the BHC Act.\213\ Banking 
entities already have experience using and complying with the loan 
securitization exclusion. Establishing an exclusion for credit funds 
based on the framework provided by the loan securitization exclusion 
allows banking entities to provide traditional extensions of credit 
regardless of the specific form, whether directly via a loan made by a 
banking entity, or indirectly through an investment in or relationship 
with a credit fund that transacts primarily in loans and certain debt 
instruments.
---------------------------------------------------------------------------

    \212\ See 12 U.S.C. 1851(g)(2), (h)(2). Paragraph (g)(2) of 
section 13 of the BHC Act makes clear that the Volcker rule is not 
intended to impede banking entities' ability to extend credit by, 
for example, selling loans or securitize loans. See 12 U.S.C. 
1851(g)(2).
    \213\ See 79 FR 5705.
---------------------------------------------------------------------------

    The credit fund exclusion limits the universe of potential funds 
that can rely on the exclusion by clearly specifying the types of 
activities in which those funds may engage. Excluded credit funds can 
transact in or hold only loans; debt instruments that would be 
permissible for the banking entity relying on the exclusion to hold 
directly; certain rights or assets that are related or incidental to 
the loans or debt instruments, including equity securities (or rights 
to acquire an equity security) received on customary terms in 
connection with such loans or debt instruments; and certain interest 
rate and foreign exchange derivatives. The credit fund exclusion, with 
these eligibility criteria, should not raise evasion concerns. 
Similarly, the agencies' expectations regarding the amount of 
permissible equity securities (or rights to acquire an equity security) 
held and the requirement that the credit fund not engage in activities 
that would constitute proprietary trading should help to ensure that 
the extensions of credit, whether directly originated or acquired from 
a third party, are held by the credit fund for the purpose of 
facilitating lending and not for the purpose of evading the 
requirements of section 13. Finally, the restrictions on guarantees and 
other limitations should eliminate the ability and incentive for either 
the banking entity sponsoring a credit fund or any affiliate to provide 
additional support beyond the ownership interest retained by the 
sponsor. Thus, the agencies expect that, together, the criteria for the 
credit fund exclusion will prevent a banking entity from having any 
incentive to bail out such funds in periods of financial stress or 
otherwise expose the banking entity to the types of risks that the 
covered fund provisions of section 13 were intended to address.
    Consistent with commenters' suggestions, the agencies are keeping 
separate the credit fund exclusion and the loan securitization 
exclusion because the structures and purposes of those two types of 
issuers differ sufficiently to warrant different requirements. For 
example, loan securitizations and credit funds have different asset 
composition and different financing and legal structures. Therefore, 
the agencies are finalizing a credit fund exclusion separate from the 
loan securitization exclusion.
Asset Requirements
    Under the final rule, a credit fund, for the purposes of the credit 
fund exclusion, is an issuer whose assets consist solely of:
     Loans;
     Debt instruments;
     Related rights and other assets that are related or 
incidental to acquiring, holding, servicing, or selling loans, or debt 
instruments; and
     Certain interest rate or foreign exchange 
derivatives.\214\
---------------------------------------------------------------------------

    \214\ Final rule Sec.  __.10(c)(15)(i).
---------------------------------------------------------------------------

    Several provisions of the exclusion are similar to and modeled on 
conditions in the loan securitization exclusion to ease compliance 
burdens. For example, any derivatives held by the credit fund must 
relate to loans, permissible debt instruments, or other rights or 
assets held and reduce the interest rate and/or foreign exchange risks 
related to these holdings.\215\ In addition, any related rights or 
other assets held that are securities must be cash equivalents, 
securities received in lieu of debts previously contracted with respect 
to loans held or, unique to the credit fund exclusion, equity 
securities (or rights to acquire equity securities) received on 
customary terms in connection with the credit fund's loans or debt 
instruments.\216\
---------------------------------------------------------------------------

    \215\ Final rule Sec.  __.10(c)(15)(i)(D).
    \216\ Final rule Sec.  __.10(c)(15)(i)(C). In a minor change 
from the 2020 proposal, the agencies are making clear that rights or 
other assets held under paragraph (c)(15)(i)(C) of that section may 
not include any derivative, other than a derivative that meets the 
requirements of paragraph (c)(15)(i)(D) of that section.
---------------------------------------------------------------------------

    In the 2020 proposal, the agencies requested comment on whether to 
impose a limit on the amount of equity securities (or rights to acquire 
equity securities) that may be held by an excluded credit fund.\217\ 
After a review of the comments and further deliberation, the agencies 
are not adopting a quantitative limit on the amount of equity 
securities (or rights to acquire equity securities) that may be held by 
an excluded credit fund. Any such equity securities or rights are 
limited by the requirements that they be (a) received on customary 
terms in connection with the fund's loans or debt instruments and (b) 
related or incidental to acquiring, holding, servicing, or selling 
those loans or debt instruments. The agencies generally expect that the 
equity securities or rights satisfying those criteria in connection 
with an investment in loans or debt instruments of a borrower (or 
affiliated borrowers) would not exceed five percent of the value of the 
fund's total investment in the borrower (or affiliated borrowers) at 
the time the investment is made. The agencies understand that the value 
of those equity securities or other rights may change over time for a 
variety of reasons, including as a result of market conditions and 
business performance, as well as more fundamental changes in the 
business and the credit fund's corresponding management of the 
investment (e.g., exchanges of debt instruments for equity in 
connection with mergers and restructurings or a disposition of all 
portion of the credit investment without a corresponding disposition of 
the equity securities or rights due to differences in market conditions 
or other factors). Accordingly, the agencies can foresee various 
circumstances where the relative value of such equity securities or 
rights in a borrower (or affiliated borrowers) would over the life of 
the investment exceed five percent on a basis consistent with the 
requirements. Nonetheless, the agencies expect that the fund's exposure 
to equity securities (or other rights), individually and collectively 
and when viewed over time, would be managed on a basis consistent with 
the fund's overall purpose.
---------------------------------------------------------------------------

    \217\ 85 FR 12133.
---------------------------------------------------------------------------

    The agencies are also not imposing additional restrictions on the 
types of equity securities (or rights to acquire an equity security) 
that a credit fund may hold. The final rule prevents a banking entity 
from relying on the credit fund exclusion unless any debt instruments 
and equity securities (or rights to acquire an equity security) held by 
the credit fund and received on customary terms in connection with the 
credit fund's loans or debt instruments are permissible for the banking 
entity to acquire and hold directly and a sponsor of a credit fund must 
ensure that the credit fund complies with certain safety and soundness 
standards.\218\ Combined with the prohibition on proprietary trading by 
a credit fund,\219\ these limitations are expected to prevent evasion 
of section 13 of the BHC Act and should be sufficient to prevent

[[Page 46440]]

banking entities from investing in or sponsoring credit funds that hold 
excessively risky equity securities (or rights to acquire an equity 
security).\220\
---------------------------------------------------------------------------

    \218\ Final rule Sec.  __.10(c)(15)(iv)(B), (iii)(B).
    \219\ Final rule Sec.  __.10(c)(15)(ii)(A).
    \220\ One commenter suggested requiring that equity securities 
(or rights to acquire an equity security) be acquired via arms-
length market transactions and adhere to bank safety and soundness 
standards. See ABA. Under the final rule, a banking entity may not 
rely on the credit fund exclusion unless any equity securities (or 
rights to acquire an equity security) held by the credit fund are 
permissible for the banking entity to acquire and hold directly 
under applicable federal banking laws and regulations. Final rule 
Sec.  __.10(c)(15)(iv)(B). In addition, the final rule requires that 
equity securities (or rights to acquire an equity security) related 
or incidental to acquiring, holding, servicing, or selling such 
loans or debt instruments must be received on customary terms in 
connection with such loans or debt instruments. Final rule Sec.  
__.10(c)(15)(i)(C)(1)(iii). Finally, a banking entity's investment 
in, and relationship with, the issuer must comply with the 
limitations imposed in Sec.  __.15, as if the issuer were a covered 
fund. Final rule Sec.  __.10(c)(15)(v)(A).
---------------------------------------------------------------------------

    The agencies are, however, clarifying that the provision allowing 
related rights and other assets does not separately permit the holding 
of derivatives. The preamble to the 2020 proposal made clear that ``any 
derivatives held by the credit fund must relate to loans, permissible 
debt instruments, or other rights or assets held, and reduce the 
interest rate and/or foreign exchange risks related to these 
holdings.'' \221\ The agencies suggested then and currently believe 
that allowing a credit fund issuer to hold derivatives not related to 
interest rate or foreign exchange hedging would not be necessary to 
facilitate the indirect extension of credit by banking entities and may 
pose the very risks that section 13 of the BHC Act was intended to 
reach. To ensure that the credit fund exclusions does not inadvertently 
allow the holding of certain derivatives unrelated to interest rate 
and/or foreign exchange risks, the final rule explicitly excludes 
derivatives from permissible related right and other assets.\222\
---------------------------------------------------------------------------

    \221\ 85 FR 12132.
    \222\ Final rule Sec.  __.10(c)(15)(i)(C)(2).
---------------------------------------------------------------------------

    The agencies are not adopting a broad expansion of permissible 
assets, as recommended by several commenters. Contrary to commenters' 
suggestions, allowing credit funds to hold unlimited amounts of non-
debt instruments or derivatives, such as credit default or total return 
swaps, could present evasion concerns and is not necessary for 
effectuating the rule of construction.\223\ The agencies believe that 
only those instruments that facilitate the extension of credit and 
directly-related hedging activities should be permitted under the 
exclusion. For example, allowing the unlimited holding of credit 
default swaps by a majority owned or sponsored credit fund could raise 
the risks that section 13 of the BHC Act was intended to address. 
Moreover, permitting excluded credit funds to invest up to 25 percent 
of total assets in any type of asset could turn the exclusion for 
credit funds into an exclusion for the type of funds that section 13 of 
the BHC Act was intended to address. Such a result would be contrary to 
section 13 of the BHC Act.
---------------------------------------------------------------------------

    \223\ The agencies' rationale, in the preamble to the 2013 rule, 
for limiting the permissible assets for the loan securitization 
exclusion is particularly relevant. See 79 FR 5691 (``Under the 
final rule as adopted, an excluded loan securitization would not be 
able to hold derivatives that would relate to risks to 
counterparties or issuers of the underlying assets referenced by 
these derivatives because the operation of derivatives, such as 
these, that expand potential exposures beyond the loans and other 
assets, would not in the Agencies' view be consistent with the 
limited exclusion contained in the rule of construction under 
section 13(g)(2) of the BHC Act, and could be used to circumvent the 
restrictions on proprietary trading and prohibitions in section 
13(f) of the BHC Act. The Agencies believe that the use of 
derivatives by an issuing entity for asset-backed securities that is 
excluded from the definition of covered fund under the loan 
securitization exclusion should be narrowly tailored to hedging 
activities that reduce the interest rate and/or foreign exchange 
risks directly related to the asset-backed securities or the loans 
supporting the asset-backed securities because the use of 
derivatives for purposes other than reducing interest rate risk and 
foreign exchange risks would introduce credit risk without 
necessarily relating to or involving a reduction of interest rate 
risk or foreign exchange risk.'').
---------------------------------------------------------------------------

    There are several additional changes recommended by commenters that 
the agencies are not including in the final rule. Specifically, the 
final rule does not:
     Allow excluded credit funds to hold commodity forward 
contracts. Although these contracts have legitimate value as hedging 
instruments, the agencies do not believe this type of hedging activity 
is consistent with the purpose of the exclusion for credit funds, which 
is to allow banking entities to share the risks of their permissible 
lending activities or to engage in permissible lending activities 
indirectly through a fund structure.
     Permit banking entities that are insured depository 
institutions or their operating subsidiaries to invest in credit funds 
through a contribution to a credit fund of troubled loans and debt 
previously contracted assets from the banking entity's portfolio. The 
conditions in the final rule are intended to ensure that a credit fund 
generally engages in activities that the banking entity may engage in 
directly and that the banking entity's investment in and relationship 
with the fund are conducted in a safe and sound manner. The agencies 
decline to deviate from these standards for any particular type of 
credit fund because doing so could permit activities that raise the 
type of concerns that section 13 of the BHC Act was intended to 
address.
     Further specify the holding period for securities held in 
lieu of debts previously contracted held by a credit fund. Generally, a 
banking entity may not rely on this exclusion unless any debt 
instruments and equity securities (or rights to acquire equity 
securities) held by the fund would be permissible for the banking 
entity to acquire and hold directly under applicable federal banking 
laws and regulations. However, the requirement that a banking entity be 
able to hold a given asset directly does not apply to securities held 
in lieu of debts previously contracted under the final regulations. 
Because a banking entity's ability to invest in or sponsor an excluded 
credit fund is not contingent on how long the credit fund holds 
securities held in lieu of debts previously contracted, the agencies do 
not believe it is necessary to amend the regulations to impose a 
specific holding period on securities held by a credit fund in lieu of 
debts previously contracted.\224\
---------------------------------------------------------------------------

    \224\ The agencies note that banking entities must otherwise 
comply with applicable law. See infra, Additional Banking Entity 
Requirements.
---------------------------------------------------------------------------

     Revise or expand on the definition of debt instrument. The 
agencies believe that the term debt instrument already has a general 
meaning that is used in the marketplace and by regulators and that a 
new definition is unnecessary given this widely understood meaning and 
could cause confusion.
     Adopt a safe harbor for banking entities that rely, in 
good faith, on a representation by the credit fund that it only invests 
in permissible assets. It is the responsibility of the banking entity 
to ensure that it complies with section 13 of the BHC Act and the 
implementing regulations, and such responsibility cannot be substituted 
solely with a representation from a credit fund.
Activity Requirements
    The agencies are adopting the activity requirements for issuers in 
the 2020 proposal without revision. Under the final rule, a credit fund 
is not a covered fund, provided that:
     The fund does not engage in activities that would 
constitute proprietary trading, as defined in Sec.  __.3(b)(1)(i) of 
the rule, as if the fund were a banking entity; \225\ and
---------------------------------------------------------------------------

    \225\ Final rule Sec.  __.10(c)(15)(ii)(A).

---------------------------------------------------------------------------

[[Page 46441]]

     The fund does not issue asset-backed securities.\226\
---------------------------------------------------------------------------

    \226\ Final rule Sec.  __.10(c)(15)(ii)(B).
---------------------------------------------------------------------------

    The agencies decline to adopt changes recommended by commenters 
because the agencies believe the activity requirements are clear and 
appropriate. The first provision explicitly references the prohibition 
on proprietary trading by a banking entity in Sec.  __.3 of the 
implementing regulations and, in particular, the short-term intent 
prong contained in Sec.  __.3(b)(1)(i). For the avoidance of doubt, a 
credit fund would not be able to elect a different definition of 
proprietary trading or trading account. Varying the definition of 
proprietary trading depending on the type of banking entity that 
sponsors or invests in the credit fund, as suggested by a commenter, 
could result in conflicting requirements for credit funds with multiple 
banking entity investors and generally increase compliance burdens on 
credit funds. The agencies also note that activities permitted under 
Sec.  __.10(c)(15) generally would not be considered proprietary 
trading, provided that an excluded credit fund does not purchase or 
sell one or more financial instruments principally for the purpose of 
short-term resale, benefit from actual or expected short-term price 
movements, realize short-term arbitrage profits, or hedge one or more 
of the positions resulting from the purchases or sales of financial 
instruments.
    The agencies are not expressly incorporating the permitted 
activities in Sec. Sec.  __.4, __.5, and __.6 of the implementing 
regulations into the text of the final credit fund exclusion. The 
exclusion for credit funds is intended to allow banking entities to 
share the risks of otherwise permissible lending activities. 
Accordingly, the agencies would not expect that a credit fund would be 
formed for the purpose of engaging, or in the ordinary course would be 
engaged, in the activities permitted under Sec. Sec.  __.4, __.5, and 
__.6 of the implementing regulations. Nevertheless, to the extent that 
a credit fund seeks to engage in any of those activities as an 
exemption from the prohibition on engaging in proprietary trading, as 
defined in Sec.  __.3(b)(1)(i) of the final rule, and does so in 
compliance with the requirements and conditions of the applicable 
exemption, then the final rule would not preclude such activities.\227\ 
Similarly, with respect to the exclusions from the definition of 
proprietary trading contained in Sec.  __.3(d) of the implementing 
regulations, the agencies note that the trading activities identified 
in Sec.  __.3(d) are by definition not deemed to be proprietary 
trading, such that the performance by an excluded credit fund of those 
activities would not be inconsistent with the final credit fund 
exclusion.\228\
---------------------------------------------------------------------------

    \227\ The agencies recognize, however, that compliance with 
certain requirements and conditions in Sec. Sec.  __.4, __.5, and 
__.6 of the implementing regulations may be inapt and/or highly 
impractical in the context of a credit fund, particularly given the 
asset and activity restrictions contained in Sec.  __.10(c)(15). For 
example, the exemptions for underwriting and market making-related 
activities in Sec.  __.4 require that a banking entity relying on 
such exemptions, among other things, be licensed or registered to 
engage in the applicable activity in accordance with applicable law. 
Moreover, to the extent that a credit fund is a banking entity with 
significant trading assets and liabilities (i.e., because it, 
together with its affiliates and subsidiaries, has trading assets 
and liabilities that equal or exceed $20 billion over the four 
previous calendar quarters), it also would be required to maintain a 
separate compliance program specific to those exemptions.
    \228\ Similarly, trading activity that satisfies the 60-day 
rebuttable presumption in Sec.  __.3(b)(4) would be presumed not to 
be proprietary trading for these purposes.
---------------------------------------------------------------------------

    Finally, the agencies are not revising the definition of ``asset-
backed security'' in the implementing regulations. The definition of 
``asset-backed security'' in the implementing regulations specifically 
refers to the meaning specified in section 3(a)(79) of the Exchange Act 
(15 U.S.C. 78c(a)(79)).\229\ This definition is used elsewhere in 
banking law,\230\ and banking entities and others in the loan 
securitization industry have adapted their operations in reliance of 
the definition contained in the Exchange Act. Moreover, the 2013 rule 
included the requirement that the fund issue asset backed securities as 
part of the loan securitization criteria, and banking entities have 
become familiar with this definition, as they have implemented and 
utilized the exclusion.
---------------------------------------------------------------------------

    \229\ Implementing regulations Sec.  __.10(d)(2).
    \230\ See 12 CFR 244 (Credit Risk Retention).
---------------------------------------------------------------------------

Requirements for a Sponsor, Investment Adviser, or Commodity Trading 
Advisor

    The agencies are adopting the proposed requirements for a sponsor, 
investment adviser, or commodity trading advisor to an excluded credit 
fund with one modification.
    Investors in a credit fund that a banking entity sponsors or for 
which the banking entity serves as an investment adviser or commodity 
trading advisor may have expectations related to the performance of the 
credit fund that raise bailout concerns. To ensure that these investors 
are adequately informed of the banking entity's role in the credit 
fund, the final rule requires a banking entity that acts as a sponsor, 
investment adviser, or commodity trading advisor to an excluded credit 
fund to provide prospective and actual investors the disclosures 
specified in Sec.  __.11(a)(8) of the implementing regulations.\231\
---------------------------------------------------------------------------

    \231\ Final rule Sec.  __.10(c)(15)(iii)(A). These disclosures 
include, among other things, that losses are borne solely by 
investors and not the banking entity, that investors should examine 
fund documents, and that ownership interests are not insured by the 
FDIC or guaranteed. Final rule Sec.  __.11(a)(8).
---------------------------------------------------------------------------

    Second, a banking entity that acts as a sponsor, investment 
adviser, or commodity trading advisor must ensure that the activities 
of the credit fund are consistent with safety and soundness standards 
that are substantially similar to those that would apply if the banking 
entity engaged in the activities directly.\232\ The agencies note, 
contrary to the suggestion of a commenter, that this provision does not 
apply to any investment adviser or commodity trading advisor to a 
credit fund who does not also sponsor or acquire an ownership interest 
in the credit fund. Rather, the requirements in Sec.  __.10(c)(15) 
apply only to a sponsor, investment adviser, or commodity trading 
adviser that relies on the exclusion to sponsor or acquire an ownership 
interest in the credit fund. The covered fund provisions in Sec.  __.10 
of the implementing regulations only affect the operations of banking 
entities that, as principal, directly or indirectly, acquire or retain 
any ownership interest in or sponsor a covered fund.\233\ Thus, the 
safety and soundness provision only applies to banking entities that 
sponsor an excluded credit fund or that have an ownership interest in 
an excluded credit fund and also serve as an investment adviser or 
commodity trading advisor to the fund.
---------------------------------------------------------------------------

    \232\ Final rule Sec.  __.10(c)(15)(iii)(B).
    \233\ Implementing regulations Sec.  __.10(a)(1).
---------------------------------------------------------------------------

    More generally, to clarify an issue raised by some commenters, the 
agencies note that whether a specific banking entity may use the credit 
fund exclusion to make or have an otherwise impermissible investment in 
or relationship with a credit fund is contingent on the permissible 
activities of the banking entity. That is, the same fund may be a 
covered fund with respect to one banking entity and an excluded credit 
fund with respect to a different banking entity. A banking entity 
continues to be responsible for ensuring that its particular 
investment, sponsorship, or adviser activities comply with section 13 
of the BHC Act and its implementing regulations. This principle applies 
to paragraphs (iii), (iv), and (v) of the credit fund exclusion.

[[Page 46442]]

    The final rule moves the requirement that the banking entity must 
comply with Sec.  __.14 of the implementing regulations to Sec.  
__.10(c)(15)(iii). This organizational change is in response to 
commenters that requested the agencies confirm that that the Sec.  
__.14 limitations do not apply to a banking entity that merely invests 
in a credit fund, as opposed to a banking entity that sponsors or 
advises the fund. The agencies believe this change is appropriate 
because the limitations on banking entities' relationships with a 
covered fund in Sec.  __.14 only apply when a banking entity serves, 
directly or indirectly, as the investment manager, investment adviser, 
commodity trading advisor, or sponsor to a covered fund.\234\ In 
addition, the agencies appreciate that mere investment by a banking 
entity in a credit fund does not raise the type of concerns Super 23A 
was intended to address, and thus the agencies are applying Sec.  __.14 
only when a banking entity acts as a sponsor, investment adviser, or 
commodity trading advisor to a credit fund, in each case as though the 
credit fund were a covered fund.\235\ The limitations in Sec.  __.15 of 
the implementing regulations regarding material conflicts of interest, 
high-risk investments, and safety and soundness and financial stability 
remain applicable to banking entities' investment in, and relationship 
with, excluded credit funds.
---------------------------------------------------------------------------

    \234\ Final rule Sec.  __.14(a)(1).
    \235\ Final rule Sec.  __.10(c)(15)(iii)(C).
---------------------------------------------------------------------------

Additional Banking Entity Requirements

    As provided in the 2020 proposal, a banking entity may not rely on 
the credit fund exclusion if it guarantees the performance of the 
fund.\236\ In a revision to the 2020 proposal, under the final rule a 
banking entity may not rely on the credit fund exclusion if the fund 
holds any debt instruments or equities (or rights to acquire an equity 
security) received on customary terms in connection with loans or debt 
instruments held by the credit fund that the banking entity is not 
permitted to acquire and hold directly under applicable federal banking 
laws and regulations.\237\ This change is to clarify, as suggested by a 
commenter, that this requirement is specific only to federal banking 
laws and regulations. Whether a credit fund's holdings are permissible 
for a banking entity to hold under state or foreign laws is not 
relevant to compliance with section 13 of the BHC Act. That said, the 
agencies note that banking entities must comply with the laws of the 
jurisdiction applicable to its activities and operations and should be 
cognizant of whether a credit fund it sponsors or in which it invests 
complies with the laws of the jurisdictions in which the credit fund 
operates.\238\
---------------------------------------------------------------------------

    \236\ Final rule Sec.  __.10(c)(15)(iv).
    \237\ Final rule Sec.  __.10(c)(15)(iv)(B).
    \238\ For example, banking entities that are organized under 
state or foreign laws may, depending on the nature of the 
organization, need to comply with other laws.
---------------------------------------------------------------------------

Investment and Relationship Limits

    Finally, the agencies are adopting the proposed provisions related 
to a banking entity's investment in and relationship with a credit fund 
with one revision. Under the final rule, a banking entity's investment 
in, and relationship with, the issuer must comply with the limitations 
in Sec.  __.15 of the implementing regulations regarding material 
conflicts of interest, high-risk investments, and safety and soundness 
and financial stability, in each case as though the credit fund were a 
covered fund.\239\
---------------------------------------------------------------------------

    \239\ Final rule Sec.  __.10(c)(15)(v)(A).
---------------------------------------------------------------------------

    In addition, a banking entity's investment in, and relationship 
with, a credit fund must be conducted in compliance with, and subject 
to, applicable banking laws and regulations, including the safety and 
soundness standards applicable to the banking entity.\240\ The agencies 
believe it is important to highlight that the requirements applicable 
to the banking entity also govern the ability of the banking entity to 
invest in a fund that relies on the credit fund exclusion as well as 
the types of transactions that a banking entity may conduct with such 
funds.\241\ This means, for example, that a banking entity that invests 
in or has a relationship with a credit fund is subject to capital 
charges and other requirements under applicable banking law.\242\
---------------------------------------------------------------------------

    \240\ Final rule Sec.  __.10(c)(15)(v)(B).
    \241\ The agencies also note that Sec.  __.10(c)(15)(v)(B) does 
not impose any additional burdens and should not generate confusion.
    \242\ For example, a banking entity's investment in or 
relationship with a credit fund could be subject to the regulatory 
capital adjustments and deductions relating to investments in 
financial subsidiaries or in the capital of unconsolidated financial 
institutions, if applicable. See 12 CFR 217.22.
---------------------------------------------------------------------------

2. Venture Capital Funds
i. Venture Capital Funds

2020 Proposal

    The 2020 proposal included an exclusion for ``qualifying venture 
capital funds.'' \243\ As described in the 2020 proposal, venture 
capital funds that provide capital to small and start-up businesses are 
covered funds unless they can rely on an exclusion other than section 
3(c)(1) or 3(c)(7) to avoid registration under the Investment Company 
Act of 1940 (Investment Company Act) or qualify for an exclusion under 
the implementing regulations.
---------------------------------------------------------------------------

    \243\ 2020 proposal Sec.  __.10(c)(16).
---------------------------------------------------------------------------

    Under the 2020 proposal, the exclusion would have been available to 
``qualifying venture capital funds,'' which the 2020 proposal defined 
as an issuer that meets the definition in 17 CFR 275.203(l)-1 (Rule 
203(l)-1), as well as several additional criteria. Specifically, the 
agencies proposed to exclude from the definition of covered fund an 
issuer that:
     Is a venture capital fund as defined in Rule 203(l)-1; and
     Does not engage in any activity that would constitute 
proprietary trading, under Sec.  __.3(b)(1)(i), as if it were a banking 
entity.
    With respect to any banking entity that acts as sponsor, investment 
adviser, or commodity trading advisor to the issuer, and that relies on 
the exclusion to sponsor or acquire an ownership interest in the 
qualifying venture capital fund, the banking entity would have been 
required to:
     Provide in writing to any prospective and actual investor 
the disclosures required under Sec.  __.11(a)(8), as if the issuer were 
a covered fund; and
     Ensure that the activities of the issuer are consistent 
with the safety and soundness standards that are substantially similar 
to those that would apply if the banking entity engaged in the 
activities directly.
    In addition, a banking entity that relied on the exclusion would 
not have been permitted, directly or indirectly, to guarantee, assume, 
or otherwise insure the obligations or performance of the issuer. 
Finally, the 2020 proposal would have required a banking entity's 
ownership interest in or relationship with a qualifying venture capital 
fund to:
     Comply with the limitations imposed in Sec.  __.14 (except 
the banking entity may acquire and retain any ownership interest in the 
issuer) and Sec.  __.15 of the implementing regulations, as if the 
issuer were a covered fund; and
     Be conducted in compliance with and subject to applicable 
banking laws and regulations, including applicable safety and soundness 
standards.

[[Page 46443]]

Comments

    Several commenters supported an exclusion for venture capital 
funds.\244\ Some of these commenters argued the Volcker Rule has 
severely impacted investment in venture funds and businesses and that 
venture capital is a critical financing source for innovative 
businesses.\245\ These commenters described their view of the positive 
economic impact of venture capital investment.\246\ For example, these 
commenters said companies funded with venture capital promote research 
and development and job creation.\247\ Similarly, several commenters 
argued that venture capital investments by banking entities can 
contribute to economic growth, innovation, and job creation.\248\ At 
least one commenter said increased venture capital investment may 
increase employment by small employers.\249\
---------------------------------------------------------------------------

    \244\ Representatives Gonzalez, Steil, Stivers, Barr, Hill, 
Riggleman, Zeldin, Davidson, Budd, Gooden, Rose, Emmer, Timmons, 
Posey, Kustoff, and Loudermilk (Gonzalez et al.); Crapo; FSF; SIFMA; 
CCMC; IIB; Goldman Sachs; Credit Suisse; AIC; National Venture 
Capital Association (NVCA); ABA; and SAF.
    \245\ E.g., Gonzalez et al. and NVCA.
    \246\ Gonzalez et al.; NVCA; and CCMC.
    \247\ Id.
    \248\ E.g., FSF; SIFMA; and Goldman Sachs.
    \249\ SAF.
---------------------------------------------------------------------------

    Several commenters said an exclusion for venture capital funds 
would benefit underserved regions where venture capital funding is not 
readily available currently.\250\ One commenter said venture capital 
fund sizes are often too small for institutional investors, and banks 
have historically served an important source of investment for small 
and regional venture capital funds.\251\ This commenter said the loss 
of banking entities as limited partners in venture capital funds has 
had a disproportionate impact on cities and regions with emerging 
entrepreneurial ecosystems areas outside of Silicon Valley and other 
traditional technology centers.\252\ Two commenters noted that an 
exclusion for venture capital funds would promote investments in and 
financing to small businesses and start-ups in a broad range of 
geographic areas, industries, and sectors.\253\
---------------------------------------------------------------------------

    \250\ FSF; SIFMA; CCMC; and NVCA.
    \251\ NVCA.
    \252\ Id.
    \253\ FSF and SIFMA.
---------------------------------------------------------------------------

    Commenters said that an exclusion for venture capital funds would 
promote the safety and soundness of banking entities.\254\ One 
commenter said the exclusion would allow banks to diversify and to 
compete with non-banking entities.\255\ Commenters also said that the 
proposed exclusion allows banking entities to make investments 
indirectly through a fund structure that they could make directly \256\ 
and incorporates criteria and activity restrictions that address any 
concerns about safety and soundness or evasion.\257\
---------------------------------------------------------------------------

    \254\ FSF; SIFMA; and Goldman Sachs.
    \255\ SIFMA.
    \256\ NVCA.
    \257\ FSF and SIFMA.
---------------------------------------------------------------------------

    Several commenters supported defining a qualifying venture capital 
fund by reference to Rule 203(l)-1 as proposed.\258\ These commenters 
also said the rule should not incorporate additional criteria as 
discussed in the preamble to the 2020 proposal, such as additional 
limitations on revenues or qualifying investments.\259\ These 
commenters said additional criteria are unnecessary to ensure that the 
fund is a bona fide venture capital fund and could unnecessarily limit 
the scope of qualifying venture capital funds.\260\ On the other hand, 
one commenter said the rule should include additional criteria to 
ensure qualifying venture capital funds serve the public interest and 
do not cause the harms at which section 13 of the Bank Holding Company 
Act was directed.\261\ One commenter argued defining venture capital 
fund by reference to Rule 203(l)-1 would be too narrow because it would 
exclude shares of emerging growth companies (EGCs) from being 
classified as qualifying investments and would not reflect certain 
companies that operate as venture investors and are exempt from having 
to register as an investment company but may not meet the technical 
definition of a venture capital fund under Rule 203(l)-1 (e.g., startup 
incubators).\262\
---------------------------------------------------------------------------

    \258\ SIFMA; NVCA; FSF; and ABA.
    \259\ SIFMA; NVCA; FSF; and ABA.
    \260\ Id.
    \261\ Better Markets.
    \262\ CCMC.
---------------------------------------------------------------------------

    While supporting an exclusion for qualifying venture capital funds 
generally, a few commenters recommended revisions to the proposed 
exclusion.\263\ Some commenters proposed changes to the requirement 
that the fund not engage in any activity that would constitute 
proprietary trading, under Sec.  __.3(b)(1)(i), as if it were a banking 
entity.\264\ One of these commenters said qualifying venture capital 
funds should be permitted to engage in permitted proprietary trading 
consistent with Sec. Sec.  __.4, __.5, and __.6 of the implementing 
regulations.\265\ Another commenter said the definition of proprietary 
trading for funds should be the same as the definition that applies to 
the banking entity and that having two definitions is not reasonable or 
cost-effective.\266\
---------------------------------------------------------------------------

    \263\ FSF and SIFMA.
    \264\ FSF and SIFMA.
    \265\ FSF.
    \266\ SIFMA.
---------------------------------------------------------------------------

    Commenters also supported changes to the requirement that the 
banking entity's investment in and relationship with qualifying venture 
capital funds must comply with Sec.  __.14 of the implementing 
regulations. One commenter recommended eliminating the requirement that 
would apply Sec.  __.14 to a banking entity's relationship with a 
venture capital fund.\267\ This commenter said that other proposed 
conditions adequately address bailout and safety and soundness 
concerns.\268\ Other commenters said the agencies should clarify that 
Sec.  __.14 does not apply to a banking entity that simply invests in a 
qualifying venture capital fund (as opposed to a banking entity that 
sponsors or advises the fund).\269\
---------------------------------------------------------------------------

    \267\ SIFMA.
    \268\ Id.
    \269\ NVCA and ABA.
---------------------------------------------------------------------------

    Other commenters did not support the proposed exclusion for 
qualifying venture capital funds.\270\ One of these commenters said if 
the agencies do adopt an exclusion for qualifying venture capital 
funds, the exclusion must include additional requirements to ensure 
that excluded venture capital funds serve the public interest and do 
not cause the harms at which section 619 of the Dodd-Frank Act was 
directed. Specifically, this commenter said the rule should: (1) 
Restrict all fund investments to ``qualifying investments'' or at least 
very significantly restrict investments in non-qualifying investments 
(e.g., limit them to no more than five percent of the fund's aggregate 
capital), (2) impose a minimum securities holding period and portfolio 
company revenue limitation of $35 million (or a similarly appropriate 
and low figure) to ensure the fund is truly focused on medium-to-long 
term venture (as opposed to growth stage) investments, and (3) 
quantitatively limit the use of leverage as a key means for 
distinguishing excluded venture capital funds from statutorily 
prohibited activities involving private equity funds.\271\
---------------------------------------------------------------------------

    \270\ Better Markets and Data Boiler. Another commenter said an 
exemption for venture capital funds was not supported by the 2020 
proposal and not permitted under the law. Occupy.
    \271\ Better Markets.

---------------------------------------------------------------------------

[[Page 46444]]

Final Exclusion

    The final rule adopts the proposed exclusion for