Download:
pdf |
pdf68846
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
12 CFR Part 44
[Docket No. OCC–2011–0014]
RIN 1557–AD44
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
12 CFR Part 248
[Docket No. R–1432]
RIN 7100 AD 82
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 351
RIN 3064–AD85
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 255
[Release No. 34–65545; File No. S7–41–11]
RIN 3235–AL07
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’’); and
Securities and Exchange Commission
(‘‘SEC’’).
ACTION: Notice of proposed rulemaking.
AGENCY:
The OCC, Board, FDIC, and
SEC (individually, an ‘‘Agency,’’ and
collectively, ‘‘the Agencies’’) are
requesting comment on a proposed rule
that would implement Section 619 of
the Dodd-Frank Wall Street Reform and
Consumer Protection Act (‘‘Dodd-Frank
Act’’) which contains certain
prohibitions and restrictions on the
ability of a banking entity and nonbank
financial company supervised by the
Board to engage in proprietary trading
and have certain interests in, or
relationships with, a hedge fund or
private equity fund.
DATES: Comments should be received on
or before January 13, 2012.
ADDRESSES: Interested parties are
encouraged to submit written comments
jointly to all of the Agencies.
Commenters are encouraged to use the
title ‘‘Restrictions on Proprietary
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
SUMMARY:
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
Trading and Certain Interests in, and
Relationships with, Hedge Funds and
Private Equity Funds’’ to facilitate the
organization and distribution of
comments among the Agencies.
Commenters are also encouraged to
identify the number of the specific
question for comment to which they are
responding.
Office of the Comptroller of the
Currency: Because paper mail in the
Washington, DC area and at the OCC is
subject to delay, commenters are
encouraged to submit comments by the
Federal eRulemaking Portal or email, if
possible. Please use the title
‘‘Restrictions on Proprietary Trading
and Certain Interests in and
Relationships with Hedge Funds and
Private Equity Funds’’ to facilitate the
organization and distribution of the
comments. You may submit comments
by any of the following methods:
• Federal eRulemaking Portal—
‘‘Regulations.gov’’: Go to http://
www.regulations.gov. Select ‘‘Document
Type’’ of ‘‘Proposed Rules,’’ and in the
‘‘Enter Keyword or ID Box,’’ enter
Docket ID ‘‘OCC–2011–14,’’ and click
‘‘Search.’’ On ‘‘View By Relevance’’ tab
at the bottom of screen, in the ‘‘Agency’’
column, locate the Proposed Rule for
the OCC, in the ‘‘Action’’ column, click
on ‘‘Submit a Comment’’ or ‘‘Open
Docket Folder’’ to submit or view public
comments and to view supporting and
related materials for this rulemaking
action.
• Click on the ‘‘Help’’ tab on the
Regulations.gov home page to get
information on using Regulations.gov,
including instructions for submitting or
viewing public comments, viewing
other supporting and related materials,
and viewing the docket after the close
of the comment period.
• Email:
[email protected].
• Mail: Office of the Comptroller of
the Currency, 250 E Street SW., Mail
Stop 2–3, Washington, DC 20219.
• Fax: (202) 874–5274.
• Hand Delivery/Courier: 250 E Street
SW., Mail Stop 2–3, Washington, DC
20219.
Instructions: You must include
‘‘OCC’’ as the agency name and ‘‘Docket
ID OCC–2011–14’’ in your comment. In
general, OCC will enter all comments
received into the docket and publish
them on the Regulations.gov Web site
without change, including any business
or personal information that you
provide such as name and address
information, email addresses, or phone
numbers. Comments received, including
attachments and other supporting
materials, are part of the public record
and subject to public disclosure. Do not
PO 00000
Frm 00002
Fmt 4701
Sfmt 4702
enclose any information in your
comment or supporting materials that
you consider confidential or
inappropriate for public disclosure.
You may review comments and other
related materials that pertain to this
proposed rulemaking by any of the
following methods:
• Viewing Comments Electronically:
Go to http://www.regulations.gov. Select
‘‘Document Type’’ of ‘‘Public
Submissions,’’ and in the ‘‘Enter
Keyword or ID Box,’’ enter Docket ID
‘‘OCC–2011–14,’’ and click ‘‘Search.’’
Comments will be listed under ‘‘View
By Relevance’’ tab at the bottom of
screen. If comments from more than one
agency are listed, the ‘‘Agency’’ column
will indicate which comments were
received by the OCC.
• Viewing Comments Personally: You
may personally inspect and photocopy
comments at the OCC, 250 E Street SW.,
Washington, DC 20219. For security
reasons, the OCC requires that visitors
make an appointment to inspect
comments. You may do so by calling
(202) 874–4700. Upon arrival, visitors
will be required to present valid
government-issued photo identification
and submit to security screening in
order to inspect and photocopy
comments.
Docket: You may also view or request
available background documents and
project summaries using the methods
described above.
Board of Governors of the Federal
Reserve System:
You may submit comments, identified
by Docket No. R–1432 and RIN 7100 AD
82, by any of the following methods:
• Agency Web site: http://
www.federalreserve.gov. Follow the
instructions for submitting comments at
http://www.federalreserve.gov/general
info/foia/ProposedRegs.cfm.
• Federal eRulemaking Portal: http://
www.regulations.gov. Follow the
instructions for submitting comments.
• Email:
[email protected].
Include the docket number in the
subject line of the message.
• Fax: (202) 452–3819 or (202) 452–
3102.
• Mail: Address to Jennifer J. Johnson,
Secretary, Board of Governors of the
Federal Reserve System, 20th Street and
Constitution Avenue NW., Washington,
DC 20551.
All public comments will be made
available on the Board’s Web site at
http://www.federalreserve.gov/general
info/foia/ProposedRegs.cfm as
submitted, unless modified for technical
reasons. Accordingly, comments will
not be edited to remove any identifying
or contact information. Public
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
comments may also be viewed
electronically or in paper in Room MP–
500 of the Board’s Martin Building (20th
and C Streets NW.,) between 9 a.m. and
5 p.m. on weekdays.
Federal Deposit Insurance
Corporation: You may submit
comments, identified by RIN number,
by any of the following methods:
• Agency Web site: http://
www.fdic.gov/regulations/laws/federal/
propose.html. Follow instructions for
submitting comments on the Agency
Web site.
• Email: [email protected]. Include
the RIN 3064–AD85 on the subject line
of the message.
• Mail: Robert E. Feldman, Executive
Secretary, Attention: Comments, Federal
Deposit Insurance Corporation, 550 17th
Street NW., Washington, DC 20429.
• Hand Delivery: Comments may be
hand delivered to the guard station at
the rear of the 550 17th Street Building
(located on F Street) on business days
between 7 a.m. and 5 p.m.
Public Inspection: All comments
received must include the agency name
and RIN 3064–AD85 for this
rulemaking. All comments received will
be posted without change to http://
www.fdic.gov/regulations/laws/federal/
propose.html, including any personal
information provided. Paper copies of
public comments may be ordered from
the FDIC Public Information Center,
3501 North Fairfax Drive, Room E–I002,
Arlington, VA 22226 by telephone at
1 (877) 275–3342 or 1 (703) 562–2200.
Securities and Exchange Commission:
You may submit comments by the
following method:
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Electronic Comments
• Use the Commission’s Internet
comment form (http://www.sec.gov/
rules/proposed.shtml); or
• Send an email to [email protected]. Please include File
Number S7–41–11 on the subject line;
or
• Use the Federal eRulemaking Portal
(http://www.regulations.gov). Follow the
instructions for submitting comments.
Paper Comments
• Send paper comments in triplicate
to Elizabeth M. Murphy, Secretary,
Securities and Exchange Commission,
100 F Street NE., Washington, DC
20549–1090.
All submissions should refer to File
Number S7–41–11. This file number
should be included on the subject line
if email is used. To help us process and
review your comments more efficiently,
please use only one method. The
Commission will post all comments on
the Commission’s Internet Web site
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
(http://www.sec.gov/rules/
proposed.shtml). Comments are also
available for Web site viewing and
printing in the Commission’s Public
Reference Room, 100 F Street NE.,
Washington, DC 20549, on official
business days between the hours of
10 a.m. and 3 p.m. All comments
received will be posted without change;
we do not edit personal identifying
information from submissions. You
should submit only information that
you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT:
OCC: Deborah Katz, Assistant Director,
or Ursula Pfeil, Counsel, Legislative and
Regulatory Activities Division, (202)
874–5090; Roman Goldstein, Senior
Attorney, Securities and Corporate
Practices Division, (202) 874–5210; Kurt
Wilhelm, Director for Financial Markets
Group, (202) 874–4660; Stephanie
Boccio, Technical Expert for Asset
Management Group, or Joel Miller,
Group Leader for Asset Management
Group, (202) 874–4660, Office of the
Comptroller of the Currency, 250 E
Street SW., Washington, DC 20219.
Board: Jeremy R. Newell, Counsel,
(202) 452–3239, or Christopher M.
Paridon, Counsel, Legal Division, (202)
452–3274; Sean D. Campbell, Deputy
Associate Director, Division of Research
and Statistics, (202) 452–3760; David
Lynch, Manager, Division of Bank
Supervision and Regulation, (202) 452–
2081, Board of Governors of the Federal
Reserve System, 20th and C Streets,
NW., Washington, DC 20551.
FDIC: Bobby R. Bean, Acting
Associate Director, Capital Markets
(202) 898–6705, or Karl R. Reitz, Senior
Capital Markets Specialist, (202) 898–
6775, Division of Risk Management
Supervision; Michael B. Phillips,
Counsel, (202) 898–3581, or Gregory S.
Feder, Counsel, (202) 898–8724, Legal
Division, Federal Deposit Insurance
Corporation, 550 17th Street NW.,
Washington, DC 20429–0002.
SEC: Josephine Tao, Assistant
Director, Elizabeth Sandoe, Senior
Special Counsel, David Bloom, Branch
Chief, Anthony Kelly, Special Counsel,
Angela Moudy, Attorney Advisor, or
Daniel Staroselsky, Attorney Advisor,
Office of Trading Practices, Division of
Trading and Markets, (202) 551–5720;
David Blass, Chief Counsel, or Gregg
Berman, Senior Advisor to the Director,
Division of Trading and Markets; Daniel
S. Kahl, Assistant Director, Tram N.
Nguyen, Branch Chief, Michael J. Spratt,
Senior Counsel, or Parisa Haghshenas,
Law Clerk, Office of Investment Adviser
Regulation, Division of Investment
Management, (202) 551–6787; David
Beaning, Special Counsel, Office of
PO 00000
Frm 00003
Fmt 4701
Sfmt 4702
68847
Structured Finance, Division of
Corporation Finance, (202) 551–3850;
John Harrington, Special Counsel, Office
of Capital Market Trends, Division of
Corporation Finance, (202) 551–3860;
Richard Bookstaber, Senior Policy
Advisor, or Jennifer Marietta-Westberg,
Assistant Director, Office of the Sell
Side; or Adam Yonce, Financial
Economist, Division of Risk Strategy
and Financial Innovation, (202) 551–
6600, U.S. Securities and Exchange
Commission, 100 F Street NE.,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
I. Background
The Dodd-Frank Act was enacted on
July 21, 2010.1 Section 619 of the DoddFrank Act added a new section 13 to the
Bank Holding Company Act of 1956
(‘‘BHC Act’’) (to be codified at 12 U.S.C.
1851) that generally prohibits any
banking entity 2 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’’),
subject to certain exemptions.3 New
section 13 of the BHC Act also provides
for nonbank financial companies
supervised by the Board that engage in
such activities or have such interests or
relationships to be subject to additional
capital requirements, quantitative
limits, or other restrictions.4
1 Dodd-Frank Wall Street Reform and Consumer
Protection Act, Public Law 111–203, 124 Stat. 1376
(2010).
2 Application of the proposed rule to smaller,
less-complex banking entities is discussed below in
Part II.F of this Supplemental Information.
3 The term ‘‘banking entity’’ is defined in section
13(h)(1) of the BHC Act, as amended by section 619
of the Dodd-Frank Act. See 12 U.S.C. 1851(h)(1).
The statutory definition includes any insured
depository institution (other than certain limited
purpose trust institutions), any company that
controls an insured depository institution, any
company that is treated as a bank holding company
for purposes of section 8 of the International
Banking Act of 1978 (12 U.S.C. 3106), and any
affiliate or subsidiary of any of the foregoing.
Section 13 of the BHC Act defines the terms ‘‘hedge
fund’’ and ‘‘private equity fund’’ as an issuer that
would be an investment company, as defined under
the Investment Company Act of 1940 (15 U.S.C.
80a–1 et seq.), but for section 3(c)(1) or 3(c)(7) of
that Act, or any such similar funds as the
appropriate Federal banking agencies (i.e., the
Board, OCC, and FDIC), the SEC, and the CFTC
may, by rule, determine should be treated as a
hedge fund or private equity fund. See 12 U.S.C.
1851(h)(2).
4 See 12 U.S.C. 1851(a)(2) and (f)(4). A ‘‘nonbank
financial company supervised by the Board’’ is a
nonbank financial company or other company that
the Financial Stability Oversight Council
(‘‘Council’’) has determined, under section 113 of
the Dodd-Frank Act, shall be subject to supervision
by the Board and prudential standards. The Board
is not proposing at this time any additional capital
requirements, quantitative limits, or other
E:\FR\FM\07NOP2.SGM
Continued
07NOP2
68848
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
A. Rulemaking Framework
Section 13 of the BHC Act requires
that implementation of its provisions
occur in several stages. First, the
Council was required to conduct a study
(‘‘Council study’’) and make
recommendations by January 21, 2011
on the implementation of section 13 of
the BHC Act. The Council study was
issued on January 18, 2011, and
included a detailed discussion of key
issues related to implementation of
section 13 and recommended that the
Agencies consider taking a number of
specified actions in issuing rules under
section 13 of the BHC Act.5 The Council
study also recommended that the
Agencies adopt a four-part
implementation and supervisory
framework for identifying and
preventing prohibited proprietary
trading, which included a programmatic
compliance regime requirement for
banking entities, analysis and reporting
of quantitative metrics by banking
entities, supervisory review and
oversight by the Agencies, and
enforcement procedures for violations.6
The Agencies have carefully considered
the Council study and its
recommendations, and have consulted
with staff of the Commodity Futures
Trading Commission (‘‘CFTC’’), in
formulating this proposal.7
Authority for developing and
adopting regulations to implement the
prohibitions and restrictions of section
13 of the BHC Act is divided between
the Agencies in the manner provided in
restrictions on nonbank financial companies
pursuant to section 13 of the BHC Act, as it believes
doing so would be premature in light of the fact that
the Council has not yet finalized the criteria for
designation of, nor yet designated, any nonbank
financial company.
5 See Financial Stability Oversight Council, Study
and Recommendations on Prohibitions on
Proprietary Trading and Certain Relationships with
Hedge Funds and Private Equity Funds (Jan. 18,
2011), available at http://www.treasury.gov/
initiatives/Documents/Volcker%20sec%
20619%20study%20final%201%
2018%2011%20rg.pdf. See 12 U.S.C. 1851(b)(1).
Prior to publishing its study, the Council requested
public comment on a number of issues to assist the
Council in conducting its study. See 75 FR 61,758
(Oct. 6, 2010). Approximately 8,000 comments were
received from the public, including from members
of Congress, trade associations, individual banking
entities, consumer groups, and individuals. As
noted in the issuing release for the Council Study,
these comments were carefully considered by the
Council when drafting the Council study.
6 See Council study at 5–6. The Agencies have
implemented this recommendation through the
proposed compliance program requirements
contained in Subpart D of this proposal with
respect to both proprietary trading and covered
fund activities and investments.
7 The Agencies also received a number of
comment letters concerning implementation of
section 13 of the BHC Act in advance of this
proposal. The Agencies have carefully considered
these comments in formulating this proposal.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
section 13(b)(2) of the BHC Act.8 The
statute also requires the Agencies, in
developing and issuing implementing
rules, to consult and coordinate with
each other, as appropriate, for the
purposes of assuring, to the extent
possible, that such rules are comparable
and provide for consistent application
and implementation of the applicable
provisions of section 13 of the BHC
Act.9 Such coordination will assist in
ensuring that advantages are not unduly
provided to, and that disadvantages are
not unduly imposed upon, companies
affected by section 13 of the BHC Act
and that the safety and soundness of
banking entities and nonbank financial
companies supervised by the Board are
protected. The statute requires the
Agencies to implement rules under
section 13 not later than 9 months after
the Council completes its study (i.e., not
later than October 18, 2011).10 The
restrictions and prohibitions of section
13 of the BHC Act become effective
12 months after issuance of final rules
by the Agencies, or July 21, 2012,
whichever is earlier.11
In addition, the statute required the
Board, acting alone, to adopt rules to
implement the provisions of section 13
of the BHC Act that provide a banking
entity or a nonbank financial company
supervised by the Board a period of time
after the effective date of section 13 of
the BHC Act to bring the activities,
investments, and relationships of the
banking entity into compliance with
that section and the Agencies’
implementing regulations.12 The Board
issued its final conformance rule as
required under section 13(c)(6) of the
BHC Act on February 8, 2011 (‘‘Board’s
8 See 12 U.S.C. 1851(b)(2). Under section
13(b)(2)(B) of the BHC Act, rules implementing
section 13’s prohibitions and restrictions must be
issued by: (i) The appropriate Federal banking
agencies (i.e., the Board, the OCC, and the FDIC),
jointly, with respect to insured depository
institutions; (ii) the Board, with respect to any
company that controls an insured depository
institution, or that is treated as a bank holding
company for purposes of section 8 of the
International Banking Act, any nonbank financial
company supervised by the Board, and any
subsidiary of any of the foregoing (other than a
subsidiary for which an appropriate Federal
banking agency, the SEC, or the CFTC is the
primary financial regulatory agency); (iii) the CFTC
with respect to any entity for which it is the
primary financial regulatory agency, as defined in
section 2 of the Dodd-Frank Act; and (iv) the SEC
with respect to any entity for which it is the
primary financial regulatory agency, as defined in
section 2 of the Dodd-Frank Act. See id.
9 See 12 U.S.C. 1851(b)(2)(B)(ii). The Secretary of
the Treasury, as Chairperson of the Council, is
responsible for coordinating the Agencies’
rulemakings under section 13 of the BHC Act. See
id.
10 See id. at 1851(b)(2)(A).
11 See id. at 1851(c)(1).
12 See id. at 1851(c)(6).
PO 00000
Frm 00004
Fmt 4701
Sfmt 4702
Conformance Rule’’).13 As noted in the
issuing release for the Board’s
Conformance Rule, this period is
intended to give markets and firms an
opportunity to adjust to section 13 of
the BHC Act.14
B. Section 13 of the BHC Act
Section 13 of the BHC Act generally
prohibits banking entities from engaging
in proprietary trading or from acquiring
or retaining any ownership interest in,
or sponsoring, a covered fund.15
However, section 13(d)(1) of that Act
expressly includes exemptions from
these prohibitions for certain permitted
activities, including:
• Trading in certain government
obligations;
• Underwriting and market makingrelated activities;
• Risk-mitigating hedging activity;
• Trading on behalf of customers;
• Investments in Small Business
Investment Companies (‘‘SBICs’’) and
public interest investments;
• Trading for the general account of
insurance companies;
• Organizing and offering a covered
fund (including limited investments in
such funds);
• Foreign trading by non-U.S.
banking entities; and
• Foreign covered fund activities by
non-U.S. banking entities.16
For purposes of this Supplementary
Information, trading activities subject to
section 13 of the BHC Act, including
those permitted under a relevant
exemption, are sometimes referred to as
‘‘covered trading activities.’’ Similarly,
activities and investments with respect
to a covered fund that are subject to
section 13 of the BHC Act, including
those permitted under a relevant
exemption, are sometimes referred to as
‘‘covered fund activities or
investments.’’
Additionally, section 13 of the BHC
Act permits the Agencies to grant, by
rule, other exemptions from the
prohibitions on proprietary trading and
acquiring or retaining an ownership
interest in, or acting as sponsor to, a
covered fund if the Agencies determine
13 See Conformance Period for Entities Engaged in
Prohibited Proprietary Trading or Private Equity
Fund or Hedge Fund Activities, 76 FR 8265 (Feb.
14, 2011).
14 See id. (citing 156 Cong. Rec. S5898 (daily ed.
July 15, 2010) (statement of Sen. Merkley)).
15 12 U.S.C. 1851(a)(1)(A) and (B).
16 See id. at 1851(d)(1). As described in greater
detail in Part III.B.4 of this Supplementary
Information, the proposed rule applies some of
these statutory exemptions only to the proprietary
trading prohibition or the covered fund prohibitions
and restrictions, but not both, where it appears
either by plain language or by implication that the
exemption was intended only to apply to one or the
other.
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
that the exemption would promote and
protect the safety and soundness of the
banking entity and the financial stability
of the United States.17 Furthermore,
under the statute, no banking entity may
engage in a permitted activity if that
activity would (i) involve or result in a
material conflict of interest or material
exposure of the banking entity to highrisk assets or high-risk trading strategies,
or (ii) pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.18
Section 13(f) of the BHC Act
separately prohibits a banking entity
that serves, directly or indirectly, as the
investment manager, investment
adviser, or sponsor to a covered fund,
and any affiliate of such a banking
entity, from entering into any
transaction with the fund, or any other
covered fund controlled by such fund,
that would be a ‘‘covered transaction’’
as defined in section 23A of the Federal
Reserve Act (‘‘FR Act’’),19 as if such
banking entity or affiliate were a
member bank and the covered fund
were an affiliate thereof, subject to
certain exceptions.20 Section 13(f) also
provides that a banking entity may enter
into certain prime brokerage
transactions with any covered fund in
which a covered fund managed,
sponsored, or advised by the banking
entity has taken an equity, partnership,
or other ownership interest, but any
such transaction (and any other
permitted transaction with such funds)
must be on market terms in accordance
with the provisions of section 23B of the
FR Act.21
Section 13 of the BHC Act does not
prohibit a nonbank financial company
supervised by the Board from engaging
in proprietary trading, or from having
the types of ownership interests in or
relationships with a covered fund that a
banking entity is prohibited or restricted
from having under section 13 of the
BHC Act. However, section 13 of the
BHC Act provides for the Board or other
appropriate Agency to impose
additional capital charges, quantitative
limits, or other restrictions on a
nonbank financial company supervised
by the Board or their subsidiaries and
affiliates that are engaged in such
activities or maintain such
relationships.22
17 Id.
at 1851(d)(1)(J).
id. at 1851(d)(2).
19 See 12 U.S.C. 371c.
20 12 U.S.C. 1851(f).
21 12 U.S.C. 371c–1.
22 See 12 U.S.C. 1851(a)(2), (d)(4).
18 See
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
II. Overview of Proposed Rule
A. General Approach
In formulating the proposed rule, the
Agencies have attempted to reflect the
structure of section 13 of the BHC Act,
which is to prohibit a banking entity
from engaging in proprietary trading or
acquiring or retaining an ownership
interest in, or having certain
relationships with, a covered fund,
while permitting such entities to
continue to provide client-oriented
financial services. However, the
delineation of what constitutes a
prohibited or permitted activity under
section 13 of the BHC Act often involves
subtle distinctions that are difficult both
to describe comprehensively within
regulation and to evaluate in practice.
The Agencies appreciate that while it is
crucial that rules under section 13 of the
BHC Act clearly define and implement
its requirements, any rule must also
preserve the ability of a banking entity
to continue to structure its businesses
and manage its risks in a safe and sound
manner, as well as to effectively deliver
to its clients the types of financial
services that section 13 expressly
protects and permits. These clientoriented financial services, which
include underwriting, market making,
and traditional asset management
services, are important to the U.S.
financial markets and the participants in
those markets, and the Agencies have
endeavored to develop a proposed rule
that does not unduly constrain banking
entities in their efforts to safely provide
such services. At the same time,
providing appropriate latitude to
banking entities to provide such clientoriented services need not and should
not conflict with clear, robust, and
effective implementation of the statute’s
prohibitions and restrictions. Given
these complexities, the Agencies request
comment on the potential impacts the
proposed approach may have on
banking entities and the businesses in
which they engage. In particular, and as
discussed further in Part VII of this
Supplemental Information, the Agencies
recognize that there are economic
impacts that may arise from the
proposed rule and its implementation of
section 13 of the BHC Act, and the
Agencies request comment on such
impacts, including quantitative data,
where possible.
In light of these larger challenges and
goals, the Agencies’ proposal takes a
multi-faceted approach to implementing
section 13 of the BHC Act. In particular,
the proposed rule includes a framework
that: (i) Clearly describes the key
characteristics of both prohibited and
permitted activities; (ii) requires
PO 00000
Frm 00005
Fmt 4701
Sfmt 4702
68849
banking entities to establish a
comprehensive programmatic
compliance regime designed to ensure
compliance with the requirements of the
statute and rule in a way that takes into
account and reflects the unique nature
of a banking entity’s businesses; and (iii)
with respect to proprietary trading,
requires certain banking entities to
calculate and report meaningful
quantitative data that will assist both
banking entities and the Agencies in
identifying particular activity that
warrants additional scrutiny to
distinguish prohibited proprietary
trading from otherwise permissible
activities. This multi-faceted approach,
which is consistent with the
implementation and supervisory
framework recommended in the Council
study, is intended to strike an
appropriate balance between
accommodating prudent risk
management and the continued
provision of client-oriented financial
services by banking entities while
ensuring that such entities do not
engage in prohibited proprietary trading
or restricted covered fund activities or
investments.23
In addition, and consistent with the
statutory requirement that the Agencies’
rules under section 13 of the BHC Act
be, to the extent possible, comparable
and provide for consistent application
and implementation, the Agencies have
proposed a common rule and
appendices. This uniform approach to
implementation is intended to provide
the maximum degree of clarity to
banking entities and market participants
and ensure that section 13’s
prohibitions and restrictions are applied
consistently across different types of
regulated entities.24
As a matter of structure, the proposed
rule is generally divided into four
subparts and contains three appendices,
as follows:
• Subpart A of the proposed rule
describes the authority, scope, purpose,
and relationship to other authorities of
the rule and defines terms used
commonly throughout the rule;
• Subpart B of the proposed rule
prohibits proprietary trading, defines
terms relevant to covered trading
activity, establishes exemptions from
23 In recognition of economic impacts that may
arise from the proposed rule and its implementation
of section 13 of the BHC Act, the Agencies are
requesting comment on the relative costs and
benefits of the proposal in Part VII of this
Supplemental Information.
24 Under this uniform approach, each Agency is
proposing the same rule provisions under section
13 of the BHC Act. Each Agency’s proposed rule
would apply only to banking entities for which the
Agency has regulatory authority under section
13(b)(2)(B) of the BHC Act.
E:\FR\FM\07NOP2.SGM
07NOP2
68850
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
the prohibition on proprietary trading
and limitations on those exemptions,
and requires certain banking entities to
report quantitative measurements with
respect to their trading activities;
• Subpart C of the proposed rule
prohibits or restricts acquiring or
retaining an ownership interest in, and
certain relationships with, a covered
fund, defines terms relevant to covered
fund activities and investments, as well
as establishes exemptions from the
restrictions on covered fund activities
and investments and limitations on
those exemptions;
• Subpart D of the proposed rule
generally requires banking entities to
establish an enhanced compliance
program regarding compliance with
section 13 of the BHC Act and the
proposed rule, including written
policies and procedures, internal
controls, a management framework,
independent testing of the compliance
program, training, and recordkeeping;
• Appendix A of the proposed rule
details the quantitative measurements
that certain banking entities may be
required to compute and report with
respect to their trading activities; 25
• Appendix B of the proposed rule
provides commentary regarding the
factors the Agencies propose to use to
help distinguish permitted market
making-related activities from
prohibited proprietary trading; and
• Appendix C of the proposed rule
details the minimum requirements and
standards that certain banking entities
must meet with respect to their
compliance program, as required under
subpart D.26
25 A banking entity must comply with proposed
Appendix A’s reporting and recordkeeping
requirements only if it has, together with its
affiliates and subsidiaries, trading assets and
liabilities the average gross sum of which (on a
worldwide consolidated basis) is, as measured as of
the last day of each of the four prior calendar
quarters, equal to or greater than $1 billion.
26 In particular, a banking entity must comply
with the minimum standards specified in Appendix
C of the proposed rule (i) with respect to its covered
trading activities, if it engages in any covered
trading activities and has, together with its affiliates
and subsidiaries, trading assets and liabilities the
average gross sum of which (on a worldwide
consolidated basis), as measured as of the last day
of each of the four prior calendar quarters, (X) is
equal to or greater than $1 billion or (Y) equals 10
percent or more of its total assets; and (ii) with
respect to its covered fund activities and
investments, if it engages in any covered fund
activities and investments and either (X) has,
together with its affiliates and subsidiaries,
aggregate investments in covered funds the average
value of which is, as measured as of the last day
of each of the four prior calendar quarters, equal to
or greater than $1 billion or (Y) sponsors and
advises, together with its affiliates and subsidiaries,
covered funds the average total assets of which are,
as measured as of the last day of each of the four
prior calendar quarters, equal to or greater than $1
billion.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
In addition, the Board’s proposed rule
also contains a subpart E, to which the
provisions of the Board’s Conformance
Rule under section 13 of the BHC Act
will be recodified from their current
location in the Board’s Regulation Y.
B. Proprietary Trading Restrictions
Subpart B of the proposed rule
implements the statutory prohibition on
proprietary trading and the various
exemptions to this prohibition included
in the statute. Section l.3 of the
proposed rule contains the core
prohibition on proprietary trading and
defines a number of related terms,
including ‘‘proprietary trading’’ and
‘‘trading account.’’ The proposed rule’s
definition of proprietary trading
generally parallels the statutory
definition, and includes engaging as
principal for the trading account of a
banking entity in any transaction to
purchase or sell certain types of
financial positions.27
The proposed rule’s definition of
trading account generally parallels the
statutory definition, and provides
further guidance regarding the
circumstances in which a position will
be considered to have been taken
principally for the purpose of short-term
resale or benefiting from actual or
expected short-term price movements,
recognizing the importance of providing
as much clarity as possible regarding
this term, which ultimately defines the
scope of accounts subject to the
prohibition on proprietary trading.28 In
particular, the proposed definition of
trading account identifies three classes
of positions that would cause an
account to be a trading account. First,
the definition includes positions taken
principally for the purpose of short-term
resale, benefitting from short-term price
movements, realizing short-term
arbitrage profits, or hedging another
trading account position.29 As described
in this notice, this language is
substantially similar to language for a
‘‘trading position’’ used in the Federal
banking agencies’ current market risk
capital rules, as proposed to be revised
(‘‘Market Risk Capital Rules’’),30 and the
Agencies propose to interpret this
language in a similar manner. Second,
with respect to a banking entity subject
to the Federal banking agencies’ Market
Risk Capital Rules, the definition
includes all positions in financial
instruments subject to the prohibition
on proprietary trading that are treated as
‘‘covered positions’’ under those capital
proposed rule § l.3(b)(1).
proposed rule § l.3(b)(2).
29 See proposed rule § l.3(b)(2)(i)(A).
30 See 76 FR 1890 (Jan. 11, 2011).
27 See
28 See
PO 00000
Frm 00006
Fmt 4701
Sfmt 4702
rules, other than certain foreign
exchange and commodities positions.
Third, the definition includes all
positions acquired or taken by certain
registered securities and derivatives
dealers (or, in the case of financial
institutions 31 that are government
securities dealers, that have filed notice
with an appropriate regulatory agency)
in connection with their activities that
require such registration or notice.32
The definition of trading account also
contains clarifying exclusions for
certain positions that do not appear to
involve the requisite short-term trading
intent, such as positions arising under
certain repurchase and reverse
repurchase arrangements or securities
lending transactions, positions acquired
or taken for bona fide liquidity
management purposes, and certain
positions of derivatives clearing
organizations or clearing agencies.33
Section l.3 of the proposed rule also
defines a number of other relevant
terms, including the term ‘‘covered
financial position.’’ This term is used to
define the scope of financial
instruments subject to the prohibition
on proprietary trading. Consistent with
the statutory language, such covered
financial positions include positions
(including long, short, synthetic and
other positions) in securities,
derivatives, commodity futures, and
options on such instruments, but do not
include positions in loans, spot foreign
exchange or spot commodities.34
Section l.4 of the proposed rule
implements the statutory exemptions for
underwriting and market making-related
activities. For each of these permitted
activities, the proposed rule provides a
number of requirements that must be
met in order for a banking entity to rely
on the applicable exemption. These
requirements are generally designed to
ensure that the activities, revenues and
other characteristics of the banking
entity’s trading activity are consistent
with underwriting and market makingrelated activities, respectively, and not
prohibited proprietary trading.35 These
requirements are intended to support
and augment other parts of the proposed
rule’s approach to implementing the
prohibition on proprietary trading,
including the compliance program
31 In the context of regulation of government
securities dealers under the Securities Exchange
Act of 1934 (‘‘Exchange Act’’), the term ‘‘financial
institution’’ as defined in section 3(a)(46) of the
Exchange Act includes a bank (as defined in section
3(a)(36) of the Exchange Act) and a foreign bank (as
defined in the International Banking Act of 1978).
See 15 U.S.C. 78c(a)(46).
32 See proposed rule § l.3(b)(2)(i)(B).
33 See proposed rule § l.3(b)(2)(iii).
34 See proposed rule § l.3(b)(3).
35 See proposed rule § l.4(a), (b).
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
requirement and the reporting of
quantitative measurements, in order to
assist banking entities and the Agencies
in identifying prohibited trading
activities that may be conducted in the
context of, or mischaracterized as,
permitted underwriting or market
making-related activities.
Section l.5 of the proposed rule
implements the statutory exemption for
risk-mitigating hedging. As with the
underwriting and market-making
exemptions, proposed § l.5 contains a
number of requirements that must be
met in order for a banking entity to rely
on the exemption. These requirements
are generally designed to ensure that the
banking entity’s trading activity is truly
risk-mitigating hedging in purpose and
effect.36 Proposed § l.5 also requires
banking entities to document, at the
time the transaction is executed, the
hedging rationale for certain
transactions that present heightened
compliance risks.37 As with the
exemptions for underwriting and market
making-related activity, these
requirements form part of a broader
implementation approach that also
includes the compliance program
requirement and the reporting of
quantitative measurements.
Section l.6 of the proposed rule
implements statutory exemptions for
trading in certain government
obligations, trading on behalf of
customers, trading by a regulated
insurance company, and trading by
certain foreign banking entities outside
the United States. Section l.6(a) of the
proposed rule describes the government
obligations in which a banking entity
may trade notwithstanding the
prohibition on proprietary trading,
which include U.S. government and
agency obligations, obligations and
other instruments of certain government
sponsored entities, and State and
municipal obligations.38 Section l.6(b)
of the proposed rule describes permitted
trading on behalf of customers and
identifies three categories of
transactions that would qualify for the
exemption.39 These categories include:
(i) Transactions conducted by a banking
entity as investment adviser, commodity
trading advisor, trustee, or in a similar
fiduciary capacity for the account of a
customer where the customer, and not
the banking entity, has beneficial
ownership of the related positions; (ii)
riskless principal transactions; and (iii)
transactions conducted by a banking
entity that is a regulated insurance
proposed rule §§ l.5(b)(1), (2).
proposed rule § l.5(b)(3).
38 See proposed rule § l.6(a).
39 See proposed rule § l.6(b).
company for the separate account of
insurance policyholders, subject to
certain conditions. Section l.6(c) of the
proposed rule describes permitted
trading by a regulated insurance
company for its general account, and
generally parallels the statutory
language governing this exemption.40
Finally, § l.6(d) of the proposed rule
describes permitted trading outside of
the United States by a foreign banking
entity.41 The proposed exemption
clarifies when a foreign banking entity
will be considered to engage in such
trading pursuant to sections 4(c)(9) or
4(c)(13) of the BHC Act, as required by
the statute, including with respect to a
foreign banking entity not currently
subject to section 4 of the BHC Act. The
exemption also clarifies when trading
will be considered to have occurred
solely outside of the United States, as
required by the statute, and provides a
number of specific criteria for
determining whether that standard is
met.
Section l.7 of the proposed rule
requires certain banking entities with
significant covered trading activities to
comply with the reporting and
recordkeeping requirements specified in
Appendix A of the proposed rule. In
addition, § l.7 requires that a banking
entity comply with the recordkeeping
requirements in § l.20 of the proposed
rule, including, where applicable, the
recordkeeping requirements in
Appendix C of the proposed rule.
Section l.7 of the proposed rule also
requires a banking entity to comply with
any other reporting or recordkeeping
requirements that an Agency may
impose to evaluate the banking entity’s
compliance with the proposed rule.42
Proposed Appendix A requires those
banking entities with significant
covered trading activities to furnish
periodic reports to the relevant Agency
regarding a variety of quantitative
measurements of its covered trading
activities and maintain records
documenting the preparation and
content of these reports. These proposed
reporting and recordkeeping
requirements vary depending on the
scope and size of covered trading
activities, and a banking entity must
comply with proposed Appendix A’s
reporting and recordkeeping
requirements only if it has, together
with its affiliates and subsidiaries,
trading assets and liabilities the average
gross sum of which (on a worldwide
consolidated basis) is, as measured as of
the last day of each of the four prior
36 See
37 See
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
proposed rule § l.6(c).
proposed rule § l.6(d).
42 See proposed rule § l.7.
40 See
calendar quarters, equal to or greater
than $1 billion. These thresholds are
designed to reduce the burden on
smaller, less complex banking entities,
which generally engage in limited
market-making and other trading
activities. Other provisions of the
proposal, and in particular the
compliance program requirement in
§ l.20 of the proposed rule, are likely
to be less burdensome and equally
effective methods for ensuring
compliance with section 13 of the BHC
Act by smaller, less complex banking
entities.
The quantitative measurements that
must be furnished under the proposed
rule are generally designed to reflect,
and provide meaningful information
regarding, certain characteristics of
trading activities that appear to be
particularly useful to help differentiate
permitted market making-related
activities from prohibited proprietary
trading and to identify whether certain
trading activities result in a material
exposure to high-risk assets or high-risk
trading strategies. In addition, proposed
Appendix B contains a detailed
commentary regarding identification of
permitted market making-related
activities and distinguishing such
activities from trading activities that
constitute prohibited proprietary
trading.
As described in Part II.B.5 of the
Supplementary Information below, the
Agencies expect to utilize the
conformance period provided in section
13(c)(2) of the BHC Act to further refine
and finalize the reporting requirements,
reflecting the substantial public
comment, practical experience, and
revision that will likely be required to
ensure appropriate, effective use of
reported quantitative data in practice.
Section l.8 of the proposed rule
prohibits a banking entity from relying
on any exemption to the prohibition on
proprietary trading if the permitted
activity would involve or result in a
material conflict of interest, result in a
material exposure to high-risk assets or
high-risk trading strategies, or pose a
threat to the safety and soundness of the
banking entity or to the financial
stability of the United States.43 This
section also defines material conflict of
interest, high-risk asset, and high-risk
trading strategy for these purposes.
C. Covered Fund Activities and
Investments
Subpart C of the proposed rule
implements the statutory prohibition
on, as principal, directly or indirectly,
acquiring and retaining an ownership
41 See
PO 00000
Frm 00007
Fmt 4701
Sfmt 4702
68851
43 See
E:\FR\FM\07NOP2.SGM
proposed rule § l.8.
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68852
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
interest in, or having certain
relationships with, a covered fund, as
well as the various exemptions to this
prohibition included in the statute.
Section l.10 of the proposed rule
contains the core prohibition on covered
fund activities and investments and
defines a number of related terms,
including ‘‘covered fund’’ and
‘‘ownership interest.’’ The proposed
rule’s definition of covered fund
generally parallels the statutory
definition of ‘‘hedge fund’’ and ‘‘private
equity fund,’’ and explains the universe
of entities that would be considered a
‘‘covered fund’’ (including those entities
determined by the Agencies to be ‘‘such
similar funds’’) and, thus, subject to the
general prohibition.44
The definition of ‘‘ownership
interest’’ provides further guidance
regarding the types of interests that
would be considered to be an ownership
interest in a covered fund.45 As
described in this Supplementary
Information, these interests may take
various forms. The definition of
ownership interest also explicitly
excludes from the definition ‘‘carried
interest’’ whereby a banking entity may
share in the profits of the covered fund
solely as performance compensation for
services provided to the covered fund
by the banking entity (or an affiliate,
subsidiary, or employee thereof).46
Section l.10 of the proposed rule
also defines a number of other relevant
terms, including the terms ‘‘prime
brokerage transaction,’’ ‘‘sponsor,’’ and
‘‘trustee.’’
Section l.11 of the proposed rule
implements the exemption for
organizing and offering a covered fund
provided for under section 13(d)(1)(G)
of the BHC Act. Section l.11(a) of the
proposed rule outlines the conditions
that must be met in order for a banking
entity to organize and offer a covered
fund under this authority. These
requirements are contained in the
statute and are intended to allow a
banking entity to engage in certain
traditional asset management and
advisory businesses in compliance with
section 13 of the BHC Act.47 The
requirements are discussed in detail in
Part III.C.2 of this Supplementary
Information.
Section l.12 of the proposed rule
permits a banking entity to acquire and
retain, as an investment in a covered
fund, an ownership interest in a covered
fund that the banking entity organizes
proposed rule § l.10(b)(1).
45 See proposed rule § l.10(b)(3).
46 See proposed rule § l.10(b)(3)(ii).
47 See 156 Cong. Rec. S5889 (daily ed. July 15,
2010) (statement of Sen. Hagan).
44 See
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
and offers under § l.11.48 This section
implements section 13(d)(4) of the BHC
Act and related provisions. Section
13(d)(4) of the BHC Act permits a
banking entity to make an investment in
a covered fund that the banking entity
organizes and offers pursuant to section
13(d)(1)(G), or for which it acts as
sponsor, for the purposes of (i)
establishing the covered fund and
providing the fund with sufficient
initial equity for investment to permit
the fund to attract unaffiliated investors,
or (ii) making a de minimis investment
in the covered fund in compliance with
applicable requirements. Section l.12
of the proposed rule implements this
authority and related limitations,
including limitations regarding the
amount and value of any individual perfund investment and the aggregate value
of all such permitted investments.49
Proposed § l.12 also clarifies how a
banking entity must calculate its
compliance with these investment
limitations (including by deducting
such investments from applicable
capital, as relevant), as well as sets forth
how a banking entity may request an
extension of the period of time within
which it must conform an investment in
a single covered fund.50
Section l.13 of the proposed rule
implements the statutory exemptions
described in sections 13(d)(1)(C), (E),
and (I) of the BHC Act that permit a
banking entity: (i) To acquire and retain
an ownership interest in, or act as
sponsor to, one or more SBICs, a public
welfare investment, or certain qualified
rehabilitation expenditures; (ii) to
acquire and retain an ownership interest
in a covered fund as a risk-mitigating
hedging activity; and (iii) in the case of
a non-U.S. banking entity, to acquire
and retain an ownership interest in, or
act as sponsor to, a foreign covered
fund.51 Section l.13(a) of the proposed
rule permits a banking entity to acquire
and retain an ownership interest in, or
act as sponsor to, an SBIC or certain
public interest investments, without
limitation as to the amount of
ownership interests it may own, hold, or
control with the power to vote.52
Section l.13(b) of the proposed rule
permits a banking entity to use an
ownership interest in a covered fund to
hedge, but only with respect to
individual or aggregated obligations or
liabilities of a banking entity that arise
from: (i) The banking entity acting as
intermediary on behalf of a customer
proposed rule § l.12.
49 See proposed rule § l.12(a)(2).
50 See proposed rule §§ l.12(b), (c), and (d).
51 See proposed rule § l.13(a)—(c).
52 See proposed rule § l.13(a).
48 See
PO 00000
Frm 00008
Fmt 4701
Sfmt 4702
that is not itself a banking entity to
facilitate the customer’s exposure to the
profits and losses of the covered fund
(similar to acting as a ‘‘riskless
principal’’); or (ii) a compensation
arrangement with an employee of the
banking entity that directly provides
investment advisory or other services to
that fund.53 Additionally, § l.13(b) of
the proposed rule requires that the
hedge represent a substantially similar
offsetting exposure to the same covered
fund and in the same amount of
ownership interest in the covered fund
arising out of the transaction that the
acquisition or retention of an ownership
interest in the covered fund is intended
to hedge or otherwise mitigate.54
Proposed § l.13(b) also requires a
banking entity to document, at the time
the transaction is executed, the hedging
rationale for all hedging transactions
involving an ownership interest in a
covered fund.55
Section l.13(c) of the proposed rule
implements section 13(d)(1)(I) of the
BHC Act and permits certain foreign
banking entities to acquire or retain an
ownership interest in, or to act as
sponsor to, a covered fund so long as
such activity occurs solely outside of
the United States and the entity meets
the requirements of sections 4(c)(9) or
4(c)(13) of the BHC Act. This statutory
exemption limits the extraterritorial
application of the statutory restrictions
on covered fund activities and
investments to foreign firms that, in the
course of operating outside of the
United States, engage in activities
permitted under relevant foreign law
outside of the United States, while
preserving national treatment and
competitive equality among U.S. and
foreign firms within the United States.56
The proposed rule defines both the type
of foreign banking entities that are
eligible for the exemption and the
circumstances in which covered fund
activities or investments by such an
entity will be considered to have
occurred solely outside of the United
States (including clarifying when an
ownership interest will be considered to
have been offered for sale or sold to a
resident of the United States). Section
l.13(d) of the proposed rule also
implements in part the rule of
construction contained in section
13(g)(2) of the BHC Act, which permits
the sale and securitization of loans.57
Proposed § l.13(d) clarifies that a
proposed rule § l.13(b)(1).
proposed rule §§ l.13(b)(2)(ii)(C) and (D).
55 See proposed rule § l.13(b)(3).
56 See 156 Cong. Rec. S5897 (daily ed. July 15,
2010) (statement of Sen. Merkley).
57 See 12 U.S.C. 1851(g)(2).
53 See
54 See
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
banking entity may acquire and retain
an ownership interest in, or act as
sponsor to, a covered fund that is an
issuer of asset-backed securities, the
assets or holdings of which are solely
comprised of: (i) Loans; (ii) contractual
rights or assets directly arising from
those loans supporting the asset-backed
securities; and (iii) a limited amount of
interest rate or foreign exchange
derivatives that materially relate to such
loans and that are used for hedging
purposes with respect to the
securitization structure.58 The authority
contained in this section of the
proposed rule would therefore allow a
banking entity to acquire and retain an
ownership interest in a loan
securitization vehicle (which would be
a covered fund for purposes of section
13(h)(2) of the BHC Act and the
proposed rule) that the banking entity
organizes and offers, or acts as sponsor
to, in excess of the three percent limits
specified in section 13(d)(4) of the BHC
Act and § l.12 of the proposed rule.
Section l.14 of the proposed rule
implements section 13(d)(1)(J) of the
BHC Act59 and permits a banking entity
to engage in any covered fund activity
or investment that the Agencies
determine promotes and protects the
safety and soundness of banking entities
and the financial stability of the United
States.60 The Agencies have proposed to
permit three activities at this time under
this authority. These activities involve
acquiring and retaining an ownership
interest in, or acting as sponsor to,
certain bank owned life insurance
(‘‘BOLI’’) separate accounts, investments
in and sponsoring of certain assetbacked securitizations, and investments
in and sponsoring of certain entities that
rely on the exclusion from the definition
of investment company in section
3(c)(1) and/or 3(c)(7) of the Investment
Company Act of 1940 (15 U.S.C. 80a–1
et seq.) (‘‘Investment Company Act’’)
but that are, in fact, common corporate
organizational vehicles.61 Additionally,
the Agencies have proposed to permit a
banking entity to acquire and retain an
ownership interest in, or act as sponsor
to, a covered fund, if such acquisition or
retention is done (i) in the ordinary
proposed rule § l.13(d).
13(d)(1)(J) of the BHC Act provides the
Agencies discretion to determine that activities not
specifically identified by sections 13(d)(1)(A)–(I) of
the BHC Act are also exempted from the general
prohibitions contained in section 13(a) of that Act,
and are thus permitted activities. In order to make
such a determination, the Agencies must find that
such activity or activities promote and protect the
safety and soundness of banking entities, as well as
promote and protect the financial stability of the
United States. See 12 U.S.C. 1851(d)(1)(J).
60 See 12 U.S.C. 1851(d)(1)(J).
61 See proposed rule § l.13(a)(1)–(2).
58 See
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
59 Section
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
course of collecting a debt previously
contracted, or (ii) pursuant to and in
compliance with the conformance or
extended transition periods
implemented under section 13(c)(6) of
the BHC Act.62
Section l.15 of the proposed rule,
which implements section 13(e)(1) of
the BHC Act,63 requires a banking entity
engaged in covered fund activities and
investments to comply with (i) the
internal controls, reporting, and
recordkeeping requirements required
under § l.20 and Appendix C of the
proposed rule, as applicable and (ii)
such other reporting and recordkeeping
requirements as the relevant supervisory
Agency may deem necessary to
appropriately evaluate the banking
entity’s compliance with subpart C.64
Section l.16 of the proposed rule
implements section 13(f) of the BHC Act
and generally prohibits a banking entity
from entering into certain transactions
with a covered fund that would be a
covered transaction as defined in
section 23A of the FR Act.65 Section
l.16(a)(2) of the proposed rule clarifies
that, for reasons explained in part III.C.7
of this Supplementary Information,
certain transactions between a banking
entity and a covered fund remain
permissible. Section l.16(b) of the
proposed rule implements the statute’s
requirement that any transaction
permitted under section 13(f) of the
BHC Act (including a prime brokerage
transaction) between the banking entity
and a covered fund is subject to section
23B of the FR Act,66 which, in general,
requires that the transaction be on
market terms or on terms at least as
favorable to the banking entity as a
comparable transaction by the banking
entity with an unaffiliated third party.
Section l.17 of the proposed rule
prohibits a banking entity from relying
on any exemption to the prohibition on
acquiring and retaining an ownership
interest in, acting as sponsor to, or
having certain relationships with, a
covered fund, if the permitted activity
or investment would involve or result in
a material conflict of interest, result in
a material exposure to high-risk assets
or high-risk trading strategies, or pose a
threat to the safety and soundness of the
banking entity or to the financial
stability of the United States.67 This
section also defines material conflict of
proposed rule at § l.14(b).
63 Section 13(e)(1) of the BHC Act requires the
Agencies to issue regulations regarding internal
controls and recordkeeping to ensure compliance
with section 13. See 12 U.S.C. 1851(e)(1).
64 See proposed rule § l.15.
65 See proposed rule § l.16.
66 12 U.S.C. 371c–1.
67 See proposed rule § l.17.
62 See
PO 00000
Frm 00009
Fmt 4701
Sfmt 4702
68853
interest, high-risk asset, and high-risk
trading strategy for these purposes.
D. Compliance Program Requirement
Subpart D of the proposed rule
requires a banking entity engaged in
covered trading activities or covered
fund activities to develop and
implement a program reasonably
designed to ensure and monitor
compliance with the prohibitions and
restrictions on covered trading activities
and covered fund activities and
investments set forth in section 13 of the
BHC Act and the proposed rule.68
Section l.20(b) of the proposed rule
specifies six elements that each
compliance program established under
subpart D must, at a minimum, include:
• Internal written policies and
procedures reasonably designed to
document, describe, and monitor the
covered trading activities and covered
fund activities and investments of the
banking entity to ensure that such
activities comply with section 13 of the
BHC Act and the proposed rule;
• A system of internal controls
reasonably designed to monitor and
identify potential areas of
noncompliance with section 13 of the
BHC Act and the proposed rule in the
banking entity’s covered trading and
covered fund activities and to prevent
the occurrence of activities that are
prohibited by section 13 of the BHC Act
and the proposed rule;
• A management framework that
clearly delineates responsibility and
accountability for compliance with
section 13 of the BHC Act and the
proposed rule;
• Independent testing for the
effectiveness of the compliance
program, conducted by qualified
banking entity personnel or a qualified
outside party;
• Training for trading personnel and
managers, as well as other appropriate
personnel, to effectively implement and
enforce the compliance program; and
• Making and keeping records
sufficient to demonstrate compliance
with section 13 of the BHC Act and the
proposed rule, which a banking entity
must promptly provide to the relevant
Agency upon request and retain for a
period of no less than 5 years.
68 See proposed rule § l.20. If a banking entity
does not engage in covered trading activities and/
or covered fund activities and investments, it need
only ensure that its existing compliance policies
and procedures include measures that are designed
to prevent the banking entity from becoming
engaged in such activities and making such
investments, and which require the banking entity
to develop and provide for the required compliance
program prior to engaging in such activities or
making such investments.
E:\FR\FM\07NOP2.SGM
07NOP2
68854
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
For a banking entity with significant
covered trading activities or covered
fund activities and investments, the
compliance program must also meet a
number of minimum standards that are
specified in Appendix C of the proposed
rule.69 The application of detailed
minimum standards for these types of
banking entities is intended to reflect
the heightened compliance risks of large
covered trading activities and covered
fund activities and investments and to
provide clear, specific guidance to such
banking entities regarding the
compliance measures that would be
required for purposes of the proposed
rule. For banking entities with smaller,
less complex covered trading activities
and covered fund activities and
investments, these detailed minimum
standards are not applicable, though the
Agencies expect that such smaller
entities will consider these minimum
standards as guidance in designing an
appropriate compliance program.
E. Conformance Provisions
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Subpart E of the Board’s proposed
rule incorporates, with minor technical
and conforming edits, the final rule
which the Board, after soliciting and
considering public comment, issued
regarding the conformance periods for
entities engaged in prohibited
proprietary trading or covered fund
activities and investments.70 That rule
implements the conformance period and
extended transition period, as
applicable, during which a banking
entity and nonbank financial company
supervised by the Board must bring its
activities, investments and relationships
into compliance with the prohibitions
and restrictions on proprietary trading
and acquiring an ownership interest in,
or having certain relationships with, a
covered fund.
69 A banking entity must comply with the
minimum standards specified in Appendix C of the
proposed rule (i) with respect to its covered trading
activities, if it engages in any covered trading
activities and has, together with its affiliates and
subsidiaries, trading assets and liabilities the
average gross sum of which (on a worldwide
consolidated basis), as measured as of the last day
of each of the four prior calendar quarters, (X) is
equal to or greater than $1 billion or (Y) equals 10
percent or more of its total assets; and (ii) with
respect to its covered fund activities and
investment, if it engages in any covered fund
activities and investments and either (X) has,
together with its affiliates and subsidiaries,
aggregate investments in covered funds the average
value of which is, as measured as of the last day
of each of the four prior calendar quarters, equal to
or greater than $1 billion or (Y) sponsors and
advises, together with its affiliates and subsidiaries,
covered funds the average total assets of which are,
as measured as of the last day of each of the four
prior calendar quarters, equal to or greater than $1
billion.
70 See 76 FR 8265 (Feb. 14, 2011).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
F. Treatment of Smaller, Less-Complex
Banking Entities
In formulating the proposed rule, the
Agencies have carefully considered and
taken into account the potential impact
of the proposed rule on small banking
entities and banking entities that engage
in little or no covered trading activities
or covered fund activities and
investments, including the burden and
cost that might be associated with such
banking entities’ compliance with the
proposed rule. In particular, the
Agencies have proposed to reduce the
effect of the proposed rule on such
banking entities by limiting the
application of certain requirements,
such as the reporting and recordkeeping
requirements of § l.7 and Appendix A
of the proposed rule and the compliance
program requirements contained in
subpart D and Appendix C of the
proposed rule, to those banking entities
that engage in little or no covered
trading activities or covered fund
activities and investments. The
Agencies have also requested comment
(i) throughout this Supplementary
Information on a number of questions
related to the costs and burdens
associated with particular aspects of the
proposal, as well as (ii) in Part VII.B of
this Supplementary Information on any
significant alternatives that would
minimize the impact of the proposal on
small banking entities.
G. Application of Section 13 of the BHC
Act to Securitization Vehicles or Issuers
of Asset-Backed Securities
Many issuers of asset-backed
securities may be included within the
definition of covered fund since they
would be an investment company but
for the exclusions contained in section
3(c)(1) or 3(c)(7) of the Investment
Company Act.71 If an issuer of assetbacked securities is considered to be a
covered fund, then a banking entity
would not be permitted to acquire or
retain any ownership interest issued by
such issuer except as otherwise
permitted under section 13 of the BHC
71 For purposes of the proposed rule, any
securitization entity that meets the requirements for
an exclusion under Rule 3a–7 or section 3(c)(5) of
the Investment Company Act, or any other
exclusion or exemption from the definition of
‘‘investment company’’ under the Investment
Company Act (other than sections 3(c)(1) or 3(c)(7)
of the Investment Company Act), would not be a
covered fund under the proposed definition.
Additionally, an issuer of asset-backed securities
that is subject to legal documents mandating
compliance with the conditions of section 3(c)(1) of
3(c)(7) of the Investment Company Act would not
be a covered fund if such issuer also can satisfy all
the conditions of an alternative exclusion or
exemption for which it is eligible.
PO 00000
Frm 00010
Fmt 4701
Sfmt 4702
Act and the proposed rule.72 Separately,
issuers of asset-backed securities may be
included within the definition of
banking entity, as noted in Part III.A.2
of this Supplementary information.
Although the proposed definition of
banking entity would not include any
entity that is a covered fund, an issuer
of asset-backed securities that is both (i)
an affiliate or subsidiary of a banking
entity,73 and (ii) does not rely on an
exclusion contained in section 3(c)(1) of
3(c)(7) of the Investment Company Act,
would be a banking entity and thus
subject to the requirements of section 13
of the BHC Act and the proposed rule,
including: (i) The prohibition on
proprietary trading; (ii) limitations on
investments in and relationships with a
covered fund; (iii) the establishment and
implementation of a compliance
program as required under the proposed
rule; and (iv) recordkeeping and
reporting requirements. Given the
breadth of the definition of ‘‘affiliate,’’
these requirements may apply to a
significant portion of the outstanding
securitization market, including issuers
of asset-backed securities that rely on
rule 3a–7 or section 3(c)(5) of the
Investment Company Act.
In recognition of these concerns, the
Agencies have requested comment
throughout this Supplementary
Information on the potential effects of
section 13 of the BHC Act and the
proposed rule on the securitization
industry and issuers of asset-backed
securities.
72 For example, under the proposed rule, a
banking entity would be able to acquire or retain
an interest or security of an issuer of asset-backed
securities that is a covered fund if: (i) The interest
or security of the issuer does not qualify as an
‘‘ownership interest’’ under § l.10(b)(3) of the
proposed rule; (ii) the issuer of asset-backed
securities is comprised solely of loans, contractual
rights or assets directly arising from those loans,
and certain specified interest rate or foreign
exchange derivatives used for hedging purposes, as
permitted under § l.13(d) or l.14(a)(2)(v) of the
proposed rule; (iii) the banking entity is a
‘‘securitizer’’ or ‘‘originator’’ and acquires and
retains such interest in compliance with the
minimum requirements of section 15G of the
Exchange Act and any implementing regulations
issued thereunder, as provided under
§ l.14(a)(2)(iii) of the proposed rule; or (v) the
banking entity organizes and offers the issuer and
the ownership interest is a permitted investment
under § l.12 of the proposed rule. The
circumstances where a banking entity may acquire
or retain an ownership interest in a covered fund
are discussed in detail in Part III.C of this
Supplemental Information.
73 The definitions of ‘‘affiliate’’ and ‘‘subsidiary’’
are discussed in detail in Part III.A.2 of this
Supplemental Information.
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
III. Section by Section Summary of
Proposed Rule
A. Subpart A—Authority and
Definitions
1. Section l.1: Authority, Purpose,
Scope, and Relationship to Other
Authorities
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
a. Authority and Scope
Section l.1 of the proposed rule
describes the authority under which
each Agency is issuing the proposed
rule, the purpose of the proposed rule,
and the banking entities to which each
Agency’s rule applies. In addition,
§ l.1(d) of the proposed rule
implements section 13(g)(1) of the BHC
Act, which provides that the
prohibitions and restrictions of section
13 apply to the activities of a banking
entity regardless of whether such
activities are authorized for a banking
entity under other applicable provisions
of law.74
b. Effective Date
Section 13(c)(1) of the BHC Act
provides that section 13 shall take effect
on the earlier of (i) 12 months after the
date of issuance of final rules
implementing that section, or (ii) 2 years
after the date of enactment of section 13,
which is July 21, 2012.75 Because the
Agencies did not issue final rules
implementing section 13 of the BHC Act
by July 21, 2011, § l.1 of the proposed
rule specifies that the effective date for
its provisions will be July 21, 2012.
The Agencies note that the proposed
effective date will impact not only the
date on which the proposed rule’s
prohibitions and restrictions on
proprietary trading and covered fund
activities and investments go into effect
(subject to the conformance period or
extended transition period provided by
section 13(c) of the BHC Act),76 but also
the date on which a banking entity must
comply with (i) the reporting and
recordkeeping requirements of § l.7
and Appendix A of the proposed rule
and (ii) the compliance program
mandate of § l.20 and Appendix C of
the proposed rule. As proposed, § l.1
would require a banking entity subject
to either the reporting and
recordkeeping or compliance program
requirements to begin complying with
these requirements as of July 21, 2012.77
With respect to the compliance program
requirement of the proposed rule, § l.1
would require a banking entity to have
developed and implemented the
proposed rule § l.1(d).
12 U.S.C. 1851(c)(1).
76 See id. at 1851(c)(2)–(6).
77 See proposed rule § l.1.
74 See
75 See
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
required program by the proposed
effective date, though the Agencies note
that prohibited activities and
investments may not be fully conformed
by that date. The Agencies expect a
banking entity to fully conform all
investments and activities to the
requirements of the proposed rule as
soon as practicable within the
conformance periods provided in
section 13 of the BHC Act and the
Board’s rules thereunder, which define
the conformance periods. With respect
to the reporting and recordkeeping
requirements of the proposed rule,
§ l.1 of the proposed rule would
require a banking entity to begin
furnishing these reports for all trading
units or asset management units as of
the effective date, though the
quantitative measurements furnished for
proprietary trading activities that are
conducted in reliance on the authority
provided by the conformance period
would not be used to identify prohibited
proprietary trading until such time as
the relevant trading activities must be
conformed.
The Agencies expect that a banking
entity may need a period of time to
prepare for effectiveness of the proposed
rule and, in particular, to implement
both the compliance program and the
reporting and recordkeeping
requirements provided under the
proposed rule. Accordingly, in order to
help assess the effects and impact of the
proposed effective date and any
alternative compliance dates, the
Agencies request comment on the
following questions:
Question 1. Does the proposed
effective date provide banking entities
with sufficient time to prepare to
comply with the prohibitions and
restrictions on proprietary trading and
covered fund activities and
investments? If not, what other period of
time is needed and why?
Question 2. Does the proposed
effective date provide banking entities
with sufficient time to implement the
proposal’s compliance program
requirement? If not, what are the
impediments to implementing specific
elements of the compliance program
and what would be a more effective
time period for implementing each
element and why?
Question 3. Does the proposed
effective date provide banking entities
sufficient time to implement the
proposal’s reporting and recordkeeping
requirements? If not, what are the
impediments to implementing specific
elements of the proposed reporting and
recordkeeping requirements and what
would be a more effective time period
PO 00000
Frm 00011
Fmt 4701
Sfmt 4702
68855
for implementing each element and
why?
Question 4. Should the Agencies use
a gradual, phased in approach to
implement the statute rather than
having the implementing rules become
effective at one time? If so, what
prohibitions and restrictions should be
implemented first? Please explain.
2. Section l.2: Definitions
Section l.2 of the proposed rule
defines a variety of terms used
throughout the proposed rule, including
‘‘banking entity,’’ which defines the
scope of entities to which the proposed
rule applies. Consistent with the
statutory definition of that term,
§ l.2(e) of the proposed rule provides
that a ‘‘banking entity’’ includes: (i) Any
insured depository institution; (ii) any
company that controls an insured
depository institution; (iii) any company
that is treated as a bank holding
company for purposes of section 8 of the
International Banking Act of 1978 (12
U.S.C. 3106); and (iv) any affiliate or
subsidiary of any of the foregoing.78 In
addition, in order to avoid application
of section 13 of the BHC Act in a way
that appears unintended by the statute
and would create internal
inconsistencies in the statutory scheme,
the proposed rule also clarifies that the
term ‘‘banking entity’’ does not include
any affiliate or subsidiary of a banking
entity, if that affiliate or subsidiary is (i)
a covered fund, or (ii) any entity
controlled by such a covered fund.79
This clarification is proposed because
the definition of ‘‘affiliate’’ and
‘‘subsidiary’’ under the BHC Act is
broad, and could include a covered fund
that a banking entity has permissibly
sponsored or made an investment in
because, for example, the banking entity
acts as general partner or managing
member of the covered fund as part of
its permitted sponsorship activities.80 If
78 See proposed rule § l.2(e). Sections l.2(a)
and (bb) of the proposed rule clarify that the terms
‘‘affiliate’’ and ‘‘subsidiary’’ have the same meaning
as in sections 2(d) and (k) of the BHC Act (12 U.S.C.
1841(d) and (k)).
79 The Agencies note that since the proposed rule
implements section 13 of the BHC Act, it
incorporates that Act’s definition of ‘‘affiliate’’ and
‘‘subsidiary.’’ See proposed rule §§ l.2(a) and (bb).
The terms affiliate and subsidiary are generally
defined in section 2 of the BHC Act according to
whether such entity controls or is controlled by
another relevant entity. See 12 U.S.C. 1841(d), (k).
The concept of control under the proposed rule, in
turn, is as defined in section 2 of the BHC Act and
as implemented by the Board. See 12 U.S.C.
1841(a)(2); 12 CFR 225.2(e).
80 Under section 2 of the BHC Act and the Board’s
Regulation Y (12 CFR part 225), a banking entity
acting as general partner or managing member of
another company would be deemed to control that
company and, as such, the company would be both
E:\FR\FM\07NOP2.SGM
Continued
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68856
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
such a covered fund were considered a
‘‘banking entity’’ for purposes of the
proposed rule, the fund itself would
become subject to all of the restrictions
and limitations of section 13 of the BHC
Act and the proposed rule, which would
be inconsistent with the purpose and
intent of the statute. For example, such
a covered fund would then generally be
prohibited from investing in other
covered funds, notwithstanding the fact
that section 13(f)(3) of the BHC Act
specifically contemplates such
investments. Accordingly, the proposed
rule would exclude from the definition
of banking entity any fund that a
banking entity may invest in or sponsor
as permitted by the proposed rule.
An entity such as a mutual fund
would generally not be a subsidiary or
affiliate of a banking entity under this
definition if the banking entity only
provides advisory or administrative
services to, has certain limited
investments in, or organizes, sponsors,
and manages a mutual fund (which
includes a registered investment
company) in accordance with BHC Act
rules.81
Section l.2(j) of the proposed rule
defines the term ‘‘covered banking
entity,’’ which is used in each Agency’s
proposed rule to describe the specific
types of banking entities to which that
Agency’s rule applies. In addition, a
number of other definitions contained
in § l.2 are discussed in further detail
below in connection with the separate
sections of the proposed rule in which
they are used.
The proposed rule also defines the
terms ‘‘buy and purchase’’ and ‘‘sell and
sale,’’ which are used throughout the
proposed rule to describe the scope of
transactions that are subject to subparts
B and C of the proposed rule. These
definitions are substantially similar to
the definitions of the same terms under
the Exchange Act, except that the
proposed definitions provide additional
clarity regarding the types of
transactions that would be considered
the purchase or sale of a commodity
future or derivative or ownership
interest in a covered fund.82 These
definitions are purposefully broad in
scope, and are intended to include a
wide range of transaction types that
would permit a banking entity to gain or
eliminate, or increase or reduce,
an ‘‘affiliate’’ and ‘‘subsidiary’’ of the banking entity
for purposes of the BHC Act. See 12 U.S.C. 1841(d),
(k).
81 See, e.g., 12 U.S.C. 1483(c)(6), (c)(8), and (k); 12
CFR 225.28(b)(6), 225.86(b)(3).
82 See proposed rule §§ l.2(g), (v); 15 U.S.C.
78c(a)(13), (14).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
exposure to a covered financial position
or ownership interest in a covered fund.
Request for Comment
The Agencies request comment on the
proposed rule’s definition of ‘‘banking
entity.’’ In particular, the Agencies
request comment on the following
questions:
Question 5. Is the proposed rule’s
definition of banking entity effective?
What alternative definitions might be
more effective in light of the language
and purpose of the statute?
Question 6. Are there any entities that
should not be included within the
definition of banking entity since their
inclusion would not be consistent with
the language or purpose of the statute or
could otherwise produce unintended
results? Should a registered investment
company be expressly excluded from
the definition of banking entity? Why or
why not?
Question 7. Is the proposed rule’s
exclusion of a covered fund that is
organized, offered and held by a
banking entity from the definition of
banking entity effective? Should the
definition of banking entity be modified
to exclude any covered fund? Why or
why not?
Question 8. Banking entities
commonly structure their registered
investment company relationships and
investments such that the registered
investment company is not considered
an affiliate or subsidiary of the banking
entity. Should a registered investment
company be expressly excluded from
the definition of banking entity? Why or
why not? Are there circumstances in
which such companies should be
treated as banking entities subject to
section 13 of the BHC Act? How many
such companies would be covered by
the proposed definition?
Question 9. Under the proposed rule,
would issuers of asset-backed securities
be captured by the proposed definition
of ‘‘banking entity’’? If so, are issuers of
asset-backed securities within certain
asset classes particularly impacted? Are
particular types of securitization
vehicles (trusts, LLCs, etc.) more likely
than others to be included in the
definition of banking entity? Should
issuers of asset-backed securities be
excluded from the proposed definition
of ‘‘banking entity,’’ and if so, why?
How would such an exclusion be
consistent with the language and
purpose of the statute?
Question 10. What would be the
potential impact of including existing
issuers of asset-backed securities 83 in
83 For purposes of this Supplemental Information,
‘‘existing issuers of asset-backed securities’’ means
PO 00000
Frm 00012
Fmt 4701
Sfmt 4702
the proposed definition of ‘‘banking
entity’’ on existing issuers of assetbacked securities and the securitization
market generally? How many existing
issuers of asset-backed securities might
be included in the proposed definition
of ‘‘banking entity’’? Are there ways in
which the proposed rule could be
amended to mitigate or eliminate
potential impact, if any, on existing
asset-backed securities 84 without
compromising the intent of the statute?
Question 11. What would be the legal
and economic impact to an issuer of
asset-backed securities of being
considered a ‘‘banking entity’’? What
additional costs would be incurred in
the establishment and implementation
of a compliance program related to the
provisions of the proposed rule as
required by § l.20 of the proposed rule
(including Appendix C, where
applicable)? Who would pay those
additional costs?
Question 12. If the ownership
requirement under the proposed rule for
credit risk retention (section 15G of the
Exchange Act) combined with the
control inherent in the position of
servicer or investment manager means
that more securitization vehicles would
be considered affiliates of banking
entities, would fewer banking entities be
willing to (i) serve as the servicer or
investment manager of securitization
transactions and/or (ii) serve as the
originator or securitizer (as defined in
section 15G of the Exchange Act) of
securitization transactions? What other
impact might the potential interplay
between these rules have on future
securitization transactions? Could there
be other potential unintended
consequences?
Question 13. Are the proposed rule’s
definitions of buy and purchase and sale
and sell appropriate? If not, what
alternative definitions would be more
appropriate? Should any other terms be
defined? If so, are there existing
definitions in other rules or regulations
that could be used in this context? Why
would the use of such other definitions
be appropriate?
B. Subpart B—Proprietary Trading
Restrictions
1. Section l.3: Prohibition on
Proprietary Trading
Section l.3 of the proposed rule
describes the scope of the prohibition
on proprietary trading and defines a
issuers that issued asset-backed securities prior to
the effective date of the proposed rule.
84 For purposes of this Supplemental Information,
‘‘existing asset-backed securities’’ means assetbacked securities that were issued prior to the
effective date of the proposed rule.
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
number of terms related to proprietary
trading. The Agencies note that the
definition of ‘‘proprietary trading’’ in
the statute and under the proposed rule
is broad. This definition must be viewed
in light of the exemptions described
later in the proposed rule, which reflect
statutory provisions permitting a
number of activities.
a. Prohibition on Proprietary Trading
Section l.3(a) of the proposed rule
implements section 13(a)(1)(A) of the
BHC Act and prohibits a banking entity
from engaging in proprietary trading
unless otherwise permitted under
§§ l.4 through l.6 of the proposed
rule. Section l.3(b)(1) of the proposed
rule defines proprietary trading in
accordance with section 13(h)(4) of the
BHC Act.85 This definition is a key
element of the proposal because, unless
an activity covered by the definition is
specifically permitted under one of the
exemptions contained in §§ l.4 through
l.6 of the proposed rule, a banking
entity is prohibited from engaging in
that activity. Specifically, the proposal
largely restates the statutory definition
of proprietary trading, defining that
term to mean engaging in the purchase
or sale of one or more covered financial
positions as principal for the trading
account of the banking entity.86 The
terms ‘‘trading account’’ and ‘‘covered
financial position’’ are defined in
§§ l.3(b)(2) and l.3(b)(3) of the
proposed rule, respectively. The
proposed definition of proprietary
trading also clarifies that proprietary
trading does not include acting as agent,
broker, or custodian for an unaffiliated
third party, because acting in these
types of capacities does not involve
trading as principal, which is one of the
requisite aspects of the statutory
definition.
b. ‘‘Trading Account’’
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
i. Definition of ‘‘Trading Account’’
Section 13(h)(6) of the BHC Act
defines the term ‘‘trading account’’ as
‘‘any account used for acquiring or
taking positions in securities [or other
enumerated instruments] principally for
the purpose of selling in the near-term
(or otherwise with the intent to resell in
order to profit from short-term price
movements),’’ as well as any such other
accounts that the Agencies by rule
determine.87 As an initial matter, the
Agencies note that it is often difficult to
clearly identify the purpose for which a
position is acquired or taken and
whether that purpose is short-term in
nature, particularly since identification
of that purpose generally depends on
the intent with which the position is
acquired or taken. Moreover, the statute
does not define the terms ‘‘near-term’’ or
‘‘short-term’’ for these purposes.
In implementing the statutory
definition of trading account, the
proposed rule generally restates the
statutory definition, with the addition of
certain details intended to provide
banking entities with greater clarity
regarding the scope of positions that fall
within the definition of trading
account.88 The proposed definition of
trading account has three prongs. First,
under the proposed rule, a trading
account includes any account that is
used by a banking entity to acquire or
take one or more covered financial
positions for the purpose of: (i) Shortterm resale; (ii) benefitting from actual
or expected short-term price
movements; (iii) realizing short-term
arbitrage profits; or (iv) hedging one or
more such positions.89 Second, the
proposed definition of trading account
also includes any account used by a
banking entity that is subject to the
Market Risk Capital Rules to acquire or
take one or more covered financial
positions that are subject to those rules,
other than certain foreign exchange and
commodity positions.90 Third, the
proposed definition of trading account
also includes any account used by a
banking entity that is a securities dealer,
swap dealer, or security-based swap
dealer to acquire or take positions in
connection with its dealing activities.91
To provide additional clarity and
guidance regarding the trading account
definition, the proposed rule also
includes a rebuttable presumption that
any account used to acquire or take a
covered financial position that is held
for sixty days or less is a trading account
under the first prong, unless the banking
entity can demonstrate that the position
was not acquired principally for shortterm trading purposes. The proposed
definition also clarifies that no account
will be a trading account to the extent
that it is used to acquire or take certain
87 See
12 U.S.C. 1851(h)(6).
Agencies note that the structure of the
proposed definition, which defines a trading
account by reference to the positions that the
account is used to acquire or take, is consistent with
the structure of the statutory language used in
section 13(h)(6) of the BHC Act.
89 See proposed rule § __.3(b)(2)(i)(A).
90 See proposed rule § l.3(b)(2)(i)(B).
91 See proposed rule § l.3(b)(2)(i)(C).
88 The
proposed rule § l.3(b)(1).
12 U.S.C. 1851(h)(4); see also proposed rule
§ l.3(b)(1). Although the statutory definition refers
to the ‘‘purchase, sale, acquisition, or disposition
of’’ covered financial positions, the proposed rule
uses the simpler terms ‘‘purchase’’ and ‘‘sale,’’
which are defined broadly in §§ l.2(g) and (v) of
the proposed rule.
85 See
86 See
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
PO 00000
Frm 00013
Fmt 4701
Sfmt 4702
68857
positions under repurchase or reverse
repurchase arrangements or securities
lending transactions, positions for bona
fide liquidity management purposes, or
certain positions held by derivatives
clearing organizations or clearing
agencies. Each of the three definitional
prongs is independent of the others—
any one prong would, if met, cause the
relevant account to fall within the
definition of ‘‘trading account.’’
The Agencies have drawn on existing
rules, in particular the Market Risk
Capital Rules and various securities and
commodities laws, in identifying
trading accounts and defining related
terms in the proposal.
ii. Positions Acquired or Taken for
Short-Term Trading Purposes
The first prong of the proposed
trading account definition refers to
positions that a banking entity acquires
or takes principally for short-term
purposes—that is, for one of the
following enumerated purposes
described in §§ l.3(b)(2)(i)(A)(1)
through (4) of the proposed rule:
• Short-term resale;
• Benefitting from actual or expected
short-term price movements;
• Realizing short-term arbitrage
profits; or
• Hedging one or more such
positions.
This prong reflects the statutory
definition’s reference to positions
acquired or taken ‘‘principally for the
purpose of selling in the near-term (or
otherwise with the intent to resell in
order to profit from short-term price
movements).’’ 92
Section l.3(b)(2)(i)(A)(1) of the
proposed rule’s definition of trading
account includes covered financial
positions acquired or taken principally
for the purpose of short-term resale.93
This part of the trading account
definition restates language contained in
the statutory definition of trading
account and describes one class of
positions that are acquired or taken for
short-term trading purposes.
Section l.3(b)(2)(i)(A)(2) of the
proposed rule includes covered
financial positions acquired or taken
principally for the purpose of
benefitting from actual or expected
short-term price movements.94 This part
of the trading account definition does
not require the resale of the position;
rather, it requires only an intent to
engage in any form of transaction on a
short-term basis (including a transaction
92 See 12 U.S.C. 1851(h)(6); see also proposed rule
§ l.3(b)(2)(i).
93 See proposed rule § l.3(b)(2)(i)(A)(1).
94 See proposed rule § l.3(b)(2)(i)(A)(2).
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68858
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
separate from, but related to, the initial
acquisition of the position) for the
purpose of benefitting from a short-term
movement in the price of the underlying
position. This part of the proposed
definition would, for example, include
a derivative or other position where the
banking entity enters into (or intends to
enter into) a subsequent transaction in
the near-term to simply offset or ‘‘close
out,’’ rather than sell, all or a portion of
the risks of the initial position, in order
to benefit from a price movement
occurring between the acquisition of the
underlying position and the subsequent
offsetting transaction. Similarly, it
would also include a derivative,
commodity future, or other position
that, regardless of the term of that
position, is subject to the exchange of
short-term variation margin through
which the banking entity intends to
benefit from short-term price
movements. The proposed definition
would also capture the acquisition of a
debt instrument where the banking
entity intends to enter into a short-term
transaction to simply offset, rather than
sell, the credit, interest rate and/or other
material risk elements of the initial
position so as to benefit from a price
movement occurring between
acquisition of the underlying position
and the subsequent offsetting
transaction.
Section l.3(b)(2)(i)(A)(3) of the
proposed rule’s definition of trading
account includes covered financial
positions acquired or taken principally
to lock in short-term arbitrage profits.95
Although similar to the positions
described in § ll.3(b)(2)(i)(A)(2) of the
proposed definition (i.e., those acquired
for the purpose of benefitting from
actual or expected short-term price
movements), this part of the definition
focuses on short-term arbitrage profits
more generally, without regard to
whether the transaction is predicated on
expected or actual movements in price.
Rather, a position acquired to lock in
arbitrage profits would include
positions acquired or taken with the
intent to benefit from differences in
multiple market prices, even in cases in
which no movement in those prices is
necessary to realize the intended profit.
Such arbitrage-based transactions might
involve profiting from the difference in
the market price of multiple related
positions or assets, or might instead
involve the difference in market price
for particular price or risk elements
associated with positions or assets. This
would include, for example, arbitrage
profits resulting from the convergence
or divergence in prices between
95 See
proposed rule § l.3(b)(2)(i)(A)(3).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
different positions held by a banking
entity engaged in relative value
convergence arbitrage, which involves
marrying a long and short position to
benefit from a convergence or
divergence in price between the two, or
any similar strategy, because such
convergence or divergence could
happen at any time (i.e., in one day, in
sixty-one days, or some other time
period).
Section l.3(b)(2)(i)(A)(4) of the
proposed rule’s definition of trading
account includes covered financial
positions acquired or taken for the
purpose of hedging another position
that is itself held in a trading account.96
In particular, the Agencies assume that,
with respect to any position the purpose
of which is to hedge another covered
financial position in the trading
account, the banking entity generally
intends to hold the hedging position,
whatever its nominal duration, for only
so long as the underlying position is
held. Accordingly, the proposed rule
makes clear that such hedging positions
fall within the definition of trading
account.
iii. Overview of Current Market Risk
Capital Rules Approach to Short-Term
Trading Positions
The first prong of the proposed
trading account definition, which
references positions acquired
principally for short-term trading
purposes, is, like the statutory definition
it implements, substantially similar to a
key portion of the definition of a
‘‘covered position’’ under the Market
Risk Capital Rules.97 For the reasons
proposed rule § l.3(b)(2)(i)(A)(4).
Federal banking agencies’ current Market
Risk Capital Rules are located at 12 CFR Part 3,
Appendix B (OCC), 12 CFR Part 208, Appendix E
and 12 CFR Part 225, Appendix E (Board), and 12
CFR Part 325, Appendix C (FDIC), and apply on a
consolidated basis to banks and bank holding
companies with trading activity (on a worldwide
consolidated basis) that equals 10 percent or more
of the institution’s total assets, or $1 billion or
more. On January 11, 2011, the Federal banking
agencies proposed revisions to the Market Risk
Capital Rules that include, inter alia, changes to the
definition of covered position. Proposed revisions
to the Market Risk Capital Rules include (i) changes
to portions of the covered position definition not
relevant to the statutory definition of trading
account in section 13 of the BHC Act and (ii) the
addition of a requirement that any position in a
trading account also be a ‘‘trading position’’ in
order to be considered a covered position. See 76
FR 1890 (Jan. 11, 2011). The revised definition of
‘‘trading position’’ that has been proposed for those
purposes is generally identical to this proposed
rule’s definition of trading account (i.e., a position
acquired or taken: (i) For the purpose of short-term
resale; (ii) with the intent of benefitting from actual
or expected short-term price movements; (iii) to
lock in short-term arbitrage profits; or (iv) to hedge
another trading position). The Agencies also note
that the first prong of the proposed rule’s trading
account definition is also substantially similar to
96 See
97 The
PO 00000
Frm 00014
Fmt 4701
Sfmt 4702
discussed below, the Agencies have
taken this similarity into account and
propose to construe the first prong of
the definition of trading account under
the proposed rule—and in particular its
reference to ‘‘short-term’’—in a manner
that is consistent with the Market Risk
Capital Rules’ approach to identifying
positions taken with short-term trading
intent.
The Market Risk Capital Rules define
a covered position to include all
positions in a bank’s ‘‘trading account,’’
as that term is defined, in part, in the
Report of Condition and Income that
banks are required to file periodically
with respect to their financial condition
(‘‘Call Report’’). Under the Market Risk
Capital Rules, a covered position is one
that is subject to a risk-based capital
charge that is based, at least in part, on
the banking organization’s internal risk
management models for purposes of
calculating the banking organization’s
risk-based capital requirement.98 In
defining the term ‘‘trading account,’’ the
Call Report notes that trading activities
typically include, among other
activities, ‘‘acquiring or taking positions
in such items principally for the
purpose of selling in the near-term or
otherwise with the intent to resell in
order to profit from short-term price
movements.’’ 99 This language is
substantially identical to the statutory
the Basel Committee’s definition of ‘‘trading book.’’
See Basel Committee on Banking Supervision,
Amendment to the Capital Accord to Incorporate
Market Risks, available at http://bis.org/publ/
bcbs119.pdf.
98 The Agencies note that the Market Risk Capital
Rules, both in their current and proposed form, also
(i) include within the definition of covered position
other positions not captured by the reference to
positions acquired for the purpose of short-term
resale or with the intent of benefitting from actual
or expected short-term price movements (e.g., all
commodity and foreign exchange positions,
regardless of the intended holding period) and (ii)
exclude from that definition certain positions
otherwise acquired with short-term trading intent
for a variety of policy reasons. The Agencies have
not proposed to incorporate such inclusions or
exclusions for purposes of the proposed rule’s
definition of trading account; rather, the Market
Risk Capital Rules and related concepts have been
referred to only to the extent that they pertain to
positions acquired for the purpose of short-term
resale or with the intent of benefitting from actual
or expected short-term price movements.
99 Report of Condition and Income at A78a (also
including, in the definition of ‘‘trading account,’’
‘‘regularly underwriting or dealing in securities;
interest rate, foreign exchange rate, commodity,
equity, and credit derivative contracts; other
financial instruments; and other assets for resale
* * * and * * * acquiring or taking positions in
such items as an accommodation to customers or
for other trading purposes.’’). Accordingly, given its
broader scope, the Call Report ‘‘trading account’’
includes trading positions that fall outside the
statutory ‘‘trading account’’ for purposes of
determining what is prohibited and permitted
covered trading activity under section 13 of the
BHC Act.
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
definition of trading account in section
13 of the BHC Act in that it refers to
acquiring or taking positions (i)
principally for the purpose of selling in
the near-term or (ii) otherwise with the
intent to resell in order to profit from
short-term price movements.
In providing guidance regarding the
application of ‘‘trading account,’’ the
Call Report also states that trading
account positions include any position
that is classified as ‘‘trading securities’’
under relevant U.S. Generally Accepted
Accounting Principles (‘‘GAAP’’)
standards for accounting.100 Under the
referenced accounting standards,
trading securities are defined as those
‘‘that are bought and held principally
for the purpose of selling them in the
near-term’’ and ‘‘generally used with the
objective of generating profits on shortterm differences in price.’’ 101 The
Agencies note that the definition of a
trading security under the relevant U.S.
GAAP accounting standards is similar to
both (i) the financial positions described
in the second prong of the Call Report’s
definition of trading account and (ii) the
financial positions described in the
statutory definition of trading account
under section 13 of the BHC Act.
Although neither the Market Risk
Capital Rules, the Call Report, nor
relevant accounting standards provide a
precise definition of what constitutes
‘‘near-term’’ or ‘‘short-term’’ for
purposes of evaluating whether a
position is of the type held in a trading
account or is a trading security,
guidance provided under relevant
accounting standards notes that ‘‘nearterm’’ for purposes of classifying trading
activities is ‘‘generally measured in
hours and days rather than months or
years.’’ 102 The Agencies expect that the
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
100 See
Report of Condition and Income at A78a,
referring to ASC Topic 320, Investments—Debt and
Equity Securities (formerly FASB Statement of
Financial Accounting Standards No. 115,
‘‘Accounting for Certain Investments in Debt and
Equity Securities’’).
101 See id. In formulating the proposed rule, the
Agencies carefully considered whether to define
trading account for purposes of the proposed rule
in a manner that formally incorporated the
accounting standards governing trading securities.
The Agencies have not proposed this approach
because: (i) The statutory proprietary trading
prohibition under section 13 of the BHC Act applies
to financial instruments, such as derivatives, to
which the trading security accounting standards
may not apply; (ii) these accounting standards
permit companies to classify, at their discretion,
assets as trading securities even where the assets
would not otherwise meet the definition of trading
security; and (iii) these accounting standards could
change in the future without consideration of the
potential impact on section 13 of the BHC Act.
102 See FASB ASC Master Glossary definition of
‘‘trading.’’ Although § l.3(b)(2)(ii) of the proposed
rule includes a rebuttable presumption that an
account used to acquire or take certain covered
financial positions that are held for 60 days or less
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
precise period of time that may be
considered near-term or short-term for
purposes of evaluating any particular
covered financial position would
depend on a variety of factors, including
the facts and circumstances of the
covered financial position’s acquisition,
the banking entity’s trading and
business strategies, and the nature of the
relevant markets. In considering the
purpose for which a covered financial
position is acquired or taken and
evaluating whether such position is
acquired or taken for short-term
purposes, the Agencies intend to rely on
a variety of information, including
quantitative measurements of banking
entities’ covered trading activities (as
described below in Part II.B.5 of this
Supplementary Information),
supervisory review of banking entities’
compliance practices and internal
controls, and supervisory review of
individual transactions.
In order to better reinforce the general
consistency between the proposal’s
approach to defining a trading account
and the ‘‘trading account’’ concept
embedded in the Market Risk Capital
Rules, the second prong of the proposed
definition of trading account, contained
in § l.3(b)(2)(i)(B) of the proposed rule,
provides that a trading account includes
any account used to acquire or take one
or more covered financial positions,
other than positions that are foreign
exchange derivatives, commodity
derivatives, or contracts of sale of a
commodity for future delivery (unless
the position is otherwise held with
short-term intent), that are also market
risk capital rule covered positions, if the
banking entity, or any affiliate of the
banking entity that is a bank holding
company, calculates risk-based capital
ratios under the Market Risk Capital
Rules.103 For these purposes, a ‘‘market
risk capital rule covered position’’ is
defined as any covered position as that
term is defined for purposes of (i) in the
case of a banking entity that is a bank
holding company or insured depository
institution, the market risk capital rule
that is applicable to the banking entity,
and (ii) in the case of a banking entity
is a trading account, the Agencies note that U.S.
GAAP does not include a presumption that
securities sold within 60 days of acquisition were
held for the purpose of selling them in the near
term.
103 The Agencies have excluded positions that are
foreign exchange derivatives, commodity
derivatives, or contracts of sale of a commodity for
future delivery from this prong of the proposed
trading account definition because all foreign
exchange and commodity positions are considered
‘‘covered positions’’ under the Market Risk Capital
Rules regardless of whether they involve the shortterm trading intent required under the statutory
definition of trading account in section 13(h)(6) of
the BHC Act.
PO 00000
Frm 00015
Fmt 4701
Sfmt 4702
68859
that is affiliated with a bank holding
company, other than a banking entity to
which a market risk capital rule is
applicable, the market risk capital rule
that is applicable to the affiliated bank
holding company.104 In particular, for
banking entities already subject to the
Market Risk Capital Rules, it appears
that positions subject to trading account
treatment under those rules because
they involve short-term trading intent
are generally the type of positions to
which the proprietary trading
restrictions of section 13 of the BHC Act
were intended to apply. In addition,
including all covered financial positions
that receive trading account treatment
under the Market Risk Capital Rules
because they meet a nearly identical
standard regarding short-term trading
intent would also eliminate the
potential for inconsistency or regulatory
arbitrage in which a banking entity
might characterize a position as
‘‘trading’’ for capital purposes but not
for purposes of the proposed rule.
The Agencies emphasize that this
second prong of the trading account
definition is being proposed in
contemplation of the proposed revisions
to the Market Risk Capital Rules and, in
particular, the proposed definition of
‘‘covered position’’ under those
proposed revisions. To the extent that
those proposed revisions with respect to
the definition of ‘‘covered position’’ are
not adopted, or adopted in a form other
than as proposed, the Agencies would
expect to take that into account in
determining whether or how to include
the proposed second prong of the
trading account definition for purposes
of the final rule to implement section 13
of the BHC Act.105
iv. Positions Acquired or Taken by
Securities Dealers, Swap Dealers, and
Security-Based Swap Dealers
The third prong of the proposed
definition of trading account is
contained in § l.3(b)(2)(i)(C) of the
104 See proposed rule § l.3(c)(8). Accordingly, in
the context of a subsidiary of a bank holding
company (other than a subsidiary, such as a bank,
to which a market risk capital rule is already
directly applicable), if that bank holding company
is subject to a market risk capital rule, any position
of that subsidiary that meets the definition of a
‘‘covered position’’ under the market risk capital
rule applicable to the bank holding company would
be subject to § l.3(b)(2)(i)(B) of the proposed rule.
105 In particular, the Agencies note that under the
proposed revisions to the Market Risk Capital
Rules, but not the existing Market Risk Capital Rule,
the term ‘‘covered position’’ expressly includes,
other than with respect to commodity and foreign
exchange positions, only positions taken with shortterm trading intent. See 76 FR 1890 (Jan. 11, 2011).
The Agencies do not intend to incorporate ‘‘covered
positions’’ under the Market Risk Capital Rules in
a way that includes positions lacking short-term
trading intent.
E:\FR\FM\07NOP2.SGM
07NOP2
68860
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
proposed rule and provides that a
trading account includes any account
used to acquire or take one or more
covered financial positions by a banking
entity that is: (i) A SEC-registered
securities or municipal securities dealer;
(ii) a government securities dealer that
registered, or that has filed notice, with
an appropriate regulatory agency; 106
(iii) a CFTC-registered swap dealer; or
(iv) a SEC-registered security-based
swap dealer, in each case to the extent
that the covered financial position is
acquired or taken in connection with
the activities that require the banking
entity to be registered, or to file notice,
as such.107 Similarly included is any
covered financial position acquired or
taken by a banking entity that is engaged
in the business of a dealer, swap dealer,
or security-based swap dealer outside of
the United States, if such position is
acquired or taken in connection with
the activities of such business.108 As a
result of this third prong, all covered
financial positions acquired or taken by
a registered dealer, swap dealer or
security-based swap dealer, a
government securities dealer that has
filed notice with an appropriate
regulatory agency, or a banking entity
engaged in the same type of dealing
activities outside the United States, are
automatically included within the scope
of positions described in the trading
account definition, if they are acquired
or taken in connection with the
activities that require the banking entity
106 See 15 U.S.C. 78c(a)(42)(E); 15 U.S.C.
78o5(a)(1)(B); 17 CFR 400.5(b); 17 CFR 449.1.
Section 15C(a)(1)(A) of the Exchange Act requires
any government securities dealer, other than a
registered broker-dealer or a financial institution, to
register with the SEC pursuant to section 15C(a)(2).
Registered broker-dealers and financial institutions
are required to file written notice with their
appropriate regulatory agency, as defined in section
3(a)(34) of the Exchange Act, prior to acting as a
government securities dealer. See 15 U.S.C. 78o–
5(a)(1)(B). The proposed definition of trading
account would cover positions of all three forms of
government securities dealers: (i) those registered
with the SEC; (ii) registered broker-dealers; and (iii)
financial institutions that have filed notice with an
appropriate regulatory agency.
107 See proposed rule § l.3(b)(2)(i)(C)(1)–(4). The
Agencies emphasize that this provision applies only
to positions taken in connection with the activities
that require the banking entity to be registered as
one of the listed categories of dealer, not to all of
the activities of that banking entity. For example,
an insured depository institution may be registered
as a swap dealer, but only the swap dealing
activities that require it to be so registered would
be covered by the second prong of the trading
account definition. A position taken in connection
with other activities of the insured depository
institution that do not trigger registration as a swap
dealer, such as lending, deposit-taking, the hedging
of business risks, or other end-user activity, would
only be included within the trading account if the
position met one of the other prongs of the trading
account definition (i.e., §§ l.3(b)(2)(i)(A) or (B) of
the proposed rule).
108 See proposed rule § l.3(b)(2)(i)(C)(5).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
to be registered, or file notice, as such
(or, in the case of a banking entity
engaged in the business of a dealer,
swap dealer, or security-based swap
dealer outside of the United States, in
connection with the activities of such
business). As discussed below, the
proposed rule contains exemptions that
permit a variety of covered trading
activity in which these types of entities
typically engage, notwithstanding the
inclusion of all covered financial
positions of such entities within the
definition of trading account.
The Agencies have proposed this
third prong of the trading account
definition because all assets or other
positions held by firms that register or
file notice as securities or derivatives
dealers as part of their dealing activity
are generally held for sale to customers
upon request or otherwise support the
firm’s trading activities (e.g., by hedging
its dealing positions), and so would
appear to involve the requisite shortterm intent and be captured within the
statutory definition of trading account.
To the extent that a covered financial
position is acquired or taken by such a
banking entity outside the scope of the
dealing activities that require the
banking entity to be registered, or to file
notice, as a dealer, swap dealer, or
security-based swap dealer, that
position may still cause the relevant
account to be a trading account under
the proposed rule if the account holding
such a position otherwise meets the
terms of the first or second prong of the
trading account definition (i.e.,
positions acquired or taken for shortterm trading purposes or certain Market
Risk Capital Rules positions).
v. Rebuttable Presumption for Certain
Positions
In order to provide greater clarity and
guidance on the application of the
trading account definition, and in
particular for those banking entities
with no experience in evaluating shortterm trading intent or that are not
subject to the Market Risk Capital Rules,
the proposed rule also includes a
rebuttable presumption regarding
certain positions that, by reason of their
holding period, are presumed to be
trading account positions. In particular,
§ l.3(b)(2)(ii) of the proposed rule
provides that an account would be
presumed to be a trading account if it is
used to acquire or take a covered
financial position, other than dealing
positions or certain Market Risk Capital
Rules covered positions that are
automatically considered part of the
trading account, that the banking entity
holds for a period of sixty days or less.
However, the presumption does not
PO 00000
Frm 00016
Fmt 4701
Sfmt 4702
apply if the banking entity can
demonstrate, based on all the facts and
circumstances, that the covered
financial position, either individually or
as a category, was not acquired or taken
principally for the purpose of short-term
resale, benefitting from short-term price
movements, realizing short-term
arbitrage profits, or hedging another
trading account position.109 Because it
appears likely that most positions held
for sixty days or less would have been
acquired with short-term trading intent,
the proposal presumes such positions
are trading account positions unless the
banking entity can demonstrate
otherwise. The purpose of the proposed
rebuttable presumption is to simplify
the process of evaluating whether
individual positions are included in the
definition of trading account. The
proposal does not apply this rebuttable
presumption to positions described in
§ l.3(b)(2)(i)(B) or (C) of the proposed
rule (i.e., certain Market Risk Capital
Rules positions and dealing positions),
because these positions are
automatically part of the trading
account, and cannot be rebutted.
However, the Agencies recognize that,
for a variety of reasons, a banking entity
may acquire a covered financial position
for purposes other than short-term
trading but nonetheless dispose of that
position within the sixty-day period
covered by the presumption.
Accordingly, § l.3(b)(2)(ii) is only a
presumption, and may be rebutted by
reference to all the facts and
circumstances surrounding the
acquisition of a particular position. For
example, if a banking entity acquired a
covered financial position with the
demonstrable intent of holding it for
investment or other non-trading
purposes but, because of developments
not expected or anticipated at the time
of acquisition (e.g., increased customer
demand, an unexpected increase in its
volatility or a need to liquidate the
position to meet unexpected liquidity
demands), held it for less than sixty
days, those facts and circumstances
would generally suggest that the
position was not acquired with shortterm trading intent, notwithstanding the
presumption.110 The proposed rule also
makes clear that this rebuttal may be
made not only with respect to a
particular transaction, but also with
respect to a particular category of
transactions, recognizing that it may be
possible to identify a category of similar
proposed rule § l.3(b)(2)(ii).
such cases, the documented intention for
acquiring or taking the position should be
consistent with the intention articulated for
financial reporting and other purposes.
109 See
110 In
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
transactions that clearly do not involve
short-term trading, notwithstanding the
typical holding period of the related
positions.
It is important to note that these
presumptions are designed to help
determine whether a transaction is
within the definition of ‘‘proprietary
trading,’’ not whether a transaction is
permissible under section 13 of the BHC
Act. A transaction may fall within the
definition of ‘‘proprietary trading’’ and
yet be permissible if it meets one of the
exemptions provided in the proposed
rule, such as the exemption for market
making-related activities.
vi. Request for Comment
The Agencies request comment on the
proposed rule’s approach to defining
trading account. In particular, the
Agencies request comment on the
following questions:
Question 14. Is the proposed rule’s
definition of trading account effective?
Is it over- or under-inclusive in this
context? What alternative definition
might be more effective in light of the
language and purpose of the statute?
How would such definition better
identify the accounts that are intended
to be covered by section 13 of the BHC
Act?
Question 15. Is the proposed rule’s
approach for determining when a
position falls within the definition of
‘‘trading account’’ for purposes of the
proposed rule from when it must be
reported in the ‘‘trading account’’ for
purpose of filing the Call Report
effective? What additional guidance
could the Agencies provide on this
distinction? Are there alternative
approaches that would be more effective
in light of the language and purpose of
the statute? Is this approach workable
for affiliates of bank holding companies
that are not subject to the Federal
banking agencies’ market Risk Capital
Rules (e.g., affiliated investment
advisers)? If not, why not? Are affiliates
of bank holding companies familiar
with the concepts from the Market Risk
Capital Rules that are being
incorporated into the proposed rule? If
not, what steps would an affiliate of a
bank holding company have to take to
become familiar with these concepts
and what would be the costs and/or
benefits of such actions? Is application
of the trading account concept from the
Federal banking agencies’ Market Risk
Capital Rules to affiliates of bank
holding companies necessary to
promote consistency and prevent
regulatory arbitrage? Please explain.
Question 16. Is the manner in which
the Agencies intend to take into
account, and substantially adopt, the
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
approach used in the Market Risk
Capital Rules and related concepts for
determining whether a position is
acquired with short-term trading intent
effective?
Question 17. Should the proposed
rule’s definition of trading account, or
its use of the term ‘‘short-term,’’ be
clarified? Are there particular
transactions or positions to which its
application would be unclear? Should
the proposed rule define ‘‘short-term’’
for these purposes? What alternative
approaches to construing the term
‘‘short-term’’ should the Agencies
consider and/or adopt?
Question 18. Are there particular
transactions or positions to which the
application of the proposed definition of
trading account is unclear? Is additional
regulatory language, guidance, or clarity
necessary?
Question 19. Is the exchange of
variation margin as a potential indicator
of short-term trading in derivative or
commodity future transactions
appropriate for the definition of trading
account? How would this impact such
transactions or the manner by which
banking entities conduct such
transactions? For instance, would
banking entities seek to avoid the use of
variation margin to avoid this rule?
What are the costs and benefits of
referring to the exchange of variation
margin to determine if positions should
be included in a banking entity’s trading
account? Please explain.
Question 20. Are there particular
transactions or positions that are
included in the definition of trading
account that should not be? If so, what
transactions or positions and why?
Question 21. Are there particular
transactions or positions that are not
included in the definition of trading
account that should be? If so, what
transactions or positions and why?
Question 22. Is the proposed rule of
construction for positions acquired or
taken by dealers, swap dealers and
security-based swap dealers appropriate
and consistent with the purpose and
language of section 13 of the BHC Act?
Is its application to any particular type
of entity, such as an insured depository
institution engaged in derivatives
dealing activities, sufficiently clear and
effective? If not, what alternative would
be clearer and/or more effective?
Question 23. Is the rebuttable
presumption included in the proposed
rule appropriate and effective? Are there
more effective ways in which to provide
clarity regarding the determination of
whether or not a position is included
within the definition of trading account?
If so, what are they?
PO 00000
Frm 00017
Fmt 4701
Sfmt 4702
68861
Question 24. Are records currently
created and retained that could be used
to demonstrate investment or other nontrading purposes in connection with
rebutting the presumption in the
proposed rule? If yes, please identify
such records and explain when they are
created and whether they would be
useful in connection with a single
transaction or a category of similar
transactions. If no, we seek commenter
input regarding the manner in which
banking entities might demonstrate
investment or other non-trading intent.
Should the Agencies require banking
entities to make and keep records to
demonstrate investment or non-trading
intent with respect to their covered
financial positions?
Question 25. How should the
proposed trading account definition
address arbitrage positions? Should all
arbitrage positions be included in the
definition of trading account, unless the
timing of such profits is long-term and
established at the time the arbitrage
position is acquired or taken? Please
explain in detail, including a discussion
of different arbitrage trading strategies
and whether subjecting such strategies
to the proposed rule would be
consistent with the language and
purpose of section 13 of the BHC Act.
Question 26. Is the holding period
referenced in the rebuttable
presumption appropriate? If not, what
holding period would be more
appropriate, and why?
Question 27. Should the proposed
rule include a rebuttable presumption
regarding positions that are presumed
not to be within the definition of trading
account? If so, why, and what would the
presumption be?
Question 28. Should any additional
accounts be included in the proposed
rule pursuant to the authority granted
under section 13(h)(6) of the BHC Act?
If so, what accounts and why? For
example, should accounts used to
acquire or take certain long-term
positions be included in the definition?
If so, how would subjecting such
accounts to the proposed rule’s
prohibitions and restrictions be
consistent with the language and
purpose of section 13 of the BHC Act?
Question 29. Do any of the activities
currently engaged in by issuers of assetbacked securities that would be
considered a banking entity constitute
proprietary trading as defined by
§ l.3(b) of this rule proposal? Would
any activities relating to investment of
funds in accounts held by issuers of
asset-backed securities (e.g., reserve
accounts, prefunding accounts,
reinvestment accounts, etc.) or the
purchase and sale of securities as part
E:\FR\FM\07NOP2.SGM
07NOP2
68862
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
of the management of a collateralized
debt obligation portfolio be considered
proprietary trading under the proposed
rule? What would be the potential
impact of the prohibition on proprietary
trading on the use of such accounts in
(i) existing securitization transactions
and (ii) future securitization
transactions? Would any of the
securities typically acquired and
retained using these accounts be
considered an ownership interest in a
covered fund under the proposed rule?
Does the exclusion of trading in certain
government obligations in § l.6(a) of
the proposed rule mitigate the impact of
the proposed rule on such issuers of
asset-backed securities and their
activities? Why or why not?
c. Excluded Positions
i. Excluded Positions Under Certain
Repurchase and Reverse Repurchase
Arrangements
Section l.3(b)(2)(iii)(A) of the
proposed rule’s definition of trading
account provides that an account will
not be a trading account to the extent
that such account is used to acquire or
take one or more covered financial
positions that arise under a repurchase
or reverse repurchase agreement
pursuant to which the banking entity
has simultaneously agreed, in writing at
the start of the transaction, to both
purchase and sell a stated asset, at
stated prices, and on stated dates or on
demand with the same counterparty.111
This clarifying exclusion is proposed
because positions held under a
repurchase or reverse repurchase
agreement operate in economic
substance as a secured loan, and are not
based on expected or anticipated
movements in asset prices. Accordingly,
these types of asset purchases and sales
do not appear to be the type of
transaction intended to be covered by
the statutory definition of trading
account.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
ii. Excluded Positions Under Securities
Lending Transactions
Section l.3(b)(2)(iii)(B) of the
proposed rule’s definition of trading
account provides that an account will
not be a trading account to the extent
that such account is used to acquire or
take one or more covered financial
positions that arise under a transaction
in which the banking entity lends or
borrows a security temporarily to or
from another party pursuant to a written
securities lending agreement under
which the lender retains the economic
interests of an owner of such security,
111 See
proposed rule § l.3(b)(2)(iii)(A).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
and has the right to terminate the
transaction and to recall the loaned
security on terms agreed to by the
parties.112 This clarifying exclusion is
proposed because a position held under
a securities lending arrangement can be
used, for example, to operate in
economic substance and function, as a
means to facilitate settlement of
securities transactions, and is not based
on expected or anticipated movements
in asset prices. Accordingly, securities
lending transactions do not appear to be
the type of transaction intended to be
covered by the statutory definition of
trading account.
iii. Excluded Positions Acquired or
Taken for Liquidity Management
Purposes
Section ll.3(b)(2)(iii)(C) of the
proposed definition of trading account
provides that an account will not be a
trading account to the extent that such
account is used to acquire or take a
position for the purpose of bona fide
liquidity management, so long as
important criteria are met.113
This proposed clarifying exclusion is
intended to make clear that, where the
purpose for which a banking acquires or
takes a position is to ensure that it has
sufficient liquid assets to meet its shortterm cash demands, and the related
position is held as part of the banking
entity’s liquidity management process,
that transaction falls outside of the types
of transactions described in the
proposed rule’s definition of trading
account. Maintaining liquidity
management positions is a critical
aspect of the safe and sound operation
of certain banking entities, and does not
involve the requisite short-term trading
intent that forms the basis of the
statutory definition of ‘‘trading
account.’’ In the context of bona fide
liquidity management activity that
would qualify for the clarifying
exclusion, a banking entity’s purpose for
acquiring or taking these types of
positions is not to benefit from shortterm profit or short-term price
movements, but rather to ensure that it
has sufficient, readily-marketable assets
available to meet its expected short-term
liquidity needs.
However, the Agencies are concerned
with the potential for abuse of this
clarifying exclusion—specifically, that a
banking entity might attempt to
improperly mischaracterize positions
acquired or taken for prohibited
112 See proposed rule § ll.3(b)(2)(iii)(B). The
language describing securities lending transactions
in the proposed rule generally mirrors that
contained in Rule 3a5–3 under the Exchange Act.
See 17 CFR 240.3a5–3.
113 See proposed rule § ll.3(b)(2)(iii)(C).
PO 00000
Frm 00018
Fmt 4701
Sfmt 4702
proprietary trading purposes as
positions acquired or taken for liquidity
management purposes. To address this,
the proposed rule requires that the
transaction be conducted in accordance
with a documented liquidity
management plan that meets five
criteria. First, the plan would be
required to specifically contemplate and
authorize any particular instrument
used for liquidity management
purposes, its profile with respect to
market, credit and other risks, and the
liquidity circumstances in which the
position may or must be used. Second,
the plan would have to require that any
transaction contemplated and
authorized by the plan be principally for
the purpose of managing the liquidity of
the banking entity, and not for the
purpose of short-term resale, benefitting
from actual or expected short-term price
movements, realizing short-term
arbitrage profits, or hedging a position
acquired or taken for such short-term
purposes. Third, the plan would have to
require that any positions acquired or
taken for liquidity management
purposes be highly liquid and limited to
financial instruments the market, credit
and other risks of which are not
expected to give rise to appreciable
profits or losses as a result of short-term
price movements.114 Fourth, the plan
would be required to limit any position
acquired or taken for liquidity
management purposes, together with
any other positions acquired or taken for
such purposes, to an amount that is
consistent with the banking entity’s
near-term funding needs, including
deviations from normal operations, as
estimated and documented pursuant to
methods specified in the plan. Fifth, the
plan would be required to be consistent
with the relevant Agency’s supervisory
requirements, guidance and
expectations regarding liquidity
management. The Agencies would
review these liquidity plans and
transactions effected in accordance with
these plans through supervisory and
examination processes to ensure that the
applicable criteria are met and that any
position acquired or taken in reliance on
the clarifying exclusion for liquidity
management transactions is fully
consistent with such plans.
114 Any instance in which positions characterized
as taken for liquidity purposes do give rise to
appreciable profits or losses as a result of short-term
price movements will be subject to significant
Agency scrutiny and, absent compelling
explanatory facts and circumstances, would be
viewed as prohibited proprietary trading under the
proposal.
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
iv. Excluded Positions of Derivatives
Clearing Organizations and Clearing
Agencies
Section l.3(b)(2)(iii)(D) of the
proposed rule’s definition of trading
account provides that an account will
not be a trading account to the extent
that such account is used to acquire or
take one or more covered financial
positions that are acquired or taken by
a banking entity that is a derivatives
clearing organization registered under
section 5b of the Commodity Exchange
Act (7 U.S.C. 7a–1) or a clearing agency
registered with the SEC under section
17A of the Exchange Act (15 U.S.C.
78q–1) in connection with clearing
derivatives or securities transactions.115
This clarifying exclusion is proposed
because, in the case of a banking entity
that acts as a registered, central
counterparty in the securities or
derivatives markets, these types of
transactions do not appear to be the type
of transaction intended to be covered by
the statutory definition of trading
account, as the purpose of such
transactions is to provide a clearing
service to third parties and not to profit
from short-term resale or short-term
price movements.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
v. Request for Comment
The Agencies request comment
regarding the proposed clarifying
exclusions and whether any other types
of activity or transactions should be
excluded from the proposed definition
of trading account for clarity. In
particular, the Agencies request
comment on the following questions:
Question 30. Are the proposed
clarifying exclusions for positions under
certain repurchase and reverse
repurchase arrangements and securities
lending transactions over- or underinclusive and could they have
unintended consequences? Is there an
alternative approach to these clarifying
exclusions that would be more
effective? Are the proposed clarifying
exclusions broad enough to include
bona fide arrangements that operate in
economic substance as secured loans
and are not based on expected or
anticipated movements in asset prices?
Are there other types of arrangements,
such as open dated repurchase
arrangements, that should be excluded
for clarity and, if so, how should the
proposed rule be revised? Alternatively,
are the proposed clarifying exclusions
narrow enough to not inadvertently
exclude from coverage any similar
arrangements or transactions that do not
have these characteristics?
115 See
proposed rule § ll.3(b)(2)(iii)(D).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
Question 31. Are repurchase and
reverse repurchase arrangements and
securities lending transactions
sufficiently similar that they should be
treated in the same way for purposes of
the proposed rule? Are there aspects of
repurchase and reverse repurchase
arrangements or securities lending
transactions that should be highlighted
in considering the application of the
proposed rule? Do repurchase and
reverse repurchase arrangements or
securities lending transactions raise any
additional or heightened concerns
regarding risk? Please identify and
explain how these concerns should be
reflected in the proposed rule.
Question 32. Are the proposed
exclusions for repurchase and reverse
repurchase arrangements and securities
lending transactions appropriate or are
there conditions that commenters
believe would be appropriate as a prerequisite to relying on these exclusions?
Please identify such conditions and
explain. Alternatively, we seek
commenter input regarding why
repurchase and reverse repurchase
arrangements and securities lending
transactions do not present the potential
for abuse, namely, that a banking entity
might attempt to improperly
mischaracterize prohibited proprietary
trading as activity that qualifies for the
proposed exclusions.
Question 33. Is the proposed
clarifying exclusion for liquidity
management transactions effective and
appropriate? If not, what alternative
would be more effective and
appropriate, and why? Is the proposed
exclusion under- or over-inclusive?
Does the proposed clarifying exclusion
place sufficient limitations on liquidity
management transactions to prevent
abuse of the clarifying exclusion? If not,
what additional limitations should be
specified? Are any of the limitations
contained in the proposed rule
inappropriate or unnecessary? If so, how
could such limitations be eliminated or
altered in way that does not permit
abuse of the clarifying exclusion?
Question 34: Is the proposed
exclusion for liquidity management
positions necessary? If not excluded,
would such activity otherwise qualify
for an exemption contained in the
proposed rule (e.g., the exemptions
contains in §§ ll.5 and ll.6(a) of the
proposed rule)? What types of banking
entities are likely to engage in the
liquidity management activities
described in the proposed exclusion?
Question 35: What types of
instruments do particular types of
banking entities currently use in
connection with liquidity management
activities (e.g., Treasuries)? Why are
PO 00000
Frm 00019
Fmt 4701
Sfmt 4702
68863
such instruments chosen for liquidity
management purposes? Would such
instruments meet the proposed
requirement that the position be highly
liquid and limited to financial
instruments the market, credit and other
risk of which are not expected to give
rise to appreciable profits or losses as a
result of short-term price movements?
Why or why not?
Question 36: What methodologies do
banking entities currently use for
estimating deviations from normal
operations in connection with liquidity
management programs?
Question 37: Which unit or units
within a banking entity are typically
responsible for liquidity management?
What is the typical reporting line
structure used to control and supervise
that unit or units? Are the
responsibilities of personnel in the unit
limited to liquidity management or do
they perform other functions in addition
to liquidity management? How is
compensation determined for personnel
in the unit of the banking entity
responsible for liquidity management?
Question 38: Would current liquidity
management programs meet the five
proposed criteria for liquidity
management programs? If not which
criteria would not be met, and why?
What effect would the proposed
liquidity management exclusions have
on current liquidity management
programs and banking entities in
general?
Question 39: Are liquidity
management programs used for
purposes other than ensuring the
banking entity has sufficient assets
available to it that are readily
marketable to meet expected short-term
liquidity needs? If so, for what
purposes, and why?
Question 40: What costs or other
burdens would arise if the proposal did
not contain an exclusion for positions
acquired or taken for liquidity
management purpose? Please explain
and quantify these costs or other
burdens in detail.
Question 41: Is the proposed liquidity
management exclusion sufficiently
clear? If not, why is the exclusion
unclear and how should the Agencies
clarify the terms of this exclusion?
Question 42. Is the proposed
clarifying exclusion for certain positions
taken by derivatives clearing
organizations and clearing agencies
effective and appropriate? If not, what
alternative would be more effective and
appropriate, and why?
Question 43. Are any additional
clarifying exclusions warranted? If so,
what clarifying exclusion, and why?
E:\FR\FM\07NOP2.SGM
07NOP2
68864
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Question 44. Should the proposed
definition exclude any position the
market risk of which cannot be hedged
by the banking entity in a two-way
market?116 If so, what would be the
basis for concluding that such positions
are clearly not within the statutory
definition of trading account?
Question 45. Should the proposed
definition include a clarifying exclusion
for any position in illiquid assets? If so,
what would be the basis for concluding
that such positions are clearly not
within the statutory definition of trading
account? How should ‘‘illiquid assets’’
be defined for these purposes? Should
the definition be consistent with the
definition given that term in the Board’s
Conformance Rule under section 13 of
the BHC Act (12 CFR 225.180 et
seq.)? 117
d. Covered Financial Position
i. Definition of ‘‘Covered Financial
Position’’
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Section l.3(b)(3)(i) of the proposed
rule defines a covered financial position
as any long, short, synthetic or other
position118 in: (i) A security, including
an option on a security; (ii) a derivative,
including an option on a derivative; or
(iii) a contract of sale of a commodity for
future delivery, or an option on such a
contract. The types of financial
instruments described in the proposed
definition are consistent with those
referenced in section 13(h)(4) of the
116 The Agencies also note that such an exclusion
would be similar to the express exclusion of similar
positions under the Federal banking agencies’ most
recent proposed revisions to the Market Risk
Capital Rules. See 76 FR 1890, 1912 (Jan. 11, 2011)
(excluding from the definition of a covered position
any position the material risk elements of which the
holder is unable to hedge in a two-way market).
117 See 76 FR 8265 (Feb. 14, 2011). The Board’s
conformance rule defines ‘‘illiquid asset’’ as ‘‘any
real property, security obligation, or other asset that
(i) is not a liquid asset; (ii) because of statutory or
regulatory restrictions applicable to the hedge fund,
private equity fund or asset, cannot be offered, sold,
or otherwise transferred by the hedge fund or
private equity fund to a person that is unaffiliated
with the relevant banking entity; or (iii) because of
contractual restrictions applicable to the hedge
fund, private equity fund or asset, cannot be
offered, sold, or otherwise transferred by the hedge
fund or private equity fund for a period of 3 years
or more to a person that is unaffiliated with the
relevant banking entity.’’ 12 CFR 225.180(g). A
‘‘liquid asset’’ is defined in paragraph (h) of the
conformance rule. See 12 CFR 225.180(h).
118 The proposed definition’s reference to any
‘‘long, short, synthetic or other position’’ is
intended to make clear that a position in an
identified category of financial instrument qualifies
as a covered financial position regardless of
whether the position is (i) an asset or liability or
(ii) is acquired through acquisition or sale of the
financial instrument or synthetically through a
derivative or other transaction.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
BHC Act as part of the statutory
definition of proprietary trading.119
To provide additional clarity,
§ ll.3(b)(3)(ii) of the proposed rule
provides that, consistent with the
statute, the term covered financial
position does not include any position
that is itself a loan, a commodity, or
foreign exchange or currency.120 The
exclusion of these types of positions is
intended to eliminate potential
confusion by making clear that the
purchase and sale of loans, commodities
and foreign exchange—none of which
are referred to in section 13(h)(4) of the
BHC Act—are outside the scope of
transactions to which the proprietary
trading restrictions apply. The reference
in § ll.3(b)(3)(ii) to a position that is,
rather than a position that is in, a loan,
a commodity, or foreign exchange or
currency is intended to capture only the
purchase and sale of these instruments
themselves. This reflects the fact that,
consistent with section 13(h)(4) of the
BHC Act and the proposed rule,
although a position that is a foreign
exchange derivative or commodity
derivative is included in the definition
of covered financial position and
therefore subject to the prohibition on
proprietary trading, a position that is a
commodity or foreign currency is not.121
For example, the spot purchase of a
commodity would meet the terms of the
exclusion, but the acquisition of a
futures position in the same commodity
would not. The Agencies request
comment on the proposed rule’s
definition of covered financial position.
In particular, the Agencies request
comment on the following questions:
Question 46. Is the proposed rule’s
definition of covered financial position
effective? Is the definition over- or
under-inclusive? What alternative
approaches might be more effective in
light of the language and purpose of
section 13 of the BHC Act, and why?
Question 47. Are there definitions in
other rules or regulations that might
inform the proposed definition of
covered financial position? If so, what
rule or regulation? How should that
approach be incorporated into the
proposed definition? Why would that
approach be more appropriate?
Question 48. Are there particular
transactions or positions to which the
119 Section 13(h)(4) of the BHC Act also permits
the Agencies to extend the scope of the proprietary
trading restrictions to other financial instruments.
The Agencies have not proposed to do so at this
time.
120 See proposed rule § ll.3(b)(ii).
121 The types of commodity- and foreign
exchange-related derivatives that are included
within the definition of ‘‘derivative’’ under the
proposed rule are discussed in detail below in Part
III.B.2.d.ii of this Supplementary Information.
PO 00000
Frm 00020
Fmt 4701
Sfmt 4702
application of the proposed definition of
covered financial position is unclear? Is
additional regulatory language,
guidance, or clarity necessary?
Question 49. The proposal would
apply to long, short, synthetic, or other
positions in one of the listed categories
of financial instruments. Does this
language adequately describe the type of
positions that are intended to fall within
the proposed definition of covered
financial position? If not, why not? Are
there different or additional concepts
that should be specified in this context?
Please explain.
Question 50. Should the Agencies
expand the scope of covered financial
positions to include other transactions,
such as spot commodities or foreign
exchange or currency, or certain subsets
of transaction (e.g., spot commodities or
foreign exchange or currency traded on
a high-frequency basis)? If so, which
instruments and why?
Question 51. What factors should the
Agencies consider in deciding whether
to extend the scope of the proprietary
trading restriction to other financial
instruments under the authority granted
in section 13(h)(4) of the BHC Act?
Please explain.
Question 52. Is the proposed
exclusion of any position that is a loan,
a commodity, or foreign exchange or
currency effective? If not, what
alternative approaches might be more
effective in light of the language and
purpose of section 13 of the BHC Act?
Should additional positions be
excluded? If so, why and under what
authority?
ii. Other Terms Used in the Definition
of Covered Financial Position
The proposal also defines a number of
terms used in the proposed definition of
covered financial position. The term
‘‘security’’ is defined by reference to
that same term under the Exchange
Act.122 The terms ‘‘commodity’’ and
‘‘contract of sale of a commodity for
future delivery’’ are defined by
reference to those same terms under the
Commodity Exchange Act.123 The
Agencies have proposed to reference
these existing definitions from the
securities and commodities laws
because these existing definitions are
generally well-understood by market
participants and have been subject to
extensive interpretation in the context
of securities and commodities trading
activities.
The proposed rule also defines the
term ‘‘derivative.’’ 124 In particular, the
proposed rule § ll.2(w).
proposed rule §§ ll.3(c)(1), (2).
124 See proposed rule § ll.2(l).
122 See
123 See
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
definition of ‘‘derivative’’ under the
proposed rule includes any ‘‘swap’’ (as
that term is defined in the Commodity
Exchange Act) and any ‘‘security-based
swap’’ (as that term is defined in the
Exchange Act), in each case as further
defined by the CFTC and SEC by joint
regulation, interpretation, guidance, or
other action, in consultation with the
Board pursuant to section 712(d) of the
Dodd-Frank Act. The Agencies have
proposed to incorporate these
definitions of ‘‘swap’’ and ‘‘securitybased swap’’ under the Federal
securities and commodities laws
because those definitions: (i) Govern the
primary Federal regulatory scheme
applicable to exchange-traded and overthe-counter derivatives; (ii) will be
frequently evaluated and applied by
banking entities in the course of their
trading activities; and (iii) capture
agreements and contracts that are or
function as derivatives.125 The proposed
rule also includes within the definition
of derivative certain other transactions
that, although not included within the
definition of ‘‘swap’’ or ‘‘security-based
swap,’’ also appear to be, or operate in
economic substance as, derivatives, and
which if not included could permit
banking entities to engage in proprietary
trading that is inconsistent with the
spirit of section 13 of the BHC Act.
Specifically, the proposed definition of
derivative also includes: (i) Any
purchase or sale of a nonfinancial
commodity for deferred shipment or
delivery that is intended to be
physically settled; (ii) any foreign
exchange forward or foreign exchange
swap (as those terms are defined in the
Commodity Exchange Act); 126 (iii) any
125 The Agencies note that they have not included
a variety of security-related derivatives within the
proposed definition of derivative, as such
transactions are ‘‘securities’’ for purposes of both
the Exchange Act and the proposed rule and, as a
result, already included in the broader definition of
‘‘covered financial position’’ to which the
prohibition on proprietary trading applies.
126 The Agencies note that foreign exchange
swaps and foreign exchange forwards are
considered swaps for purposes of the Commodity
Exchange Act definition of that term unless the
Secretary of the Treasury determines, pursuant to
section 1a(47)(E) of that Act (7 U.S.C. 1a(47)(E)),
that foreign exchange swaps and forwards should
not be regulated as swaps under the Commodity
Exchange Act and are not structured to evade
certain provisions of the Dodd-Frank Act. On May
5, 2011, the Treasury Secretary proposed to exercise
that authority to exclude foreign exchange forwards
and foreign exchange swaps from the definition of
‘‘swap.’’ See Determination of Foreign Exchange
Swaps and Foreign Exchange Forwards Under the
Commodity Exchange Act, 76 FR 25774 (May 5,
2011). If the Secretary of the Treasury issues a final
determination, as proposed, a ‘‘foreign exchange
swap’’ and ‘‘foreign exchange forward’’ would be
excluded from the definition of ‘‘swap’’ under the
Commodity Exchange Act and, therefore, would fall
outside of the proposed rule’s definition of
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
agreement, contract, or transaction in
foreign currency described in section
2(c)(2)(C)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(C)(i)); 127 (iv) any
agreement, contract, or transactions in a
commodity other than foreign currency
described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(D)(i)); and (v) any transaction
authorized under section 19 of the
Commodity Exchange Act (7 U.S.C.
23(a) or (b)). The Agencies are
requesting comment on whether
including these five types of
transactions within the proposed
definition of derivative is appropriate.
To provide additional clarity, the
proposed definition of derivative also
clarifies two types of transactions that
are outside the scope of the definition.
First, the proposed definition of
derivative would not include any
consumer, commercial, or other
agreement, contract, or transaction that
the CFTC and SEC have further defined
by joint regulation, interpretation,
guidance, or other action as not within
the definition of swap, as that term is
defined in the Commodity Exchange
Act, or security-based swap, as that term
is defined in the Exchange Act. The SEC
and CFTC have, in proposing rules
further defining the terms ‘‘swap’’ and
‘‘security-based swap,’’ proposed to not
include a variety of agreements,
‘‘derivative.’’ Accordingly, the Agencies have
proposed to expressly include such transactions in
the proposed definition of derivative, but have
requested comment on a variety of questions related
to whether foreign exchange swaps and forwards
should be included or excluded from the definition
of derivative. The Agencies note that, aside from
foreign exchange swaps and forwards, the
Commodity Exchange Act’s definition of ‘‘swap’’
(and therefore the proposed definition of
‘‘derivative’’) also includes other types of foreign
exchange derivatives, including non-deliverable
foreign exchange forwards (NDFs), foreign exchange
options, and currency options, which fall outside of
the Secretary of the Treasury’s authority to issue a
determination to exclude certain transactions from
the ‘‘swap’’ definition.
127 Section 2(c)(2)(C)(i) was added to the
Commodity Exchange Act in 2008 to address retail
foreign exchange transactions that were
documented as automatically renewing spot
contracts (so-called rolling spot transactions) and
therefore not futures contracts subject to the
Commodity Exchange Act, but which were
functionally and economically similar to futures.
See Retail Foreign Exchange Transactions, 76 FR
41375, 47376–77 (July 15, 2011). However, section
2(c)(2)(C)(i) of the Commodity Exchange Act does
not apply to transactions entered into by U.S.
financial institutions, including insured depository
institutions, brokers, dealers, and certain retail
foreign exchange dealers. See 7 U.S.C.
2(c)(2)(C)(i)(I)(aa). To apply this definitional prong
to such banking entities, the definition of derivative
includes a transaction ‘‘described in’’ section
2(c)(2)(C)(i) of the Commodity Exchange Act. In
other words, the use of this phrase is intended to
capture any transaction described in section
2(c)(2)(C)(i) without regard to the identity of the
counterparty.
PO 00000
Frm 00021
Fmt 4701
Sfmt 4702
68865
contracts, and transactions within those
definitions by joint regulation or
interpretation, and the Agencies have
proposed to expressly reflect such
exclusions in the proposed rule’s
definition in order to avoid the potential
application of its restrictions to
transactions that are not commonly
thought to be derivatives.128 Second, the
proposed definition of derivative also
does not include any identified banking
product, as defined in section 402(b) of
the Legal Certainty for Bank Products
Act of 2000 (7 U.S.C. 27(b)), that is
subject to section 403(a) of that Act (7
U.S.C. 27a(a)). This provision is
proposed to clearly exclude identified
banking products that are expressly
excluded (i) from the definition of
‘‘security-based swap’’ and (ii) from
Commodity Exchange Act and CFTC
jurisdiction pursuant to section 403(a)
of the Legal Certainty for Bank Products
Act of 2000.129
The proposed rule defines a ‘‘loan’’ as
any loan, lease, extension of credit, or
secured or unsecured receivable.130 The
Agencies note that the proposed
definition of loan is expansive, and
includes a broad array of loans and
similar credit transactions, but does not
include any asset-backed security that is
issued in connection with a loan
securitization or otherwise backed by
loans.
The Agencies request comment on the
proposed rule’s definition of terms used
in the definition of covered financial
position. In particular, the Agencies
request comment on the following
questions:
Question 53. Are the proposed rule’s
definitions of commodity and contract
of sale of a commodity for future
delivery appropriate? If not, what
128 See 76 FR 29818 (May 23, 2011). For example,
the SEC and CFTC have proposed to not include (i)
certain insurance products within the definitions of
‘‘swap’’ and ‘‘security-based swap’’ by regulation
and (ii) certain consumer agreements (e.g.,
agreements to acquire or lease real property or
purchase products at a capped price) and
commercial agreements (e.g., employment contracts
or the purchase of real property, intellectual
property, equipment or inventory) by joint
interpretation. See id. at 29832–34. The Agencies
have proposed to define ‘‘derivative’’ in the
proposed rule by reference to the definition of
’’swap’’ and ‘‘security-based swap’’ under the
Federal securities and commodities laws in
contemplation of the SEC and CFTC’s proposed
regulatory and interpretative exclusions; to the
extent that such exclusions are not included in any
final action taken by the SEC and CFTC, the
Agencies will consider whether to state such
exclusions expressly within the proposed rule’s
definition of derivative.
129 Examples of excluded identified banking
products are deposit accounts, savings accounts,
certificates of deposit, or other deposit instruments
issued by a bank.
130 See proposed rule § ll.2(q).
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68866
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
alternative definitions would be more
appropriate?
Question 54. Is the proposed
definition of derivative effective? If not,
what alternative definition would be
more effective? Should the proposed
rule expressly incorporate the definition
of ‘‘swap’’ and security-based swap’’
under the Federal commodities and
securities laws? If not, what alternative
approach should be taken? Are there
transactions included in those
incorporated definitions that should not
be included in the proposed rule’s
definition? If so, what transactions and
why? Are there transactions excluded
from those incorporated definitions that
should be included within the proposed
rule’s definition? If so, what
transactions and why?
Question 55. Is the proposed
inclusion of foreign exchange forwards
and swaps in the definition of derivative
effective? If not, why not? On what basis
would the Agencies conclude that such
transactions are not derivatives? Are
these transactions economically or
functionally more similar to secured
loans or repurchase arrangements than
to commodity forwards and swaps?
Would there be any unintended
consequences to banking entities if such
transactions are included in the
proposal’s definition of derivative?
What effect is including foreign
exchange swaps and forwards in the
definition of derivative likely to have on
banking entities, participants in the
foreign exchange markets, and the
liquidity and efficiency of foreign
exchange markets generally? If included
within the definition of derivative,
should transactions in foreign exchange
swaps and forwards be permitted under
section 13(d)(1)(J) of the BHC Act? If so,
why and on what basis? Please quantify
your responses, to the extent feasible.
Question 56. Is the proposed
inclusion of any purchase or sale of a
nonfinancial commodity for deferred
shipment or delivery that is intended to
be physically settled in the definition of
derivative effective? If not, why not?
Would there be any unintended
consequences to banking entities if such
transactions are included in the
proposal’s definition of derivative?
Question 57. Is the proposed
inclusion of foreign currency
transactions described in section
2(c)(2)(C)(i) of the Commodity Exchange
Act in the definition of derivative
effective? If not, why not? Would there
be any unintended consequences to
banking entities if such transactions are
included in the proposal’s definition of
derivative?
Question 58. Is the proposed
inclusion of commodity transactions
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act in the
definition of derivative effective? If not,
why not? Would there be any
unintended consequences to banking
entities if such transactions are included
in the proposal’s definition of
derivative?
Question 59. Is the proposed
inclusion of any transaction authorized
under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b)) in
the definition of derivative effective? If
not, why not? Would there be any
unintended consequences to banking
entities if such transactions are included
in the proposal’s definition of
derivative?
Question 60. Is the manner in which
the proposed definition of derivative
excludes any transaction that the CFTC
or SEC exclude by joint regulation,
interpretation, guidance, or other action
from the definition of ‘‘swap’’ or
‘‘security-based swap’’ effective? If not,
what alternative approach would be
more appropriate? Should such
exclusions be restated in the proposed
rule’s definition? If so, why?
Question 61. Is the proposed rule’s
definition of loan appropriate? If not,
what alternative definition would be
more appropriate? Should the definition
of ‘‘loan’’ exclude a security? Should
other types of traditional banking
products be included in the definition
of ‘‘loan’’? If so, why?
iii. Definition of Other Terms Related to
Proprietary Trading
Section l.3(d) of the proposed rule
defines a variety of other terms used
throughout subpart B of the proposed
rule. These definitions are discussed in
further detail below in the relevant
summary of the separate sections of the
proposed rule in which they are used.
The Agencies request comment on the
proposed rule’s definition of other terms
used in subpart B of the proposed rule.
In particular, the Agencies request
comment on the following questions:
Question 62. Are the proposed rule’s
definitions of other terms in § l.3(d)
appropriate? If not, what alternative
definitions would be more appropriate?
Question 63. Is the definition of
additional terms for purposes of subpart
B of the proposed rule necessary? If so,
what terms should be defined? How
should those terms be defined?
2. Section l.4: Permitted Underwriting
and Market Making-Related Activities
Section l.4 of the proposed rule
implements section 13(d)(1)(B) of the
BHC Act, which permits banking
entities to engage in certain
underwriting and market making-related
PO 00000
Frm 00022
Fmt 4701
Sfmt 4702
activities, notwithstanding the
prohibition on proprietary trading.131
Section l.4(a) addresses permitted
underwriting activities, and § l.4(b)
addresses permitted market makingrelated activities.
a. Permitted Underwriting Activities
Section l.4(a) of the proposed rule
permits a banking entity to purchase or
sell a covered financial position in
connection with the banking entity’s
underwriting activities to the extent that
such activities are designed not to
exceed the reasonably expected nearterm demands of clients, customers, or
counterparties (the ‘‘underwriting
exemption’’). In order to rely on this
exemption, a banking entity’s
underwriting activities must meet all
seven of the criteria listed in § l.4(a)(2).
These seven criteria are intended to
ensure that any banking entity relying
on the underwriting exemption is
engaged in bona fide underwriting
activities, and conducts those activities
in a way that is not susceptible to abuse
through the taking of speculative,
proprietary positions as a part of, or
mischaracterized as, underwriting
activity.
First, the banking entity must have
established the internal compliance
program required by subpart D of the
proposed rule, as further described
below in Part III.D of this
SUPPLEMENTARY INFORMATION. This
requirement is intended to ensure that
any banking entity relying on the
underwriting exemption has reasonably
designed written policies and
procedures, internal controls, and
independent testing in place to support
its compliance with the terms of the
exemption.
Second, the covered financial position
that is being purchased or sold must be
a security. This requirement reflects the
common usage and understanding of the
term ‘‘underwriting.’’ 132
Third, the transaction must be
effected solely in connection with a
distribution of securities for which the
banking entity is acting as an
underwriter. This prong is intended to
give effect to the essential element of the
underwriting exemption—i.e., that the
transaction be in connection with
underwriting activity. For these
purposes, the proposed rule defines
both (i) a distribution of securities and
(ii) an underwriter. The definitions of
these terms are generally identical to the
131 See
12 U.S.C. 1851(d)(1)(B).
Agencies note, however, that a derivative
or commodity future transaction may be otherwise
permitted under another exemption (e.g., the
exemptions for market making-related or riskmitigating hedging activities).
132 The
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
definitions provided for the same terms
in the SEC’s Regulation M,133 which
governs the activities of underwriters,
issuers, selling security holders, and
others in connection with offerings of
securities under the Exchange Act.134
The Agencies have proposed to use
similar definitions because the
meanings of these terms under
Regulation M are generally wellunderstood by market participants and
define the scope of underwriting
activities in which banking entities
typically engage, including
underwriting of SEC-registered
offerings, underwriting of unregistered
distributions, and acting as a placement
agent in private placements.
With respect to the definition of
distribution, the Agencies note that
Regulation M defines a distribution of
securities as ‘‘an offering of securities,
whether or not subject to registration
under the Securities Act that are
distinguished from ordinary trading
transactions by the magnitude of the
offering and the presence of special
selling efforts.’’ 135 The manner in
which this Regulation M definition
distinguishes a distribution of securities
from other transactions appears to be
relevant in the context of the
underwriting exemption and useful to
address potential evasion of the general
prohibition on proprietary trading,
while permitting bona fide underwriting
activities. Accordingly, in order to
qualify as a distribution for purposes of
the proposal, as with Regulation M, the
offering must meet the two elements—
‘‘magnitude’’ and ‘‘special selling efforts
and selling methods.’’ The Agencies
have not defined the terms ‘‘magnitude’’
and ‘‘special selling efforts and selling
methods’’ in the proposed rule, but
would expect to rely on the same factors
considered under Regulation M in
assessing these elements. For example,
the number of shares to be sold, the
percentage of the outstanding shares,
public float, and trading volume that
those shares represent are all relevant to
an assessment of magnitude.136 In
addition, delivering a sales document,
such as a prospectus, and conducting
road shows are generally indicative of
special selling efforts and selling
methods.137 Another indicator of special
selling efforts and selling methods is
133 17
CFR 242.100 et seq.
proposed rule §§ l.4(a)(3), (4); 17 CFR
242.100(b).
135 17 CFR 242.100.
136 See Review of Antimanipulation Regulation of
Securities Offering, Exchange Act Release No.
33924 (Apr. 19, 1994), 59 FR 21681, 21684 (Apr. 26,
1994) (‘‘Regulation M Concept Release’’).
137 See Regulation M Concept Release, 59 FR at
21684–85.
134 See
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
compensation that is greater than that
for secondary trades but consistent with
underwriting compensation for an
offering. Similar to the approach taken
under Regulation M, the Agencies note
that ‘‘magnitude’’ does not imply that a
distribution must be large; instead, this
factor is a means to distinguish a
distribution from ordinary trading, and
therefore does not preclude small
offerings or private placements from
qualifying for the underwriting
exemption.
The definition of ‘‘underwriter’’ in the
proposed rule is generally similar to that
under the SEC’s Regulation M, except
that the proposed rule’s definition
would also include, within that
definition, a person who has an
agreement with another underwriter to
engage in a distribution of securities for
or on behalf of an issuer or selling
security holder.138 Consistent with
current practices and the Council study,
the Agencies propose to take into
consideration the extent to which the
banking entity is engaged in the
following activities when determining
whether a banking entity is acting as an
underwriter as part of a distribution of
securities:
• Assisting an issuer in capital
raising;
• Performing due diligence;
• Advising the issuer on market
conditions and assisting in the
preparation of a registration statement
or other offering documents;
• Purchasing securities from an
issuer, a selling security holder, or an
underwriter for resale to the public;
• Participating in or organizing a
syndicate of investment banks;
• Marketing securities; and
• Transacting to provide a postissuance secondary market and to
facilitate price discovery.
The Agencies note that the precise
activities performed by an underwriter
may vary depending on the liquidity of
the securities being underwritten and
the type of distribution being
conducted. For example, each factor
need not be present in a private
placement.
There may be circumstances in which
an underwriter would hold securities
that it could not sell in the distribution
for investment purposes. If the
acquisition of such unsold securities
were in connection with the
underwriting pursuant to the permitted
underwriting activities exemption, the
underwriter would also be able to
dispose of such securities at a later
time.139
proposed rule § l.4(a)(4)(ii).
Agencies note, however, that such sale
would have to be made in compliance with other
138 See
139 The
PO 00000
Frm 00023
Fmt 4701
Sfmt 4702
68867
Fourth, to the extent that the
transaction involves a security for
which a person must generally be a
registered securities dealer, municipal
securities dealer or government
securities dealer in order to underwrite
the security, the banking entity must
have the appropriate dealer registration
(or in the case of a financial institution
that is a government securities dealer,
has filed notice of that status as required
by section 15C(a)(1)(B) of the Exchange
Act) or otherwise be exempt from
registration or excluded from regulation
as a dealer.140 Similarly, if the banking
entity is engaged in the business of a
dealer outside the United States in a
manner for which no U.S. registration is
required, the banking entity must be
subject to substantive regulation of its
dealing business in the jurisdiction in
which the business is located. This
requirement is intended to ensure that
(i) any underwriting activity conducted
in reliance on the exemption is subject
to appropriate regulation and (ii)
banking entities are not simultaneously
characterizing the transaction as
underwriting for purposes of the
exemption while characterizing it in a
different manner for purposes of
applicable securities laws.
Fifth, the underwriting activities of
the banking entity with respect to the
covered financial position must be
designed not to exceed the reasonably
expected near-term demands of clients,
customers and counterparties.141 This
requirement restates the statutory
limitation on the underwriting
exemption.
Sixth, the underwriting activities of
the banking entity must be designed to
generate revenues primarily from fees,
commissions, underwriting spreads or
other income, and not from appreciation
in the value of covered financial
positions it holds related to such
activities or the hedging of such covered
financial position.142 This requirement
applicable provisions of the Federal securities laws
and regulations.
140 See proposed rule § l.4(a)(2)(iv). For
example, if a banking entity is a bank engaged in
underwriting asset-backed securities for which it
would be required to register as a securities dealer
but for the exclusion contained in section
3(a)(5)(C)(iii) of the Exchange Act, the proposed
rule would not require that banking entity be a
registered securities dealer in order to rely on the
underwriting exemption for that transaction. The
proposed rule does not apply the dealer
registration/notice requirement to the underwriting
of exempted securities, security-based swaps,
commercial paper, bankers acceptances or
commercial bills because the underwriting of such
instruments does not require registration as a
securities dealer under the Exchange Act.
141 See proposed rule § l.4(a)(2)(v).
142 For these purposes, underwriting spreads
would include any ‘‘gross spread’’ (i.e., the
E:\FR\FM\07NOP2.SGM
Continued
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68868
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
is intended to ensure that activities
conducted in reliance on the
underwriting exemption demonstrate
patterns of revenue generation and
profitability consistent with, and related
to, the services an underwriter provides
to its customers in bringing securities to
market, rather than changes in the
market value of the securities
underwritten.
Seventh, the compensation
arrangements of persons performing
underwriting activities at the banking
entity must be designed not to
encourage proprietary risk-taking.
Activities for which a banking entity has
established a compensation incentive
structure that rewards speculation in,
and appreciation of, the market value of
securities underwritten, rather than
success in bringing securities to market
for a client, are inconsistent with
permitted underwriting activities under
the proposed rule. Although a banking
entity relying on the underwriting
exemption may appropriately take into
account revenues resulting from
movements in the price of securities
that the banking entity underwrites to
the extent that such revenues reflect the
effectiveness with which personnel
have managed underwriting risk, the
banking entity should provide
compensation incentives that primarily
reward client revenues and effective
client service, not proprietary risktaking.
The Agencies request comment on the
proposed rule’s implementation of the
underwriting exemption. In particular,
the Agencies request comment on the
following questions:
Question 64. Is the proposed rule’s
implementation of the underwriting
exemption effective? If not, what
alternative approach would be more
effective? For example, should the
exemption include other transactions
that do not involve a distribution of
securities for which the banking entity
is acting as underwriter?
Question 65. Are the seven
requirements included in the
underwriting exemption effective? Is the
application of each requirement to
potential transactions sufficiently clear?
Should any of the requirements be
changed or eliminated? Should other
requirements be added in order to better
provide an exemption that is not
susceptible to abuse through the taking
of speculative, proprietary positions in
the context of, or mischaracterized as,
underwriting? Alternatively, are any of
difference between the price an underwriter sells
securities to the public and the price it purchases
them from the issuer) designed to compensate the
underwriter for its services.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
the proposed requirements
inappropriately restrictive in that they
would be inconsistent with the statutory
exemption for certain underwriting
activities? If so, how?
Question 66. Do underwriters
currently have processes in place that
would prevent or reduce the likelihood
of taking speculative, proprietary
positions in the context of, or
mischaracterized as, underwriting? If so,
what are those processes?
Question 67. Would any of the
proposed requirements cause
unintended consequences? Would the
proposed requirements alter current
underwriting practices in any way?
Would any of the proposed
requirements trigger an unwillingness to
engage in underwriting? What impact, if
any, would the proposed exemption
have on capital raising? Please explain.
Question 68. What increased costs, if
any, would underwriters incur to satisfy
the seven proposed requirements of the
underwriting exemption? Would
underwriters pass the increased costs
onto issuers, selling security holders, or
their customers in connection with
qualifying for the proposed exemption?
Question 69. In addition to the
specific activities highlighted above for
purposes of evaluating whether a
banking entity is acting as an
underwriter as part of distribution of
securities (e.g., assisting an issuer in
capital raising, performing due
diligence, etc), are there other or
alternative activities that should be
considered? Please explain.
Question 70. Should the requirement
that a covered financial position be a
security be expanded to include other
financial instruments? If so, why? How
are such other instruments underwritten
within the meaning of section
13(d)(1)(B) of the BHC Act?
Question 71. Is the proposed
definition of a ‘‘distribution’’ of
securities appropriate, or over- or underinclusive in this context? Is there any
category of underwriting activity that
would not be captured by the proposed
definition? If so, what are the mechanics
of that underwriting activity? Should it
be permitted under the proposed rule,
and, if so, why? Would an alternative
definition better identify offerings
intended to be covered by the proposed
definition? If so, what alternative
definition, and why?
Question 72. Is the proposed
definition of ‘‘underwriter’’ appropriate,
or over- or under-inclusive in this
context? Would an alternative
definition, such as the statutory
definition of ‘‘underwriter’’ under the
Securities Act, better identify persons
PO 00000
Frm 00024
Fmt 4701
Sfmt 4702
intended to be covered by the proposed
definition? If so, why?
Question 73. How accurately can a
banking entity engaging in underwriting
predict the near-term demands of
clients, customers, and counterparties
with respect to an offering? How can
principal risk that is retained in
connection with underwriting activities
to support near-term client demand be
distinguished from positions taken for
speculative purposes?
Question 74. Is the requirement that
the underwriting activities of a banking
entity relying on the underwriting
exemption be designed to generate
revenues primarily from fees,
commissions, underwriting spreads or
similar income effective? If not, how
should the requirement be changed?
Does the requirement appropriately
capture the type and nature of revenues
typically generated by underwriting
activities? Is any further clarification or
additional guidance necessary?
Question 75. Is the requirement that
the compensation arrangements of
persons performing underwriting
activities at a banking entity be designed
not to reward proprietary risk-taking
effective? If not, how should the
requirement be changed? Are there
other types of compensation incentives
that should be clearly referenced as
consistent, or inconsistent, with
permitted underwriting activity? Are
there specific and identifiable
characteristics of compensation
arrangements that clearly incentivize
prohibited proprietary trading?
Question 76. Are there other types of
underwriting activities that should also
be included within the scope of the
underwriting exemption? If so, what
additional activities and why? How
would an exemption for such additional
activities be consistent with the
language and purpose of section 13 of
the BHC Act? What criteria,
requirements, or restrictions would be
appropriate to include with respect to
such additional activities to prevent
misuse or evasion of the prohibition on
proprietary trading?
Question 77. Does the proposed
underwriting exemption appropriately
accommodate private placements? If
not, what changes are necessary to do
so?
Question 78. The creation, offer and
sale of certain structured securities such
as trust preferred securities or tender
option bonds, among others, may
involve the purchase of another security
and repackaging of that security through
an intermediate entity. Should the sale
of the security by a banking entity to an
intermediate entity as part of the
creation of the structured security be
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
permitted under one of the exemptions
to the prohibition on proprietary trading
currently included in the proposed rule
(e.g., underwriting or market making)?
Why or why not? For purposes of
determining whether an exemption is
available under these circumstances,
should gain on sale resulting from the
sale of the purchased security to the
intermediate entity as part of the
creation of the structured security be
considered a relevant factor? Why or
why not? What other factors should be
considered in connection with the
creation of the structured securities and
why? Would the analysis be different if
the banking entity acquired and retained
the security to be sold to the
intermediate entity as part of the
creation of the structured securities as
part of its underwriting of the
underlying security? Why or why not?
Question 79. We seek comment on the
application of the proposed exemption
to a banking entity retaining a portion
of an underwriting. Please discuss
whether or not firms frequently retain
securities in connection with a
distribution in which the firm is acting
as underwriter. Please identify the types
of offerings in which this may be done
(e.g., fixed income offerings, securitized
products, etc.). Please identify and
discuss any circumstances which can
contribute to the decision regarding
whether or not to retain a portion of an
offering. Please describe the treatment of
retained securities (e.g., the time period
of retention, the type of account in
which securities are retained, the
potential disposition of the securities).
Please discuss whether or not the
retention is documented and, if so, how.
Should the Agencies require disclosure
of securities retained in connection with
underwritings? Should the Agencies
require specific documentation to
demonstrate that the retained portion is
connected to an underwriting pursuant
to the proposed rule? If so, what kind of
documentation should be required?
Please discuss how you believe
retention should be addressed under the
proposal.
b. Permitted Market Making-Related
Activities
Section l.4(b) of the proposed rule
permits a banking entity to purchase or
sell a covered financial position in
connection with the banking entity’s
market making-related activities (the
‘‘market-making exemption’’).
i. Approach to Implementing the
Exemption for Market Making-Related
Activities.
As the Council study noted,
implementing the statutory exception
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
for permitted market making-related
activities requires a regulatory regime
that differentiates permitted market
making-related activity, and in
particular the taking of principal
positions in the course of making a
market in particular financial
instruments, from prohibited
proprietary trading. Although the
purpose and function of these two
activities are markedly different—
market making-related activities provide
intermediation and liquidity services to
customers, while proprietary trading
involves the generation of profit through
speculative risk-taking—clearly
distinguishing these activities may be
difficult in practice. Market makingrelated activities, like prohibited
proprietary trading, sometimes require
the taking of positions as principal, and
the amount of principal risk that must
be assumed by a market maker varies
considerably by asset class and differing
market conditions.143 It may be difficult
to distinguish principal positions that
appropriately support market makingrelated activities from positions taken
for short-term, speculative purposes. In
particular, it may be difficult to
determine whether principal risk has
been retained because (i) the retention
of such risk is necessary to provide
intermediation and liquidity services for
a relevant financial instrument or (ii)
the position is part of a speculative
trading strategy designed to realize
profits from price movements in
retained principal risk.144
In order to address these
complexities, the Agencies have
proposed a multi-faceted approach that
draws on several key elements. First,
similar to the underwriting exemption,
the proposed rule includes a number of
criteria that a banking entity’s activities
must meet in order to rely on the
exemption for market making-related
activities. These criteria are intended to
ensure that the banking entity is
engaged in bona fide market making. As
described in greater detail in Part III.D
of the Supplementary Information,
among these criteria is the requirement
143 With respect to certain kinds of market
making-related activities, such as market making in
securities, these principal positions are often
referred to as ‘‘inventory’’ or ‘‘inventory positions.’’
However, since certain types of market makingrelated activities, such as market making in
derivatives, involve the retention of principal
positions arising out of multiple derivatives
transactions in particular risks (e.g., retained
principal interest rate risk), rather than retention of
actual financial instruments, the broader term
‘‘principal positions’’ is used in this discussion.
144 The Council study contains a detailed
discussion of the challenges involved in delineating
prohibited proprietary trading from permitted
market making-related activities. See Council study
at 15–18.
PO 00000
Frm 00025
Fmt 4701
Sfmt 4702
68869
that the banking entity have in place a
programmatic compliance regime to
guide its compliance with section 13 of
the BHC Act and the proposed rule.
This compliance regime includes
requirements that a banking entity have
effective policies, procedures, and
internal controls that are designed to
ensure that prohibited proprietary
trading positions are not taken under
the guise of permitted market makingrelated activity. Second, as described in
greater detail in Part III.B.5 of this
Supplementary Information, Appendix
B of the proposed rule contains a
detailed commentary regarding how the
Agencies propose to identify permitted
market making-related activities. This
commentary includes six principles the
Agencies propose to use as a guide to
help distinguish market-making related
activities from prohibited proprietary
trading. Third, also as described in
greater detail in Part III.B.5 of this
Supplementary Information, § l.7 and
Appendix A of the proposed rule
require a banking entity with significant
covered trading activities to report
certain quantitative measurements for
each of its trading units.145 These
quantitative measurements are intended
to assist both banking entities and the
Agencies in assessing whether the
quantitative profile of a trading unit
(e.g., the types of revenues it generates
and the risks it retains) is consistent
with permitted market making-related
activities under the proposed rule.
The proposal’s multi-faceted
approach is intended, through the
incorporation of multiple regulatory and
supervisory tools, to strike an
appropriate balance in implementing
the market-making exemption in a way
that articulates the scope of permitted
activities and meaningfully addresses
the potential for misuse of the
exemption, while not unduly
constraining the important liquidity and
intermediation services that market
makers provide to their customers and
to the capital markets at large.
The Agencies request comment on the
proposed rule’s approach to
implementing the exemption for
permitted market making-related
activities. In particular, the Agencies
request comment on the following
questions:
Question 80. Is the proposed rule’s
approach to implementing the
exemption for permitted market makingrelated activities (i) appropriate and (ii)
likely to be effective? If not, what
145 The definition of ‘‘trading unit’’ for this
purpose is discussed in detail in Part III.B.5 of this
Supplementary Information.
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68870
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
alternative approach would be more
appropriate or effective?
Question 81. Does the proposed
multi-faceted approach appropriately
take into account and address the
challenges associated with
differentiating prohibited proprietary
trading from permitted market makingrelated activities? Should the approach
include other elements? If so, what
elements and why? Should any of the
proposed elements be revised or
eliminated? If so, why and how?
Question 82. Does the proposed
multi-faceted approach provide banking
entities and market participants with
sufficient clarity regarding what
constitutes permitted market makingrelated activities? If not, how could
greater clarity be provided?
Question 83. What impact will the
proposed multi-faceted approach have
on the market making-related services
that a banking entity provides to its
customers? How will the proposed
approach impact market participants
who use the services of market makers?
How will the approach impact the
capital markets at large, and in
particular the liquidity, efficiency and
price transparency of capital markets? If
any of these impacts are positive, how
can they be amplified? If any of these
impacts are negative, how can they be
mitigated? Would the proposed rule’s
prohibition on proprietary trading and
exemption for market making-related
activity reduce incentives or
opportunities for banking entities to
trade against customers, as opposed to
trading on behalf of customers? If so,
please discuss the benefits arising from
such reduced incentives or
opportunities.
Question 84. What burden will the
proposed multi-faceted approach have
on banking entities, their customers,
and other market participants? How can
any burden be minimized or eliminated
in a manner consistent with the
language and purpose of the statute?
Question 85. Are there particular asset
classes that raise special concerns in the
context of market making-related
activity that should be considered in
connection with the proposed marketmaking exemption? If so, what asset
class(es) and concern(s), and how
should the concerns be addressed in the
proposed exemption?
Question 86. Are there other market
making-related activities that the rule
text should more clearly permit? Why or
why not?
ii. Required Criteria for Permitted
Market Making-Related Activities
As part of the proposal’s multi-faceted
approach to implementing the
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
exemption for permitted market makingrelated activities, § l.4(b)(2) of the
proposed rule specifies seven criteria
that a banking entity’s market makingrelated activities must meet in order to
rely on the exemption, each of which
are described in detail below. These
criteria are designed to ensure that any
banking entity relying on the exemption
is engaged in bona fide market makingrelated activities and conducts those
activities in a way that is not susceptible
to abuse through the taking of
speculative, proprietary positions as a
part of, or mischaracterized as, market
making-related activity.
First Criterion—Establishment of
Internal Compliance Program
Section l.4(b)(2)(i) of the proposed
rule requires a banking entity to
establish a comprehensive compliance
program to monitor and control its
market making-related activities.
Subpart D of the proposed rule further
describes the appropriate elements of an
effective compliance program. This
criterion is intended to ensure that any
banking entity relying on the marketmaking exemption has reasonably
designed written policies and
procedures, internal controls, and
independent testing in place to support
its compliance with the terms of the
exemption.
Second Criterion—Bona Fide Market
Making
Section l.4(b)(2)(ii) of the proposed
rule articulates the core element of the
statutory exemption, which is that the
activity must be market making-related.
In order to give effect to this
requirement, § ll.4(b)(2)(ii) of the
proposed rule requires the trading desk
or other organizational unit that
purchases or sells a particular covered
financial position to hold itself out as
being willing to buy and sell, or
otherwise enter into long and short
positions in, the covered financial
position for its own account on a regular
or continuous basis. Notably, this
criterion requires that a banking entity
relying on the exemption with respect to
a particular transaction must actually
make a market in the covered financial
position involved; simply because a
banking entity makes a market in one
type of covered financial position does
not permit it to rely on the marketmaking exemption for another type of
covered financial position.146 Similarly,
146 The Agencies note that a market maker may
often make a market in one type of covered
financial positions and hedge its activities using
different covered financial positions in which it
does not make a market. Such hedging transactions
would meet the terms of the market-making
PO 00000
Frm 00026
Fmt 4701
Sfmt 4702
the particular trading desk or other
organizational unit of the banking entity
that is relying on the exemption for a
particular type of covered financial
position must also be the trading desk
or other organizational unit that is
actually making the market in that
covered financial position; market
making in a particular covered financial
position by one trading desk of a
banking entity does not permit another
trading desk of the banking entity to rely
on the market-making exemption for
that type of covered financial position.
The language used in § l.4(b)(2)(ii) of
the proposed rule to describe bona fide
market making-related activity is similar
to the definition of ‘‘market maker’’
under section 3(a)(38) of the Exchange
Act.147 The Agencies have proposed to
use similar language because the
Exchange Act definition is generally
well-understood by market participants
and is consistent with the scope of bona
fide market making-related activities in
which banking entities typically engage.
In assessing whether a particular
trading desk or other organizational unit
holds itself out as being willing to buy
and sell, or otherwise enter into long
and short positions in, a covered
financial position for its own account on
a regular or continuous basis in liquid
markets, the Agencies expect to take an
approach similar to that used by the
SEC in the context of assessing whether
a person is engaging in bona fide market
making. The precise nature of a market
maker’s activities often varies
depending on the liquidity, trade size,
market infrastructure, trading volumes
and frequency, and geographic location
of the market for any particular covered
financial position. In the context of
relatively liquid positions, such as
equity securities or other exchangetraded instruments, a trading desk or
other organizational unit’s market
making-related activity should generally
include:
• Making continuous, two sided
quotes and holding oneself out as
willing to buy and sell on a continuous
basis;
• A pattern of trading that includes
both purchases and sales in roughly
comparable amounts to provide
liquidity;
exemption if the hedging transaction met the
requirements of § l.4(b)(3) of the proposed rule.
147 Section 3(a)(38) of the Exchange Act defines
‘‘market maker’’ as ‘‘any specialist permitted to act
as a dealer, any dealer acting in the capacity of
block positioner, and any dealer who, with respect
to a security, holds himself out (by entering
quotations in an inter-dealer quotation
communications system or otherwise) as being
willing to buy and sell such security for his own
account on a regular or continuous basis.’’ 15 U.S.C.
78c(a)(38).
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
• Making continuous quotations that
are at or near the market on both sides;
and
• Providing widely accessible and
broadly disseminated quotes.148
In less liquid markets, such as overthe-counter markets for debt and equity
securities or derivatives, the appropriate
indicia of market making-related
activities will vary, but should generally
include:
• Holding oneself out as willing and
available to provide liquidity by
providing quotes on a regular (but not
necessarily continuous) basis; 149
• With respect to securities, regularly
purchasing covered financial positions
from, or selling the positions to, clients,
customers, or counterparties in the
secondary market; and
• Transaction volumes and risk
proportionate to historical customer
liquidity and investments needs.150
The Agencies would apply these
indicia when evaluating when a banking
entity is eligible for the market makingrelated activities exemption, but also
recognize that these indicia cannot be
applied at all times and under all
circumstances because some may be
inapplicable to the specific asset class or
market in which the market making
activity is conducted.
The bona fide market making-related
activity described in § l.4(b)(2)(ii) of
the proposed rule would include block
positioning if undertaken by a trading
desk or other organizational unit of a
banking entity for the purpose of
148 The Agencies note that these indicia are
generally consistent with the indicia of bona fide
market making in equity markets articulated by the
SEC for purposes of describing the exception to the
locate requirement of the SEC’s Regulation SHO for
market makers engaged in bona fide market-making
activities. See Exchange Act Release No. 58775
(October 14, 2008), 73 FR 61690, 61698–61699 (Oct.
17, 2008); see also 17 CFR 242.203(b)(2)(iii).
149 The frequency of such regular quotations will
itself vary; less illiquid markets may involve
quotations on a daily or more frequent basis, while
highly illiquid markets may trade only by
appointment.
150 The Agencies also note that the CFTC and SEC
have identified, in a proposed rule further defining
the terms ‘‘swap dealer’’ and ‘‘security-based swap
dealer’’ under the Commodity Exchange Act and
Exchange Act, a variety of distinguishing
characteristics of swap dealers and security-based
swap dealers in the context of derivatives,
including that: (i) Dealers tend to accommodate
demand for swaps and security-based swaps from
other parties; (ii) dealers are generally available to
enter into swaps or security-based swaps to
facilitate other parties’ interest in entering into
those instruments; (iii) dealers tend not to request
that other parties propose the terms of swaps or
security-based swaps, but instead tend to enter into
those instruments on their own standard terms or
on terms they arrange in response to other parties’
interest; and (iv) dealers tend to be able to arrange
customized terms for swaps or security-based swaps
upon request, or to create new types of swaps or
security-based swaps at the dealer’s own initiative.
See 75 FR 80174, 80176 (Dec. 21, 2010).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
intermediating customer trading.151 In
addition, bona fide market makingrelated activity may include taking
positions in securities in anticipation of
customer demand, so long as any
anticipatory buying or selling activity is
reasonable and related to clear,
demonstrable trading interest of clients,
customers, or counterparties.
Third Criterion—Reasonably Expected
Near-Term Demands of Clients,
Customers, and Counterparties
Under § l.4(b)(2)(iii) of the proposed
rule, the market making-related
activities of the trading desk or other
organization unit that conducts a
transaction in reliance on the marketmaking exemption must be designed not
to exceed the reasonably expected nearterm demands of clients, customers, and
counterparties. This criterion
implements the language in section
13(d)(1)(B) of the BHC Act and is
intended to prevent a trading desk
relying on the market-making
exemption from taking a speculative
proprietary position unrelated to
customer needs as part of its purported
market making-related activities. As
described in further detail in Parts
III.B.5 and III.D of the Supplementary
Information, the proposed rule also
includes a programmatic compliance
requirement and requires reporting of
quantitative measurements for certain
banking entities, both of which are
designed, in part, to meaningfully
circumscribe the principal positions
taken as part of market making-related
activities to those which are necessary
to meet the reasonably expected near151 The definition of ‘‘market maker’’ in the
Exchange Act includes a dealer acting in the
capacity of a block positioner. Although the term
‘‘block positioner’’ is not defined in the proposed
rule, the Agencies note that the SEC has adopted
a definition of ‘‘qualified block positioner’’ in the
SEC’s Rule 3b–8(c) (17 CFR 240.3b–8(c)), which
may serve as guidance in determining whether a
block positioner engaged in block positioning is
engaged in bona fide market making-related
activities for purposes of § l.4(b)(2)(ii) of the
proposed rule. Under the SEC’s Rule 3b–8(c),
among other things, a qualified block positioner
must meet all of the following conditions: (i)
Engages in the activity of purchasing long or selling
short, from time to time, from or to a customer
(other than a partner or a joint venture or other
entity in which a partner, the dealer, or a person
associated with such dealer participates) a block of
stock with a current market value of $200,000 or
more in a single transaction, or in several
transactions at approximately the same time, from
a single source to facilitate a sale or purchase by
such customer; (ii) has determined in the exercise
of reasonable diligence that the block could not be
sold to or purchased from others on equivalent or
better terms; and (iii) sells the shares comprising
the block as rapidly as possible commensurate with
the circumstances. The Agencies note that the rule
establishes a minimum dollar value threshold for a
block. The size of a block will vary among different
asset classes.
PO 00000
Frm 00027
Fmt 4701
Sfmt 4702
68871
term demands of clients, customers, and
counterparties. The Agencies expect
that the programmatic compliance
requirement and required reporting of
quantitative measurements will play an
important role in assessing a banking
entity’s compliance with
§ l.4(b)(2)(iii)’s requirement. In
addition, as described in Part II.B.5 of
the Supplementary Information,
Appendix B of the proposed rule
provides additional, detailed
commentary regarding how the
Agencies expect a firm relying on the
market-making exemption to manage
principal positions and how the
Agencies propose to assess whether
such positions are consistent with
market making-related activities under
the proposed rule.
In order for a banking entity’s
expectations regarding near-term
customer demand to be considered
reasonable, such expectations should be
based on more than a simple
expectation of future price appreciation
and the generic increase in marketplace
demand that such price appreciation
reflects. Rather, a banking entity’s
expectation should generally be based
on the unique customer base of the
banking entity’s specific market-making
business lines and the near-term
demands of those customers based on
particular factors beyond a general
expectation of price appreciation. To the
extent that a trading desk or other
organizational unit of a banking entity is
engaged wholly or principally in trading
that is not in response to, or driven by,
customer demands, the Agencies would
not expect those activities to qualify
under § l.4(b) of the proposed rule,
regardless of whether those activities
promote price transparency or liquidity.
For example, a trading desk or other
organizational unit of a banking entity
that is engaged wholly or principally in
arbitrage trading with non-customers
would not meet the terms of the
proposed rule’s market making
exemption. In the case of a market
maker engaging in market making in a
security that is executed on an
organized trading facility or exchange,
that market maker’s activities are
generally consistent with reasonably
expected near-term customer demand
when such activities involve passively
providing liquidity by submitting
resting orders that interact with the
orders of others in a non-directional or
market-neutral trading strategy and the
market maker is registered, if the
exchange or organized trading facility
E:\FR\FM\07NOP2.SGM
07NOP2
68872
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
registers market makers.152 However,
activities by such a person that
primarily takes liquidity on an
organized trading facility or exchange,
rather than provides liquidity, would
not qualify for the market-making
exemption under the proposed rule,
even if those activities were conducted
by a registered market maker.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Fourth Criterion—Registration Under
Securities or Commodities Laws
Under § l.4(b)(2)(iv) of the proposed
rule, a banking entity relying on the
market-making exemption with respect
to trading in securities or certain
derivatives must be appropriately
registered as a dealer, or exempt from
registration or excluded from regulation
as a dealer, under applicable securities
or commodities laws. With respect to a
market-making transaction in one or
more covered financial positions that
are securities, other than exempted
securities, security-based swaps,
commercial paper, bankers acceptances
or commercial bills, for which a person
must be a registered securities dealer,
municipal securities dealer or
government securities dealer in order to
deal in the security, the banking entity
must have the appropriate dealer
registration (or in the case of a financial
institution that is a government
securities dealer, has filed notice of that
status as required by section
15C(a)(1)(B) of the Exchange Act) or
otherwise be exempt from registration or
excluded from regulation as a dealer.153
152 The Agencies emphasize that the status of
being a registered market maker is not, on its own,
a sufficient basis for relying on the exemption for
market making-related activity contained in
§ l.4(b). however, being a registered market maker
is required under these circumstances if the
applicable exchange or organized trading facility
registers market makers. Registration as a market
maker generally involves filing a prescribed form
with an exchange or organized trading facility, in
accordance with its rules and procedures, and
complying with the applicable requirements for
market makers set forth in the rules of that
exchange or organized trading facility. See, e.g.,
Nasdaq Rule 4612, New York Stock Exchange Rule
104, CBOE Futures Exchange Rule 515, BATS
Exchange Rule 11.5.
153 See proposed rule §§ l.4(b)(2)(iv)(A), (D), (E).
For example, if a banking entity is a bank engaged
in market-making in qualified Canadian
government obligations for which it would be
required to register as a securities dealer but for the
exclusion contained in section 3(a)(5)(C)(i)(I) of the
Exchange Act, the proposed rule would not require
that banking entity to be a registered securities
dealer in order to rely on the market-making
exemption for that market-making transaction. Such
a bank would, however, be required to file notice
that it is a government securities dealer and comply
with rules applicable to financial institutions that
are government securities dealers. See 15 U.S.C.
78c(a)(42)(E); 15 U.S.C. 78o–5(a)(1)(B); 17 CFR
400.5(b); 17 CFR 449.1. Similar to the underwriting
exemption, the proposed rule does not apply the
dealer registration requirement to market making in
securities that are exempted securities, commercial
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
Similarly, with respect to a marketmaking transaction involving a swap or
security-based swap for which a person
must generally be a registered swap
dealer or security-based swap dealer,
respectively, the banking entity must be
appropriately registered or otherwise be
exempt from registration or excluded
from regulation as a swap dealer or
security-based swap dealer.154 If the
banking entity is engaged in the
business of a securities dealer, swap
dealer or security-based swap dealer
outside the United States in a manner
for which no U.S. registration is
required, the banking entity must be
subject to substantive regulation of its
dealing business in the jurisdiction in
which the business is located. This
requirement is intended to ensure that
(i) any market making-related activity
conducted in reliance on the exemption
is subject to appropriate regulation and
(ii) a banking entity does not
simultaneously characterize the
transaction as market making-related for
purposes of the exemption while
characterizing it in a different manner
for purposes of applicable securities or
commodities laws.
Fifth Criterion—Revenues From Fees,
Commissions, Bid/Ask Spreads or Other
Similar Income
Under § l.4(b)(2)(v) of the proposed
rule, the market making-related
activities of the banking entity must be
designed to generate revenues primarily
from fees, commissions, bid/ask spreads
or other income not attributable to
appreciation in the value of covered
financial positions it holds in trading
accounts or the hedging of such
positions. This criterion is intended to
ensure that activities conducted in
reliance on the market-making
exemption demonstrate patterns of
revenue generation and profitability
consistent with, and related to, the
intermediation and liquidity services a
market maker provides to its customers,
rather than changes in the market value
paper, bankers acceptances or commercial bills
because dealing in such securities does not require
registration as securities dealer under the Exchange
Act; however, registering as a municipal securities
dealer or government securities dealer is required,
if applicable.
154 See proposed rule §§ l.4(b)(2)(iv)(B), (C). A
banking entity may be required to be a registered
securities dealer if it engages in market-making
transactions involving security-based swaps with
persons that are not eligible contract participants.
See 15 U.S.C. 78c(a)(5) (the definition of ‘‘dealer’’
in section 3(a)(5) of the Exchange Act, 15 U.S.C.
78c(a)(5), generally includes ‘‘any person engaged
in the business of buying and selling securities (not
including security-based swaps, other than securitybased swaps with or for persons that are not eligible
contract participants), for such person’s own
account.’’).
PO 00000
Frm 00028
Fmt 4701
Sfmt 4702
of the positions or risks held in
inventory. Similar to the requirement
that a firm relying on the market-making
exemption design its activities not to
exceed reasonably expected near-term
client, customer, or counterparty
demands, the Agencies expect that the
programmatic compliance requirement
and required reporting of quantitative
measurements will play an important
role in assessing a banking entity’s
compliance with § l.4(b)(2)(v)’s
requirement. In addition, as described
in Part III.B.5 of this Supplementary
Information, Appendix B of the
proposed rule provides additional,
detailed commentary regarding how the
Agencies propose to assess whether the
types of revenues generated by a
banking entity relying on the marketmaking exemption are consistent with
market making-related activities.
Sixth Criterion—Compensation
Incentives
Under § l.4(b)(2)(vii) of the proposed
rule, the compensation arrangements of
persons performing market makingrelated activities at the banking entity
must be designed not to encourage or
reward proprietary risk-taking.
Activities for which a banking entity has
established a compensation incentive
structure that rewards speculation in,
and appreciation of, the market value of
a covered financial position held in
inventory, rather than success in
providing effective and timely
intermediation and liquidity services to
customers, are inconsistent with
permitted market making-related
activities. Although a banking entity
relying on the market-making
exemption may appropriately take into
account revenues resulting from
movements in the price of principal
positions to the extent that such
revenues reflect the effectiveness with
which personnel have managed
principal risk retained, a banking entity
relying on the market-making
exemption should provide
compensation incentives that primarily
reward customer revenues and effective
customer service, not proprietary risktaking. In addition, as described in Part
III.B.5 of this Supplementary
Information, Appendix B of the
proposed rule provides further
commentary regarding how the
Agencies propose to assess whether the
compensation incentives provided to
trading personnel performing trading
activities in reliance on the marketmaking exemption are consistent with
market making-related activities.
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Seventh Criterion—Consistency With
Appendix B Commentary
Under § l.4(b)(2)(vi) of the proposed
rule, the market making-related
activities of the trading desk or other
organizational unit that conducts the
purchase or sale are required to be
consistent with the commentary
provided in Appendix B, which
provides guidance that the Agencies
propose to apply to help distinguish
permitted market making-related
activities from prohibited proprietary
trading. Appendix B’s proposed
commentary, which is described in
detail below in Part III.B.5 of this
Supplementary Information, discusses
various factors by which the Agencies
propose to distinguish prohibited
proprietary trading from permitted
market making-related activities (e.g.,
how and to what extent a market maker
hedges the risk of its market-making
transactions, including (i) further detail
related directly to other criteria in
§ l.4(b)(2) (e.g., the types of revenues
generated by market makers), and (ii)
expectations regarding other factors not
expressly included in § l.4(b)(2)).
B. Market Making-Related Hedging
Section l.4(b)(3) of the proposed rule
provides that certain hedging
transactions related to market-making
positions and holdings will also be
deemed to be made in connection with
a banking entity’s market makingrelated activities for purposes of the
market-making exemption. In particular,
§ l.4(b)(3) provides that the purchase
or sale of a covered financial position
for hedging purposes will qualify for the
market-making exemption if it meets
two requirements. First, the purchase or
sale must be conducted in order to
reduce the specific risks to the banking
entity in connection with and related to
individual or aggregated positions,
contracts, or other holdings acquired
pursuant to the market-making
exemption. Where the purpose of a
transaction is to hedge a market makingrelated position, it would appear to be
market making-related activity of the
type described in section 13(d)(1)(B) of
the BHC Act. Second, the hedging
transaction must also meet the criteria
specified in the general exemption for
risk-mitigating hedging activity for
purposes of the proprietary trading
prohibition, which is contained in
§§ l.5(b) and (c) of the proposed rule
and described in detail in Part III.B.3 of
this Supplementary Information. Those
criteria are intended to clearly define
the scope of appropriate risk-mitigating
hedging activities, to foreclose reliance
on the exemption for prohibited
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
proprietary trading that is conducted in
the context of, or mischaracterized as,
hedging activity, and to require
documentation regarding the hedging
purpose of certain transactions that are
established at a level of organization
that is different than the level of
organization establishing or responsible
for the underlying risk or risks that are
being hedged, which in the context of
the market making-related activity
would generally be the trading desk.
iii. Request for Comment
The Agencies request comment on the
proposed criteria that must be met in
order to rely on the market-making
exemption. In particular, the Agencies
request comment on the following
questions (as well as related questions
in Part III.B.5 of this Supplementary
Information):
Question 87. Are the seven criteria
included in the market-making
exemption effective? Is the application
of each criterion to potential
transactions sufficiently clear? Should
any of the criteria be changed or
eliminated? Should other criteria be
added?
Question 88. Is incorporation of
concepts from the definition of ‘‘market
maker’’ under the Exchange Act useful
for purposes of section 13 of the BHC
Act and consistent with its purposes? If
not, what alternative definition would
be more useful or more consistent?
Question 89. Is the proposed
exemption overly broad or narrow? For
example, would it encompass activity
that should be considered prohibited
proprietary trading under the proposed
rule? Alternatively, would it prohibit
forms of market making or market
making-related activities that are
permitted under other rules or
regulations?
Question 90. We seek commenter
input on the types of banking entities
and forms of activities that would not
qualify for the proposed market-making
exemption but that commenters
consider to otherwise be market making.
Please discuss the impact of not
permitting such activities under the
proposed exemption (e.g., the impact on
liquidity).
Question 91. Is the requirement that a
trading desk or other organizational unit
relying on the market-making
exemption hold itself out as being
willing to buy and sell, or otherwise
enter into long and short positions in,
the relevant covered financial position
for its own account on a regular or
continuous basis effective? If not, what
alternative would be more effective?
Does the proposed requirement
appropriately differentiate between
PO 00000
Frm 00029
Fmt 4701
Sfmt 4702
68873
market making-related activities in
different markets and asset classes? If
not, how could such differences be
better reflected? Should the requirement
be modified to include certain arbitrage
trading activities engaged in by market
makers that promote liquidity or price
transparency, but do not serve customer,
client or counterparty demands, within
the scope of market making-related
activity? If so why? How could such
liquidity- or price transparencypromoting activities be meaningfully
identified and distinguished from
prohibited proprietary trading practices
that also may incidentally promote
liquidity or price transparency? Do
particular markets or instruments, such
as the market for exchange-traded funds,
raise particular issues that are not
adequately or appropriately addressed
in the proposal? If so, how could the
proposal better address those
instruments, markets or market features?
Question 92. Do the proposed indicia
of market making in liquid markets
accurately reflect the factors that should
generally be used to analyze whether a
banking entity is engaged in market
making-related activities for purposes of
section 13 of the BHC Act and the
proposed rule? If not, why not? Should
any of the proposed factors be
eliminated or modified? Should any
additional factors be included? Is
reliance on the SEC’s indicia of bona
fide market making for purposes of
Regulation SHO under the Exchange Act
and the equity securities market
appropriate in the context of section 13
of the BHC Act and the proposed rule
with respect to liquid markets? If not,
why not?
Question 93. Do the proposed indicia
of market making in illiquid markets
accurately reflect the factors that should
generally be used to analyze whether a
banking entity is engaged in market
making-related activities for purposes of
section 13 of the BHC Act and the
proposed rule? If not, why not? Should
any of the proposed factors be
eliminated or modified? Should any
additional factors be included?
Question 94. How accurately can a
banking entity predict the near-term
demands of clients, customers, and
counterparties? Are there measures that
can distinguish the amount of principal
risk that should be retained to support
such near-term client, customer, or
counterparty demand from positions
taken for speculative purposes? How is
client, customer, or counterparty
demand anticipated in connection with
market making-related activities, and
how does such approach vary by asset
class?
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68874
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Question 95. Is the requirement that a
banking entity relying on the marketmaking exemption be registered as a
dealer (or in the case of a financial
institution that is a government
securities dealer, has filed notice of that
status as required by section
15C(a)(1)(B) of the Exchange Act), or
exempt from registration or excluded
from regulation as a dealer under
relevant securities or commodities laws
effective? If not, how should the
requirement be changed? Does the
requirement appropriately take into
account the particular registration
requirements applicable to dealing in
different types of financial instruments?
If not, how could it better do so? Does
the requirement appropriately take into
account the various registration
exemptions and exclusions available to
certain entities, such as banks, under
the securities and commodities laws? If
not, how could it better do so?
Question 96. Is the requirement that a
trading desk or other organizational unit
of a banking entity relying on the
market-making exemption be designed
to generate revenues primarily from
fees, commissions, bid/ask spreads or
similar income effective? If not, how
should the requirement be changed?
Does the requirement appropriately
capture the type and nature of revenues
typically generated by market makingrelated activities? Is any further
clarification or additional guidance
necessary? Can revenues primarily from
fees, commissions, bid/ask spreads or
similar income be meaningfully
separated from other types of revenues?
Question 97. Is the requirement that
the compensation arrangements of
persons performing market makingrelated activities at a banking entity not
be designed to encourage proprietary
risk-taking effective? If not, how should
the requirement be changed? Are there
other types of compensation incentives
that should be clearly referenced as
consistent, or inconsistent, with
permitted market making-related
activity? Are their specific and
identifiable characteristics of
compensation arrangements that clearly
incentivize prohibited proprietary
trading?
Question 98. Is the inclusion of
market making-related hedging
transactions within the market-making
exemption effective and appropriate?
Are the proposed requirements that
certain hedging transactions must meet
in order to be considered to have been
made in connection with market
making-related activity effective and
sufficiently clear? If not, what
alternative requirements would be more
effective and/or clearer? Should any of
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
the proposed requirements be
eliminated? If so, which ones, and why?
Question 99. Should the terms
‘‘client,’’ ‘‘customer,’’ or ‘‘counterparty’’
be defined for purposes of the marketmaking exemption? If so, how should
these terms be defined? For example,
would an appropriate definition of
‘‘customer’’ be: (i) A continuing
relationship in which the banking entity
provides one or more financial products
or services prior to the time of the
transaction; (ii) a direct and substantive
relationship between the banking entity
and a prospective customer prior to the
transaction; (iii) a relationship initiated
by the banking entity to a prospective
customer to induce transactions; or (iv)
a relationship initiated by the
prospective customer with a view to
engaging in transactions?
Question 100. Are there other types of
market making-related activities that
should also be included within the
scope of the market-making exemption?
If so, what additional activities and
why? How would an exemption for such
additional activities be consistent with
the language and intent of section 13 of
the BHC Act? What criteria,
requirements, or restrictions would be
appropriate to include with respect to
such additional activities? How would
such criteria, requirements, or
restrictions prevent circumvention or
evasion of the prohibition on
proprietary trading?
Question 101. Do banking entities
currently have processes in place that
would prevent or reduce the likelihood
of taking speculative, proprietary
positions in the context of, or
mischaracterized as, market makingrelated activities? If so, what processes?
3. Section l.5: Permitted RiskMitigating Hedging Activities
Section l.5 of the proposed rule
permits a banking entity to purchase or
sell a covered financial position if the
transaction is made in connection with,
and related to, individual or aggregated
positions, contracts, or other holdings of
a banking entity and is designed to
reduce the specific risks to the banking
entity in connection with and related to
such positions, contracts, or other
holdings (the ‘‘hedging exemption’’).
This section of the proposed rule
implements, in relevant part, section
13(d)(1)(C) of the BHC Act, which
provides an exemption from the
prohibition on proprietary trading for
certain risk-mitigating hedging
activities.
PO 00000
Frm 00030
Fmt 4701
Sfmt 4702
a. Approach to Implementing the
Hedging Exemption
Like market making-related activities,
risk-mitigating hedging activities
present certain implementation
challenges because of the potential that
prohibited proprietary trading could be
conducted in the context of, or
mischaracterized as, a hedging
transaction. This is because it may often
be difficult to identify in retrospect
whether a banking entity engaged in a
particular transaction to manage or
eliminate risks arising from related
positions, on the one hand, or to profit
from price movements related to the
hedge position itself, on the other. The
intent with which a purported hedge
position is acquired may often be
difficult to discern in practice.
In light of these complexities, the
Agencies have again proposed a multifaceted approach to implementation. As
with the underwriting and marketmaking exemptions, the Agencies have
proposed a set of criteria that must be
met in order for a banking entity to rely
on the hedging exemption. The
proposed criteria are intended to define
the scope of permitted risk-mitigating
hedging activities and to foreclose
reliance on the exemption for prohibited
proprietary trading that is conducted in
the context of, or mischaracterized as,
permitted hedging activity. This
includes implementation of the
programmatic compliance regime
required under subpart D of the
proposed rule and, in particular,
requires that a banking entity with
significant trading activities implement
robust, detailed hedging policies and
procedures and related internal controls
that are designed to prevent prohibited
proprietary trading in the context of
permitted hedging activity.155 In
particular, a banking entity’s
compliance regime must include written
hedging policies at the trading unit level
and clearly articulated trader mandates
for each trader to ensure that the
decision of when and how to put on a
hedge is consistent with such policies
and mandates, and not fully left to a
trader’s discretion.156 In addition, to
address potential supervisory concerns
raised by certain types of hedging
transactions, § l.5 of the proposed rule
also requires a banking entity to
document certain hedging transactions
at the time the hedge is established.
This multi-faceted approach is intended
to articulate the Agencies’ expectations
regarding the scope of permitted risk155 These aspects of the compliance program
requirement are described in further detail in Part
III.D of this Supplementary Information.
156 See, e.g., proposed rule Appendix C.II.a.
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
mitigating hedging activities in a
manner that limits potential abuse of the
hedging exemption while not unduly
constraining the important risk
management function that is served by
a banking entity’s hedging activities.
b. Required Criteria for Permitted RiskMitigating Hedging Activitiesm
Section l.5(b) of the proposed rule
describes the seven criteria that a
banking entity must meet in order to
rely on the hedging exemption. First,
§ l.5(b)(1) of the proposed rule requires
the banking entity to have established
an internal compliance program,
consistent with the requirements of
subpart D, that is designed to ensure the
banking entity’s compliance with the
requirements of this paragraph,
including reasonably-designed written
policies and procedures, internal
controls, and independent testing. This
criterion is intended to ensure that any
banking entity relying on the exemption
has appropriate internal control
processes in place to support its
compliance with the terms of the
exemption.
Second, § l.5(b)(2)(i) of the proposed
rule requires that a transaction for
which a banking entity is relying on the
hedging exemption have been made in
accordance with written policies,
procedures and internal controls
established by the banking entity
pursuant to subpart D. This criterion
would preclude reliance on the hedging
exemption if the transaction was
inconsistent with a banking entity’s own
hedging policies and procedures, as
such inconsistency would appear to be
indicative of prohibited proprietary
trading.
Third, § l.5(b)(2)(ii) of the proposed
rule requires that the transaction hedge
or otherwise mitigate one or more
specific risks, including market risk,
counterparty or other credit risk,
currency or foreign exchange risk,
interest rate risk, basis risk, or similar
risks, arising in connection with and
related to individual or aggregated
positions, contracts, or other holdings of
a banking entity. This criterion
implements the essential element of the
hedging exemption—i.e., that the
transaction be risk-mitigating. Notably,
and consistent with the statutory
reference to mitigating risks of
individual or aggregated positions, this
criterion would include the hedging of
risks on a portfolio basis. For example,
it would include the hedging of one or
more specific risks arising from a
portfolio of diverse holdings, such as
the hedging of the aggregate risk of one
or more trading desks. However, in each
case, the Agencies would expect that the
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
transaction or series of transactions
being used to hedge is, in the aggregate,
demonstrably risk-reducing with respect
to the positions, contracts, or other
holdings that are being hedged. A
banking entity relying on the exemption
should be prepared to identify the
specific position or portfolio of
positions that is being hedged and
demonstrate that the hedging
transaction is risk-reducing in the
aggregate, as measured by appropriate
risk management tools.
In addition, this criterion would
include a series of hedging transactions
designed to hedge movements in the
price of a portfolio of positions. For
example, a banking entity may need to
engage in dynamic hedging, which
involves rebalancing its current hedge
position(s) based on a change in the
portfolio resulting from permissible
activities or from a change in the price,
or other characteristic, of the individual
or aggregated positions, contracts, or
other holdings. The Agencies recognize
that, in such dynamic hedging, material
changes in risk may require a
corresponding modification to the
banking entity’s current hedge
positions.157
The Agencies also expect that a
banking entity relying on the exemption
would be able to demonstrate that the
banking entity is already exposed to the
specific risks being hedged; generally,
the purported hedging of risks to which
the banking entity is not actually
exposed would not meet the terms of
the exemption. However, the hedging
exemption would be available in certain
cases where the hedge is established
slightly before the banking entity
becomes exposed to the underlying risk
if such anticipatory hedging activity: (i)
Is consistent with appropriate risk
management practices; (ii) otherwise
meets the terms of the hedging
exemption; and (iii) does not involve
the potential for speculative profit. For
example, if a banking entity was
contractually obligated, or otherwise
highly likely, to become exposed to a
particular risk and there was a sound
risk management rationale for hedging
that risk slightly in advance of actual
exposure, the hedging transaction
would generally be consistent with the
requirement described in § l.5(b)(2)(ii)
of the proposed rule.
Fourth, § l.5(b)(2)(iii) of the
proposed rule requires that the
transaction be reasonably correlated,
based upon the facts and circumstances
157 This corresponding modification to the hedge
should also be reasonably correlated to the material
changes in risk that are intended to be hedged or
otherwise mitigated, as required by proposed rule
§ l.5(b)(2)(iii).
PO 00000
Frm 00031
Fmt 4701
Sfmt 4702
68875
of the underlying and hedging positions
and the risks and liquidity of those
positions, to the risk or risks the
transaction is intended to hedge or
otherwise mitigate. A transaction that is
only tangentially related to the risks that
it purportedly mitigates would appear to
be indicative of prohibited proprietary
trading. Importantly, the Agencies have
not proposed that a transaction relying
on the hedging exemption be fully
correlated; instead, only reasonable
correlation is required.158 The degree of
correlation that may be reasonable will
vary depending on the underlying risks
and the availability of alternative
hedging options—risks that can be
easily and cost-effectively hedged with
extremely high or near-perfect
correlation would typically be expected
to be so hedged, whereas other risks
may be difficult or impossible to hedge
with anything greater than partial
correlation. Moreover, it is important to
consider the fact that trading positions
are often subject to a number of different
risks, and some risks may be hedged
easily and at low cost but may only
account for a small proportion of the
total risk in the position.159 More
generally, potential correlation levels
between asset classes can differ
significantly, and analysis of the
reasonableness of correlation would
depend on the facts and circumstances
of the initial position(s), risk(s) created,
liquidity of the instrument, and the
legitimacy of the hedge. Regardless of
the precise degree of correlation, if the
predicted performance of a hedge
position during the period that the
hedge position and the related position
are held would result in a banking
entity earning appreciably more profits
on the hedge position than it stood to
lose on the related position, the hedge
would appear likely to be a proprietary
trade designed to result in profit rather
than an exempt hedge position.
Fifth, § l.5(b)(2)(iv) of the proposed
rule requires that the hedging
transaction not give rise, at the
158 Although certain accounting standards, such
as FASB ASC Topic 815 hedge accounting, address
circumstances in which a transaction may be
considered a hedge of another transaction, the
proposed rule does not refer to or rely on these
accounting standards, because such standards (i)
are designed for financial statement purposes, not
to identify proprietary trading and (ii) change often
and are likely to change in the future without
consideration of the potential impact on section 13
of the BHC Act.
159 Interest rate risk in an equity derivative
transaction is one example—the hedging of interest
rate risk in an equity derivative position may only
result in a small reduction in overall risk and
interest rates may only exhibit a small correlation
with the value of the equity derivative, but the lack
of perfect or significant correlation would not
impair reliance on the hedging exemption.
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68876
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
inception of the hedge, to significant
exposures that are not themselves
hedged in a contemporaneous
transaction. A transaction that creates
significant new risk exposure that is not
itself hedged at the same time would
appear to be indicative of prohibited
proprietary trading. For example, overhedging, correlation trading, or pairs
trading strategies that generate profits
through speculative, proprietary risktaking would fail to meet this criterion.
Similarly, a transaction involving a pair
of positions that hedge each other with
respect to one type of risk exposure, but
create or contain a residual risk
exposure would, taken together,
constitute prohibited proprietary trading
and not risk-mitigating hedging if those
positions were taken collectively for the
purpose of profiting from short-term
movements in the effective price of the
residual risk exposure. However, the
proposal also recognizes that any
hedging transaction will inevitably give
rise to certain types of new risk, such as
counterparty credit risk or basis risk
reflecting the differences between the
hedge position and the related position;
the proposed criterion only prohibits
the introduction of additional
significant exposures through the
hedging transaction. In addition,
proposed § l.5(b)(2)(iv) only requires
that no new and significant exposures
be introduced at the inception of the
hedge, and not during the entire period
that the hedge is maintained, reflecting
the fact that new, unanticipated risks
can and sometimes do arise out of
hedging positions after the hedge is
established. The Agencies have
proposed to address the appropriate
management of risks that arise out of a
hedge position after inception through
§ l.5(b)(2)(v) of the proposed rule.
Sixth, § l.5(b)(2)(v) of the proposed
rule requires that any transaction
conducted in reliance on the hedging
exemption be subject to continuing
review, monitoring and management
after the hedge position is established.
Such review, monitoring, and
management must: (i) Be consistent
with the banking entity’s written
hedging policies and procedures; (ii)
maintain a reasonable level of
correlation, based upon the facts and
circumstances of the underlying and
hedging positions and the risks and
liquidity of those positions, to the risk
or risks the purchase or sale is intended
to hedge or otherwise mitigate; and (iii)
mitigate any significant exposure arising
out of the hedge after inception. In
accordance with a banking entity’s
written internal hedging policies,
procedures, and internal controls, a
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
banking entity should actively review
and manage its hedging positions and
the risks that may arise out of those
positions over time. A banking entity’s
internal hedging policies should be
designed to ensure that hedges remain
effective as correlations or other factors
change. In particular, a risk-mitigating
hedge position typically should be
unwound as exposure to the underlying
risk is reduced or increased as
underlying risk increases, as selective
hedging activity would appear to be
indicative of prohibited proprietary
trading.160 A banking entity’s written
internal hedging policies, procedures,
and internal controls for monitoring and
managing its hedges also should be
reasonably designed to prevent the
occurrence of such prohibited
proprietary trading activity and be
reasonably specific about the level of
hedging that is expected to be
maintained regardless of opportunities
for profit associated with over- or underhedging.
Seventh, § l.5(b)(2)(vi) of the
proposed rule requires that the
compensation arrangements of persons
performing the risk-mitigating hedging
activities are designed not to reward
proprietary risk-taking. Hedging
activities for which a banking entity has
established a compensation incentive
structure that rewards speculation in,
and appreciation of, the market value of
a covered financial position, rather than
success in reducing risk, are
inconsistent with permitted riskmitigating hedging activities.
c. Documentation Requirement
Section l.5(c) of the proposed rule
imposes a documentation requirement
on certain types of hedging transactions.
Specifically, for any transaction that a
banking entity conducts in reliance on
the hedging exemption that involves a
hedge established at a level of
organization that is different than the
level of organization establishing the
positions, contracts, or other holdings
the risks of which the hedging
transaction is designed to reduce, the
banking entity must, at a minimum,
document the risk-mitigating purpose of
the transaction and identify the risks of
the individual or aggregated positions,
contracts, or other holdings of a banking
entity that the transaction is designed to
160 The
Agencies note that in some cases, it may
be appropriate for a banking entity to unwind a
hedge, even if the underlying risk remains, if the
cost of that hedge become uneconomic, better
hedging options become available, or the overall
risk profile of the banking entity has changed such
that no longer hedging the risk is consistent with
appropriate risk management practices.
PO 00000
Frm 00032
Fmt 4701
Sfmt 4702
reduce.161 Such documentation must be
established at the time the hedging
transaction is effected, not after the fact.
The Agencies are concerned that
hedging transactions established at a
different level of organization than the
positions being hedged may present or
reflect heightened potential for
prohibited proprietary trading, as a
banking entity may be able, after the
fact, to point to a particular, offsetting
exposure within its organization after a
position is established and characterize
that position as a hedge even when, at
the time the position was established, it
was intended to generate speculative
proprietary gains, not mitigate risk. To
address this concern, the Agencies have
proposed to require a banking entity,
when establishing a hedge at a different
level of organization than that
establishing or responsible for the
underlying positions or risks being
hedged, to document the hedging
purpose of the transaction and risks
being hedged so as to establish a
contemporaneous, documentary record
that will assist the Agencies in assessing
the actual reasons for which the
position was established.
d. Request for Comment
The Agencies request comment on the
proposed implementation of the riskmitigating hedging exemption with
respect to proprietary trading. In
particular, the Agencies request
comment on the following questions:
Question 102. Is the proposed rule’s
approach to implementing the hedging
exemption effective? If not, what
alternative approach would be more
effective?
Question 103. Does the proposed
multi-faceted approach appropriately
take into account and address the
challenges associated with
differentiating prohibited proprietary
trading from permitted hedging
activities? Should the approach include
other elements? If so, what elements and
why? Should any of the proposed
elements be revised or eliminated? If so,
why and how?
Question 104. Does the proposed
approach to implementing the hedging
exemption provide banking entities and
market participants with sufficient
clarity regarding what constitutes
permitted hedging activities? If not, how
could greater clarity be provided?
161 For example, a hedge would be established at
a different level of organization of the banking
entity if multiple market making desks were
exposed to similar risks and, to hedge such risks,
a portfolio hedge was established at the direction
of a supervisor or risk manager responsible for more
than one desk rather than at each of the market
making desks that established the initial positions,
contracts, or other holdings.
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Question 105. What impact will the
proposed approach to implementing the
hedging exemption have on the hedging
and risk management activities of a
banking entity and the services it
provide to its clients? If any of these
impacts are positive, how can they be
amplified? If any of these impacts are
negative, how can they be mitigated?
Question 106. What burden will the
proposed approach to implementing the
hedging exemption have on banking
entities? How can any burden be
minimized or eliminated in a manner
consistent with the language and
purpose of the statute?
Question 107. Are the criteria
included in the hedging exemption
effective? Is the application of each
criterion to potential transactions
sufficiently clear? Should any of the
criteria be changed or eliminated?
Should other requirements be added?
Question 108. Is the requirement that
a transaction hedge or otherwise
mitigate one or more specific risks,
including market risk, counterparty or
other credit risk, currency or foreign
exchange risk, interest rate risk, basis
risk, or similar risks, arising in
connection with and related to
individual or aggregated positions,
contracts, or other holdings of a banking
entity effective? If not, what
requirement would be more effective?
Does the proposed approach sufficiently
articulate the types of risks that a
banking entity typically hedges? Does
the proposal sufficiently address
application of the hedging exemption to
portfolio hedging strategies? If not, how
should the proposal be changed?
Question 109. Does the manner in
which section l.5 of the proposal
would implement the risk-mitigating
hedging exemption effectively address
transactions that hedge or otherwise
mitigate specific risks arising in
connection with and related to
aggregated positions, contracts, or other
holdings of a banking entity? Do certain
hedging strategies or techniques that
involve hedging the risks of aggregated
positions (e.g., portfolio hedging) (i)
create the potential for abuse of the
hedging exemption or (ii) give rise to
challenges in determining whether a
banking entity is engaged in exempt,
risk-mitigating hedging activity or
prohibited proprietary trading? If so,
what hedging strategies and techniques,
and how? Should additional
restrictions, conditions, or requirements
be placed on the use of the hedging
exemption with respect to aggregated
positions so as to limit potential abuse
of the exemption, assist banking entities
and the Agencies in determining
compliance with the exemption, or
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
otherwise improve the effectiveness of
the rule? If so, what additional
restrictions, conditions, or
requirements, and why?
Question 110. Is the requirement that
the transaction be reasonably correlated
to the risk or risks the transaction is
intended to hedge or otherwise mitigate
effective? If not, how should the
requirement be changed? Should some
specific level of correlation and/or
hedge effectiveness be required? Should
the proposal specify in greater detail
how correlation should be measured?
Should the proposal require hedges to
be effective in periods of financial
stress? Does the proposal sufficiently
reflect differences in levels of
correlation among asset classes? If not,
how could it better do so?
Question 111. Is the requirement that
the transaction not give rise, at the
inception of the hedge, to significant
exposures that are not themselves
hedged in a contemporaneous
transaction effective? Does the
requirement establish an appropriate
range for legitimate hedging while
constraining impermissible proprietary
trading? Is this requirement sufficiently
clear? If not, what alternative would be
more effective and/or clearer? Are there
types of risk-mitigating hedging
activities that may give rise to new and
significant exposures that should be
permitted under the hedging
exemption? If so, what activities?
Should the requirement that no
significant exposure be introduced be
extended for the duration of the hedging
position? If so, why?
Question 112. Is the requirement that
any transaction conducted in reliance
on the hedging exemption be subject to
continuing review, monitoring and
management after the transaction is
established effective? If not, what
alternative would be more effective?
Question 113. Is the requirement that
the compensation arrangements of
persons performing risk-mitigating
hedging activities at a banking entity be
designed not to reward proprietary risktaking effective? If not, how should the
requirement be changed? Are there
other types of compensation incentives
that should be clearly referenced as
consistent, or inconsistent, with
permitted risk-mitigating hedging
activity? Are there specific and
identifiable characteristics of
compensation arrangements that clearly
incentivize prohibited proprietary
trading?
Question 114. Is the proposed
documentation requirement effective? If
not, what alternative would be more
effective? Are there certain additional
types of hedging transactions that
PO 00000
Frm 00033
Fmt 4701
Sfmt 4702
68877
should be subject to the documentation
requirement? If so, what transactions
and why? Should all types of hedging
transactions be subject to the
documentation requirement? If so, why?
Should banking entities be required to
document more aspects of a particular
transactions (e.g., all of the criteria
applicable to § l.5(b) of the proposed
rule)? If so, what aspects and why?
What burden would the proposed
documentation requirement place on
banking entities? How might such
burden be reduced or eliminated in a
manner consistent with the language
and purpose of the statute?
Question 115. Aside from the required
documentation, do the substantive
requirements of the proposed riskmitigating hedging exemption suggest
that additional documentation would be
required to achieve compliance with the
proposed rule? If so, what burden would
this additional documentation
requirement place on banking entities?
How might such burden be reduced or
eliminated in a manner consistent with
the language and purpose of the statute?
4. Section l.6: Other Permitted Trading
Activities
Section l.6 of the proposed rule
permits a banking entity to engage in
certain other trading activities described
in section 13(d)(1) of the BHC Act.
These permitted activities include
trading in certain government
obligations, trading on behalf of
customers, trading by insurance
companies, and trading outside of the
United States by certain foreign banking
entities. Section l.6 of the proposed
rule does not contain all of the statutory
exemptions contained in section
13(d)(1) of the BHC Act. Several of these
exemptions appear, either by plain
language or by implication, to be
intended to apply only to covered fund
activities and investments, and so the
Agencies have not proposed to include
them in the proposed rule’s proprietary
trading provisions.162 Those exemptions
are referenced in other portions of the
proposed rule pertaining to covered
funds.
The Agencies request comment on the
proposed rule’s approach to
implementing the exemptions contained
in section 13(d)(1) of the BHC Act to the
proposed rule’s proprietary trading
provisions. In particular, the Agencies
162 In particular, the proposed rule does not apply
(i) the exemption in section 13(d)(1)(E) of the BHC
Act for SBICs and certain public welfare or
qualified rehabilitation investments, or (ii) the
exemptions in sections 13(d)(1)(G) and 13(d)(1)(I) of
the BHC Act for certain covered funds activities and
investments, to the proprietary trading provisions of
subpart B.
E:\FR\FM\07NOP2.SGM
07NOP2
68878
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
request comment on the following
questions:
Question 116. Is the proposed rule’s
approach of identifying which of the
statutory exemptions contained in
section 13(d)(1) of the BHC Act apply to
the proposed rule’s proprietary trading
provisions effective and/or consistent
with the language and purpose of the
statute? If not, what alternative would
be more effective and/or consistent with
the language and purpose of the statute?
Question 117. Are there statutory
exemptions that should apply to the
proposed rule’s proprietary trading
provisions that were not included? If so,
what exemptions and why?
Question 118. Are there statutory
exemptions that were included in the
proposed rule’s proprietary trading
provisions that should not have been
included? If so, what exemptions and
why?
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
a. Permitted Trading in Government
Obligations
Section l.6(a) of the proposed rule,
which implements section 13(d)(1)(A) of
the BHC Act,163 permits the purchase or
sale of a covered financial position that
is: (i) An obligation of the United States
or any agency thereof; 164 (ii) an
obligation, participation, or other
instrument of or issued by the
Government National Mortgage
Association, the Federal National
Mortgage Association, the Federal Home
Loan Mortgage Corporation, a Federal
Home Loan Bank, the Federal
Agricultural Mortgage Corporation or a
Farm Credit System institution
chartered under and subject to the
provisions of the Farm Credit Act of
1971 (12 U.S.C. 2001 et seq.); or (iii) an
obligation issued by any State or any
political subdivision thereof.165 The
proposed rule also clarifies that these
obligations include limited as well as
general obligations of the relevant
government entity. The Agencies note
that, consistent with the statutory
163 Section 13(d)(1)(A) of the BHC Act permits a
banking entity to purchase, sell, acquire or dispose
securities and other instruments described in
section 13(h)(4) of the BHC Act if those securities
or other instruments are specified types of
government obligations, notwithstanding the
prohibition on proprietary trading. See 12 U.S.C.
1851(d)(1)(A).
164 The Agencies propose that United States
‘‘agencies’’ for this purpose will include those
agencies described in section 201.108(b) of the
Board’s Regulation A. See 12 CFR 201.108(b). The
Agencies also note that the terms of the exemption
would encompass the purchase or sale of
enumerated government obligations on a forward
basis (e.g., in a to-be-announced market).
165 Consistent with the statutory language, the
proposed rule does not extend the government
obligations exemption to transactions in obligations
of an agency of any State or political subdivision
thereof.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
language, the types of instruments
described with respect to the
enumerated government-sponsored
entities include not only obligations of
such entities, but also participations and
other instruments of or issued by such
entity. This would include, for example,
pass-through or participation certificates
that are issued and guaranteed by one of
these government-sponsored entities
(e.g., the Federal National Mortgage
Association and the Federal Home Loan
Mortgage Corporation) in connection
with their securitization activities.
The Agencies request comment on the
proposed rule’s approach to
implementing the government
obligation exemption. In particular, the
Agencies request comment on the
following questions:
Question 119. Is the proposed rule’s
application to trading in government
obligations sufficiently clear? Should
such obligations expressly include, for
example, instruments issued by third
parties but insured or guaranteed by an
enumerated government entity or
otherwise backed by its full faith and
credit?
Question 120. Should the Agencies
adopt an additional exemption for
proprietary trading in State or
municipal agency obligations under
section 13(d)(1)(J) of the BHC Act? If so,
how would such an exemption promote
and protect the safety and soundness of
banking entities and the financial
stability of the United States?
Question 121. Should the Agencies
adopt an additional exemption for
proprietary trading in options or other
derivatives referencing an enumerated
government obligation under section
13(d)(1)(J) of the BHC Act? For example,
should the Agencies provide an
exemption for options or other
derivatives with respect to U.S.
government debt obligations? If so, how
would such an exemption promote and
protect the safety and soundness of
banking entities and the financial
stability of the United States?
Question 122. Should the Agencies
adopt an additional exemption for
proprietary trading in the obligations of
foreign governments and/or
international and multinational
development banks under section
13(d)(1)(J) of the BHC Act? If so, what
types of obligations should be exempt?
How would such an exemption promote
and protect the safety and soundness of
banking entities and the financial
stability of the United States?
Question 123. Should the Agencies
adopt an additional exemption for
proprietary trading in any other type of
government obligations under section
13(d)(1)(J) of the BHC Act? If so, how
PO 00000
Frm 00034
Fmt 4701
Sfmt 4702
would such an exemption promote and
protect the safety and soundness of
banking entities and the financial
stability of the United States?
Question 124. Are the definitions of
‘‘government security’’ and ‘‘municipal
security’’ in sections 3(a)(42) and
3(a)(29) of the Exchange Act helpful in
determining the proper scope of this
exemption? If so, please explain their
utility and how incorporating such
definitions into the exemption would be
consistent with the language and
purpose of section 13 of the BHC Act.
b. Permitted Trading on Behalf of
Customers
Section 13(d)(1)(D) of the BHC Act
permits a banking entity to purchase or
sell a covered financial position on
behalf of customers, notwithstanding
the prohibition on proprietary trading.
Section l.6(b) of the proposed rule
implements this section. Because the
statute does not specifically define
when a transaction would be conducted
‘‘on behalf of customers,’’ the proposed
rule identifies three categories of
transactions that, while they may
involve a banking entity acting as
principal for certain purposes, appear to
be on behalf of customers within the
purpose and meaning of the statute. As
proposed, only transactions meeting the
terms of these three categories would be
considered on behalf of customers for
purposes of the exemption.
Section l.6(b)(i) of the proposed rule
provides that a purchase or sale of a
covered financial position is on behalf
of customers if the transaction (i) is
conducted by a banking entity acting as
investment adviser, commodity trading
advisor, trustee, or in a similar fiduciary
capacity for a customer and for the
account of that customer, and (ii)
involves solely covered financial
positions of which the banking entity’s
customer, and not the banking entity or
any subsidiary or affiliate of the banking
entity, is beneficial owner (including as
a result of having long or short exposure
under the relevant covered financial
position). This category is intended to
capture a wide range of trading activity
conducted in the context of customerdriven investment or commodity
advisory, trust, or fiduciary services, so
long as that activity is structured in a
way that the customer, and not the
banking entity providing those services,
benefits from any gains and suffers from
any losses on such covered financial
positions.166 A transaction that is
166 For example, in the case of a banking entity
acting as investment adviser to a registered mutual
fund, any trading by the banking entity in its
capacity of investment adviser and on behalf of that
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
structured so as to involve a listed form
of relationship but nonetheless allows
gains or losses from trading activity to
inure to the benefit or detriment of the
banking entity would fall outside the
scope of this category.
Section l.6(b)(ii) of the proposed rule
provides that a transaction is on behalf
of customers if the banking entity is
acting as riskless principal. These type
of transactions are similarly customerdriven and do not expose the banking
entity to gains or losses on the value of
the traded positions, notwithstanding
the fact that the banking entity
technically acts as principal. The
Agencies note that the proposed
language describing riskless principal
transactions generally mirrors that used
in the Board’s Regulation Y, OCC
interpretive letters, and the SEC’s Rule
3a5–1 under the Exchange Act.167
Section l.6(b)(iii) of the proposed
rule addresses trading for the separate
account of insurance policyholders by a
banking entity that is an insurance
company. In particular, this part of the
proposed rule provides that a purchase
or sale of a covered financial position is
on behalf of customers if:
• The banking entity is an insurance
company engaging in the transaction for
a separate account;
• The banking entity is directly
engaged in the business of insurance
and subject to regulation by a State
insurance regulator or foreign insurance
regulator; 168
• The banking entity purchases or
sells the covered financial position
solely for a separate account established
by the insurance company in
connection with one or more insurance
policies issued by that insurance
company;
• All profits and losses arising from
the purchase or sale of the covered
financial position are allocated to the
separate account and inure to the
benefit or detriment of the owners of the
insurance policies supported by the
separate account, and not the banking
entity; and
• The purchase or sale is conducted
in compliance with, and subject to, the
insurance company investment and
other laws, regulations, and written
guidance of the State or jurisdiction in
which such insurance company is
domiciled.
fund would be permitted pursuant to § l.6(b)(i) of
the proposed rule, so long as the relevant criteria
were met.
167 See 12 CFR 225.28(b)(7)(ii); 17 CFR 240.3a5–
1(b); OCC Interpretive Letter 626 (July 7, 1993).
168 The proposed rule provides definitions of the
terms ‘‘State insurance regulator’’ and ‘‘foreign
insurance regulator.’’ See proposed rule
§§ l.3(c)(4), (13).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
This category is included within the
exemption for transactions on behalf of
customers because such insurancerelated transactions are generally
customer-driven and do not expose the
banking entity to gains or losses on the
value of separate account assets, even
though the banking entity may be
treated as the owner of those assets for
certain purposes. However, to limit the
potential for abuse of the exemption, the
proposed rule also includes related
requirements designed to ensure that
the separate account trading activity is
subject to appropriate regulation and
supervision under insurance laws and
not structured so as to allow gains or
losses from trading activity to inure to
the benefit or detriment of the banking
entity.169 The proposed rule defines a
‘‘separate account’’ as an account
established or maintained by a regulated
insurance company subject to regulation
by a State insurance regulator or foreign
insurance regulator under which
income, gains, and losses, whether or
not realized, from assets allocated to
such account, are, in accordance with
the applicable contract, credited to or
charged against such account without
regard to other income, gains, or losses
of the insurance company.170
The Agencies request comment on the
proposed rule’s approach to
implementing the exemption for trading
on behalf of customers. In particular, the
Agencies request comment on the
following questions:
Question 125. Is the proposed rule’s
articulation of three categories of
transactions on behalf of customers
effective and sufficiently clear? If not,
what alternative would be more
effective and/or clearer? Should any of
the categories be eliminated? Should
any additional categories be added?
Please explain.
Question 126. Is the proposed rule’s
exemption of certain investment
adviser, commodity trading advisor,
trustee or similar fiduciary transactions
effective? What other types of
relationships are or should be captured
by the proposed rule’s reference to
‘‘similar fiduciary relationships,’’ and
why? Is application of this part of the
exemption to particular transactions
sufficiently clear? Should any other
specific types of fiduciary or other
relationships be specified in the rule? If
so, what types and why? What impact
will the proposed rule’s implementation
of the exemption have on the
169 The Agencies would not consider profits to
inure to the benefit of the banking entity if the
banking entity were solely to receive payment, out
of separate account profits, of fees unrelated to the
investment performance of the separate account.
170 See proposed rule § l.2(z).
PO 00000
Frm 00035
Fmt 4701
Sfmt 4702
68879
investment adviser, commodity trading
advisor, trustee or similar fiduciary
activities of banking entities? If such
impacts are negative, how could they be
mitigated or eliminated in a manner
consistent with the purpose and
language of the statute?
Question 127. Is the proposed rule’s
exemption of riskless principal
transactions effective? If not, what
alternative would be more appropriate?
Is the description of qualifying riskless
principal activity sufficiently clear? If
not, how should it be clarified? Should
the riskless principal transaction
exemption include a requirement that
the banking entity must purchase (or
sell) the covered financial position as
principal at the same price to satisfy the
customer buy (or sell) order, exclusive
of any explicitly disclosed markup or
markdown, commission equivalent, or
other fee? Why or why not? Should the
riskless principal exemption include a
requirement with respect to the
timeframe in which the principal
transaction must be allocated to a
riskless principal or customer account?
Why or why not?
Question 128. Is the proposed rule’s
exemption of trading for separate
accounts by insurance companies
effective? If not, what alternative would
be more appropriate? Does the proposed
exemption sufficiently address the
variety of customer-driven separate
account structures typically used? If not,
how should it address such structures?
Does the proposed exemption
sufficiently address the variety of
regulatory or supervisory regimes to
which insurance companies may be
subject?
Question 129. What impact will the
proposed rule’s implementation of the
exemption have on the insurance
activities of insurance companies
affiliated with banking entities? If such
impacts are negative, how could they be
mitigated or eliminated in a manner
consistent with the purpose and
language of the statute?
Question 130. Should the term
‘‘customer’’ be defined for purposes of
the exemption for transactions on behalf
of customers? If so, how should it be
defined? For example, would an
appropriate definition be (i) a
continuing relationship in which the
banking entity provides one or more
financial products or services prior to
the time of the transaction, (ii) a direct
and substantive relationship between
the banking entity and a prospective
customer prior to the transaction, or (iii)
a relationship initiated by the banking
entity to a prospective customer for
purposes of the transaction?
E:\FR\FM\07NOP2.SGM
07NOP2
68880
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Question 131. Is the exemption for
trading on behalf of customers in the
proposed rule over- or under-inclusive?
If it is under-inclusive, please discuss
any additional activities that should
qualify as trading on behalf of customers
under the rule. What are the mechanics
of the particular trading activity and
how does it qualify as being on behalf
of customers? Are there certain
requirements or restrictions that should
be placed on the activity, if permitted by
the rule, to prevent evasion of the
prohibition on proprietary trading? How
would permitting the activity be
consistent with the purpose and
language of section 13 of the BHC Act?
If the proposed exemption is overinclusive, please explain what aspect of
the proposed exemption does not
involve trading on behalf of customers
within the language and purpose of the
statute.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
c. Permitted Trading by a Regulated
Insurance Company
Section l.6(c) of the proposed rule
implements section 13(d)(1)(F) of the
BHC Act,171 which permits a banking
entity to purchase or sell a covered
financial position if the banking entity
is a regulated insurance company acting
for its general account or an affiliate of
an insurance company acting for the
insurance company’s general account,
subject to certain conditions. Section
l.6(d) of the proposed rule generally
restates the statutory requirements of
the exemption, which provide that:
• The insurance company must
directly engage in the business of
insurance and be subject to regulation
by a State insurance regulator or foreign
insurance regulator;
• The insurance company or its
affiliate must purchase or sell the
covered financial position solely for the
general account of the insurance
company;
• The purchase or sale must be
conducted in compliance with, and
subject to, the insurance company
investment laws, regulations, and
written guidance of the State or
jurisdiction in which such insurance
company is domiciled; and
• The appropriate Federal banking
agencies, after consultation with the
Council and the relevant insurance
commissioners of the States, must not
have jointly determined, after notice
and comment, that a particular law,
regulation, or written guidance
described above is insufficient to protect
the safety and soundness of the banking
171 See
12 U.S.C. 1851(d)(1)(F).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
entity or of the financial stability of the
United States.172
The proposed rule defines a ‘‘general
account’’ as all of the assets of the
insurance company that are not legally
segregated and allocated to separate
accounts under applicable State law.173
The Agencies request comment on the
proposed rule’s approach to
implementing the exemption for general
account trading by insurance
companies. In particular, the Agencies
request comment on the following
questions:
Question 132. Should any of the
statutory requirements for the
exemption be further clarified in the
proposed rule? If so, how? Should any
additional requirements be added? If so,
what requirements and why?
Question 133. Does the proposed rule
appropriately and clearly define a
general account for these purposes? If
not, what alternative definition would
be more appropriate?
Question 134. For purposes of the
exemption, are the insurance company
investment laws, regulations, and
written guidance of any particular State
or jurisdiction insufficient to protect the
safety and soundness of the banking
entity, or of the financial stability of the
United States? If so, why?
Question 135. What impact will the
proposed rule’s implementation of the
exemption have on the insurance
activities of insurance companies
affiliated with banking entities? If such
impacts are negative, how could they be
mitigated or eliminated in a manner
consistent with the purpose and
language of the statute?
d. Permitted Trading Outside of the
United States
Section l.6(d) of the proposed rule
implements section 13(d)(1)(H) of the
BHC Act,174 which permits certain
172 The Federal banking agencies have not
proposed at this time to determine, as part of the
proposed rule, that the insurance company
investment laws, regulations, and written guidance
of any particular State or jurisdiction are
insufficient to protect the safety and soundness of
the banking entity, or of the financial stability of the
United States. The Federal banking agencies expect
to monitor, in conjunction with the Federal
Insurance Office established under section 502 of
the Dodd-Frank Act, the insurance company
investment laws, regulations, and written guidance
of States or jurisdictions to which exempt
transactions are subject and make such
determinations in the future, where appropriate.
173 See proposed rule § l.3(c)(6).
174 Section 13(d)(1)(H) of the BHC Act permits a
banking entity to engage in proprietary trading,
notwithstanding the prohibition on proprietary
trading, if it is conducted by a banking entity
pursuant to paragraph (9) or (13) of section 4(c) of
the BHC Act and the trading occurs solely outside
of the United States and the banking entity is not
directly or indirectly controlled by a banking entity
PO 00000
Frm 00036
Fmt 4701
Sfmt 4702
foreign banking entities to engage in
proprietary trading that occurs solely
outside of the United States.175 This
statutory exemption limits the
extraterritorial application of the
prohibition on proprietary trading to the
foreign activities of foreign firms, while
preserving national treatment and
competitive equality among U.S. and
foreign firms within the United States.
Consistent with the statute, the
proposed rule defines both the type of
foreign banking entities that are eligible
for the exemption and the
circumstances in which proprietary
trading by such an entity will be
considered to have occurred solely
outside of the United States.
i. Foreign Banking Entities Eligible for
the Exemption
Section l.6(d)(1)(i) of the proposed
rule provides that, in order to be eligible
for the foreign trading exemption, the
banking entity must not be directly or
indirectly controlled by a banking entity
that is organized under the laws of the
United States or of one or more States.
This requirement limits the scope of the
exemption to banking entities that are
organized under foreign law and
controlled only by entities organized
under foreign law. Consistent with the
statutory language, a banking entity
organized under the laws of the United
States or any State and the subsidiaries
and branches of such banking entity
(wherever organized or licensed) may
not rely on the exemption.176 Similarly,
a U.S. subsidiary or branch of a foreign
banking entity would not qualify for the
exemption.
Section l.6(d)(1)(ii) of the proposed
rule incorporates the statutory
requirement that the banking entity
must also conduct the transaction
pursuant to sections 4(c)(9) or 4(c)(13) of
the BHC Act. Section l.6(d)(2) clarifies
when a banking entity would meet that
requirement, the criteria for which vary
depending on whether or not the
banking entity is a foreign banking
organization.177
that is organized under the laws of the United
States or of one or more States. See 12 U.S.C.
1851(d)(1)(H).
175 This section’s discussion of the concept
‘‘solely outside of the United States’’ is provided
solely for purposes of the proposed rule’s
implementation of section 13(d)(1)(H) of the BHC
Act, and does not affect a banking entity’s
obligation to comply with additional or different
requirements under applicable securities, banking,
or other laws.
176 Under the proposal, a ‘‘State’’ means any
State, territory or possession of the United States,
and the District of Columbia. See proposed rule
§ l.2(aa).
177 Section l.6(d)(2) only addresses when a
transaction will be considered to have been
conducted pursuant to section 4(c)(9) of the BHC
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Section 4(c)(9) of the BHC Act
provides that the restrictions on
interests in nonbanking organizations
contained in that statute do not apply to
the ownership of shares held or
activities conducted by any company
organized under the laws of a foreign
country the greater part of whose
business is conducted outside the
United States, if the Board by regulation
or order determines that, under the
circumstances and subject to the
conditions set forth in the regulation or
order, the exemption would not be
substantially at variance with the
purposes of the BHC Act and would be
in the public interest.178 The Board has
implemented section 4(c)(9) as part of
subpart B of the Board’s Regulation
K,179 which specifies a number of
conditions and requirements that a
foreign banking organization must meet
in order to use such authority. Such
conditions and requirements include,
for example, a qualifying foreign
banking organization test that requires
the foreign banking organization to
demonstrate that more than half of its
worldwide business is banking and that
more than half of its banking business
is outside the United States. The
proposed rule makes clear that if a
banking entity is a foreign banking
organization, it will qualify for the
foreign trading exemption if the entity is
a qualifying foreign banking
organization that conducts the
transaction in compliance with subpart
B of the Board’s Regulation K, and the
transaction occurs solely outside of the
United States.
Section 13 of the BHC Act also
applies to foreign companies that
control a U.S. insured depository
institution but are not currently subject
to the BHC Act generally or to the
Board’s Regulation K—for example,
because the foreign company controls a
savings association or an FDIC-insured
industrial loan company. Accordingly,
the proposed rule also clarifies when
this type of foreign banking entity
would be considered to have conducted
a transaction ‘‘pursuant to section
4(c)(9)’’ for purposes of the foreign
trading exemption.180 In particular, the
draft rule proposes that to qualify for the
foreign trading exemption, such firms
must meet at least two of three
requirements that evaluate the extent to
which the foreign entity’s business is
conducted outside the United States, as
measured by assets, revenues, and
income. This test largely mirrors the
qualifying foreign banking organization
test that is made applicable under
section 4(c)(9) of the BHC Act and
§ 211.23(a) of the Board’s Regulation K,
except that the test does not also require
such a foreign entity to demonstrate that
more than half of its banking business
is outside the United States.181
Act. Although the statute also references section
4(c)(13) of the BHC Act, the Board has applied the
authority contained in that section solely to the
foreign activities of U.S. banking organizations
which, by the express terms of section 13(d)(1)(H)
of the BHC Act, are unable to rely on the foreign
trading exemption.
178 See 12 U.S.C. 1843(c)(9).
179 See 12 CFR 211.20 et seq.
180 The Board emphasizes that this clarification
would be applicable solely in the context of section
13(d)(1) of the BHC Act. The application of section
4(c)(9) to foreign companies in other contexts is
likely to involve different legal and policy issues
and may therefore merit different approaches.
181 See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a);
proposed rule § l.6(d)(2). This difference reflects
the fact that foreign entities subject to section 13 of
the BHC Act, but not the BHC Act generally, are
likely to be, in many cases, predominantly
commercial firms. A requirement that such firms
also demonstrate that more than half of their
banking business is outside the United States would
likely make the exemption unavailable to such
firms and subject their global activities to the
prohibition on proprietary trading, a result that the
statute does not appear to have intended.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
ii. Trading Solely Outside of the United
States
The proposed rule also clarifies when
a transaction will be considered to have
occurred solely outside of the United
States for purposes of the exemption. In
interpreting this aspect of the statutory
language, the proposal focuses on the
extent to which material elements of the
transaction occur within, or are
conducted by personnel within, the
United States. This focus seeks to avoid
extraterritorial application of the
prohibition of proprietary trading
outside the United States while
preserving competitive parity within
U.S. markets. The proposed rule does
not evaluate solely whether the risk of
the transaction or management or
decision-making with respect to the
transaction rests outside the United
States, as such an approach would
appear to permit foreign banking
entities to structure transactions so as to
be ‘‘outside of the United States’’ for
risk and booking purposes while
engaging in transactions within U.S.
markets that are prohibited for U.S.
banking entities.
In particular, § l.6(d)(3) of the
proposed rule provides that a
transaction will be considered to have
occurred solely outside of the United
States only if four conditions are met:
• The transaction is conducted by a
banking entity that is not organized
under the laws of the United States or
of one or more States;
• No party to the transaction is a
resident of the United States;
PO 00000
Frm 00037
Fmt 4701
Sfmt 4702
68881
• No personnel of the banking entity
that is directly involved in the
transaction is physically located in the
United States; 182 and
• The transaction is executed wholly
outside the United States.
These four criteria are intended to
ensure that a transaction executed in
reliance on the exemption does not
involve U.S. counterparties, U.S. trading
personnel, U.S. execution facilities, or
risks retained in the United States. The
presence of any of these factors would
appear to constitute a sufficient locus of
activity in the U.S. marketplace so as to
preclude availability of the exemption.
A resident of the United States is
defined in § l.2(t) of the proposed rule,
and includes: (i) Any natural person
resident in the United States; (ii) any
partnership, corporation or other
business entity organized or
incorporated under the laws of the
United States or any State; (iii) any
estate of which any executor or
administrator is a resident of the United
States; (iv) any trust of which any
trustee, beneficiary or, if the trust is
revocable, settlor is a resident of the
United States; (v) any agency or branch
of a foreign entity located in the United
States; (vi) any discretionary or nondiscretionary account or similar account
(other than an estate or trust) held by a
dealer or fiduciary for the benefit or
account of a resident of the United
States; (vii) any discretionary account or
similar account (other than an estate or
trust) held by a dealer or fiduciary
organized or incorporated in the United
States, or (if an individual) a resident of
the United States; or (viii) any
partnership or corporation organized or
incorporated under the laws of any
foreign jurisdiction formed by or for a
resident of the United States principally
for the purpose of engaging in one or
more transactions described in
§ l.6(d)(1) or § l.13(c)(1) of the
proposed rule.183 The proposed
definition is designed to capture the
scope of U.S. counterparties, decisionmakers and personnel that, if involved
in the transaction, would preclude that
transaction from being considered to
have occurred solely outside the United
States. The Agencies note that the
proposed definition is similar but not
identical to the definition of ‘‘U.S.
person’’ for purposes of the SEC’s
Regulation S, which governs securities
offerings and sales outside of the United
182 Personnel directly involved in the transaction
would generally not include persons performing
purely administrative, clerical, or ministerial
functions.
183 See proposed rule § l.2(t).
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68882
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
States that are not registered under the
Securities Act.184
banking entities and the financial
stability of the United States?
iii. Request for Comment
e. Discretionary Exemptions for
Proprietary Trading Under Section
13(d)(1)(J) of the BHC Act
Section 13(d)(1)(J) of the BHC Act
permits the Agencies to grant, by rule,
other exemptions from the prohibition
on proprietary trading if the Agencies
determine that the exemption would
promote and protect the safety and
soundness of the banking entity and the
financial stability of the United
States.185 The Agencies have not, at this
time, proposed any such discretionary
exemptions with respect to the
prohibition on proprietary trading. The
Agencies request comment as follows:
Question 142. Should the Agencies
adopt any exemption from the
prohibition on proprietary trading under
section 13(d)(1)(J) of the BHC Act? If so,
what exemption and why? How would
such an exemption promote and protect
the safety and soundness of banking
entities and the financial stability of the
United States?
The Agencies request comment on the
proposed rule’s approach to
implementing the foreign trading
exemption. In particular, the Agencies
request comment on the following
questions:
Question 136. Is the proposed rule’s
implementation of the foreign trading
exemption effectively delineated? If not,
what alternative would be more
effective and/or clearer?
Question 137. Are the proposed rule’s
provisions regarding when an activity
will be considered to have been
conducted pursuant to section 4(c)(9) of
the BHC Act effective and sufficiently
clear? If not, what alternative would be
more effective and/or clearer? Do those
provisions effectively address the
application of the foreign trading
exemption to foreign banking entities
not subject to the BHC Act generally? If
not, how should the proposed rule
apply the exemption?
Question 138. Are the proposed rule’s
provisions regarding when an activity
will be considered to have occurred
solely outside the United States
effective and sufficiently clear? If not,
what alternative would be more
effective and/or clearer? Should any
requirements be modified or removed?
If so, which requirements and why?
Should additional requirements be
added? If so, what requirements and
why?
Question 139. Is the proposed rule’s
definition of ‘‘resident of the United
States’’ effective and sufficiently clear?
If not, what alternative would be more
effective and/or clearer? Is the definition
over- or under-inclusive? If so, why?
Should the definition more closely
track, or incorporate by reference, the
definition of ‘‘U.S. person’’ under the
SEC’s Regulation S under the Securities
Act? If so, why?
Question 140. Does the proposed rule
effectively define a resident of the
United States for these purposes? If not,
how should the definition be altered?
Question 141. Should the Agencies
use the authority provided in section
13(d)(1)(J) of the BHC Act to allow U.S.controlled banking entities to engage in
proprietary trading pursuant to section
4(c)(13) of the BHC Act outside of the
United States under certain
circumstances? If so, under what
circumstances should this be permitted
and how would such activity promote
and protect the safety and soundness of
184 See
17 CFR 230.902(k).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
5. Section l.7: Reporting and
Recordkeeping Requirements
Applicable to Trading Activities
Section l.7 of the proposed rule,
which implements in part section
13(e)(1) of the BHC Act,186 requires
certain banking entities to comply with
the reporting and recordkeeping
requirements specified in Appendix A
of the proposed rule. In addition, § l.7
requires banking entities to comply with
the recordkeeping requirements in
§ l.20 of the proposed rule, related to
the banking entity’s compliance
program,187 as well as any other
reporting or recordkeeping requirements
that the relevant Agency may impose to
evaluate the banking entity’s
compliance with the proposed rule.188
Proposed Appendix A requires a
banking entity with significant trading
activities to furnish periodic reports to
the relevant Agency regarding various
quantitative measurements of its trading
activities and create and retain records
documenting the preparation and
185 See 12 U.S.C. 1851(d)(1)(J). In addition to
permitting the Agencies to provide additional
exemptions from the prohibition on proprietary
trading, section 13(d)(1)(J) also states that the
Agencies may provide additional exemptions from
the prohibition on investing in or sponsoring a
covered fund, as discussed in Part III.C.5 of this
Supplementary Information.
186 Section 13(e)(1) of the BHC Act requires the
Agencies to issue regulations regarding internal
controls and recordkeeping to ensure compliance
with section 13. See 12 U.S.C. 1851(e)(1). Section
l.20 and Appendix C of the proposed rule also
implement section 13(e)(1) of the BHC Act.
187 See Supplementary Information, Part III.D.
188 See proposed rule § l.7.
PO 00000
Frm 00038
Fmt 4701
Sfmt 4702
content of these reports. The
measurements vary depending on the
scope, type, and size of trading
activities. In addition, proposed
Appendix B contains a detailed
commentary regarding the
characteristics of permitted market
making-related activities and how such
activities may be distinguished from
trading activities that, even if conducted
in the context of a banking entity’s
market-making operations, would
constitute prohibited proprietary
trading.
A banking entity must comply with
proposed Appendix A’s reporting and
recordkeeping requirements only if it
has, together with its affiliates and
subsidiaries, trading assets and
liabilities the average gross sum of
which (on a worldwide consolidated
basis) is, as measured as of the last day
of each of the four prior calendar
quarters, equal to or greater than
$1 billion.189 The Agencies have not
proposed to extend the reporting and
recordkeeping requirements to banking
entities with smaller amounts of trading
activity, as it appears that the more
limited benefits of applying these
requirements to such banking entities,
whose trading activities are typically
small, less complex, and easier to
supervise, would not justify the burden
associated with complying with the
reporting and recordkeeping
requirements.
a. General Approach to Reporting and
Recordkeeping Requirements
The reporting and recordkeeping
requirements of § l.7 and Appendix A
of the proposed rule are an important
part of the proposed rule’s multi-faceted
approach to implementing the
prohibition on proprietary trading.
These requirements are intended, in
particular, to address some of the
difficulties associated with (i)
identifying permitted market makingrelated activities and distinguishing
such activities from prohibited
proprietary trading and (ii) identifying
certain trading activities resulting in
material exposure to high-risk assets or
high-risk trading strategies. To do so,
the proposed rule requires certain
189 See proposed rule § l.7(a). The Agencies note
that this $1 billion trading asset and liability
threshold is the same standard that is used in the
Market Risk Capital Rules for determining which
bank holding companies and insured depository
institutions must calculate their risk-based capital
requirements for trading positions under those
rules. These banking entities maintain large and
complex portfolios of trading assets and are
therefore the most likely to be engaged in the types
of trading activities that will require significant
oversight of compliance with the restrictions on
proprietary trading.
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
banking entities to calculate and report
detailed quantitative measurements of
their trading activity, by trading unit.
These measurements will help banking
entities and the Agencies in assessing
whether such trading activity is
consistent with permitted trading
activities in scope, type and profile. The
quantitative measurements that must be
reported under the proposed rule are
generally designed to reflect, and to
provide meaningful information
regarding, certain characteristics of
trading activities that appear to be
particularly useful in differentiating
permitted market making-related
activities from prohibited proprietary
trading. For example, the proposed
quantitative measurements measure the
size and type of revenues generated, and
the types of risks taken, by a trading
unit. Each of these measurements
appears to be useful in assessing
whether a trading unit is (i) engaged in
permitted market making-related
activity or (ii) materially exposed to
high-risk assets or high-risk trading
strategies. Similarly, the proposed
quantitative measurements also measure
how much revenue is generated per
such unit of risk, the volatility of a
trading unit’s profitability, and the
extent to which a trading unit trades
with customers. Each of those
characteristics appears to be useful in
assessing whether a trading unit is
engaged in permitted market makingrelated activity.
However, the Agencies recognize that
no single quantitative measurement or
combination of measurements can
accurately identify prohibited
proprietary trading without further
analysis of the context, facts, and
circumstances of the trading activity. In
addition, certain quantitative
measurements may be useful for
assessing one type of trading activity,
but not helpful in assessing another type
of trading activity. As a result, the
Agencies propose to use a variety of
quantitative measurements to help
identify transactions or activities that
warrant more in-depth analysis or
review.
To be effective, this approach requires
identification of useful quantitative
measurements as well as judgment
regarding the type of measurement
results that suggest a further review of
the trading unit’s activity is warranted.
The Agencies intend to take a heuristic
approach to implementation in this area
that recognizes that quantitative
measurements can only be usefully
identified and employed after a process
of substantial public comment, practical
experience, and revision. In particular,
the Agencies note that, although a
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
variety of quantitative measurements
have traditionally been used by market
participants and others to manage the
risks associated with trading activities,
these quantitative tools have not been
developed, nor have they previously
been utilized, for the explicit purpose of
identifying trading activity that warrants
additional scrutiny in differentiating
prohibited proprietary trading from
permitted market making-related
activities. Additional study and analysis
will be required before quantitative
measurements may be effectively
designed and employed for that
purpose.
Consistent with this heuristic
approach, the proposed rule includes a
large number of potential quantitative
measurements on which public
comment is sought, many of which
overlap to some degree in terms of their
informational value. Not all of these
quantitative measurements may
ultimately be adopted, depending on
their relative strengths, weaknesses,
costs, and benefits. The Agencies note
that some of the proposed quantitative
measurements may not be relevant to all
types of trading activities or may
provide only limited benefits, relative to
cost, when applied to certain types of
trading activities. In addition, certain
quantitative measurements may be
difficult or impracticable to calculate for
a specific covered trading activity due to
differences between asset classes,
market structure, or other factors. The
Agencies have therefore requested
comment on a large number of issues
related to the relevance, practicability,
costs, and benefits of the quantitative
measurements proposed. The Agencies
also seek comment on whether the
quantitative measurements described in
the proposal may be appropriate to use
in assessing compliance with section 13
of the BHC Act.
In addition to the proposed
quantitative measurements, a banking
entity may itself develop and implement
other quantitative measurements in
order to effectively monitor its covered
trading activities for compliance with
section 13 of the BHC Act and the
proposed rule and to establish,
maintain, and enforce an effective
compliance program, as required by
§ l.20 of the proposed rule and
Appendix C. The Agencies note that the
proposed quantitative measurements in
Appendix A are intended to assist
banking entities and Agencies in
monitoring compliance with the
proprietary trading restrictions and,
thus, are related to the compliance
program requirements in § l.20 of the
proposed rule and proposed Appendix
C. Nevertheless, implementation of the
PO 00000
Frm 00039
Fmt 4701
Sfmt 4702
68883
proposed quantitative measurements
under Appendix A would not
necessarily provide all the data
necessary for the banking entity to
establish an effective compliance
program, and a banking entity may need
to develop and implement additional
quantitative measurements. The
Agencies recognize that appropriate and
effective quantitative measurements
may differ based on the profile of the
banking entity’s businesses in general
and, more specifically, of the particular
trading unit, including types of
instruments traded, trading activities
and strategies, and history and
experience (e.g., whether the trading
desk is an established, successful
market maker or a new entrant to a
competitive market). In all cases,
banking entities must ensure that they
have robust measures in place to
identify and monitor the risks taken in
their trading activities, to ensure the
activities are within risk tolerances
established by the banking entity, and to
monitor for compliance with the
proprietary trading restrictions in the
proposed rule.
To the extent that data regarding
measurements, as set forth in the
proposed rule, are collected, the
Agencies propose to utilize the
automatic two-year conformance period
provided in section 13 of the BHC Act
to carefully review that data, further
study the design and utility of these
measurements, and if necessary,
propose changes to the reporting
requirements as the Agencies believe are
needed to ensure that these
measurements are as effective as
possible.190 This heuristic, gradual
approach to implementing reporting
requirements for quantitative
measurements would be intended to
ensure that the requirements are
formulated in a manner that maximizes
their utility for identifying trading
activity that warrants additional
scrutiny in assessing compliance with
the prohibition on proprietary trading,
while limiting the risk that the use of
quantitative measurements could
inadvertently curtail permissible market
making-related activities that provide an
important service to market participants
and the capital markets at large.
In addition, the Agencies request
comment on the use of numerical
thresholds for certain quantitative
190 Section 13(c)(2) of the BHC Act provides
banking entities two years from the date that the
proposed rule becomes effective (with the
possibility of up to three, one-year extensions) to
bring their activities, investments, and relationships
into compliance with section 13, including the
prohibition on proprietary trading. See 12 U.S.C.
1851(c)(2).
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68884
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
measurements that, if reported by a
banking entity, would require the
banking entity to review its trading
activities for compliance and summarize
that review to the relevant Agency. The
Agencies have not proposed specific
numerical thresholds in the proposal
because substantial public comment and
analysis would be beneficial prior to
formulating and proposing specific
numerical thresholds. Instead, the
Agencies intend to carefully consider
public comments that are provided on
this issue and to separately determine
whether it would be appropriate to
propose, subsequent to finalizing the
current proposal, such numerical
thresholds.
The Agencies request comment on the
proposed approach to implementing
reporting requirements for proprietary
trading. In particular, the Agencies
request comment on the following
questions:
Question 143. Is the use of the
proposed reporting requirements as part
of the multi-faceted approach to
implementing the prohibition on
proprietary trading appropriate? Why or
why not?
Question 144. Is the proposed gradual
approach to implementing reporting
requirements effective? If not, what
approach would be more effective? For
example, should the Agencies defer
reporting of quantitative measurements
until banking entities have developed
and refined their compliance programs
through the supervision and
examination process? What would be
the costs and benefits of such an
approach?
Question 145. What role, if any, could
or should the Office of Financial
Research (‘‘OFR’’) play in receiving and
analyzing banking entities’ reported
quantitative measurements? Should
reporting to the OFR be required instead
of reporting to the relevant Agency, and
would such reporting be consistent with
the composition and purpose of OFR? In
the alternative, should reporting to
either (i) only the relevant Agency (or
Agencies) or (ii) both the relevant
Agency (or Agencies) and OFR be
required? If so, why? What are the
potential costs and benefits of reporting
quantitative measurements to the OFR?
Please explain.
Question 146. Is there an alternative
manner in which the Agencies should
develop and propose the reporting
requirements for quantitative
measurements? If so, how should they
do so?
Question 147. Does the proposed
approach provide sufficient time for the
development and implementation of
effective reporting requirements? If not,
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
what alternative approach would be
preferable?
Question 148. Should a trading unit
be permitted not to furnish a
quantitative measurement otherwise
required under Appendix A if it can
demonstrate that the measurement is
not, as applied to that unit, calculable
or useful in achieving the purposes of
the Appendix with respect to the
trading unit’s covered trading activities?
How might a banking entity make such
a demonstration?
Question 149. Is the manner in which
the Agencies propose to utilize the
conformance period for review of
collected data and refinement of the
reporting requirements effective? If not,
what process would be more effective?
Question 150. Is the proposed
$1 billion trading asset and liability
threshold, which is also currently used
in the Market Risk Capital Rules for
purposes of identifying which banks
and bank holdings companies must
comply with those rules, an appropriate
standard for triggering the reporting and
recordkeeping requirements of the
proposed rule? Why or why not? If not,
what alternative standard would be a
better benchmark for triggering the
reporting and recordkeeping
requirements?
Question 151. What are the typical
trading activities (e.g., market makingrelated activities) of a banking entity
with less than $1 billion in gross trading
assets and liabilities? How complex are
those trading activities?
Question 152. Should the proposed
$1 billion trading and asset liability
threshold used for triggering the
reporting and recordkeeping
requirements adjust each time the
thresholds for complying with the
Market Risk Capital Rules adjust, or
otherwise be adjusted over time? If not,
how and when should the numerical
threshold be adjusted?
Question 153. Should all banking
entities be required to comply with the
reporting and recordkeeping
requirements set forth in Appendix A in
order to better protect against prohibited
proprietary trading, rather than only
those banking entities that meet the
proposed $1 billion trading asset and
liability threshold? Why or why not?
Question 154. Should banking entities
that fall under the proposed $1 billion
trading asset and liability threshold be
required to comply with the reporting
and recordkeeping provisions for a pilot
period in order to help inform judgment
regarding the levels of quantitative
measurements at such entities and the
appropriate frequency and scope of
examination by the relevant Agency for
such banking entities? Why or why not?
PO 00000
Frm 00040
Fmt 4701
Sfmt 4702
b. Proposed Appendix A—Purpose and
Definitions
Section I of proposed Appendix A
describes the purpose of the appendix,
which is to specify reporting
requirements that are intended to assist
banking entities that are engaged in
significant trading activities and the
Agencies in identifying trading
activities that warrant further review or
examination to verify compliance with
the proprietary trading restrictions,
including whether an otherwisepermitted activity under §§ l.4 through
l.6(a) of the proposed rule is consistent
with the requirement that such activity
not result, directly or indirectly, in a
material exposure by the banking entity
to high-risk assets and high-risk trading
strategies. In particular, section I
provides that the purpose of the
appendix is to assist the relevant
Agency and banking entities in:
• Better understanding and
evaluating the scope, type, and profile
of the banking entity’s covered trading
activities;
• Monitoring the banking entity’s
covered trading activities;
• Identifying covered trading
activities that warrant further review or
examination by the banking entity to
verify compliance with the proprietary
trading restrictions;
• Evaluating whether the trading
activities of trading units engaged in
market making-related activities under
§ l.4(b) of the proposed rule are
consistent with the requirements
governing permitted market makingrelated activities;
• Evaluating whether the trading
activities of trading units that are
engaged in permitted trading activity
under §§ l.4, l.5, or l.6(a) of the
proposed rule (e.g., permitted
underwriting, market making-related
activity, risk-mitigating hedging, or
trading in certain government
obligations) are consistent with the
requirement that such activity not
result, directly or indirectly, in a
material exposure by the banking entity
to high-risk assets and high-risk trading
strategies;
• Identifying the profile of particular
trading activities of the banking entity,
and the individual trading units of the
banking entity, to help establish the
appropriate frequency and scope of
examination by the relevant Agency of
such activities; and
• Assessing and addressing the risks
associated with the banking entity’s
trading activities.
The types of trading and market
making-related activities in which
banking entities engage is often highly
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
complex, and any quantitative
measurement is capable of producing
both ‘‘false negatives’’ and ‘‘false
positives’’ that suggest that prohibited
proprietary trading is occurring when it
is not, or vice versa. Recognizing this,
section I of proposed Appendix A
makes clear that the quantitative
measurements that may be required to
be reported would not be intended to
serve as a dispositive tool for identifying
permissible or impermissible activities.
Section II of proposed Appendix A
defines relevant terms used in the
appendix. These include certain
definitions that clarify how and when
certain calculations must be made, as
well as a definition of ‘‘trading unit’’
that governs the level of organization at
which a banking entity must calculate
quantitative measurements. The
proposed definition of ‘‘trading unit’’
covers multiple organizational levels of
a banking entity, including:
• Each discrete unit engaged in the
coordinated implementation of a
revenue generation strategy that
participates in the execution of any
covered trading activity; 191
• Each organizational unit used to
structure and control the aggregate risktaking activities and employees of one
or more trading units described above;
• All trading operations, collectively;
and
• Any other unit of organization
specified by the relevant Agency with
respect to a particular banking entity.192
191 As noted in Appendix A, the Agencies expect
that this would generally be the smallest unit of
organization used by the banking entity to structure
and control its risk-taking activities and employees,
and would include each unit generally understood
to be a single ‘‘trading desk.’’ For example, if a
banking entity has one set of employees engaged in
market making-related activities in the equities of
U.S. non-financial corporations, and another set of
employees engaged in market making-related
activities in the equities of U.S. financial
corporations, the two sets of employees would
appear to be part of a single trading unit if both sets
of employees structure and control their trading
activities together, making and executing highly
coordinated decisions about required risk levels,
inventory levels, sources of revenue growth and
similar features. On the other hand, if the risk
decisions and revenue strategies are considered and
executed separately by the two sets of employees,
with only loose coordination, they would appear to
be two distinct trading units. In determining
whether a set of employees constitute a single
trading unit, important factors would likely include
whether compensation is strongly linked to the
group’s performance, whether risk levels and
trading limits are managed and set jointly or
separately, and whether trades are booked together
or separately.
192 This latter prong of the definition has been
included to ensure that the Agencies have the
ability to require banking entities to report
quantitative measurements in other ways to prevent
a banking entity from organizing its trading
operations so as to undermine the effectiveness of
the reporting requirement.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
The definition of ‘‘trading unit’’ is
intended to capture multiple layers of a
banking entity’s organization structure,
including individual trading desks,
intermediate divisions that oversee a
variety of trading desks, and all trading
operations in the aggregate. As
described below, under the proposal,
the quantitative measurements specified
in section IV of proposed Appendix A
must be calculated and reported for
each such ‘‘trading unit.’’ Accordingly,
the definition of trading unit is
purposefully broad and captures
multiple levels of organization so as to
ensure that quantitative measurements
provide meaningful information, at both
a granular and aggregate level, to help
banking entities and the Agencies
evaluate the quantitative profile of
trading operations in a variety of
contexts.
The Agencies expect that the scope
and nature of trading units to which the
quantitative measurements are applied
would have an important impact on the
informational content and utility of the
resulting measurements. Applying a
quantitative measurement to a trading
unit at a level that aggregates a variety
of distinct trading activities may
obscure or ‘‘smooth’’ differences
between distinct lines of business, asset
categories and risk management
processes in a way that renders the
measurement relatively uninformative,
because it does not adequately reflect
the specific characteristics of the trading
activities being conducted. Similarly,
applying a quantitative measurement to
a trading unit at a highly granular level
could, if it captured only a narrow
portion of activity that is conducted as
part of a broader business strategy,
introduce meaningless ‘‘noise’’ into the
measure or result in a measurement that
is idiosyncratic in nature. This highly
granular application could render the
measurement relatively uninformative
because it would not accurately reflect
the entirety of the trading activities
being conducted. In order to address the
potential weaknesses of applying the
quantitative measurements at an
aggregate and a granular level,
respectively, the proposal requires
reporting at both levels. The
informational inputs required to
calculate any particular quantitative
measurement at either level are the
same. Consequently, it is expected that,
depending on the nature of the systems
of a particular institution, there may be
little, if any, incremental burden
associated with calculating and
reporting quantitative measurements at
multiple levels.
The Agencies request comment on the
proposed reporting requirements in
PO 00000
Frm 00041
Fmt 4701
Sfmt 4702
68885
Appendix A. In particular, the Agencies
request comment on the following
questions:
Question 155. Are the ways in which
the proposed rule would make use of
reported quantitative measurements
effective? If not, what uses would be
more effective? Should the proposed
rule instead use quantitative
measurements as a dispositive tool for
identifying prohibited proprietary
trading? If so, what types of quantitative
measurements should be employed,
what numerical amount would indicate
impermissible proprietary trading
activity, and why? Should the
quantitative measurements play a less
prominent role than proposed in
identifying prohibited proprietary
trading and why?
Question 156. Are the proposed
definitions of terms provided in
Appendix A effective? If not, how
should the definitions be amended?
Question 157. Is the proposed
definition of ‘‘trading unit’’ effective? Is
it sufficiently clear? If not, what
alternative definition would be more
effective and/or clearer? Should the
definition include more or less granular
levels of activity? If so, what specific
criteria should be used to determine the
appropriate level of granularity?
Question 158. If you are a banking
entity, how would your trading activity
be categorized, in terms of quantity and
type, under the proposed definition of
trading unit in Appendix A? For each
trading unit type, what categories of
quantitative measurements (e.g., riskmanagement measurements) or specific
quantitative measurements (e.g.,
Stressed Value-at-Risk (‘‘Stress VaR’’))
are best suited to assist in distinguishing
prohibited proprietary trading from
permitted trading activity?
Question 159. Is the proposed rule’s
requirement that quantitative
measurements be reported at multiple
levels of organization, including for
quantitative measurements historically
reported on an aggregate basis (e.g.,
Value-at-Risk (‘‘VaR’’) or Stress VaR)
appropriate? If not, what alternative
would be more effective? What burdens
are associated with such a requirement?
How might those burdens be reduced or
limited? Please quantify your answers,
to the extent feasible.
c. Proposed Appendix A—Scope of
Required Reporting
Part III of proposed Appendix A
defines the scope of the reporting
requirements. The proposed rule adopts
a tiered approach that requires banking
entities with the most extensive trading
activities to report the largest number of
quantitative measurements, while
E:\FR\FM\07NOP2.SGM
07NOP2
68886
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
banking entities with smaller trading
activities have fewer or no reporting
requirements. This tiered approach is
intended to reflect the heightened
compliance risks of banking entities
with extensive trading activities and
limit the regulatory burden imposed on
banking entities with relatively small or
no trading activities, which appear to
pose significantly less compliance risk.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Banking Entities With Gross Trading
Assets and Liabilities of $5 Billion or
More
For any banking entity that has,
together with its affiliates and
subsidiaries, trading assets and
liabilities the average gross sum of
which (on a worldwide consolidated
basis), as measured as of the last day of
each of the four prior calendar quarters,
equals or exceeds $5 billion, the
proposal would require the banking
entity to furnish quantitative
measurements for all trading units of the
banking entity engaged in trading
activity subject to §§ l.4, l.5, or l.6(a)
of the proposed rule (i.e., permitted
underwriting and market making-related
activity, risk-mitigated hedging, and
trading in certain government
obligations). The scope of data to be
furnished depends on the activity in
which the trading unit is engaged. First,
for the trading units of such a banking
entity that are engaged in market
making-related activity pursuant to
§ l.4(b) of the proposed rule, proposed
Appendix A requires that a banking
entity furnish seventeen quantitative
measurements.193 Second, all trading
units of such a banking entity engaged
in trading activity subject to §§ l.4(a),
l.5, or l.6(a) of the proposed rule
would be required to report five
quantitative measurements designed to
measure the general risk and
profitability of the trading unit.194 The
Agencies expect that each of these
general types of measurements will be
useful in assessing the extent to which
any permitted trading activity involves
exposure to high-risk assets or high-risk
trading strategies. These requirements
would apply to all type of trading units
engaged in underwriting and market
making-related activity, risk-mitigated
hedging, and trading in certain
government obligations. These
193 See proposed rule Appendix A.III.A. These
seventeen quantitative measurements are discussed
further below.
194 See proposed rule Appendix A.III.A. These
five quantitative measurements are: (i)
Comprehensive Profit and Loss; (ii) Comprehensive
Profit and Loss Attribution; (iii) VaR and Stress
VaR; (iv) Risk Factor Sensitivities; and (v) Risk and
Position Limits. Each of these and other
quantitative measurements discussed in proposed
Appendix A are discussed in detail below.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
additional measurements are designed
to help evaluate the extent to which the
quantitative profile of a trading unit’s
activities is consistent with permissible
market making-related activities.
Banking Entities With Gross Trading
Assets and Liabilities Between
$1 Billion and $5 Billion
For any banking entity that has,
together with its affiliates and
subsidiaries, trading assets and
liabilities the average gross sum of
which (on a worldwide consolidated
basis), as measured as of the last day of
each of the four prior calendar quarters,
equals or exceeds $1 billion but is less
than $5 billion, the proposal would
require quantitative measurements to be
furnished for trading units that are
engaged in market making-related
activity subject to § l.4(b) of the
proposed rule. Trading units of such
banking entities that are engaged in
market making-related activities must
report eight quantitative measurements
that are designed to help evaluate the
extent to which the quantitative profile
of a trading unit’s activities is consistent
with permissible market making-related
activities.195 The proposal applies a
smaller number of measurements to a
smaller universe of trading units for this
class of banking entities because they
are likely to pose lesser compliance risk
and fewer supervisory and examination
challenges. A less burdensome reporting
regime, coupled with other elements of
the proposal (e.g., the compliance
program requirement), is likely to be
equally as effective in ensuring
compliance with section 13 of the BHC
Act and the proposed rule for banking
entities with smaller trading operations.
Frequency of Calculation and Reporting
Section III.B of proposed Appendix A
specifies the frequency of required
calculation and reporting of quantitative
measurements. Under the proposed
rule, each required quantitative
measurement must be calculated for
each trading day. Required quantitative
measurements must be reported to the
relevant Agency on a monthly basis,
within 30 days of the end of the relevant
calendar month, or on such other
reporting schedule as the relevant
Agency may require. Section III.C of
proposed Appendix A requires a
195 See proposed rule Appendix A.III.A. These
eight quantitative measurements are (i)
Comprehensive Profit and Loss; (ii) Comprehensive
Profit and Loss Attribution; (iii) Portfolio Profit and
Loss; (iv) Fee Income and Expense; (v) Spread Profit
and Loss; (vi) VaR; (vii) Volatility of Comprehensive
Profit and Loss and Volatility of Portfolio Profit and
Loss; and (viii) Comprehensive Profit and Loss to
Volatility Ratio and Portfolio Profit and Loss to
Volatility Ratio.
PO 00000
Frm 00042
Fmt 4701
Sfmt 4702
banking entity to create and retain
records documenting the preparation
and content of any quantitative
measurement furnished by the banking
entity, as well as such information as is
necessary to permit the relevant Agency
to verify the accuracy of such
measurements, for a period of 5 years.
This would include records for each
trade and position.
Question 160. Is the proposed tiered
approach to identifying which banking
entities and trading units must comply
with the reporting requirements
effective? If not, what alternative would
be more effective? Does the proposal
strike the appropriate balance between
the potential benefits of the reporting
requirements for monitoring and
assuring compliance and the potential
costs of those reporting requirements? If
not, how could that balance be
improved? Should the relevant gross
trading assets and liabilities threshold
for any category be increased or
reduced? If so, why?
Question 161. Should the $1 billion
and $5 billion gross trading assets and
liabilities thresholds used to identify the
extent to which a banking entity is
required to furnish quantitative
measurements be increased or reduced?
If so, why? Should the thresholds be
indexed in some way to account for
fluctuations in capital markets activity
over time? If so, what would be an
appropriate method of indexation?
Question 162. Is the proposed
$5 billion trading asset and liability
threshold an appropriate standard for
triggering enhanced reporting
requirements under the proposed rule?
Why or why not? If not, what alternative
standard would be a better benchmark
for triggering enhanced reporting
requirements?
Question 163. Should the proposed
$5 billion trading and asset liability
threshold used for triggering enhanced
reporting requirements under the
proposed rule be subject to adjustment
over time? If so, how and when should
the numerical threshold be adjusted?
Question 164. Is there a different
criterion other than gross trading assets
and liabilities that would be more
appropriate for identifying banking
entities that must furnish quantitative
measurements? If so, what is the
alternative criterion, and why would it
be more appropriate? Are worldwide
gross trading assets and liabilities the
appropriate criterion for foreign-based
banking entities? If not, what alternative
criterion would be more appropriate,
and why?
Question 165. Are the quantitative
measurements specified for the various
types of banking entities and trading
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
units effective? If not, what alternative
set of measurements would be more
effective? For each type of trading unit,
does the proposal strike the appropriate
balance between the potential benefits
of the reporting requirements for
monitoring and assuring compliance
and the potential costs of those
reporting requirements? If not, how
could that balance be improved?
Question 166. Should banking entities
with gross trading assets and liabilities
between $1 billion and $5 billion also
be required to calculate and report some
of the quantitative measurements
proposed for banking entities meeting
the $5 billion threshold for purposes of
assessing whether the banking entity’s
underwriting, market making, riskmitigating hedging, and trading in
certain government obligations activities
involve a material exposure to high-risk
assets or high-risk trading strategies? If
so, which quantitative measurements
and why? If not, why not?
Question 167. Is the proposed
frequency of reporting effective? If not,
what frequency would be more
effective? Should the quantitative
measurements be required to be
reported quarterly, annually, or upon
the request of the applicable Agency
and why?
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
d. Proposed Appendix A—Quantitative
Measurements
Section IV of proposed Appendix A
describes, in detail, the individual
quantitative measurements that must be
furnished. These measurements are
grouped into the following five broad
categories, each of which is described in
more detail below:
• Risk-management measurements—
VaR, Stress VaR, VaR Exceedance, Risk
Factor Sensitivities, and Risk and
Position Limits;
• Source-of-revenue measurements—
Comprehensive Profit and Loss,
Portfolio Profit and Loss, Fee Income
and Expense, Spread Profit and Loss,
and Comprehensive Profit and Loss
Attribution;
• Revenues-relative-to-risk
measurements—Volatility of
Comprehensive Profit and Loss,
Volatility of Portfolio Profit and Loss,
Comprehensive Profit and Loss to
Volatility Ratio, Portfolio Profit and
Loss to Volatility Ratio, Unprofitable
Trading Days based on Comprehensive
Profit and Loss, Unprofitable Trading
Days based on Portfolio Profit and Loss,
Skewness of Portfolio Profit and Loss,
and Kurtosis of Portfolio Profit and
Loss;
• Customer-facing activity
measurements—Inventory Turnover,
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
Inventory Aging, and Customer-facing
Trade Ratio; and
• Payment of fees, commissions, and
spreads measurements—Pay-to-Receive
Spread Ratio.
The Agencies have proposed these
quantitative measurements because,
taken together, these measurements
appear useful for understanding the
context in which trading activities occur
and identifying activities that may
warrant additional scrutiny to
determine whether these activities
involve prohibited proprietary trading
because the trading activity either is
inconsistent with permitted market
making-related activities or presents a
material exposure to high-risk assets or
high-risk trading strategies. As
described below, different quantitative
measurements are proposed to identify
different aspects and characteristics of
trading activity for the purpose of
helping to identify prohibited
proprietary trading, and the Agencies
expect that the quantitative
measurements will be most useful for
this purpose when implemented and
reviewed collectively, rather than in
isolation. The Agencies believe that, in
the aggregate, many banking entities
already collect and review many of
these measurements as part of their risk
management activities, and expect that
many of the quantitative measurements
proposed would be readily computed
and monitored at the multiple levels of
organization that are included in
proposed Appendix A’s definition of
‘‘trading unit,’’ to which they would
apply.
The first set of quantitative
measurements relates to risk
management, and includes VaR, Stress
VaR, VaR Exceedance, Risk Factor
Sensitivities, and Risk and Position
Limits. These measurements are widely
used by banking entities to measure and
manage trading risks and activities. In
the case of VaR, Stress VaR, VaR
Exceedance, and Risk Factor
Sensitivities, these measures provide
internal, model-based assessments of
overall risk, stated in terms of large but
plausible losses that may occur or
changes in revenue that would be
expected to result from movements in
underlying risk factors. In the case of
Risk and Position Limits, the measure
provides an explicit assessment of
management’s expectation of how much
risk is required to perform permitted
market-making and hedging activities.
With the exception of Stress VaR, each
of these measurements are routinely
used to manage and control risk taking
activities, and are also used by some
banking entities for purposes of
calculating regulatory capital and
PO 00000
Frm 00043
Fmt 4701
Sfmt 4702
68887
allocating capital internally. In the
context of permitted market makingrelated activities, these risk management
measures are useful in assessing
whether the actual risk taken is
consistent with the level of principal
risk that a banking entity must retain in
order to service the near-term demands
of customers. Significant, abrupt or
inconsistent changes to key risk
management measures, such as VaR,
that are inconsistent with prior
experience, the experience of similarly
situated trading units and management’s
stated expectations for such measures
may indicate impermissible proprietary
trading. In addition, indicators of
unanticipated or unusual levels of risk
taken, such as a significant number of
VaR Exceedance or breaches of internal
Risk and Position Limits, may suggest
behavior that is inconsistent with
appropriate levels of risk and may
warrant further scrutiny.
The second set of quantitative
measurements relates to the source of
revenues, and includes Comprehensive
Profit and Loss, Portfolio Profit and
Loss, Fee Income, Spread Profit and
Loss, and Comprehensive Profit and
Loss Attribution. These measurements
are intended to capture the extent,
scope, and type of profits and losses
generated by trading activities and
provide important context for
understanding how revenue is generated
by trading activities. Because permitted
market making-related activities seek to
generate profits by providing customers
with intermediation and related services
while maintaining, and to the extent
practicable minimizing, the risks
associated with any asset or risk
inventory required to meet customer
demands, these revenue measurements
would appear to provide helpful
information to banking entities and the
Agencies regarding whether actual
revenues are consistent with these
expectations. The Agencies note that
although banking entities already
routinely calculate and analyze the
extent and source of revenues derived
from their trading activities, calculating
the proposed source of revenue
measurements according to the
specifications described in proposed
Appendix A may require banking
entities to implement new processes to
calculate and furnish the required data.
The third set of measurements relates
to realized risks and revenue relative to
realized risks, and includes Volatility of
Profit and Loss, Comprehensive Profit
and Loss to Volatility Ratio and
Portfolio Profit and Loss to Volatility
Ratio, Unprofitable Trading Days based
on Comprehensive Profit and Loss and
Unprofitable Trading Days based on
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68888
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Portfolio Profit and Loss, and Skewness
of Portfolio Profit and Loss and Kurtosis
of Portfolio Profit and Loss. These
measurements are intended to provide
banking entities and the Agencies with
ex post, data-based assessments of risk,
as a supplement to internal, modelbased assessments of risk, and give
further context around the riskiness of
underlying trading activities and the
profitability of these activities relative to
the risks taken. Some of these
measurements, such as the skewness
and kurtosis measurements, are
proposed in order to capture
asymmetric, ‘‘fat tail’’ risks that (i) are
not well captured by simple volatility
measures, (ii) may not be well captured
by internal risk measurement metrics,
such as VaR, and (iii) can be associated
with proprietary trading strategies that
seek to earn short-term profits by taking
exposures to these types of risks. The
Agencies expect that these realized-risk
and revenue-relative-to-realized-risk
measurements would provide
information useful in assessing whether
trading activities are producing
revenues that are consistent, in terms of
the degree of risk that is being assumed,
with typical market making-related
activities. Market making and related
activities seek to generate profitability
primarily by generating fees,
commissions, spreads and other forms
of customer revenue that are relatively,
though not completely, insensitive to
market fluctuations and generally result
in a high level of revenue relative to risk
over an appropriate time frame. In
contrast, proprietary trading strategies
seek to generate revenue primarily
through favorable changes in asset
valuations. The Agencies note that each
of the proposed measurements relating
to realized risks and revenues relative to
realized risks are generally consistent
with existing revenue, risk, and
volatility data routinely collected by
banking entities with large trading
operations or are simple, standardized
functions of such data.
The fourth set of quantitative
measurements relates to customer-facing
activity measurements, and includes
Inventory Risk Turnover, Inventory
Aging, and Customer-facing Trade Ratio.
These measurements are intended to
provide banking entities and Agencies
with meaningful information regarding
the extent to which trading activities are
directed at servicing the demands of
customers. Quantitative measurements
such as Inventory Risk Turnover and
Inventory Aging assess the extent to
which size and volume of trading
activity is aimed at servicing customer
needs, while the Customer-facing Trade
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
Ratio provides directionally useful
information regarding the extent to
which trading transactions are
conducted with customers. The
Agencies expect that these
measurements will be useful in
assessing whether permitted market
making-related activities are focused on
servicing customer demands. Although
the Agencies understand that banking
entities typically measure inventory
aging and turnover in the context of
cash instruments (e.g., equity and debt
securities), they note that applying these
measurements, as well as the Customerfacing Trade Ratio generally, would
require banking entities to implement
new processes to calculate and furnish
the related data.
The fifth set of quantitative
measurements relates to the payment of
fees, commissions, and spreads, and
includes the Pay-to-Receive Spread
Ratio. This measurement is intended to
measure the extent to which trading
activities generate revenues for
providing intermediation services,
rather than generate expenses paid to
other intermediaries for such services.
Because market making-related
activities ultimately focus on servicing
customer demands, they typically
generate substantially more fees,
spreads and other sources of customer
revenue than must be paid to other
intermediaries to support customer
transactions. Proprietary trading
activities, however, that generate almost
no customer facing revenue will
typically pay a significant amount of
fees, spreads and commissions in the
execution of trading strategies that are
expected to benefit from short-term
price movements. Accordingly, the
Agencies expect that the proposed Payto-Receive Spread Ratio measurement
will be useful in assessing whether
permitted market making-related
activities are primarily generating,
rather than paying, fees, spreads and
other transactional revenues or
expenses. A level of fees, commissions,
and spreads paid that is inconsistent
with prior experience, the experience of
similarly situated trading units and
management’s stated expectations for
such measures could indicate
impermissible proprietary trading.
For each individual quantitative
measurement, proposed Appendix A
describes the measurement, provides
general guidance regarding how the
measurement should be calculated
(where needed) and specifies the period
over which each calculation should be
made. The proposed quantitative
measurements attempt to incorporate,
wherever possible, measurements
already used by banking entities to
PO 00000
Frm 00044
Fmt 4701
Sfmt 4702
manage risks associated with their
trading activities. Of the measurements
proposed, the Agencies expect that a
large majority of measurements
proposed are either (i) already routinely
calculated by banking entities or (ii)
based solely on underlying data that are
already routinely calculated by banking
entities. However, calculating these
measurements according to the
specifications described in proposed
Appendix A and at the various levels of
organization mandated may require
banking entities to implement new
processes to calculate and furnish the
required data.
The extent of the burden associated
with calculating and reporting
quantitative measurements will likely
vary depending on the particular
measurements and differences in the
sophistication of management
information systems at different banking
entities. As noted, the proposal tailors
these data collections to the size and
type of activity conducted by each
banking entity in an effort to minimize
the burden in particular on firms that
engage in few or no trading activities
subject to the proposed rule.
The Agencies have also attempted to
provide, to the extent possible, a
standardized description and general
method of calculating each quantitative
measurement that, while taking into
account the potential variation among
trading practices and asset classes,
would facilitate reporting of sufficiently
uniform information across different
banking entities so as to permit
horizontal reviews and comparisons of
the quantitative profile of trading units
across firms.
The Agencies request comment on the
proposed quantitative measurements. In
particular, the Agencies request
comment on the following questions:
Question 168. Are the proposed
quantitative measurements appropriate
in general? If not, what alternative(s)
would be more appropriate, and why?
Should certain quantitative
measurements be eliminated, and if so,
why? Should additional quantitative
measurements be added? If so, which
measurements and why? How would
those additional measurements be
described and calculated?
Question 169. How many of the
proposed quantitative measurements do
banking entities currently utilize? What
are the current benefits and costs
associated with calculating such
quantitative measurements? Would the
reporting and recordkeeping
requirements proposed in Appendix A
for such quantitative measurements
impose any significant, additional
benefits or costs?
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Question 170. Which of the proposed
quantitative measurements do banking
entities currently not utilize? What are
the potential benefits and costs to
calculating these quantitative
measurements and complying with the
proposed reporting and recordkeeping
requirements? Please quantify your
answers, to the extent feasible.
Question 171. Is the scope and
frequency of required reporting
appropriate? If not, what alternatives
would be more appropriate? What
burdens would be associated with
reporting quantitative measurements on
that basis, and how could those burdens
be reduced or eliminated in a manner
consistent with the purpose and
language of the statute? Please quantify
your answers, to the extent feasible.
Question 172. For each of the
categories of quantitative measurements
(e.g., quantitative measurements relating
to risk management), what factors
should be considered in order to further
refine the proposed category of
quantitative measurements to better
distinguish prohibited proprietary
trading from permitted trading activity?
For example, should the timing of a
calculation be considered significant in
certain contexts (e.g., should specific
quantitative measurements be
calculated during the middle of a
trading day instead of the end of the
day)? Please quantify your answers, to
the extent feasible.
Question 173. In light of the size,
scope, complexity, and risk of covered
trading activities, do commenters
anticipate the need to hire new staff
with particular expertise in order to
calculate the required quantitative
measurements (e.g., collect data and
make computations)? Do commenters
anticipate the need to develop
additional infrastructure to obtain and
retain data necessary to compute the
proposed quantitative measurements?
Please explain and quantify your
answers, to the extent feasible.
Question 174. For each individual
quantitative measurement that is
proposed:
• Is the use of the quantitative
measurement to help distinguish
between permitted and prohibited
trading activities effective? If not, what
alternative would be more effective?
Does the quantitative measurement
provide any additional information of
value relative to other quantitative
measurements proposed?
• Is the use of the quantitative
measurement to help determine whether
an otherwise-permitted trading activity
is consistent with the requirement that
such activity must not result, directly or
indirectly, in a material exposure by the
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
banking entity to high-risk assets and
high-risk trading strategies effective? If
not, what alternative would be more
effective?
• What factors should be considered
in order to further refine the proposed
quantitative measurement to better
distinguish prohibited proprietary
trading from permitted trading activity?
For example, should the timing of a
calculation be considered significant in
certain contexts (e.g., should specific
quantitative measurements be
calculated during the middle of a
trading day instead of at the end of the
day)?
• If the quantitative measurement is
proposed to be applied to a trading unit
that is engaged in activity pursuant to
§§ l.4(a), l.5, or l.6(a) of the
proposed rule, is the quantitative
measurement calculable in relation to
such activity? Is the quantitative
measurement useful for determining
whether underwriting, risk-mitigating
hedging, or trading in certain
government obligations is resulting,
directly or indirectly, in a material
exposure by the banking entity to highrisk assets or high-risk trading
strategies?
• Is the description of the quantitative
measurement sufficiently clear? What
alternative would be more appropriate
or clearer? Is the description of the
quantitative measurement appropriate,
or is it overly broad or narrow? If it is
overly broad, what additional
clarification is needed? Should the
Agencies provide this additional
clarification in the appendix’s
description of the quantitative
measurement? If the description is
overly narrow, how should it be
modified to appropriately describe the
quantitative measurement, and why?
• Is the general calculation guidance
effective and sufficiently clear? If not,
what alternative would be more
effective or clearer? Is more or less
specific calculation guidance necessary?
If so, what level of specificity is needed
to calculate the quantitative
measurement? What are the different
calculation options and methodologies
that could be used to reach the desired
level of specificity? What are the costs
and benefits of these different options?
If the proposed calculation guidance is
not sufficiently specific, how should the
calculation guidance be modified to
reach the appropriate level of
specificity? For example, rather than
provide this level of specificity in
proposed Appendix A, should the
Agencies instead make each banking
entity responsible for determining the
best method of calculating the
quantitative measurement at this level
PO 00000
Frm 00045
Fmt 4701
Sfmt 4702
68889
of specificity, based on the banking
entity’s business and profile, which
would then be subject to supervision,
review, or examination by the relevant
Agency? If the proposed calculation
guidance is overly specific, why is it too
specific and how should the guidance
be modified to reach the appropriate
level of specificity?
• Is the general calculation guidance
for the measurement consistent with
how banking entities currently calculate
the quantitative measurement, if they do
so? If not, how does the proposed
guidance differ from methodology
currently used by banking entities?
What is the purpose of the current
calculation methodology used by
banking entities?
• What operational or logistical
challenges might be associated with
performing the calculation of the
quantitative measurement and obtaining
any necessary informational inputs?
• Is the quantitative measurement not
calculable for any specific type of
trading unit? If so, what type of trading
unit, and why is the quantitative
measurement not calculable for that
type of trading unit? Is there an
alternative quantitative measurement
that would reflect the same trading
activity but not pose the same
calculation difficulty? Are there
particular challenges to documenting
that a specific quantitative measurement
is not calculable?
• Is the quantitative measurement
substantially likely to frequently
produce false negatives or false
positives that suggest that prohibited
proprietary trading is occurring when it
is not, or vice versa? If so, why? If so,
what alternative quantitative
measurement would better help identify
prohibited proprietary trading?
• Should the quantitative
measurement better account for
distinctions among trading activities,
trading strategies, and asset classes? If
so, how? For example, should the
quantitative measurements better
account for distinctions between trading
activities in cash and derivatives
markets? If so, how? Are there any other
distinctions for which the quantitative
measurements may need to account? If
so, what distinctions, and why?
• Does the quantitative measurement
provide useful information as applied to
all types of trading activities, or only a
certain subset of trading activities? If it
only provides useful information for a
subset of trading activities, how should
this issue be addressed? How beneficial
is the information that the quantitative
measurement provides for this subset of
trading activities? Do any of the other
quantitative measurements provide the
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68890
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
same level of beneficial information for
this subset of trading activities? Should
the quantitative measurement be
required to be reported for all trading
activities, only a relevant subset of
trading activities, or not at all?
• Does the quantitative measurement
provide useful information as applied to
all asset classes, or only a certain subset
of asset classes? If it only provides
useful information for a subset of asset
classes, how should this issue be
addressed? How beneficial is the
information the quantitative
measurement provides for this subset of
asset classes? Do any of the other
quantitative measurements provide the
same level of beneficial information for
this subset of asset classes? Should the
quantitative measurement be required to
be reported for all asset classes, only a
relevant subset of asset classes, or not at
all?
• Is the calculation period effective
and sufficiently clear? If not, what
alternative would be more effective or
clearer?
• How burdensome and costly would
it be to calculate the measurement at the
specified calculation frequency and
calculation period? Are there any
difficulties or costs associated with
calculating the measurement for
particular trading units? How significant
are those potential costs relative to the
potential benefits of the measurement in
monitoring for impermissible
proprietary trading? Are there potential
modifications that could be made to the
measurement that would reduce the
burden or cost? If so, what are those
modifications? Please quantify your
answers, to the extent feasible.
Question 175. In light of the size,
scope, complexity, and risk of covered
trading activities, are there certain types
of quantitative measurements that will
not be appropriate for some types of
banking entities, desks, or levels? If so,
would it be appropriate to require only
certain quantitative measurements for
such banking entities, desks, or levels?
Question 176. How might the number
of quantitative measurements impact
behavior of banking entities? Is there a
cost of requiring more quantitative
measurements, such as the cost of
increased uncertainty regarding the
combined results of such quantitative
measurements? To what extent and in
what ways might uncertainty as to how
the quantitative measurements are
applied and evaluated impact behavior?
Proposed Appendix B—Commentary
Regarding Identification of Permitted
Market Making-Related Activities
Proposed Appendix B provides
commentary that is intended to assist a
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
banking entity in distinguishing
permitted market making-related
activities from trading activities that,
even if conducted in the context of a
banking entity’s market making
operations, would constitute prohibited
proprietary trading. As noted in Part I of
proposed Appendix B, the commentary
applies to all banking entities that are
engaged in market making-related
activities in reliance on § l.4(b) of the
proposed rule. Part II of proposed
Appendix B clarifies that all defined
terms used in Appendix B have the
meaning given those terms in §§ l.2
and l.3 of the proposed rule and
Appendix A.
The commentary regarding
identification of permitted market
making-related activities, which is
contained in Part III of proposed
Appendix B, includes three principal
components. The first component
provides an overview of market makingrelated activities and describes, in
detail, typical practices in which market
makers engage and typical
characteristics of market making-related
activities, articulating the general
framework within which the Agencies
view market making-related
activities.196 For example, the
commentary provides that market
making-related activities, in the context
of a banking entity acting as principal,
generally involve either (i) in the case of
market making in a security that is
executed on an organized trading
facility or exchange, passively providing
liquidity by submitting resting orders
that interact with the orders of others on
an organized trading facility or
exchange and acting as a registered
market maker, where such exchange or
organized trading facility provides the
ability to register as a market maker, or
(ii) in other cases, providing an
intermediation service to its customers
by assuming the role of a counterparty
that stands ready to buy or sell a
position that the customer wishes to sell
or buy. The second component of the
commentary provides an overview of
prohibited proprietary trading activities,
which describes the general framework
within which the Agencies view
prohibited proprietary trading and
contrasts that activity to the practices
and characteristics of market makingrelated activities.197 The third
component describes certain challenges
that arise in distinguishing permitted
196 See proposed rule Appendix B, § III.A. The
practices and characteristics that are described
generally reinforce and augment the specific
requirements that a banking entity must meet in
order to rely on the market-making exemption
under § ll.4(b) of the proposed rule.
197 See proposed rule Appendix B, § III.B.
PO 00000
Frm 00046
Fmt 4701
Sfmt 4702
market making-related activities and
prohibited proprietary trading,
particularly in cases in which both of
these activities occur within the context
of a market making operation,198 and
proposes guidance that the Agencies
would apply in distinguishing
permitted market making-related
activities from prohibited proprietary
trading. This guidance includes six
factors that would cause a banking
entity to be considered, absent
explanatory circumstances, to be
engaged in prohibited proprietary
trading, and not permitted market
making-related activity. The six factors
are:
• Trading activity in which a trading
unit retains risk in excess of the size and
type required to provide intermediation
services to customers; 199
• Trading activity in which a trading
unit primarily generates revenues from
price movements of retained principal
positions and risks, rather than
customer revenues;
• Trading activity in which a trading
unit: (i) Generates only very small or
very large amounts of revenue per unit
of risk taken; (ii) does not demonstrate
consistent profitability; or (iii)
demonstrates high earnings volatility;
• Trading activity in which a trading
unit either (i) does not transact through
a trading system that interacts with
orders of others or primarily with
customers of the banking entity’s market
making desk to provide liquidity
services, or (ii) holds principal positions
in excess of reasonably expected near
term customer demands;
• Trading activity in which a trading
unit routinely pays rather than earns
fees, commissions, or spreads; and
198 See proposed rule Appendix B, § III.C.
Proposed Appendix B notes, for example, that it
may be difficult to distinguish (i) inventory
positions that appropriately support market
making-related activities from (ii) positions taken
for proprietary purposes. See id.
199 For simplicity and ease of reading, the
Agencies have used the term ‘‘customer’’
throughout the discussion of market making-related
activity. However, as discussed in proposed
Appendix B, a market maker’s ‘‘customers’’
generally vary depending on the asset class and
market in which the market maker is providing
intermediation services. In the context of market
making in a security that is executed on an
organized trading facility or an exchange, a
‘‘customer’’ is any person on behalf of whom a buy
or sell order has been submitted by a broker-dealer
or any other market participant. In the context of
market making in a covered financial position in an
over-the-counter market, a ‘‘customer’’ generally
would be a market participant that makes use of the
market maker’s intermediation services, either by
requesting such services or entering into a
continuing relationship with the market maker with
respect to such services. In certain cases, depending
on the conventions of the relevant market (e.g., the
over-the-counter derivatives market), such a
‘‘customer’’ may consider itself or refer to itself
more generally as a ‘‘counterparty.’’
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
• The use of compensation incentives
for employees of a particular trading
activity that primarily reward
proprietary risk-taking.200
The proposed commentary makes
clear that the enumerated factors are
subject to certain facts and
circumstances that may explain why a
trading activity may meet one or more
factors but does not involve prohibited
proprietary trading, and provides a
range of examples of such explanatory
facts and circumstances.201 The
Agencies emphasize that these examples
are not meant to be exhaustive, as a
variety of other circumstances may exist
to explain why a particular trading
activity, even if meeting one of the
factors, may nonetheless be a permitted
market making-related activity.202
In addition, for each of these six
factors, the proposed rule provides
general guidance as to (i) the types of
facts and circumstances on which the
relevant Agency may base any
determination that a banking entity’s
trading activity met the relevant factor
and (ii) which quantitative
measurements, if furnished by a banking
entity pursuant to Appendix A, the
relevant Agency would use to help
assess the extent to which a banking
entity’s activities met the relevant
factor.
The Agencies request comment on the
proposed commentary regarding
identification of permitted market
making-related activities. In particular,
the Agencies request comment on the
following questions:
Question 177. Is the overview of
permitted market making-related
activities and prohibited proprietary
trading proposed in Appendix B
accurate? If not, what alternative
overview would be more accurate? Does
the overview appropriately account for
differences in market making-related
activities across different asset classes?
If not, which type of market makingrelated activity does the overview not
sufficiently describe or account for?
Question 178. Is the requirement that
a market maker engaged in market
making that is executed on an exchange
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
200 See
proposed rule Appendix B, § III.C.1–6.
The Agencies note that each of these six criteria is
directly related to the overview of market makingrelated activities provided in section III.A. of
proposed Appendix B.
201 The proposed commentary does not
contemplate explanatory facts and circumstances
for the compensation incentives factor, given that
the choice of compensation incentives provided to
trading personnel is under the full control of the
banking entity.
202 The Agencies also note that, although a
particular trading activity may not meet the
requirements applicable to permitted market
making-related activities, it may still be exempt
under another available exemption.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
or an organized trading facility must be
a registered market maker, provided the
relevant exchange or organized trading
facility provides the ability to register,
appropriate, or is it over- or underinclusive? Please discuss and provide
detailed examples of any such markets
where registering as a market maker is
not feasible or should not be required
for purposes of this rule, and
unregistered market makers provide
similar services or perform similar
functions.
Question 179. With respect to market
making that is executed on an exchange
or an organized trading facility, what
potential impact or unintended
consequences might result from limiting
the market making exemption to
registered market makers when the
relevant exchange or organized trading
facility registers market makers? Would
such a requirement result in any
potential decrease in the passive
provision of liquidity by the submission
of resting orders? Do you anticipate that
any such decrease would be exacerbated
in times of market stress? If yes, please
describe the impact on liquidity and the
marketplace in general. Please discuss
whether and how any potential decrease
in liquidity could be mitigated. In
addition, would such a requirement
result in additional costs that would be
borne by market participants purchasing
and selling on an exchange or organized
trading facility? Please identify and
discuss any other additional costs.
Please discuss whether and how any
such consequences can be mitigated.
Question 180. In addition to benefits
discussed in the Supplementary
Information, are there other benefits that
would be achieved by requiring that a
market maker be registered with respect
to market making on an exchange or an
organized trading facility? Is there a way
to amplify these benefits? Could these
benefits be realized through alternative
means? If so, how?
Question 181. In addition to
registered market makers on exchanges
or organized trading facilities, what
other classes of liquidity providers
exist? Are their obligations and
activities similar to, or different than
those of registered market makers? If so,
how? Are the compensated in a different
manner?
Question 182. How much liquidity is
provided by registered market makers
versus other liquidity providers by asset
class (e.g., equities, etc.) with respect to
trading on an exchange or an organized
trading facility? The Agencies encourage
commenters to provide data in support
of comments.
Question 183. Is there any specific
element of market making-related
PO 00000
Frm 00047
Fmt 4701
Sfmt 4702
68891
activity that the overview does not take
into account in its description of market
making? If so, how should the overview
account for this element? Are there any
descriptions of market making-related
activity in the overview that should not
be considered to be market makingrelated activity? If so, why? Is there any
specific element of prohibited
proprietary trading activity that the
overview does not take into account in
its description of prohibited proprietary
trading? If so, how should the overview
account for this element? Are there any
descriptions of prohibited proprietary
trading activity in the overview that
should not be considered to be
prohibited proprietary trading? If so,
why?
Question 184. Are each of the six
factors specified for helping to
distinguish permitted market makingrelated activity from prohibited
proprietary trading appropriate? If not,
how should they be changed, and why?
Should any factors be eliminated or
added? If so, which ones and why?
Could any of the proposed factors occur
as a result of the banking entity
engaging in one of the other permitted
activities (e.g., underwriting, trading on
behalf of customers)? If so, would the
facts and circumstances that the
Agencies propose to consider be
sufficient to determine and verify that
the banking entity is not engaged in
prohibited proprietary trading? If not,
how should this issue be addressed?
Question 185. Are the facts and
circumstances that would be used to
determine whether a banking entity’s
activities satisfy a certain factor
appropriate? If not, how should they be
changed, and why? Should any be
eliminated or added? If so, which ones,
and why?
Question 186. Are the identified
quantitative measurements that the
Agencies would use to help assess a
particular factor appropriate? If not,
how should they be changed, and why?
Should any be eliminated or added? If
so, which ones, and why?
f. Incorporation of Numerical
Thresholds in the Commentary
Regarding Identification of Permitted
Market Making-Related Activities
As noted above, the Agencies are
currently requesting comment on
whether to incorporate, as part of the
proposed rule, numerical thresholds for
certain quantitative measurements, and
if so, how to do so. For example, the
proposed rule could include one or
more numerical thresholds that, if met
by a banking entity, would require the
banking entity to review its trading
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68892
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
activities for compliance and summarize
that review to the relevant Agency.
The primary purpose of using some
form of threshold would be to provide
banking entities with a clear standard
regarding trading activity that presented
a quantitative profile sufficiently
questionable to warrant further review
and explanation to the relevant Agency.
Such clarity would appear to provide
significant benefits both to banking
entities in conducting their trading
activities in conformance with the
proposed rule and to Agencies in
monitoring trading activities and
obtaining additional, more detailed
information in circumstances
warranting closer scrutiny. In addition
to the benefits of transparency,
thresholds would also encourage
consistent review by banking entities
and the Agencies of transactions, both
within a banking entity and across all
banking entities. The purpose of such
thresholds would not be to serve as
bounds of permitted conduct or as a
comprehensive, dispositive tool for
determining whether prohibited
proprietary trading has occurred.
Numerical thresholds have not been
included in the proposed rule because
the Agencies believe that public
comment and further review is
warranted before numerical thresholds
and specific numerical amounts may be
proposed. Instead, the Agencies request
comment on whether such thresholds
would be desirable and, if so, what
particular form such thresholds should
take and what specific numerical
thresholds would be appropriate. To
facilitate the comment process, this
request for comment includes a number
of illustrative examples of numerical
thresholds on which specific comment
is sought.
In particular, the Agencies request
comment on the following questions:
Question 187. What are the potential
benefits and costs of incorporating into
the proposed rule one or more
numerical thresholds for certain
quantitative measurements that, if
reported by a banking entity, would
require the banking entity to review its
trading activities for compliance and
summarize that review to the relevant
Agency? Would such thresholds provide
useful clarity to banking entities and/or
market participants regarding the types
of trading activities that merit additional
scrutiny? Should numerical thresholds
be used for any purposes other than
highlighting trading activities that
should be reviewed, the results of which
would be reported to the relevant
Agency? If so, for what purpose, and
how and why?
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
Question 188. For which of the
relevant quantitative measurements
might it be appropriate and effective to
include a numerical threshold that
would trigger banking entity review and
explanation? How should a numerical
threshold be formulated, and why?
Should a numerical threshold for a
single quantitative measurement be
applied individually, or should the
threshold instead be triggered by
exceeding some combination of
numerical thresholds for different
measurements? For any particular
threshold, what numerical amount
should be used, and why? How would
such numerical amount be consistent
with a level at which further review and
explanation is warranted? Should the
amount vary by asset class or other
characteristic? If so, how?
Question 189. For each of the
following illustrative examples of
potential thresholds, is the threshold
formulated effectively? If not, what
alternative formulation would be more
effective? Should the threshold
formulation vary by asset class or other
characteristic? If so, how and why? If
the threshold was utilized, what actual
numerical amount should be specified,
and why? How would such numerical
amount be consistent with a level at
which further review and explanation is
warranted? Should the numerical
amount vary by asset class or other
characteristic? If so, how and why?
• ‘‘If a trading unit reports an increase
in VaR, Stress VaR, or Risk Factor
Sensitivities greater than [l] over a
period of [l] months, or such other
threshold as [Agency] may require, the
banking entity must (i) promptly review
and investigate the trading unit’s
activities to verify whether the trading
unit is operating in compliance with the
proprietary trading restrictions and (ii)
report to [Agency] a summary of such
review, including any explanatory
circumstances.’’
• ‘‘If a trading unit reports an average
Comprehensive Profit and Loss that is
less than [l] times greater than the
Portfolio Profit and Loss, exclusive of
Spread Profit and Loss, for [l]
consecutive months, or such other
threshold as [Agency] may require, the
banking entity must (i) promptly review
and investigate the trading unit’s
activities to verify whether the trading
unit is operating in compliance with the
proprietary trading restrictions and (ii)
report to [Agency] a summary of such
review, including any explanatory
circumstances.’’
• ‘‘If a trading unit reports a
Comprehensive Profit and Loss to
Volatility Ratio that is less than [l]
times greater than that trading desk’s
PO 00000
Frm 00048
Fmt 4701
Sfmt 4702
Portfolio Profit and Loss to Volatility
Ratio over a period of [l] months, or
such other threshold as [Agency] may
require, the banking entity must (i)
promptly review and investigate the
trading unit’s activities to verify
whether the trading unit is operating in
compliance with the proprietary trading
restrictions and (ii) report to [Agency] a
summary of such review, including any
explanatory circumstances.’’
• ‘‘If a trading unit reports a number
of Unprofitable Trading Days Based on
Portfolio Profit and Loss that is less than
[l] greater than the number of
Unprofitable Trading Days Based on
Comprehensive Profit and Loss for [l]
consecutive months, or such other
threshold as [Agency] may require, the
banking entity must (i) promptly review
and investigate the trading unit’s
activities to verify whether the trading
unit is operating in compliance with the
proprietary trading restrictions and (ii)
report to [Agency] a summary of such
review, including any explanatory
circumstances.’’
• ‘‘If a trading unit reports a Pay-toReceive Spread Ratio that is less than
[l] over a period of [l] months, or
such other threshold as [Agency] may
require, the banking entity must (i)
promptly review and investigate the
trading unit’s activities to verify
whether the trading unit is operating in
compliance with the proprietary trading
restrictions and (ii) report to [Agency] a
summary of such review, including any
explanatory circumstances.’’
6. Section l.8: Limitations on
Permitted Trading Activities
Section l.8 of the proposed rule
implements section 13(d)(2) of the BHC
Act, which places certain limitations on
the permitted trading activities (e.g.,
permitted market making-related
activities, risk-mitigating hedging, etc.)
in which a banking entity may
engage.203 Consistent with the statute,
§ l.8(a) of the proposed rule provides
that no transaction, class of transactions,
or activity is permissible under §§ l.4
through l.6 of the proposed rule if the
transaction, class of transactions, or
activity would:
• Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
• Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
• Pose a threat to the safety and
soundness of the banking entity or U.S.
financial stability.
203 See
E:\FR\FM\07NOP2.SGM
12 U.S.C. 1851(d)(2).
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
The proposed rule further defines
‘‘material conflict of interest,’’ ‘‘highrisk asset,’’ and ‘‘high-risk trading
strategy’’ for these purposes.
a. Scope of ‘‘Material Conflict of
Interest’’
Section l.8(b) of the proposed rule
defines the scope of material conflicts of
interest which, if arising in connection
with a permitted trading activity, are
prohibited under the proposal.204
Conflicts of interest may arise in a
variety of circumstances related to
permitted trading activities. For
example, a banking entity may acquire
substantial amounts of nonpublic
information about the financial
condition of a particular company or
issuer through its lending, underwriting,
investment advisory or other activities
which, if improperly transmitted to and
used in trading operations, would
permit the banking entity to use such
information to its customers’, clients’ or
counterparties’ disadvantage. Similarly,
a banking entity may conduct a
transaction that places the banking
entity’s own interests ahead of its
obligations to its customers, clients or
counterparties, or it may seek to gain by
treating one customer involved in a
transaction more favorably than another
customer involved in that transaction.
Concerns regarding conflicts of interest
are likely to be elevated when a
transaction is complex, highly
structured or opaque, involves illiquid
or hard-to-value instruments or assets,
requires the coordination of multiple
internal groups (such as multiple
trading desks or affiliated entities), or
involves a significant asymmetry of
information or transactional data among
participants.205 In all cases, the
existence of a material conflict of
interest depends on the specific facts
and circumstances.
To address these types of material
conflicts of interest, § l.8(b) of the
proposed rule specifies that a material
conflict of interest between a banking
entity and its clients, customers, or
counterparties exists if the banking
entity engages in any transaction, class
of transactions, or activity that would
involve or result in the banking entity’s
interests being materially adverse to the
interests of its client, customer, or
counterparty with respect to such
204 Section l.17(b) of the proposed rule defines
the scope of material conflicts of interest which, if
arising in connection with permitted covered fund
activities, are prohibited.
205 See, e.g., U.S. Senate Permanent
Subcommittee on Investigations, Wall Street and
the Financial Crisis: Anatomy of a Financial
Collapse (Apr. 13, 2011), available at http://
hsgac.senate.gov/public/_files/Financial_Crisis/
FinancialCrisisReport.pdf.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
transaction, class of transactions, or
activity, unless the banking entity has
appropriately addressed and mitigated
the conflict of interest, where possible,
and subject to specific requirements
provided in the proposal, through either
(i) timely and effective disclosure, or (ii)
informational barriers.206 Unless the
conflict of interest is addressed and
mitigated in one of the two ways
specified in the proposal, the related
transaction, class of transactions or
activity would be prohibited under the
proposed rule, notwithstanding the fact
that it may be otherwise permitted
under §§ l.4 through l.6 of the
proposed rule.207
However, while these conflicts may
be material for purposes of the proposed
rule, the mere fact that the buyer and
seller are on opposite sides of a
transaction and have differing economic
interests would not be deemed a
‘‘material’’ conflict of interest with
respect to transactions related to bona
fide underwriting, market making, riskmitigating hedging or other permitted
activities, assuming the activities are
conducted in a manner that is consistent
with the proposed rule and securities
and banking laws and regulations.
Section l.8(b)(1) of the proposed rule
describes the two requirements that
must be met in cases where a banking
entity addresses and mitigates a material
conflict of interest through timely and
effective disclosure. First, § l.8(b)(1)(i)
of the proposed rule requires that the
banking entity, prior to effecting the
specific transaction or class or type of
transactions, or engaging in the specific
activity, for which a conflict may arise,
make clear, timely, and effective
disclosure of the conflict or potential
conflict of interest, together with any
other necessary information.208 This
would also require such disclosure to be
proposed rule § l.8(b)(1).
Agencies note that a banking entity
subject to Appendix C must implement a
compliance program that includes, among other
things, policies and procedures that explain how
the banking entity monitors and prohibits conflicts
of interest with clients, customers, and
counterparties. Further, as noted in the discussion
of the definition of ‘‘material conflict of interest’’ in
Part III.B.6 of this Supplemental Information, the
discussion of that definition is provided solely for
purposes of the proposed rule’s definition of
material conflict of interest, and does not affect the
scope of that term in other contexts or a banking
entity’s obligation to comply with additional or
different requirements with respect to a conflict
under applicable securities, banking, or other laws
(e.g., section 27B of the Securities Act, which
governs conflicts of interest relating to certain
securitizations; section 206 of the Investment
Advisers Act of 1940, which applies to conflicts of
interest between investment advisers and their
clients; or 12 CFR 9.12, which applies to conflicts
of interest in the context of a national bank’s
fiduciary activities).
208 See proposed rule § l.8(b)(1)(A).
206 See
207 The
PO 00000
Frm 00049
Fmt 4701
Sfmt 4702
68893
provided in reasonable detail and in a
manner sufficient to permit a reasonable
client, customer, or counterparty to
meaningfully understand the conflict of
interest.209 Disclosure that is only
general or generic, rather than specific
to the individual, class, or type of
transaction or activity, or that omits
details or other information that would
be necessary to a reasonable client’s,
customer’s, or counterparty’s
understanding of the conflict of interest,
would not meet this standard. Second,
§ l.8(b)(1)(ii) of the proposed rule
requires that the disclosure be made
explicitly and effectively, and in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
mitigate, any materially adverse effect
on the client, customer, or counterparty
that was created or would be created by
the conflict or potential conflict.210
The Agencies note that, in order to
provide the requisite opportunity for the
client, customer or counterparty to
negate or substantially mitigate the
disadvantage created by the conflict, the
disclosure would need to be provided
sufficiently close in time to the client’s,
customer’s, or counterparty’s decision to
engage in the transaction or activity to
give the client, customer, or
counterparty an opportunity to
meaningfully evaluate and, if necessary,
take steps that would negate or
substantially mitigate the conflict.
Disclosure provided far in advance of
the individual, class, or type of
transaction, such that the client,
customer, or counterparty is unlikely to
take that disclosure into account when
evaluating a transaction, would not
suffice. Conversely, disclosure provided
without a sufficient period of time for
the client, customer, or counterparty to
evaluate and act on the information it
receives, or disclosure provided after
the fact, would also not suffice under
the proposal. The Agencies note that the
proposed definition would not prevent
or require disclosure with respect to
transactions or activities that align the
interests of the banking entity with its
clients, customers, or counterparties or
that otherwise do not involve ‘‘material’’
conflicts of interest as discussed above.
The proposed disclosure standard
reflects the fact that some types of
conflicts may be appropriately resolved
through the disclosure of clear and
meaningful information to the client,
customer, or counterparty that provides
such party with an informed
opportunity to consider and negate or
substantially mitigate the conflict.
209 See
210 See
E:\FR\FM\07NOP2.SGM
id.
proposed rule § l.8(b)(1)(B).
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68894
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
However, in the case of a conflict in
which a client, customer, or
counterparty does not have sufficient
information and opportunity to negate
or mitigate the materially adverse effect
on the client, customer, or counterparty
created by the conflict, the existence of
that conflict of interest would prevent
the banking entity from availing itself of
any exemption (e.g., the underwriting or
market-making exemptions) with
respect to the relevant transaction, class
of transactions, or activity. The
Agencies note that the proposed
disclosure provisions are provided
solely for purposes of the proposed
rule’s definition of material conflict of
interest, and do not affect a banking
entity’s obligation to comply with
additional or different disclosure or
other requirements with respect to a
conflict under applicable securities,
banking, or other laws (e.g., section 27B
of the Securities Act, which governs
conflicts of interest relating to certain
securitizations; section 206 of the
Investment Advisers Act of 1940, which
governs conflicts of interest between
investment advisers and their clients; or
12 CFR 9.12, which applies to conflicts
of interest in the context of a national
bank’s fiduciary activities).
Section l.8(b)(2) of the proposed rule
describes the requirements that must be
met in cases where a banking entity uses
information barriers that are reasonably
designed to prevent a material conflict
of interest from having a materially
adverse effect on a client, customer or
counterparty. Information barriers can
be used to restrict the dissemination of
information within a complex
organization and to prevent material
conflicts by limiting knowledge and
coordination of specific business
activities among units of the entity.
Examples of information barriers
include, but are not limited to,
restrictions on information sharing,
limits on types of trading, and greater
separation between various functions of
the firm. Information barriers may also
require that banking entity units or
affiliates have no common officers or
employees. Such information barriers
have been recognized in Federal
securities laws and rules as a means to
address or mitigate potential conflicts of
interest or other inappropriate
activities.211
211 For example, information barriers have been
used in complying with the requirement in section
15(g) of the Exchange Act that registered brokers
and dealers establish, maintain and enforce written
policies and procedures reasonably designed, taking
into consideration the nature of such broker’s or
dealer’s business, to prevent the misuse of material,
nonpublic information by such broker or dealer or
any person associated with such broker or dealer.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
In order to address and mitigate a
conflict of interest through the use of
the information barriers pursuant to
§ l.8(b)(2) of the proposed rule, a
banking entity would be required to
establish, maintain, and enforce
information barriers that are
memorialized in written policies and
procedures, including physical
separation of personnel, functions, or
limitations on types of activity, that are
reasonably designed, taking into
consideration the nature of the banking
entity’s business, to prevent the conflict
of interest from involving or resulting in
a materially adverse effect on a client,
customer or counterparty.212
Importantly, the proposed rule also
provides that, notwithstanding a
banking entity’s establishment of such
information barriers, if the banking
entity knows or should reasonably know
that a material conflict of interest arising
out of a specific transaction, class or
type of transactions, or activity may
involve or result in a materially adverse
effect on a client, customer, or
counterparty, the banking entity may
not rely on those information barriers to
address and mitigate any conflict of
interest. In such cases, the transaction or
activity would be prohibited, unless the
banking entity otherwise complies with
the requirements of § l.8(b)(1).213 This
aspect of the proposal is intended to
make clear that, in specific cases in
which a banking entity has established
an information barrier but knows or
should reasonably know that it has
failed or will fail to prevent a conflict
of interest arising from a specific
transactions or activity that
disadvantages a client, customer, or
counterparty, the information barrier is
insufficient to address that conflict and
the transaction would be prohibited,
unless the banking entity is otherwise
able to address and mitigate the conflict
proposed rule § l.8(b)(2). As part of
maintaining and enforcing information barriers, a
banking entity should have processes to review,
test, and modify information barriers on a
continuing basis. In addition, banking entities
should have ongoing monitoring to maintain and to
enforce information barriers, for example by
identifying whether such barriers have not
prevented unauthorized information sharing and
addressing instances in which the barriers were not
effective. This may require both remediating any
identified breach as well as updating the
information barriers to prevent further breaches, as
necessary. Periodic assessment of the effectiveness
of information barriers and periodic review of the
written policies and procedures are also important
to the maintenance and enforcement of effective
information barriers and reasonably designed
policies and procedures. Such assessments can be
done either (i) internally by a qualified employee
or (ii) externally by a qualified independent party.
213 See proposed rule § l.8(b)(2).
212 See
PO 00000
Frm 00050
Fmt 4701
Sfmt 4702
through timely and effective disclosure
under the proposal.214
The Agencies note that the proposed
definition of material conflict of interest
does not address instances in which a
banking entity has made a material
misrepresentation to its client,
customer, or counterparty in connection
with a transaction, class of transactions,
or activity, as such transactions or
activity appears to involve fraud rather
than a conflict of interest. However, the
Agencies note that such
misrepresentations are generally illegal
under a variety of Federal and State
regulatory schemes (e.g., the Federal
securities laws). In addition, the
Agencies note that any activity
involving a material misrepresentation
to, or other fraudulent conduct with
respect to, a client, customer, or
counterparty would not be permitted
under the proposed rule in the first
instance. For example, a trading activity
involving a material misrepresentation
to a client, customer, or counterparty
would fail, on its face, to satisfy the
proposed terms of the underwriting or
market-making exemption.
b. Definition of ‘‘High-Risk Asset’’ and
‘‘High-Risk Trading Strategy’’
Section l.8(c) of the proposed rule
defines ‘‘high-risk asset’’ and ‘‘high-risk
trading strategy’’ for proposes of § l.8’s
proposed limitations on permitted
trading activities. Section l.8(c)(1)
defines a ‘‘high-risk asset’’ as an asset or
group of assets that would, if held by
the banking entity, significantly increase
the likelihood that the banking entity
would incur a substantial financial loss
or would fail. Section l.8(c)(2) defines
a ‘‘high-risk trading strategy’’ as a
trading strategy that would, if engaged
in by the banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would fail.215
c. Request for Comment
The Agencies request comment on the
proposed limitations on permitted
trading activities. In particular, the
214 In addition, if a conflict occurs to the
detriment of a client, customer, or counterparty
despite an information barrier, the Agencies would
also expect the banking entity to review the
effectiveness of its information barrier and make
adjustments, as necessary, to avoid future
occurrences, or review whether such information
barrier is appropriate for that type of conflict.
215 The Agencies note that a banking entity
subject to proposed Appendix C must implement a
compliance program that includes, among other
things, policies and procedures that explain how
the banking entity monitors and prohibits exposure
to high-risk assets and high-risk trading strategies,
and identifies a variety of assets and strategies (e.g.,
assets or strategies with significant embedded
leverage).
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Agencies request comment on the
following questions:
Question 190. Is the manner in which
the proposed rule implements the
limitations of section 13(d)(2) of the
BHC Act effective and sufficiently clear?
If not, what alternative would be more
effective and/or clearer?
Question 191. Is the proposed rule’s
definition of material conflict of interest
effective and sufficiently clear? If not,
what alternative would be more
effective and/or clearer?
Question 192. Is the proposed
definition of material conflict of interest
over-or under-inclusive? If so, how
should the definition be broader or
narrower? Is there an alternative
definition that would be appropriate? If
so, what definition? Why would that
alternative definition better define
material conflict of interest for purposes
of implementing section 13 of the BHC
Act?
Question 193. Would the proposed
definition of material conflict of interest
have any unintended chilling effect on
underwriting, market making, riskmitigating hedging or other permitted
activities? If so, what alternatives might
limit such an effect?
Question 194. Would the proposed
definition of material conflict of interest
lead to unintended consequences? If so,
what unintended consequences and
why? Please suggest modifications to
the proposed definition that would
mitigate those consequences.
Question 195. Is it likely that the
proposed definition of material conflict
of interest would anticipate all future
material conflicts of interest,
particularly as the financial markets
evolve and change? If not, what
alternative definition would better
anticipate future material conflicts of
interest?
Question 196. Does the proposed rule
provide sufficient guidance for
determining when a material conflict of
interest exists? If not, what additional
detail should be provided? Should the
Agencies adopt an approach similar to
that under the securities laws, in which
a material conflict of interest is not
specifically defined?
Question 197. Are there transactions,
classes or types of transactions, or
activities inherent in underwriting,
market-making, risk-mitigating hedging
or other permitted activities that should
not be prohibited but may be captured
by the proposed definition of material
conflict of interest? If so, what
transactions and activities? Should they
be permitted under the proposed rule?
If so, why and under what conditions,
if any? Conversely, are there
transactions or activities that would be
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
permitted under the proposed rule that
should be prohibited? If so, what
transactions and activities? Why should
they be prohibited under the proposed
rule?
Question 198. Please discuss the
inherent conflicts of interest that arise
from bona fide underwriting, market
making-related activity, risk-mitigating
hedging, or any other permitted activity,
and provide specific examples of such
inherent conflicts. Do you believe that
such conflicts ever result in a materially
adverse interest between a banking
entity and a client, customer, or
counterparty? How should the proposal
address inherent conflicts that result
from otherwise-permitted activities?
Question 199. Is the manner in which
the proposed rule permits the use of
disclosure in certain cases to address
and mitigate conflicts of interest
appropriate? Why or why not? Should
additional or alternative requirements
be placed on the use of disclosure to
address and mitigate conflicts? If so,
what additional and alternative
requirements, and why? Is the level of
detail and specificity required by the
proposed rule with respect to disclosure
appropriate? If not, what alternative
level of detail and specificity would be
more appropriate?
Question 200. Should the proposed
rule require written disclosure to a
client, customer, or counterparty
regarding a material conflict of interest?
If so, please explain why written
disclosure should be required. Are there
certain circumstances where written
disclosure should be required, but
others where oral disclosure should be
sufficient? For example, should oral
disclosure be permitted for transactions
in certain fast-moving markets or
transactions with sophisticated clients,
customers, or counterparties? If oral
disclosure is permitted under certain
circumstances, should subsequent
written disclosure be required? Please
explain.
Question 201. Should the proposed
rule provide further detail regarding the
types of conflicts of interest that cannot
be addressed and mitigated through
disclosure? If so, what type of additional
detail would be helpful, and why?
Should the proposed rule enumerate an
exhaustive or non-exhaustive list of
conflicts that cannot be addressed and
mitigated through disclosure? If so,
what conflicts should that list include,
and why?
Question 202. Should the proposed
rule provide further detail regarding the
frequency at which disclosure must be
made? Should general disclosure be
permitted for certain types of
transactions, classes of transactions, or
PO 00000
Frm 00051
Fmt 4701
Sfmt 4702
68895
activities? For example, should a
banking entity be permitted to make a
one-time, written disclosure to a client,
customer, or counterparty prior to
engaging in a certain type of transaction
or activity? Should general disclosure be
permitted for certain types of clients,
customers, or counterparties (e.g.,
highly sophisticated parties)? Please
explain why specific disclosure (i.e.,
prior to each transaction, class of
transaction, or activity) would not be
necessary under the identified
circumstances. Are there any clients,
customers, or counterparties that should
be able to waive a material conflict of
interest under certain circumstances? If
so, under what circumstances would a
waiver approach be appropriate and
consistent with the statute? Please
explain.
Question 203. Should the proposed
definition of material conflict of interest
deem certain potential conflicts of
interest to not be material conflicts of
interest if a banking entity establishes,
maintains, and enforces policies and
procedures (other than information
barriers) reasonably designed to prevent
transactions, classes of transactions, or
activities that would involve or result in
a material conflict of interest? If so, for
what types of potential conflicts? What
policies and procedures would be
appropriate? How would this approach
be consistent with the purpose and
language of the statute? Should such
policies and procedures only be
considered effective if they prevent the
banking entity from receiving an
advantage to the disadvantage of the
client, customer, or counterparty?
Question 204. Are there any particular
types of clients, customers, or
counterparties for whom disclosure of a
material conflict of interest should not
be required under the proposal,
consistent with the statute? Please
identify the types of clients, customers,
or counterparties for whom disclosure
might not be necessary and explain.
Why might disclosures be useful for
some clients, customers, or
counterparties, but not others? Please
explain. What characteristics should a
firm use in determining whether or not
a client, customer, or counterparty
needs a particular disclosure?
Question 205. Are there additional
steps that a banking entity that seeks to
manage conflicts of interest through the
use of disclosure should be required to
take with regard to disclosure? If so,
what steps?
Question 206. Are there
circumstances in which disclosure
might be impracticable or ineffective? If
so, what circumstances, and why?
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68896
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Question 207. Is the manner in which
the proposed rule permits the use of
information barriers to address and
mitigate conflicts of interest
appropriate? Why or why not? Should
additional or alternative requirements
be placed on the use of information
barriers to address and mitigate
conflicts? If so, what additional and
alternative requirements, and why?
Question 208. Should the proposed
rule mandate the use of other means of
managing potential conflicts of interest?
If so, what specific means should be
considered? How effective are any such
methods as currently used? Can such
methods be circumvented? If so, in what
ways?
Question 209. What burdens or costs
might be associated with the disclosurerelated or information barrier-related
requirements contained in the proposed
definition of material conflict of
interest? How might these burdens or
costs be eliminated or reduced in a
manner consistent with the purpose and
language of section 13 of the BHC Act?
Question 210. Are there specific
transactions, classes of transactions or
activities that should be managed
through consent? If so, what
transactions or activities, and why?
What form of consent should be
required? What level of detail should
any such consent include? Should
consent only apply to certain conflicts
and not others? If so, which conflicts?
Are there circumstances in which
obtaining consent might be
impracticable or ineffective? Should
consent be limited to certain types of
clients, customers, or counterparties? If
so, which clients, customers, or
counterparties? Are there certain types
of clients, customers, or counterparties
for whom consent would never be
sufficient? Are there additional steps
that a banking entity that seeks to
manage conflicts of interest through the
use of consent should be required to
take? Please specify such steps.
Question 211. What is the potential
relationship between, and interplay of,
the proposed rule and Section 621 of the
Dodd-Frank Act regarding conflicts of
interest relating to certain
securitizations which contains a
prohibition on material conflicts of
interest?
Question 212. Should the proposed
rule provide for specific types of
procedures that would be more effective
in managing and mitigating conflicts of
interest than others? Do banking entities
currently use certain procedures that
effectively manage and mitigate material
conflicts of interest? If so, please
describe such procedures and explain
why such procedures are effective. Is
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
the proposed rule consistent with such
procedures? Why or why not? What are
the costs and benefits of modifying your
current procedures in response to the
proposed rule?
Question 213. Is the proposed rule’s
definition of a high-risk asset effective
and sufficiently clear? If not, what
alternative would be more effective and/
or clearer? Should the proposed rule
specify particular assets that are deemed
high-risk per se? If so, what assets and
why?
Question 214. Is the proposed rule’s
definition of a high-risk trading strategy
effective and sufficiently clear? If not,
what alternative would be more
effective and/or clearer? Should the
proposed rule specify particular trading
strategies that are deemed high-risk per
se? If so, what trading strategies and
why?
C. Subpart C—Covered Fund Activities
and Investments
As noted above, except as otherwise
permitted, section 13(a)(1)(B) of the
BHC Act prohibits a banking entity from
acquiring or retaining any ownership in,
or acting as sponsor to, a covered
fund.216 Subpart C of the proposed rule
applies those portions of section 13 of
the BHC Act that operate as a
prohibition or restriction on a banking
entity’s ability, as principal, directly or
indirectly, to acquire or retain an
ownership interest in, act as sponsor to,
or have certain relationships with, a
covered fund. Subpart C also
implements the permitted activity and
investment authorities provided for
under section 13(d)(1) of the BHC Act
related to covered fund activities and
investments, as well as the rule of
construction related to the sale and
securitization of loans under section
13(g)(2) of that Act. Additionally,
subpart C contains a discussion of the
internal controls, reporting and
recordkeeping requirements applicable
to covered fund activities and
investments, and incorporates by
reference the minimum compliance
standards for banking entities contained
in subpart D of the proposed rule, as
well as Appendix C, to the extent
applicable.
1. Section l.10: Prohibition of
Acquisition or Retention of Ownership
Interests in, and Certain Relationships
With, a Covered Fund
Section l.10 of the proposed rule
defines the scope of the prohibition on
acquisition or retention of ownership
interests in, and certain relationships
with, a covered fund, as well as defines
216 See
PO 00000
12 U.S.C. 1851(a)(1)(B).
Frm 00052
Fmt 4701
Sfmt 4702
a number of key terms related to such
prohibition.
a. Prohibition Regarding Covered Fund
Activities and Investments
Section l.10(a) of the proposed rule
implements section 13(a)(1)(B) of the
BHC Act and prohibits a banking entity
from, as principal, directly or indirectly,
acquiring or retaining an equity,
partnership, or other ownership interest
in, or acting as sponsor to, a covered
fund, unless otherwise permitted under
subpart C of the proposed rule.217 This
prohibition reflects the statute’s purpose
and effect of limiting a banking entity’s
ability to invest in or have exposure to
a covered fund.
The Agencies note that the general
prohibition in § l.10(a) of the proposed
rule applies solely to a banking entity’s
acquisition or retention of an ownership
interest in or acting as sponsor to a
covered fund ‘‘as principal, directly or
indirectly.’’ 218 As such, the proposed
rule would not prohibit the acquisition
or retention of an ownership interest
(including a general partner or
membership interest) in a covered fund:
(i) By a banking entity in good faith in
a fiduciary capacity, except where such
ownership interest is held under a trust
that constitutes a company as defined in
section (2)(b) of the BHC Act; (ii) by a
banking entity in good faith in its
capacity as a custodian, broker, or agent
for an unaffiliated third party; (iii) by a
‘‘qualified plan,’’ as that term is defined
in section 401 of the Internal Revenue
Code of 1956 (26 U.S.C. 401), if the
ownership interest would be attributed
to a banking entity solely by operation
of section 2(g)(2) of the BHC Act; or (iv)
by a director or employee of a banking
entity who acquires the interest in his
or her personal capacity and who is
directly engaged in providing advisory
or other services to the covered fund,
unless the banking entity, directly or
indirectly, extended credit for the
purpose of enabling the director or
employee to acquire the ownership
interest in the fund and the credit was
used to acquire such ownership interest
in the fund.
Among other things, § l.10(b) of the
proposed rule defines the term ‘‘covered
fund.’’ 219 This definition explains the
universe of entities to which the
proposed rule § l.10(a).
Agencies note that this language is
intended to prevent a banking entity from evading
the restrictions contained in section 13(a)(1)(B) of
the BHC Act on acquiring or retaining an ownership
interest in a covered fund.
219 See proposed rule § l.10(b)(1). The term
banking entity, which is discussed above in Part
III.A.2 of this Supplementary Information, is
defined in § l.2(e).
217 See
218 The
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
prohibition contained in § l.10(a)
applies unless the activity is specifically
permitted under an available exemption
contained in subpart C of the proposed
rule. Other related terms, including
‘‘ownership interest,’’ ‘‘prime brokerage
transaction,’’ ‘‘sponsor,’’ and ‘‘trustee,’’
are in turn defined in §§ l.10(b)(2)
through l.10(b)(6) of the proposed rule.
b. ‘‘Covered Fund’’ and Related
Definitions
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
i. Definition of ‘‘Covered Fund’’
Section 13(h)(2) of the BHC Act
defines the terms ‘‘hedge fund’’ and
‘‘private equity fund’’ to mean ‘‘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,’’ or such similar
funds as the Agencies may by rule
determine.220 Given that the statute
defines a ‘‘hedge fund’’ and ‘‘private
equity fund’’ synonymously, the
proposed rule implements this statutory
definition by combining the terms into
the definition of a ‘‘covered fund.’’ 221
Sections 3(c)(1) and 3(c)(7) of the
Investment Company Act are exclusions
from the definition of ‘‘investment
company’’ in that Act and are
commonly relied on by a wide variety
of entities that would otherwise be
covered by the broad definition of
‘‘investment company’’ contained in
that Act. As a result, the statutory
definition in section 13(h)(2) of the BHC
Act could potentially include within its
scope many entities and corporate
structures that would not usually be
thought of as a ‘‘hedge fund’’ or ‘‘private
equity fund.’’ For instance, joint
ventures, acquisition vehicles, certain
wholly-owned subsidiaries, and other
widely-utilized corporate structures
typically rely on the exclusion
contained in section 3(c)(1) or 3(c)(7) of
the Investment Company Act. These
types of entities are generally not used
to engage in investment or trading
activities. Additionally, as noted in Part
II.G of this Supplementary Information,
certain securitization vehicles may be
included in this definition.
220 12 U.S.C. 1851(h)(2). Sections 3(c)(1) and
3(c)(7) of the Investment Company Act, in relevant
part, provide two exclusions from the definition of
‘‘investment company’’ for, as appropriate, (1) any
issuer whose outstanding securities are beneficially
owned by not more than one hundred persons and
which is not making and does not presently
propose to make a public offering of its securities
(other than short-term paper), or (2) any issuer, the
outstanding securities of which are owned
exclusively by persons who, at the time of
acquisition of such securities, are qualified
purchasers, and which is not making and does not
at that time proposes to make a public offering of
such securities. See 15 U.S.C. 80a–3(c)(1) and (c)(7).
221 See proposed rule § l.10(b)(1).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
The proposed rule follows the scope
of the statutory definition by covering
an issuer only if it 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.222
Additionally, the proposed rule
incorporates the statutory application of
the rule to ‘‘such similar funds as the
Agencies may determine by rule as
provided in section 13(b)(2) of the BHC
Act.’’ 223 The Agencies have proposed to
include as ‘‘similar funds’’ a commodity
pool,224 as well as the foreign equivalent
of any entity identified as a ‘‘covered
fund.’’ 225 These entities have been
included in the proposed rule as
‘‘similar funds’’ given that they are
generally managed and structured
similar to a covered fund, except that
they are not generally subject to the
Federal securities laws due to the
instruments in which they invest or the
fact that they are not organized in the
United States or one or more States.
ii. Definition of ‘‘Ownership Interest’’
The proposed rule defines
‘‘ownership interest’’ in order to make
clear the scope of section 13(a)(1)(B) of
the BHC Act and § l.10(a)’s prohibition
on a banking entity acquiring or
retaining any equity, partnership, or
other ownership interest in a covered
fund. The definition of ownership
interest includes a description of what
222 See proposed rule § l.10(b)(1)(i). Under the
proposed rule, if an issuer (including an issuer of
asset-backed securities) may rely on another
exclusion or exemption from the definition of
‘‘investment company’’ under the Investment
Company Act other than the exclusions contained
in section 3(c)(1) or 3(c)(7) of that Act, it would not
be considered a covered fund, as long as it can
satisfy all of the conditions of an alternative
exclusion or exemption for which it is eligible.
223 12 U.S.C. 1851(b)(2).
224 ‘‘Commodity pool’’ is defined in the
Commodity Exchange Act to mean any investment
trust, syndicate, or similar form of enterprise
operated for the purpose of trading in commodity
interests, including any: (i) Commodity for future
delivery, security futures product, or swap; (ii)
agreement, contract, or transaction described in
section 2(c)(2)(C)(i) or 2(c)(2)(D)(i) of the
Commodity Exchange Act; (iii) commodity option
authorized under section 4c of the Commodity
Exchange Act; or (iv) leverage transaction
authorized under section 23 of the Commodity
Exchange Act. See 7 U.S.C. 1a(10).
225 See proposed rule § l.10(b)(1)(iii). The
proposed rule makes clear that any issuer, as
defined in section 2(a)(22) of the Investment
Company Act, (15 U.S.C. 80a–2(a)(22)), that is
organized or offered outside of the United States,
would qualify as a covered fund if, were it
organized or offered under the laws, or offered for
sale or sold to a resident, of the United States or
of one or more States, it would be either: (i) An
investment company, as defined in the Investment
Company Act, but for section 3(c)(1) or 3(c)(7) of
that Act; (ii) a commodity pool; or (iii) any such
similar fund as the appropriate Federal banking
agencies, the SEC, and the CFTC may determine, by
rule, as provided in section 13(b)(2) of the BHC Act.
PO 00000
Frm 00053
Fmt 4701
Sfmt 4702
68897
interests constitute an ownership
interest, as well as an exclusion from
the definition of ownership interest for
carried interest.226 The proposed rule
defines ownership interest to mean,
with respect to a covered fund, any
equity, partnership, or other similar
interest (including, without limitation, a
share, equity security, warrant, option,
general partnership interest, limited
partnership interest, membership
interest, trust certificate, or other similar
interest) in a covered fund, whether
voting or nonvoting, as well as any
derivative of such interest. 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. To the extent
that a debt security or other interest of
a covered fund exhibits substantially the
same characteristics as an equity or
other ownership interest (e.g., provides
the holder with 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), the Agencies
could consider such instrument an
ownership interest as an ‘‘other similar
instrument.’’
Many banking entities that serve as
investment adviser or commodity
trading advisor to a covered fund are
compensated for services they provide
to the fund through receipt of so-called
‘‘carried interest.’’ In recognition of the
manner in which such compensation is
traditionally provided, the proposed
rule also clarifies that an ownership
interest with respect to a covered fund
does not include an interest held by a
banking entity (or an affiliate, subsidiary
or employee thereof) in a covered fund
for which the banking entity (or an
affiliate, subsidiary or employee thereof)
serves as investment manager,
investment adviser or commodity
trading advisor, so long as: (i) The sole
purpose and effect of the interest is to
allow the banking entity (or the affiliate,
subsidiary or employee thereof) to share
in the profits of the covered fund as
performance compensation for services
provided to the covered fund by the
banking entity (or the affiliate,
subsidiary or employee thereof),
provided that the banking entity (or the
affiliate, subsidiary or employee thereof)
may be obligated under the terms of
such interest to return profits previously
received; (ii) all such profit, once
allocated, is distributed to the banking
entity (or the affiliate, subsidiary or
226 See
E:\FR\FM\07NOP2.SGM
proposed rule § l.10(b)(3).
07NOP2
68898
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
employee thereof) promptly after being
earned or, if not so distributed, the
reinvested profit of the banking entity
(or the affiliate, subsidiary or employee
thereof) does not share in the
subsequent profits and losses of the
covered fund; (iii) the banking entity (or
the affiliate, subsidiary or employee
thereof) does not provide funds to the
covered fund in connection with
acquiring or retaining this carried
interest; and (iv) the interest is not
transferable by the banking entity (or the
affiliate, subsidiary or employee thereof)
except to an affiliate or subsidiary.227
The proposed rule therefore permits a
banking entity to receive an interest as
performance compensation for services
provided by it or one of its affiliates,
subsidiaries, or employees to a covered
fund, but only if the enumerated
conditions are met.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
iii. Definition of ‘‘Prime Brokerage
Transaction’’
Section 13(f)(3) of the BHC Act
permits a banking entity to enter into a
prime brokerage transaction with a
covered fund in which a covered fund
managed, organized, or sponsored by
such banking entity (or an affiliate or
subsidiary thereof) has taken an
ownership interest.228 However, section
13 of the BHC Act does not define what
qualifies as a prime brokerage
transaction. In order to provide clarity
regarding the types of services and
relationships that are permitted as a
prime brokerage transaction, the
proposed rule defines a ‘‘prime
brokerage transaction’’ to mean one or
more products or services provided by
a banking entity to a covered fund, such
as custody, clearance, securities
borrowing or lending services, trade
execution, or financing, data,
operational, and portfolio management
support.229
iv. Definition of ‘‘Sponsor’’ and
‘‘Trustee’’
The proposed rule defines ‘‘sponsor’’
in the same manner as section 13(h)(5)
of the BHC Act.230 Section l.10(b)(5) of
the proposed rule defines the term
‘‘sponsor’’ as an entity that: (i) Serves as
a general partner, managing member,
trustee, or commodity pool operator of
a covered fund; (ii) in any manner
selects or controls (or has employees,
officers, or directors, or agents who
constitute) a majority of the directors,
trustees, or management of a covered
fund; or (iii) shares with a covered fund,
proposed rule § l.10(b)(3)(ii).
12 U.S.C. 1851(f)(3).
229 See proposed rule § l.10(b)(4).
230 See 12 U.S.C. 1851(h)(5).
227 See
for the corporate, marketing,
promotional, or other purposes, the
same name or a variation of the same
name.231
The definition of ‘‘sponsor’’ contained
in section 13(h)(5) of the BHC Act
focuses on the ability to control the
decision-making and operational
functions of the fund. In keeping with
this focus, the proposed rule defines the
term ‘‘trustee’’ (which is a part of the
definition of ‘‘sponsor’’) to exclude
trustee that does not exercise
investment discretion with respect to a
covered fund, including a directed
trustee, as that term is used in section
403(a)(1) of the Employee’s Retirement
Income Security Act (29 U.S.C.
1103(a)(1)). The proposed rule provides
that a ‘‘trustee’’ includes any banking
entity that directs a directed trustee, or
any person who possesses authority and
discretion to manage and control the
assets of the covered fund.232
v. Request for Comment
The Agencies request comment on the
proposed rule’s approach to defining the
terms covered fund, ownership interest,
and other related terms. In particular,
the Agencies request comment on the
following questions:
Question 215. Is the proposed rule’s
approach to applying section 13 of the
BHC Act’s restrictions related to covered
fund activities and investments to those
instances where a banking entity acts
‘‘as principal or beneficial owner’’
effective? If not, why? What alternative
approach might be more effective in
light of the language and purpose of the
statute?
Question 216. Does the proposed rule
effectively address the circumstances
under which an investment by a
director or employee of a banking entity
in a covered fund would be attributed
to a banking entity? If not, why? What
alternative might be more effective?
Question 217. Does the proposed
rule’s definition of ‘‘covered fund’’
effectively implement the statute? What
alternative definitions might be more
effective in light of the language and
purpose of the statute?
Question 218. Is specific inclusion of
commodity pools within the definition
of ‘‘covered fund’’ effective and
consistent with the language and
purpose of the statute? Why or why not?
Question 219. The proposed
definition of ‘‘sponsor’’ focuses on ‘‘the
ability to control the decision-making
and operational functions of the fund.’’
In the securitization context, is this an
appropriate manner to determine the
228 See
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
231 See
232 See
PO 00000
proposed rule § l.10(b)(5).
proposed rule § l.10(b)(6)(ii).
Frm 00054
Fmt 4701
Sfmt 4702
identity of the sponsor? If not, what
factors should be used to determine the
identity of the sponsor in the
securitization context for purposes of
the proposed rule and why? Is the
definition of ‘‘sponsor’’ set forth in the
SEC’s Regulation AB 233 an appropriate
party to treat as sponsor for purposes of
the proposed rule? Is additional
guidance necessary with respect to how
the proposed definition of ‘‘sponsor’’
should be applied to a securitization
transaction?
Question 220. Should the application
of the proposed definition of ‘‘sponsor’’
mean that the servicer or investment
manager in a securitization transaction
would be considered the sponsor for
purposes of the proposed rule? What
impact would this interpretation of the
proposed definition have on existing
securitizations?
Question 221. Should the definition
of ‘‘covered fund’’ focus on the
characteristics of an entity rather than
whether it would be an investment
company but for section 3(c)(1) or
3(c)(7) of the Investment Company Act?
If so, what characteristics should be
considered and why? Would a
definition focusing on an entity’s
characteristics rather than its form be
consistent with the language and
purpose of the statute?
Question 222. Instead of adopting a
unified definition of ‘‘covered fund’’ for
those entities included under section
13(h)(2) of the BHC Act, should the
Agencies consider having separate
definitions for ‘‘hedge fund’’ and
‘‘private equity fund’’? If so, which
definitions and why?
Question 223. Should the Agencies
consider using the authority provided
under section 13(d)(1)(J) of the BHC Act
to exempt the acquisition or retention of
an ownership interest in a covered fund
with certain attributes or characteristics,
including, for example: (i) A
performance fee or allocation to an
investment manager’s equity account
calculated by taking into account
income and realized and unrealized
gains; (ii) borrowing an amount in
excess of one-half of its total capital
commitments or has gross notional
exposure in excess of twice its total
capital commitments; (iii) sells
securities or other assets short; (iv) has
restricted or limited investor
redemption rights; (v) invests in public
and non-public companies through
privately negotiated transactions
resulting in private ownership of the
business; (vi) acquires the unregistered
equity or equity-like securities of such
companies that are illiquid as there is
233 See
E:\FR\FM\07NOP2.SGM
17 CFR 229.1101(l).
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
no public market and third party
valuations are not readily available; (vii)
requires holding those investments
long-term; (viii) has a limited duration
of ten years or less; or (ix) returns on
such investments are realized and the
proceeds of the investments are
distributed to investors before the
anticipated expiration of the fund’s
duration? Which, if any, of these
characteristics are appropriate to
describe a hedge fund or private equity
fund that should be considered a
covered fund for purposes of this rule?
Are there any other characteristics that
would be more appropriate to describe
a covered fund? If so, which
characteristics and why?
Question 224. Is specific inclusion of
certain non-U.S. entities as a ‘‘covered
fund’’ under § l.10(b)(1)(iii) of the
proposed rule necessary, or would such
entities already be considered to be a
‘‘covered fund’’ under § l.10(b)(1)(i) of
the proposed rule? If so, why? Does the
proposed rule’s language on non-U.S.
entities correctly describe those nonU.S. entities, if any, that should be
included in the definition of ‘‘covered
fund’’? Why or why not? What
alternative language would be more
effective? Should we define non-U.S.
funds by reference to the following
structural characteristics: whether they
are limited in the number or type of
investors; whether they operate without
regard to statutory or regulatory
requirements relating to the types of
instruments in which they may invest or
the degree of leverage they may incur?
Why or why not?
Question 225. Are there any entities
that are captured by the proposed rule’s
definition of ‘‘covered fund,’’ the
inclusion of which does not appear to
be consistent with the language and
purpose of the statute? If so, which
entities and why?
Question 226. Are there any entities
that are not captured by the proposed
rule’s definition of ‘‘covered fund,’’ the
exclusion of which does not appear to
be consistent with the language and
purpose of the statute? If so, which
entities and why?
Question 227. Do the proposed rule’s
definitions of ‘‘covered fund’’ and/or
‘‘ownership interest’’ pose unique
concerns or challenges to issuers of
asset-backed securities and/or
securitization vehicles? If so, why? Do
certain types of securitization vehicles
(trusts, LLCs, etc.) typically issue assetbacked securities which would be
included in the proposed definition of
ownership interest? What would be the
impact of the application of the
proposed rules to these securitization
vehicles? Are certain asset classes
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
(collateralized debt obligations, future
flows, corporate debt repackages, etc.)
more likely to be impacted by the
proposed definition of ‘‘covered fund’’
because the issuer cannot rely on an
exemption other than 3(c)(1) or 3(c)(7)
of the Investment Company Act?
Question 228. How many existing
issuers of asset-backed securities would
be included in the proposed definition
of ‘‘covered fund?’’ What would be the
legal and economic impact of the
proposed rule on holders of assetbacked securities issued by existing
securitization vehicles that would be
included in the proposed definition of
covered fund?
Question 229. Are there entities that
issue asset-backed securities (as defined
in Section 3(a) of the Exchange Act) that
should be exempted from the
requirements of the proposed rule? How
would such an exemption promote and
protect the safety and soundness of the
banking entity and the financial stability
of the United States as required by
section 13(d)(1)(J) of the BHC Act?
Question 230. Since certain existing
asset-backed securities may have a term
that exceeds the conformance or
extended transition periods provided for
under section 13(c) of the BHC Act,
should the Agencies consider using the
authority contained in section
13(d)(1)(J) of that Act to exclude those
existing asset-backed securities from the
proposed definition of ‘‘ownership
interest’’ and/or should the rule permit
a banking entity to acquire or retain an
ownership interest in existing assetbacked issuers? If so, how would either
approach be consistent with the
language and purpose of the statute?
Question 231. Many issuers of assetbacked securities have features and
structures that resemble some of the
features of hedge funds and private
equity funds (e.g., CDOs are managed by
an investment adviser that has the
discretion to choose investments,
including investments in securities). If
the proposed definition of ‘‘covered
fund’’ were to exempt any entity issuing
asset-backed securities, would this
allow for interests in hedge funds or
private equity funds to be structured as
asset-backed securities and circumvent
the proposed rule? If this approach is
taken, how should the proposal address
this concern?
Question 232. Are the structural
similarities between an entity that
issues asset-backed securities and hedge
funds and private equity funds of
sufficient concern that the Agencies
should not exclude any entity that
issues asset-backed securities from the
definition of covered fund?
PO 00000
Frm 00055
Fmt 4701
Sfmt 4702
68899
Question 233. Should entities that
rely on a separate exclusion from the
definition of investment company other
than sections 3(c)(1) or 3(c)(7) of the
Investment Company Act be included in
the definition of ‘‘covered fund’’? Why
or why not?
Question 234. Do the proposed rule’s
definitions of ‘‘ownership interest’’ and
‘‘carried interest’’ effectively implement
the statute? What alternative definitions
might be more appropriate in light of
the language and purpose of the statute?
Are there other types of instruments that
should be included or excluded from
the definition of ‘‘ownership interest’’?
Does the proposed definition of
ownership interest capture most
interests that are typically viewed as
ownership interests? Is the proposed
rule’s exemption of carried interest from
the definition of ownership interest
with respect to a covered fund
appropriate? Does the exemption
adequately address existing
compensation arrangements and the
way in which a banking entity becomes
entitled to carried interest? Is it
consistent with the current tax
treatment of these arrangements?
Question 235. In the context of assetbacked securities, the distinction
between debt and equity may be
complicated (e.g., trust certificates
issued in a residential mortgage backed
security transaction) and the legal,
accounting and tax treatment may differ
for the same instrument. Is guidance
necessary with respect to the
application of the definition of
ownership interest for asset-backed
securitization transactions?
Question 236. In many securitization
transactions, the residual interest
represents the ‘‘equity’’ in the
transaction. As this often constitutes the
portion of the securitization transaction
with the most risk, because it may
absorb any losses experienced by the
underlying assets before any other
interests issued by the securitization
vehicle, should the Agencies instead use
their authority under section 13(d)(1)(J)
of the BHC Act to exempt the buying
and selling of any ownership interest in
a securitization vehicle that is a covered
fund other than the residual interest?
Question 237. For purposes of
limiting either an exclusion for issuers
of asset-backed securities from the
proposed definition of ‘‘covered fund’’
and/or an exclusion of asset-backed
securities from the proposed definition
of ‘‘ownership interest,’’ what definition
of asset-backed security most effectively
implements the language of section 13
of the BHC Act? Section 3(a)(77) of the
Exchange Act and the SEC’s Regulation
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68900
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
AB 234 provide two possible definitions.
Is either of these definitions sufficient,
and if so why? If one of the definitions
is too narrow, what additional entities/
securities should be included and why?
If one of the definitions is too broad,
what entities/securities should be
excluded and why? Would some other
definition of asset-backed security be
more consistent with the language and
purpose of section 13 of the BHC Act?
Question 238. Are there special
concerns raised by not including as an
ownership interest the residual interests
in a securitization vehicle? Should the
Agencies instead exempt the buying and
selling of any ownership interest in a
securitization vehicle that is a covered
fund other than the residual interest?
Question 239. Should the legal form
of a beneficial interest be a determining
factor for deciding whether a beneficial
interest is an ‘‘ownership interest’’? For
example, should pass-through trust
certificates issued as part of a
securitization transaction be excluded
from the definition of ‘‘ownership
interest’’? Should the definition of
ownership interest explicitly include
debt instruments with equity features
(e.g., voting rights, profit participations,
etc.)?
Question 240. How should the
proposed rule address those instances in
which both debt and equity interests are
issued, and the debt interests receive all
of the economic benefits and all of the
control rights? Should the debt interests
(other than the residual interest) be
counted as ownership interests even
though they are not legally ownership
and do not receive any profit
participation? Should the equity
interests be counted as ownership
interests even though the holder does
not receive economic benefits or have
any control rights? Should the residual
interest be considered the only
‘‘ownership interest’’ for purposes of the
proposed rule? Should mezzanine
interests that lack both control rights
and profit participation be considered
an ownership interest? If the mezzanine
interests obtain control rights (because
more senior classes have been repaid),
should they become ‘‘ownership
interests’’ at that time for purposes of
the proposed rule? If both debt and
equity interests are counted as
ownership interests, how should
percentages of ownership interests be
calculated when the units of
measurement do not match (e.g., a
single trust certificate, a single residual
certificate with no face value and
multiple classes of currencydenominated notes)?
234 See
17 CFR 229.1101(c).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
Question 241. Does the proposed
rule’s definition of ‘‘prime brokerage
transaction’’ effectively implement the
statute? What other types of transactions
or services, if any, should be included
in the definition? Should any types of
transactions or services be excluded
from the definition? Would an
alternative definition be more effective,
and if so, why?
Question 242. Do the proposed rule’s
definitions of ‘‘sponsor’’ and ‘‘trustee’’
effectively implement the statute? Is the
exclusion of ‘‘directed trustee’’ from the
definition of ‘‘trustee’’ appropriate?
Question 243. Do the proposed rule’s
other definitions in § l.10(b) effectively
implement the statute? What alternative
definitions might be more effective in
light of the language and purpose of the
statute? Are additional definitions
needed, and if so, what definition(s)?
2. Section l.11: Permitted Organizing
and Offering of a Covered Fund
Section l.11 of the proposed rule
implements section 13(d)(1)(G) of the
BHC Act and permits a banking entity
to organize and offer a covered fund,
including acting as sponsor of the fund,
if certain criteria are met.235 This
exemption is designed to permit a
banking entity to be able to engage in
certain traditional asset management
and advisory businesses in compliance
with section 13 of the BHC Act.236
a. Required Criteria for Permitted
Organizing and Offering of Covered
Funds
Section l.11 of the proposed rule
provides for and describes the
conditions that must be met in order to
enable a banking entity to qualify for the
exemption to organize and offer a
covered fund.237 These conditions
include: (i) The banking entity must
provide bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services;238 (ii) the
covered fund must be organized and
offered only in connection with the
provision of bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services and only to
persons that are customers of such
services of the banking entity; (iii) the
proposed rule § l.11.
Cong. Rec. S5889 (daily ed. July 15, 2010)
(statement of Sen. Hagan).
237 See proposed rule §§ l.11(a)–(h).
238 While section 13(d)(1)(G) of the BHC Act does
not explicitly mention ‘‘commodity trading
advisory services,’’ the Agencies have proposed to
include commodity pools within the definition of
‘‘covered fund’’ and commodity trading advisory
services in the same way as investment advisory
services because commodity trading advisory
services are the functional equivalent of investment
advisory services to commodity pools.
235 See
banking entity may not acquire or retain
an ownership interest in the covered
fund except as permitted under subpart
C of the proposed rule; (iv) the banking
entity must comply with the restrictions
governing relationships with covered
funds under § l.16 of the proposed
rule; (v) the banking entity may 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; (vi)
the covered fund, for corporate,
marketing, promotional, or other
purposes, (A) may not share the same
name or a variation of the same name
with the banking entity(or an affiliate or
subsidiary thereof), and (B) may not use
the word ‘‘bank’’ in its name; (vii) no
director or employee of the banking
entity may take or retain an ownership
interest in the covered fund, except for
any director or employee of the banking
entity who is directly engaged in
providing investment advisory or other
services to the covered fund; and (viii)
the banking entity must (A) clearly and
conspicuously disclose, in writing, to
any prospective and actual investor in
the covered fund (such as through
disclosure in the covered fund’s offering
documents) the enumerated disclosures
contained in § l.11(h) of the proposed
rule, and (B) comply with any
additional rules of the appropriate
Agency or Agencies, designed to ensure
that losses in such covered fund are
borne solely by investors in the covered
fund and not by the banking entity.239
These requirements are explained in
detail below.
i. Bona Fide Services
Section l.11(a) of the proposed rule
requires that, in order to qualify for the
exemption related to organizing and
offering a covered fund, a banking entity
provide bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services.240 Banking
entities provide a wide range of
customer-oriented services which may
qualify as bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services.241
Additionally, depending on the type of
banking entity that conducts the activity
or provides the service, variations in the
236 156
PO 00000
Frm 00056
Fmt 4701
Sfmt 4702
239 See id. at § l.11(a)–(h). The Agencies are not
proposing any such additional rules at this time,
although they may do so in the future.
240 See 12 U.S.C. 1851(d)(1)(G)(i); proposed rule
§ l.11(a).
241 See, e.g., 12 U.S.C. 1843(c)(4), (c)(8), (k),12
CFR 225.28(b)(5) and (6), 12 CFR 225.86, 12 CFR
225.125 (with respect to a bank holding company);
12 U.S.C. 24 (Seventh), 92a, 12 CFR Part 9 (with
respect to a national bank); 12 U.S.C. 1831a, 12 CFR
Part 362 (with respect to a state nonmember bank).
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
precise services involved may occur.
For example, a national bank and an
SEC-registered investment adviser may
provide substantially similar investment
advisory services to clients, but be
subject to different statutory and
regulatory requirements. In recognition
of potential variations in services and
functional regulation, the proposed rule
does not specify what services would
qualify as ‘‘bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services’’ under
§ l.11(a) of the proposed rule. Instead,
the proposed rule largely mirrors the
statutory language of section
13(d)(1)(G)(i) of the BHC Act and
reflects the intention that so long as a
banking entity provides trust, fiduciary,
investment advisory, or commodity
trading advisory services in compliance
with relevant statutory and regulatory
requirements, the requirement
contained in § l.11(a) of the proposed
rule would generally be deemed to be
satisfied.
ii. ‘‘Customers of Such Services’’
Requirement
Section 13(d)(1)(G)(ii) of the BHC Act
requires that a banking entity organize
and offer a covered fund ‘‘only in
connection with’’ the provision of
qualified services to persons that are
customers of such services of the
banking entity.242 Section l.11(b) of the
proposed rule implements the statute
and reflects the statutory requirement
that there are two independent
conditions contained in section
13(d)(1)(G)(ii) of the BHC Act: (i) A
covered fund must be organized and
offered in connection with bona fide
trust, fiduciary, investment advisory, or
commodity trading advisory services,
and (ii) the banking entity providing
those services may offer the covered
fund only to persons that are customers
of those services of the banking
entity.243 Requiring a customer
relationship in connection with
organizing and offering a covered fund
helps to ensure that a banking entity is
engaging in the covered fund activity for
others and not on the banking entity’s
own behalf.244
Section 13(d)(1)(G)(ii) of the BHC Act
does not explicitly require that the
customer relationship be pre-existing.
Accordingly, the proposed rule provides
that it may be established through or in
connection with the banking entity’s
organization and offering of a covered
fund, so long as that fund is a
242 See
12 U.S.C. 1851(d)(1)(G)(ii).
proposed rule § l.11(b).
244 See 156 Cong. Rec. at S5897 (daily ed. July 15,
2010) (statement of Sen. Merkley).
243 See
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
manifestation of the provision by the
banking entity of bona fide trust,
fiduciary, investment advisory or
commodity trading advisory services to
the customer. This application of the
customer requirements is consistent
with the manner in which trust,
fiduciary, investment advisory, and
commodity trading advisory services are
provided by banking entities.
Historically, banking entities have
raised capital commitments for covered
funds from existing customers as well as
individuals or entities that have no preexisting relationship with the banking
entity.
Banking entities commonly organize
and offer funds to customers of the
banking entity’s trust, fiduciary, and
investment advisory or commodity
trading advisory services as a way of
ensuring the efficient and consistent
provision of these services. For
example, a person often obtains the
investment advisory services of the
banking entity by acquiring an interest
in a fund organized and offered by the
banking entity. This is distinguished
from a fund organized and offered by a
banking entity for the purpose of itself
investing as principal, indirectly
through its investment in the fund, in
assets held by the fund. Under the
proposed rule, a banking entity could,
consistent with past practice, provide a
covered fund to persons that are
customers of such services for purposes
of the exemption so long as the fund is
organized and offered as a means of
providing bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services to customers.
The banking entity may not organize
and offer a covered fund as a means of
itself investing in the fund or assets held
in the fund.245
The Agencies note that a banking
entity could, through organizing and
offering a covered fund pursuant to the
authority contained in § l.11 of the
proposed rule that itself makes
investments or engages in trading
activity, seek to evade the restrictions
contained in section 13 of the BHC Act
and the proposed rule. In order to
address these concerns, the proposed
rule provides that a banking entity
relying on the authority contained in
§ l.11 must organize and offer a
245 The proposed rule does not change any
requirement imposed by separate statute,
regulation, or other law, if applicable. For instance,
a banking entity that conducts a private placement
of a covered fund pursuant to the SEC’s Regulation
D pertaining to private offerings would still be
expected to comply with the relevant requirements
related to such offering, including the limitations
related to the manner in which and types of persons
to whom it may offer or sell interests in such fund.
See 12 CFR 230.501 et seq.
PO 00000
Frm 00057
Fmt 4701
Sfmt 4702
68901
covered fund pursuant to a credible
plan or similar documentation outlining
how the banking entity intends to
provide advisory or similar services to
its customers through organizing and
offering such fund.
iii. Compliance With Investment
Limitations
Section 13(d)(1)(G)(iii) of the BHC Act
limits the ability of a banking entity that
organizes and offers a covered fund to
acquire or retain an ownership interest
in that covered fund.246 Separately,
other provisions of section 13 of the
BHC Act provide independent
exemptions which permit a banking
entity to acquire or retain an ownership
interest in a covered fund.247 Section
l.11(c) of the proposed rule
incorporates these statutory provisions
by prohibiting a banking entity from
acquiring or retaining an ownership
interest in a covered fund that it
organizes and offers except as permitted
under subpart C of the proposed rule.248
The limits on a banking entity’s ability
to invest in a covered fund that it
organizes and offers are described in
§ l.12 of the proposal.
iv. Compliance With Section 13(f) of the
BHC Act
Section l.11(d) of the proposed rule
requires that the banking entity comply
with the limitations on certain
relationships with covered funds.249
These limitations apply in several
contexts, and are contained in § l.16 of
the proposed rule, discussed in detail
below. In general, § l.16 of the
proposed rule prohibits certain
transactions or relationships that would
be covered by section 23A of the FR Act,
and provides that any permitted
transaction is subject to section 23B of
the FR Act, in each instance as if such
banking entity were a member bank and
such covered fund were an affiliate
thereof.250
v. No Guarantees or Insurance of Fund
Performance
Section l.11(e) of the proposed rule
prohibits the banking entity from,
directly or indirectly, guaranteeing,
assuming or otherwise insuring the
obligations or performance of the
covered fund or any covered fund in
which such covered fund invests.251
246 See
12 U.S.C. 1851(d)(1)(G)(iii).
e.g., id. at 1851(d)(1)(C).
248 See proposed rule § l.11(c).
249 12 U.S.C. 1851(d)(1)(G)(iv); proposed rule
§ l.11(d).
250 See Supplementary Information, Part III.C.7.
251 12 U.S.C. 1851(d)(1)(G)(v); proposed rule
§ l.11(e).
247 See,
E:\FR\FM\07NOP2.SGM
07NOP2
68902
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
This prong implements section
13(d)(1)(G)(iv) of the BHC Act and is
intended to prevent a banking entity
from engaging in bailouts of a covered
fund in which it has an interest.252
vi. Limitation on Name Sharing With a
Covered Fund
Section l.11(f) of the proposed rule
prohibits the covered fund from sharing
the same name or a variation of the
same name with the banking entity, for
corporate, marketing, promotional, or
other purposes.253 This section
implements section 13(d)(1)(G)(v) of the
BHC Act and addresses the concern that
name-sharing could undermine market
discipline and encourage a banking
entity to bail out a covered fund it
organizes and offers in order to preserve
the entity’s reputation.254 Thus, under
§ l.11(f) of the proposed rule, a covered
fund would be prohibited from sharing
the same name or variation of the same
name with a banking entity that
organizes and offers or serves as sponsor
to that fund (or an affiliate or subsidiary
of such banking entity). A covered fund
would also be prohibited under the
proposed rule from using the word
‘‘bank’’ in its name.255
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
vii. Limitation on Ownership by
Directors and Employees
Section l.11(g) of the proposed rule
implements section 13(d)(1)(G)(vii) of
the BHC Act. The provision prohibits
any director or employee of the banking
entity from acquiring or retaining an
ownership interest in the covered fund,
except for any director or employee of
the banking entity who is directly
engaged in providing investment
advisory or other services to the covered
fund.256 This allows an individual
acting as fund manager or adviser and
employed by a banking entity to acquire
or retain an ownership interest in a
covered fund that aligns the manager or
adviser’s incentives with those of its
customers by allowing the individual to
have ‘‘skin in the game’’ with respect to
a covered fund for which that
individual provides management or
252 See 156 Cong. Rec. S5897 (daily ed. July 15,
2010) (statement of Sen. Merkley).
253 12 U.S.C. 1851(d)(1)(G)(vi); proposed rule
§ l.11(f).
254 156 Cong. Rec. S5897 (daily ed. July 15, 2010)
(statement of Sen. Merkley).
255 Similar restrictions on a fund sharing the same
name, or variation of the same name, with an
insured depository institution or company that
controls an insured depository institution or having
the word ‘‘bank’’ in its name, have been used
previously in order to prevent customer confusion
regarding the relationship between such companies
and a fund. See, e.g., Bank of Ireland, 82 Fed. Res.
Bull. 1129 (1996).
256 See 12 U.S.C. 1851(d)(1)(G)(vii); proposed rule
§ l.11(g).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
advisory services (which customers or
clients often request).257
The Agencies recognize that director
or employee investments in a covered
fund may provide an opportunity for a
banking entity to evade the limitations
regarding the amount or value of
ownership interests a banking entity
may acquire or retain in a covered fund
or funds contained in section 13(d)(4) of
the BHC Act and § l.12 of the proposed
rule. In order to address this concern,
the proposed rule would generally
attribute an ownership interest in a
covered fund acquired or retained by a
director or employee to such person’s
employing banking entity, if the banking
entity either extends credit for the
purpose of allowing the director or
employee to acquire such ownership
interest, guarantees the director or
employee’s purchase, or guarantees the
director or employee against loss on the
investment.
viii. Disclosure Requirements
Section l.11(h) of the proposed rule
requires that, in connection with
organizing and offering a covered fund,
the banking entity (i) clearly and
conspicuously disclose, in writing, to
prospective and actual investors in the
covered fund (such as through
disclosure in the covered fund’s offering
documents) that ‘‘any losses in [such
covered fund] will be borne solely by
investors in [the covered fund] and not
by [the banking entity and its affiliates
or subsidiaries]; therefore, [the banking
entity’s and its affiliates’ or
subsidiaries’] losses in [such covered
fund] will be limited to losses
attributable to the ownership interests
in the covered fund held by [the
banking entity and its affiliates or
subsidiaries] in their capacity as
investors in [the covered fund],’’ and (ii)
comply with any additional rules of the
appropriate Agency as provided in
section 13(b)(2) of the BHC Act designed
to ensure that losses in any such
covered fund are borne solely by the
investors in the covered fund and not by
the banking entity.258 The proposed rule
also provides, as an additional
disclosure requirement related to
organizing and offering a covered fund,
that a banking entity clearly and
conspicuously disclose, in writing, to
any prospective and actual investor
(such as through disclosure in the
covered fund’s offering documents): (i)
That such investor should read the fund
offering documents before investing in
257 See 156 Cong. Rec. S5897 (daily ed. July 15,
2010) (statement of Sen. Merkley).
258 12 U.S.C. 1851(d)(1)(G)(viii); proposed rule
§ l.11(h).
PO 00000
Frm 00058
Fmt 4701
Sfmt 4702
the covered fund; (ii) that the
‘‘ownership interests in the covered
fund are not insured by the FDIC, and
are not deposits, obligations of, or
endorsed or guaranteed in any way, by
any banking entity’’ (unless that
happens to be the case); and (iii) the role
of the banking entity and its affiliates,
subsidiaries, and employees in
sponsoring or providing any services to
the covered fund. As noted above, the
proposed rule clarifies that a banking
entity may satisfy the requirements of
this prong with respect to a covered
fund by making the required
disclosures, in writing, in the covered
fund’s offering documents.259
ix. Request for Comment
The Agencies request comment on the
proposed rule’s approach with respect
to implementing the exemption
permitting banking entities to organize
and offer a covered fund. In particular,
the Agencies request comment on the
following questions:
Question 244. Is the proposed rule’s
approach to implementing the
exemption for organizing and offering a
covered fund effective? If not, what
alternative approach would be more
effective and why?
Question 245. Should the approach
include other elements? If so, what
elements and why? Should any of the
proposed elements be revised or
eliminated? If so, why and how?
Question 246. Is the proposed rule’s
approach to implementing the scope of
bona fide trust, fiduciary, investment
advisory and commodity trading
advisory services consistent with the
statute? If not, what alternative
approach would be more effective?
Should the scope of such services be
broader or, in the alternative, more
limited? Are there specific services
which should be included but which are
not currently under the proposed rule?
Question 247. Does the proposed rule
effectively implement the ‘‘customers of
such services’’ requirement? If not, what
alternative approach would be more
effective and why? Is the proposed
rule’s approach consistent with the
statute? Why or why not? How do
banking entities currently sell or
provide interests in covered funds? Do
banking entities rely on a concept of
‘‘customer’’ by reference to other laws or
259 As contemplated in § l.11(a)(8)(ii) of the
proposed rule, to the extent that any additional
rules are issued to ensure that losses in a covered
fund are borne solely by the investors in the
covered fund and not by the banking entity, a
banking entity would be required to comply with
those as well in order to satisfy the requirements
of section 13(d)(1)(G)(viii) of the BHC Act.
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
regulations, and if so, what laws or
regulations?
Question 248. Does the proposed rule
effectively and clearly recognize the
manner in which banking entities
provide trust, fiduciary, investment
advisory, or commodity trading
advisory services to customers? If not,
how should the proposed rule be
modified to be more effective or clearer?
Question 249. Should the Agencies
consider adopting a definition of
‘‘customer of such services’’ for
purposes of implementing the
exemption related to organizing and
offering a covered fund? If so, what
criteria should be included in such
definition? For example, should the
customer requirement specify that the
relationship be pre-existing? Should the
Agencies consider adopting an existing
definition related to ‘‘customer’’ and if
so, what definitions (for instance, the
SEC’s ‘‘pre-existing, substantive
relationship’’ concept applicable to
private offerings under its Regulation D)
would provide for effective
implementation of the customer
requirement in section 13(d)(1)(G) of the
BHC Act? If so, why and how? How
should the customer requirement be
applied in the context of non-U.S.
covered funds? Is there an equivalent
concept used for such non-U.S. covered
fund offerings?
Question 250. Should the Agencies
distinguish between direct and indirect
customer relationships for purposes of
implementing section 13(d)(1)(G) of the
BHC Act? Should the rule differentiate
between a customer relationship
established by a customer as opposed to
a banking entity? If so, why?
Question 251. Does the proposed rule
effectively implement the prohibition
on a banking entity guaranteeing or
insuring the obligations or performance
of certain covered funds? If not, what
alternative approach would be more
effective, and why?
Question 252. Does the proposed rule
effectively implement the requirement
that a banking entity comply with the
limitation on certain relationships with
a covered fund contained in § l.16 of
the proposed rule? If not, what
alternative approach would be more
effective, and why?
Question 253. Does the proposed rule
effectively implement the prohibition
on a covered fund sharing the same
name or variation of the same name
with a banking entity? If not, what
alternative approach would be more
effective and why? Should the
prohibition on a covered fund sharing
the same name be limited to specific
types of banking entities (e.g., insured
depository institutions and bank
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
holding companies) or only to the
banking entity that organizes and offers
the fund, and if so why?
Question 254. Does the proposed rule
effectively implement the limitation on
director or employee investments in a
covered fund organized and offered by
a banking entity? If not, what alternative
approach would be more effective and
why? Should the agencies provide
additional guidance on what ‘‘other
services’’ should be included for
purposes of satisfying § l.11(g)? Why or
why not?
Question 255. Are the disclosure
requirements related to organizing and
offering a covered fund appropriate? If
not, what alternative disclosure
requirement(s) should the proposed rule
include? Should the Agencies consider
adoption of a model disclosure form
related to this requirement? Does the
timing of the proposed disclosure
requirement adequately address
disclosure to secondary market
purchasers?
3. Section l.12: Permitted Investment
in a Covered Fund
Section l.12 of the proposed rule
describes the limited circumstances
under which a banking entity may
acquire or retain, as an investment, an
ownership interest in a covered fund
that the banking entity or one of its
subsidiaries or affiliates organizes and
offers. This section implements section
13(d)(4) of the BHC Act and related
provisions, and describes the statutory
limits on both (i) the amount and value
of an investment by a banking entity in
a covered fund, and (ii) the aggregate
value of all investments in all covered
funds made by the banking entity.
As described below, a banking entity
that makes or retains an investment in
a covered fund under § l.12 of the
proposed rule is generally subject to
three principal limitations related to
such investment. First, the banking
entity’s investment in a covered fund
may not represent more than 3 percent
of the total outstanding ownership
interests of such fund (after the
expiration of any seeding period
provided under the rule). Second, the
banking entity’s investment in a covered
fund may not result in more than 3
percent of the losses of the covered fund
being allocable to the banking entity’s
investment. Third, a banking entity may
invest no more than 3 percent of its tier
1 capital in covered funds.260
260 See,
PO 00000
e.g., proposed rule §§ l.12(b)(2), (c).
Frm 00059
Fmt 4701
Sfmt 4702
68903
a. Authority and Limitations on
Permitted Investments
Section 13(d)(4) of the BHC Act
permits a banking entity to acquire and
retain an ownership interest in a
covered fund that the banking entity
organizes and offers pursuant to section
13(d)(1)(G), for the purposes of (i)
establishing the covered fund and
providing the fund with sufficient
initial equity for investment to permit
the fund to attract unaffiliated investors,
or (ii) making a de minimis investment
in the covered fund in compliance with
applicable requirements.261 Section
l.12 of the proposed rule implements
this authority and related limitations.
Consistent with this statutory
provision, the proposed rule requires a
banking entity to (i) actively seek
unaffiliated investors to ensure that the
banking entity’s investment conforms
with the limits of § l.12, and (ii) reduce
through redemption, sale, dilution, or
other methods the aggregate amount and
value of all ownership interests of the
banking entity in a single fund held
under § l.12 to an amount that does not
exceed 3 percent of the total outstanding
ownership interests of the fund not later
than 1 year after the date of
establishment of the fund (or such
longer period as may be provided by the
Board pursuant to § l.12(e) of the
proposed rule) (the ‘‘per-fund
limitation’’). Additionally, § l.12 of the
proposed rule implements the statutory
requirement that the aggregate value of
all ownership interests of the banking
entity in all covered funds held as an
investment not exceed 3 percent of the
tier 1 capital of the banking entity (the
‘‘aggregate funds limitation’’).262
b. Permitted Investment in a Single
Covered Fund
Section l.12(b) of the proposed rule
describes the limitations and
restrictions on a banking entity’s ability
to make or retain an investment in a
single covered fund. This section
implements the requirements of section
13(d)(4) of the BHC Act.263
Section l.12 of the proposed rule
describes the manner in which the
limitations on the amount and value of
ownership interests in a covered fund
must be calculated, in recognition of the
fact that a covered fund may have
multiple classes of ownership interests
which possess different characteristics
261 See
12 U.S.C. 1851(d)(4).
proposed rule at § l.12(a)(2)(ii). The
process and manner in which a banking entity’s 3
percent tier 1 capital limit is determined for
purposes of the proposed rule is discussed in detail
below in Part III.C.3 of this Supplementary
Information.
263 See 12 U.S.C. 1851(d)(4)(B).
262 See
E:\FR\FM\07NOP2.SGM
07NOP2
68904
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
or values that impact a person’s
ownership in that fund. A banking
entity must apply the limits to both the
total value and amount of its investment
in a covered fund. For purposes of
applying these limits, the banking entity
must calculate (without regard to
committed funds not yet called for
investment): (i) The value of all
investments or capital contributions
made with respect to any ownership
interest by the banking entity in a
covered fund, divided by the value of all
investments or capital contributions
made by all persons in that covered
fund, and (ii) the total number of
ownership interests held as an
investment by the banking entity in a
covered fund divided by the total
number of ownership interests held by
all persons in that covered fund.264
Therefore, under the proposed rule,
such calculation would include as the
numerator the amount or value of a
banking entity’s investment in a covered
fund, and as the denominator the
amount or value (matched to the unit of
measurement in the numerator) of all
classes of ownership interests held by
all persons in that covered fund. As
noted above, the banking entity’s
investment in a covered fund also may
not result in more than 3 percent of the
losses of the covered fund being
allocable to the banking entity’s
investment.265
In order to ensure that a banking
entity calculates its investment in a
covered fund accurately and does not
evade the per-fund investment
limitation, the proposed rule requires
that the banking entity must calculate
its investment in the same manner and
according to the same standards utilized
by the covered fund for determining the
aggregate value of the fund’s assets and
ownership interests in the covered
fund.266
Under the proposed rule, the amount
and value of a banking entity’s
investment in any single covered fund
is (i) the total amount or value held by
the banking entity directly and through
any entity that is controlled, directly or
indirectly, by the banking entity,267 plus
proposed rule § l.12(b)(2).
the proposed rule, a banking entity’s
investment in a covered fund may not result in
more than 3 percent of the losses of the covered
fund being allocable to the banking entity’s
investment since the banking entity’s permitted
investment in a covered fund may be no more than
3 percent of the value and amount of such fund’s
total ownership interests, and the banking entity
may not, directly or indirectly, guarantee, assume,
or otherwise insure the obligations or performance
of the covered fund. See 12 U.S.C. 1851(d)(1)(G)(v);
proposed rule § l.11(e).
266 See proposed rule § l.12(b)(4).
267 See proposed rule § l.12(b)(1)(A).
264 See
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
265 Under
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
(ii) the pro rata amount or value of any
covered fund held by any entity (other
than certain operating entities noted
below) that is not controlled, directly or
indirectly, by the banking entity but in
which the banking entity owns,
controls, or holds with the power to
vote more than 5 percent of the voting
shares.268
Additionally, the proposed rule
provides that, to the extent that a
banking entity is contractually obligated
to directly invest in, or is found to be
acting in concert through knowing
participation in a joint activity or
parallel action toward a common goal of
investing in, one or more investments
with a covered fund that is organized
and offered by the banking entity
(whether or not pursuant to an express
agreement), such investment shall be
included in the calculation of a banking
entity’s per-fund limitation.269 In this
way, the proposed rule prevents a
banking entity from evading the
limitations under § l.12 of the
proposed rule through committed coinvestments.
Section l.12(b)(3) of the proposed
rule provides that the amount and value
of a banking entity’s investment in a
covered fund may at no time exceed the
3 percent limits contained in § l.12(b)
of the proposed rule after the conclusion
of any conformance period, if
applicable.270 In cases where a fund
calculates its value or stands ready to
issue or redeem interests frequently
(e.g., daily), a banking entity must
calculate its per-fund limitation no less
frequently than the fund performs such
calculation or issues or redeems
interests. In recognition of the fact that
not every covered fund may calculate or
determine its valuation daily (for
instance, if it does not allow
redemptions except infrequently or
invests principally in illiquid assets for
which no market price is readily
available), the proposed rule would not
require a daily calculation of value for
such fund (unless a daily calculation is
determined by the fund).271 In such
cases, the calculation of the amount and
value of a banking entity’s per-fund
limitation must be made no less
frequently than at the end of every
268 See proposed rule § l.12(b)(1)(B). As noted
above, whether or not an investment is controlled
or noncontrolled will be determined consistent
with the BHC Act, as implemented by the Board.
See 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e).
269 See proposed rule § l.12(b)(2)(B).
270 See proposed rule § l.12(b)(3).
271 With respect to an issuer of asset-backed
securities, depending on the transaction structure,
such calculation may need to be made each time a
payment is made to any holder of the issuer’s assetbacked securities.
PO 00000
Frm 00060
Fmt 4701
Sfmt 4702
quarter.272 Additionally, since a banking
entity must organize and offer any
covered fund in which it invests, the
Agencies expect that such banking
entity would closely and regularly
monitor not only the value of such
fund’s interests, but also any changes in
the fund’s investors’ relative ownership
percentages.273
c. Aggregate Permitted Investments in
All Covered Funds and Calculation of a
Banking Entity’s Tier 1 Capital
In addition to a limit on investments
in a single covered fund, section
13(d)(4) of the BHC Act requires the
banking entity to comply with the
aggregate funds limitation on
investments in all covered funds.274 As
required under section 13(d)(4)(B)(ii)(II)
of the BHC Act, the proposed rule
provides that the aggregate of a banking
entity’s ownership interests in all
covered funds that are held under
§ l.12 of the proposed rule may not
exceed 3 percent of the tier 1 capital of
a banking entity.275 In order to maintain
equality in application of the aggregate
funds limitation, the proposed rule
provides that, for purposes of
determining compliance with § l.12 of
the proposed rule, the aggregate of all of
a banking entity’s investments in all
covered funds under § l.12 of the
proposed rule must be valued pursuant
to applicable accounting standards.276
This value calculation is separate and in
addition to the required calculation of
the value of a banking entity’s
investment in a covered fund as part of
determining compliance with the perfund limitation.
Tier 1 capital is a banking law
concept that, in the United States, is
272 The Agencies note that while calculation of a
banking entity’s ownership interest in a covered
fund must be determined no less frequently than at
the end of every quarter, it is possible that no
change in a banking entity’s ownership interest
(e.g., no redemptions or other changes in investor
composition) may occur during every quarter.
273 For instance, where a banking entity acts as
sponsor to a covered fund, in connection with the
organizing and offering of that fund it may include
a requirement (such as a ‘‘tag-along’’ redemption
right) in the fund’s organizational documents in
order to assist the banking entity in complying with
the per-fund investment limitation.
274 As noted in the discussion regarding the perfund limitation, the proposed rule provides that, for
purposes of determining compliance with § l.12,
the banking entity’s permitted investment in a
covered fund shall be calculated in the same
manner and according to the same standards
utilized by the covered fund for determining the
aggregate value of the fund’s assets and ownership
interests. However, the value of a banking entity’s
aggregate permitted investments in all covered
funds shall be determined in accordance with
applicable accounting standards. See proposed rule
§ l.12(c)(1).
275 See 12 U.S.C. 1851(d)(4)(B)(ii)(II); proposed
rule § l.12(a)(2)(ii).
276 See proposed rule § l.12(c)(1).
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
calculated and reported by certain
depository institutions and bank
holding companies in order to
determine their compliance with
regulatory capital standards.
Accordingly, the proposed rule clarifies
that for purposes of the aggregate funds
limitation in § l.12, a banking entity
that is a bank, a bank holding company,
a company that controls an insured
depository institution that reports tier 1
capital, or uninsured trust company that
reports tier 1 capital (each a ‘‘reporting
banking entity’’) must apply the
reporting banking entity’s tier 1 capital
as of the last day of the most recent
calendar quarter that has ended, as
reported to the relevant Federal banking
agency.277
However, not all entities subject to
section 13 of the BHC Act calculate and
report tier 1 capital. In order to provide
a measure of equality related to the
aggregate funds limitation contained in
section 13(d)(4)(B)(ii)(II) of the BHC Act
and § l.12(c) of the proposed rule, the
proposed rule clarifies how the
aggregate funds limitation shall be
calculated for entities that are not
required to calculate and report tier 1
capital in order to determine
compliance with regulatory capital
standards. Under the proposed rule,
with respect to any banking entity that
is not affiliated with a reporting banking
entity and not itself required to report
capital in accordance with the riskbased capital rules of a Federal banking
agency, the banking entity’s tier 1
capital for purposes of the aggregate
funds limitation shall be the total
amount of shareholders’ equity of the
top-tier entity within such organization
as of the last day of the most recent
calendar quarter that has ended, as
determined under applicable accounting
standards.278 For a banking entity that is
not itself required to report tier 1 capital
but is a subsidiary of a reporting
banking entity that is a depository
institution (e.g., a subsidiary of a
national bank), the aggregate funds
limitation shall be the amount of tier 1
capital reported by such depository
institution.279 For a banking entity that
is not itself required to report tier 1
capital but is a subsidiary of a reporting
banking entity that is not a depository
institution (e.g., a nonbank subsidiary of
a bank holding company), the aggregate
funds limitation shall be the amount of
tier 1 capital reported by the top-tier
affiliate of such banking entity that
holds and reports tier 1 capital.280 Thus,
for purposes of calculating the aggregate
funds limitation under § l.12(c)(2) of
the proposed rule, the tier 1 capital for
the different types of banking entities
would be as follows:
Type of banking entity
Tier 1 capital for purposes of § l.12
Depository institution that is a reporting banking entity (or a subsidiary
thereof).
Tier 1 capital of the depository institution as of the last day of the most
recent calendar quarter that has ended, as reported to the relevant
Federal banking agency.
Tier 1 capital of the bank holding company as of the last day of the
most recent calendar quarter that has ended, as reported to the
Board.
Tier 1 capital of the top tier entity within such organization as of the
last day of the most recent calendar quarter that has ended, as reported to the Board.
Shareholders’ equity of the top-tier entity within such organization as of
the last day of the most recent calendar quarter that has ended,
under applicable accounting standards.
Bank holding company or a subsidiary thereof (other than a reporting
banking entity).
Company that controls an insured depository institution and that is a
reporting banking entity (or a subsidiary thereof other than a reporting banking entity).
Other banking entity (including an industrial loan company holding
company, thrift holding company, or a subsidiary thereof).
Section 12(d) of the proposed rule
also implements the provision
contained in section 13(d)(4)(b)(iii) of
the BHC Act regarding the deduction of
a banking entity’s aggregate investment
in a covered fund held under section
13(d)(4) of that Act from the assets and
tangible equity of the banking entity.
The statute also provides that the
amount of the deduction must increase
commensurate with the leverage of the
underlying fund.282
Section l.12(d) of the proposal
requires a banking entity to deduct the
aggregate value of its investments in
covered funds from tier 1 capital. Since
§ l.12 of the proposed rule implements
the authorities contained in section
13(d)(4) of the BHC Act related to an
investment in a fund organized and
offered by the banking entity (or an
affiliate or subsidiary thereof), the
deduction contained in § l.12(d)
applies only to those ownership
interests held as an investment by a
banking entity pursuant to § l.12 of the
proposed rule.283 For instance, a
banking entity that acquires or retains
an ownership interest in a covered fund
as a permitted risk-mitigating hedge
under § l.13(b) of the proposed rule, or
that acquires or retains an ownership
interest in the course of collecting a debt
previously contracted in good faith,
would not be required to deduct the
value of such ownership interest from
its tier 1 capital.284 The deduction
required under § l.12(d) of the
proposed rule must be calculated
consistent with other like deductions
under the applicable risk-based capital
rules.285
proposed rule § l.12(c)(1)(A).
proposed rule § l.12(c)(2)(ii)(B)(2).
279 See proposed rule § l.12(c)(2)(ii)(A).
280 See proposed rule § l.12(c)(1)(B).
281 If the aggregate value of all investments in all
covered funds attributable to such a depository
institution is less than 3 percent of its tier 1 capital,
then that amount of capital which is greater than
the amount supporting the depository institution’s
investments (or those held by its subsidiaries) in a
covered fund, but less than 3 percent of the
depository institution’s tier 1 capital, may be used
to support an investment in a covered fund by an
affiliated banking entity that is not itself a
depository institution that holds and reports tier 1
capital or controlled, directly or indirectly, by such
a depository institution.
282 See 12 U.S.C. 1851(d)(4)(B)(iii).
283 See proposed rule § l.12(d).
284 The Agencies note that since this deduction
from capital implements Section 13(d)(4)(B)(iii) of
the BHC Act, it is being included in this proposed
rule which deals with Section 13 of the BHC Act.
However, the Agencies may relocate this deduction
as part of any later revised capital rules if, in the
future, it is determined that inclusion in such rules
is more appropriate.
285 See 12 CFR part 208, Appendices A, E, and
F (for a state member bank); 12 CFR part 225,
Appendices A, E, and G (for a bank holding
Additionally, in the case of a depository
institution that is itself a reporting
banking entity and is also a subsidiary
or affiliate of a reporting banking entity,
the aggregate of all investments in all
covered funds held by the depository
institution (including investments by its
subsidiaries) may not exceed 3 percent
of either the tier 1 capital of the
depository institution or of the top-tier
reporting banking entity that controls
such depository institution.281
d. Deduction of an Investment in a
Covered Fund From Tier 1 Capital
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68905
277 See
278 See
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
PO 00000
Frm 00061
Fmt 4701
Sfmt 4702
E:\FR\FM\07NOP2.SGM
Continued
07NOP2
68906
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
e. Extension of Time To Divest an
Ownership Interest in a Single Covered
Fund
Section 13(d)(4)(C) of the BHC Act
permits the Board, upon application by
a banking entity, to extend for up to 2
additional years the period of time
within which a banking entity must
reduce its attributable ownership
interests in a covered fund to no more
than 3 percent of such fund’s total
ownership interests.286 The statute
provides the possibility of an extension
only with respect to the per-fund
limitation, and not to the aggregate
funds limitation.287 Section l.12(e) of
the proposed rule implements this
provision of the statute. In order to grant
any extension, the Board must
determine that the extension would be
consistent with safety and soundness
and would not be detrimental to the
public interest.288
Section l.12(e) of the proposed rule
requires any banking entity that seeks
an extension of this conformance period
to submit a written request to the Board.
Under the proposal, any such request
must: (i) Be submitted in writing to the
Board at least 90 days prior to the
expiration of the applicable time period;
(ii) provide the reasons why the banking
entity believes the extension should be
granted; and (iii) provide a detailed
explanation of the banking entity’s plan
for reducing or conforming its
investment(s).
In addition, the proposed rule
provides that any extension request by
a banking entity must address each of
the following matters (to the extent they
are relevant): (i) Whether the investment
would—(A) involve or result in material
conflicts of interest between the banking
entity and its clients, customers or
counterparties; (B) result, directly or
indirectly, in a material exposure by the
banking entity to high-risk assets or
company); 12 CFR part 3, Appendices A, B, and C
(for a national bank); 12 CFR part 325, Appendices
A, C, and D (for a state nonmember bank); and 12
CFR part 167, Appendix C (for a federal thrift).
286 12 U.S.C. 1851(d)(4)(C).
287 See id.
288 As noted in Part III.C.2.a.ii of this
Supplementary Information, the Agencies recognize
the potential for evasion of the restrictions
contained in section 13 of the BHC Act through
organizing and offering a covered fund pursuant to
the authority contained in § l.11 of the proposed
rule. Therefore, in addition to taking action against
a banking entity that does not actively seek
unaffiliated investors to reduce or dilute the
investment of the banking entity as provided under
§ l.12(a)(2) of the proposed rule, the Agencies
expect that if a banking entity is habitually or
routinely seeking an extension of the one-year
period provided under § l.12(a)(2)(i)(B), this could
be evidence of seeking to evade the restrictions
contained in the proposed rule and, as appropriate,
the Agencies may take action against such banking
entity.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
high-risk trading strategies; (C) pose a
threat to the safety and soundness of the
banking entity; or (D) pose a threat to
the financial stability of the United
States; (ii) market conditions; (iii) the
contractual terms governing the banking
entity’s interest in the covered fund; (iv)
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 section 12(a)(2)(i)(B) of
the proposed rule; (v) the total exposure
of the 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 or the financial stability of the
United States; (vi) the cost to the
banking entity of divesting or disposing
of the investment within the applicable
period; (vii) whether the divestiture or
conformance of the investment would
involve or result in a material conflict
of interest between the banking entity
and unaffiliated clients, customers or
counterparties to which it owes a duty;
(viii) the banking entity’s prior efforts to
divest or sell interests in the covered
fund, including activities related to the
marketing of interests in such covered
fund; and (ix) any other factor that the
Board believes appropriate.289 Under
the proposed rule, the Board would
consider requests for an extension in
light of all relevant facts and
circumstances, including the factors
described above.
Section l.12(e) of the proposed rule
also would allow the Board to impose
conditions on any extension granted
under the proposed rule if the Board
determines conditions are necessary or
appropriate to protect the safety and
soundness of banking entities or the
financial stability of the United States,
address material conflicts of interest or
other unsound practices, or otherwise
further the purposes of section 13 of the
BHC Act and the proposed rule.290 In
cases where the banking entity is
primarily supervised by another
Agency, the Board would consult with
such Agency both in connection with its
review of the application and, if
applicable, prior to imposing conditions
in connection with the approval of any
request by the banking entity for an
proposed rule § l.12(e)(1)(ii).
in section 13 of the BHC Act or the
proposed rule limits or otherwise affects the
authority that the Board, the other Federal banking
agencies, the SEC, or the CFTC may have under
other provisions of law. In the case of the Board,
these authorities include, but are not limited to,
section 8 of the Federal Deposit Insurance Act and
section 8 of the BHC Act. See 12 U.S.C. 1818, 1847.
289 See
290 Nothing
PO 00000
Frm 00062
Fmt 4701
Sfmt 4702
extension of the conformance period
under the proposed rule.291
f. Request for Comment
The Agencies request comment on the
proposed rule’s approach to
implementing the exemption which
allows a banking entity to make or
retain a permitted investment in a
covered fund that it organizes and
offers. In particular, the Agencies
request comment on the following
questions:
Question 256. Is the proposed rule’s
approach to implementing the
exemption that allows a banking entity
to make or retain a permitted
investment in a covered fund effective?
If not, what alternative approach would
be more effective and why?
Question 257. Should the approach
include other elements? If so, what
elements and why? Should any of the
proposed elements be revised or
eliminated? If so, why and how?
Question 258. Should the proposed
rule specify at what point a covered
fund will be considered to have been
‘‘established’’ for purposes of
commencing the period in which a
banking entity may own more than 3
percent of the total outstanding
ownership interests in such fund? If so,
why and how?
Question 259. Does the proposed rule
effectively implement the requirement
that a banking entity comply with the
limitations on an investment in a single
covered fund? If not, what alternative
approach would be more effective and
why?
Question 260. Does the proposed rule
effectively implement the requirement
that a banking entity comply with the
limitations on the aggregate of all
investments in all covered funds? If not,
what alternative approach would be
more effective and why?
Question 261. Is the proposed rule’s
approach to calculating a banking
entity’s investment in a covered fund
effective? Should the per-fund
calculation be based on committed
capital, rather than invested capital?
Why or why not? Is the timing of the
calculation of a banking entity’s
ownership interest in a single covered
fund appropriate? If not, why not, and
what alternative approach would be
more effective and why? For example,
should the per-fund calculation be
required on a less-frequent basis (e.g.,
monthly) for funds that compute their
value and allow purchases and
redemptions on a daily basis (e.g.,
daily)? Why or why not?
291 See
E:\FR\FM\07NOP2.SGM
proposed rule §§ l.12(e)(iii) and (iv).
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Question 262. Is the proposed rule’s
approach to parallel investments
effective? Why or why not? Should this
provision require a contractual
obligation and/or knowing
participation? Why or why not? How
else could the proposed rule define
parallel investments? What
characteristics would more closely
achieve the scope and intended
purposes of section 13 of the BHC Act?
Question 263. Is the proposed rule’s
treatment of investments in a covered
fund by employees and directors of a
banking entity effective? If not, what
alternative approach would be more
effective and why?
Question 264. Is the proposed rule’s
approach to differentiating between
controlled and noncontrolled
investments in a covered fund unduly
complex or burdensome? If so, what
alternative approach, if any, would be
more effective and why?
Question 265. Is the proposed rule’s
approach to valuing an investment in a
covered fund according to the same
standards utilized by the covered fund
for determining the aggregate value of
its assets and ownership interests
effective? If not, what alternative
valuation approach would be more
effective and why? Should the rule
specify one methodology for valuing an
investment in a covered fund?
Question 266. Is the proposed rule’s
approach regarding when to require the
calculation of a banking entity’s
aggregate investments in all covered
funds effective? What is the potential
impact of calculating a banking entity’s
aggregate investment limit under the
proposed rule on a quarterly basis as
opposed to solely at the time an
investment in a covered fund is made?
Would calculation of the aggregate
investment limit solely at the time an
investment in a covered fund is made be
consistent with the language and
purpose of the statute? Does the
proposed rule provide sufficient
guidance for an issuer of asset-backed
securities about how and when to make
such calculation? Why or why not?
Question 267. Is the proposed rule’s
approach to determining and calculating
a banking entity’s relevant tier 1 capital
limit effective? If not, what alternative
approach would be more effective and
why? With respect to applying the
aggregate funds limitation to a banking
entity that is not affiliated with an entity
that is required to hold and report tier
1 capital, is total shareholder equity on
a consolidated basis as of the last day of
the most recent calendar quarter that
has ended an effective proxy for tier 1
capital? If not, what alternative
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
approach would be more effective and
why?
Question 268. Should the proposed
rule be modified to permit a banking
entity to bring its investments in
covered funds into compliance with the
proposed rule within a reasonable
period of time if, for example, the
banking entity’s aggregate permitted
investments in covered funds exceeds 3
percent of its tier 1 capital for reasons
unrelated to additional investments
(e.g., a banking entity’s tier 1 capital
decreases)? Why or why not?
Question 269. Does the proposed rule
effectively and appropriately implement
the deduction from capital for an
investment in a covered fund contained
in section 13(d)(4)(B)(iii) of the BHC
Act? If not, what alternative approach
would be more effective or appropriate,
given the statutory language of the BHC
Act and overall structure of section
13(d)(4), and why? What effect, if any,
should the Agencies give to the crossreference in section 13(d)(4) to section
13(d)(3) of the BHC Act, which provides
Agencies with discretion to require
additional capital, if appropriate, to
protect the safety and soundness of
banking entities engaged in activities
permitted under section 13 of the BHC
Act? How, if at all, should a banking
entity’s deduction of its investment in a
covered fund be increased
commensurate with the leverage of the
covered fund? Should the amount of the
deduction be proportionate to the
leverage of the covered fund? For
example, instead of a dollar-for-dollar
deduction, should the deduction be set
equal to the banking entity’s investment
in the covered fund times the difference
between 1 and the covered fund’s
equity-to-assets ratio?
Question 270. Does the proposed rule
effectively implement the Board’s
statutory authority to grant an extension
of the period of time a banking entity
may retain in excess of 3 percent of the
ownership interests in a single covered
fund? Are the enumerated factors that
the Board may consider in connection
with reviewing such an extension
appropriate (including factors related to
the effect of an extension of the covered
fund), and if not, why not? Are there
additional factors that the Board should
consider in reviewing such a request?
Are there specific additional conditions
or limitations that the Board should, by
rule, impose in connection with
granting such an extension? If so, what
conditions or limitations would be more
effective?
Question 271. Given that the statute
does not provide for an extension of
time for a banking entity to comply with
the aggregate funds limitation, within
PO 00000
Frm 00063
Fmt 4701
Sfmt 4702
68907
what period of time should a banking
entity be required to bring its
investments into conformance with the
aggregate funds limit? Should the
proposed rule expressly contain a grace
period for complying with these limits?
Why or why not? If yes, what grace
period would be most effective and
why?
Question 272. Does the proposed rule
effectively implement the prohibition
on a banking entity guaranteeing or
insuring the obligations or performance
of certain covered funds? If not, what
alternative approach would be more
effective and why?
Question 273. In the context of
securitization transactions, control and
ownership are often completely
separated. Is additional guidance
necessary with respect to how control
should be determined with respect to
issuers of asset-backed securities for
purposes of determining the calculation
of the per-fund and aggregate ownership
limitations?
Question 274. In many securitization
transactions, the voting rights of
investors are extremely limited and
management may be contractually
delegated to a third party (because
issuers of asset-backed securities rarely
have a board with any authority or any
employees). The servicer or manager has
the ‘‘ability to control the decisionmaking and operational functions of the
fund.’’ When calculating the per-fund
and aggregate ownership limitations, to
whom should the proposed rule allocate
‘‘control’’ in this type of situation?
Which participants in a securitization
transaction would need to include the
activities of an issuer of asset-backed
securities in their calculations of perfund and aggregate ownership, and what
is the potential impact of such
inclusion?
Question 275. For purposes of
calculating the per-fund and aggregate
ownership limitations, how should the
proposed rule address those instances in
which equity is issued, but the equity
holder does not receive economic
benefits or have any control rights? For
instance, in order to enhance or achieve
bankruptcy remoteness, a single
purpose trust without an owner (i.e, an
orphan trust) may hold all of the equity
interests in a securitization vehicle.
Such interests often do not have any
meaningful economic or control rights.
4. Section l.13: Other Permitted
Covered Fund Activities and
Investments
Section 13 of the proposed rule
implements the statutory exemptions
described in sections 13(d)(1)(C), (E),
and (I) of the BHC Act that permit a
E:\FR\FM\07NOP2.SGM
07NOP2
68908
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
banking entity: (i) To acquire an
ownership interest in, or act as sponsor
to, one or more SBICs, a public welfare
investment, or a certain qualified
rehabilitation expenditure; 292 (ii) to
acquire or retain an ownership interest
in a covered fund as a risk-mitigating
hedging position; and (iii) in the case of
a non-U.S. banking entity, to acquire or
retain an ownership interest in or
sponsor a foreign covered fund.
Additionally, § l.13 of the proposed
rule implements in part the rule of
construction related to the sale and
securitization of loans contained in
section 13(g)(2) of the BHC Act. Similar
to § l.6 of the proposed rule (which
implements certain permitted
proprietary trading activities), § l.13
contains only the statutory exemptions
contained in section 13(d)(1) of the BHC
Act that the Agencies have determined
apply, either by plain language or by
implication, to investments in or
relationships with a covered fund.293
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
a. Permitted Investments in SBICs and
Related Funds
Section l.13(a) of the proposed rule
implements sections 13(d)(1)(E) and (J)
of the BHC Act 294 and permits a
banking entity to acquire or retain any
ownership interest in, or act as sponsor
to: (i) One or more SBICs, as defined in
section 102 of the Small Business
Investment Act of 1958 (12 U.S.C.
§ 662); (ii) an investment that is
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
292 Section l.13(a) of the proposed rule also
implements a proposed determination by the
Agencies under section 13(d)(1)(J) of the BHC Act
that a banking entity may not only invest in such
entities as provided under section 13(d)(1)(E) of the
BHC Act, but also may sponsor an entity described
in that paragraph and that such activity, since it
generally would facilitate investment in small
businesses and support the public welfare, would
promote and protect the safety and soundness of
banking entities and the financial stability of the
United States.
293 In particular, § l.13 of the proposed rule does
not include: (i) The exemption in section
13(d)(1)(A) of the BHC Act for trading in certain
permitted government obligations; (ii) the
exemption in section 13(d)(1)(H) of the BHC Act for
certain foreign proprietary trading activities; and
(iii) the exemption contained in section 13(d)(1)(B)
of the BHC Act related to underwriting and marketmaking related activities. Each of these exemptions
appear relevant only to covered trading activities
and not to covered fund activities.
294 Section 13(d)(1)(E) of the BHC Act permits a
banking entity to make investments in one or more
SBICs, investments designed primarily to promote
the public welfare, investments of the type
permitted under 12 U.S.C. 24(eleventh), and
investments that are qualified rehabilitation
expenditures with respect to a qualified
rehabilitated building or certified historic structure.
See 12 U.S.C. 1851(d)(1)(E).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
low- and moderate-income communities
or families (such as providing housing,
services, or jobs); and (iii) an investment
that is a qualified rehabilitation
expenditure with respect to a qualified
rehabilitation 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.295 Since
section 13(d)(1)(E) of the BHC Act does
not limit a banking entity’s investment
to a limited partnership or other noncontrolling investment, § l.13(a) of the
proposed rule would permit a banking
entity to be a shareholder, general
partner, managing member, or trustee of
an SBIC without regard to whether the
interest is a controlling or noncontrolling interest.296
In addition to the acquisition or
retention of an ownership interest,
permitting a banking entity to act as
sponsor to these types of public interest
investments will provide valuable
expertise and services to these types of
entities, as well as help enable banking
entities to provide valuable funding and
assistance to small business and lowand moderate-income communities.
Therefore, the Agencies believe this
exemption would be consistent with the
safe and sound operation of banking
entities, and would also promote the
financial stability of the United States.
The Agencies request comment on the
proposed rule’s approach to
implementing the exemption for
permitted investments in and
relationships with SBICs and certain
related funds. In particular, the
Agencies request comment on the
following questions:
Question 276. Is the proposed rule’s
approach to implementing the SBIC,
public welfare and qualified
rehabilitation investment exemption for
acquiring or retaining an ownership
interest in a covered fund effective? If
not, what alternative approach would be
more effective?
Question 277. Should the approach
include other elements? If so, what
elements and why? Should any of the
proposed elements be revised or
eliminated? If so, why and how?
Question 278. Should the proposed
rule permit a banking entity to sponsor
an SBIC and other identified public
interest investments? Why or why not?
Does the Agencies’ determination under
section 13(d)(1)(J) of the BHC Act
proposed rule § l.13(a).
296 Pursuant to the exemption contained in
§ l.13(a) of the proposed rule, a banking entity may
acquire an ownership interest in, or act as sponsor
to, a low income housing credit fund, if such fund
qualifies as an SBIC, public welfare investment or
qualified rehabilitation expenditure.
295 See
PO 00000
Frm 00064
Fmt 4701
Sfmt 4702
regarding sponsoring of an SBIC, public
welfare or qualified rehabilitation
investment effectively promote and
protect the safety and soundness of
banking entities and the financial
stability of the United States? If not,
why not?
Question 279. What would the effect
of the proposed rule be on a banking
entity’s ability to sponsor and syndicate
funds supported by public welfare
investments or low income housing tax
credits which are utilized to assist banks
and other insured depository
institutions with meeting their
Community Reinvestment Act (‘‘CRA’’)
obligations?
Question 280. Does the proposed rule
unduly constrain a banking entity’s
ability to meet the convenience and
needs of the community through CRA or
other public welfare investments or
services? If so, why and how could the
proposed rule be revised to address this
concern?
b. Permitted Risk-Mitigating Hedging
Activities
Section l.13(b) of the proposed rule
permits a banking entity to acquire and
retain an ownership interest in a
covered fund if the transaction is made
in connection with, and related to,
certain individual or aggregated
positions, contracts, or other holdings of
the banking entity and is designed to
reduce the specific risks to the banking
entity in connection with and related to
such positions, contracts, or other
holdings. This section of the proposed
rule implements, in relevant part,
section 13(d)(1)(C) of the BHC Act,
which provides an exemption from the
prohibition on acquiring or retaining an
ownership interest in a covered fund for
certain risk-mitigating hedging
activities.297
Interests by a banking entity in a
covered fund may not typically be used
as hedges for specific positions,
contracts, or other holdings of a banking
entity. However, two situations where a
banking entity may potentially acquire
or retain an ownership interest in a
covered fund as a hedge are (i) when
acting as intermediary on behalf of a
customer that is not itself a banking
entity to facilitate the exposure by the
customer to the profits and losses of the
covered fund (similar to acting as a
‘‘riskless principal’’),298 and (ii) to cover
297 See
12 U.S.C. 1851(d)(1)(C).
order to prevent evasion of the general
limitation that a banking entity may not acquire or
retain more than 3 percent of the ownership
interests in any single covered fund that such
banking entity organizes and offers, the proposed
rule limits a banking entity’s ability to acquire or
retain an ownership interest in a covered fund as
298 In
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
a compensation arrangement with an
employee of the banking entity that
directly provides investment advisory or
other services to that fund. Section
l.13(b) of the proposed rule provides
an exemption for banking entity to
acquire or retain an ownership interest
in a covered fund in these limited
situations.299
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
i. Approach for Hedges Using an
Ownership Interest in a Covered Fund
As noted above in the discussion of
§ l.5 of the proposed rule, riskmitigating hedging activities present
certain implementation challenges
because of the potential that prohibited
activities or investments could be
conducted in the context of, or
mischaracterized as, hedging
transactions. In light of these
complexities, the Agencies have
proposed a multi-faceted approach to
implementation, which is discussed in
detail above in reference to § l.5 of the
proposed rule.300 As with the hedging
exemption provided under § l.5, this
multi-faceted approach is intended to
clearly articulate the Agencies’
expectations regarding the scope of
permitted hedging activities under
§ l.13(b) in a manner that limits
potential abuse of the hedging
exemption while not unduly
constraining the important risk
management function that is served by
a banking entity’s hedging activities.
However, because of the possibility that
using an ownership interest in a covered
fund as a hedging instrument may mask
an intent to evade the limitations on the
amount and value of ownership
interests in a covered fund or funds
under § l.12, the proposed rule
contains several additional
requirements related to a banking
entity’s ability to use an ownership
interest in a covered fund as a hedging
instrument.
ii. Required Criteria for Permitted RiskMitigating Hedging Activities Involving
a Covered Fund
Section l.13(b) of the proposed rule
describes the criteria that a banking
entity must meet in order to rely on the
hedging exemption with respect to
ownership interests of a covered fund.
The majority of these requirements are
substantially similar to those discussed
in detail above in connection with the
risk-mitigating hedging exemption
contained in § l.5 of the proposed rule,
a permitted risk-mitigating hedge to those situations
where the customer of the banking entity is not
itself a banking entity. See proposed rule
§ l.13(b)(1)(i)(A).
299 See proposed rule § l.13(b).
300 See Supplementary Information, Part III.B.3.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
and include the requirements that: (i)
The hedge is made in connection with
and related to individual or aggregated
obligations or liabilities of the banking
entity that are: (A) taken by the banking
entity when acting as intermediary on
behalf of a customer that is not itself a
banking entity to facilitate the exposure
by the customer to the profits and losses
of the covered fund, or (B) directly
connected to a compensation
arrangement with an employee that
directly provides investment advisory or
other services to the covered fund; (ii)
the banking entity has established the
internal compliance program required
by subpart D designed to ensure the
banking entity’s compliance with the
requirements of this paragraph,
including reasonably designed written
policies and procedures regarding the
instruments, techniques and strategies
that may be used for hedging, internal
controls and monitoring procedures,
and independent testing; (iii) the
transaction is designed to reduce the
specific risks to the banking entity in
connection with and related to such
obligations or liabilities; (iv) the
acquisition or retention of an ownership
interest in a covered fund: (A) Is made
in accordance with the written policies,
procedures and internal controls
established by the banking entity
pursuant to subpart D; (B) hedges or
otherwise mitigates an exposure to a
covered fund through a substantially
similar offsetting exposure to the same
covered fund and in the same amount
of ownership interest in that covered
fund that arises out of a transaction
conducted solely to accommodate a
specific customer request with respect
to, or directly connected to its
compensation arrangement with an
employee that directly provides
investment advisory or other services to,
that covered fund; (C) does not give rise,
at the inception of the hedge, to
significant exposures that were not
already present in individual or
aggregated positions, contracts, or other
holdings of a banking entity and are not
hedged contemporaneously; and (D) is
subject to continuing review,
monitoring and management by the
banking entity that: (1) Is consistent
with its written hedging policies and
procedures; (2) maintains a substantially
similar offsetting exposure to the same
amount and type of ownership interest,
based upon the facts and circumstances
of the underlying and hedging positions
and the risks and liquidity of those
positions, to the risk or risks the
purchase or sale is intended to hedge or
otherwise mitigate; and (3) mitigates any
significant exposure arising out of the
PO 00000
Frm 00065
Fmt 4701
Sfmt 4702
68909
hedge after inception; and (v) the
compensation arrangements of persons
performing the risk-mitigating hedging
activities are designed not to reward
proprietary risk-taking.301
These requirements, while
substantially similar to those contained
in § l.5 above, are different in several
material aspects. First, § l.13(b)(1)(i) of
the proposed rule provides that any
banking entity relying on this
exemption may only hedge or otherwise
mitigate one or more specific risks
arising in connection with and related
to the two situations enumerated in that
section. These are risks taken by the
banking entity when acting as
intermediary on behalf of a customer
that is not itself a banking entity to
facilitate the exposure by the customer
to the profits and losses of the covered
fund, or directly connected to its
compensation arrangement with an
employee that directly provides
investment advisory or other services to
the covered fund.302 Second,
§ l.13(b)(2)(ii)(B) of the proposed rule
requires that the acquisition or retention
of an ownership interest in a covered
fund hedge or otherwise mitigate a
substantially similar offsetting exposure
to the same covered fund and in the
same amount of ownership interest in
that covered fund, which requires
greater equivalency between the
reference asset and hedging instrument
than the correlation required under
§ l.5. Third, § l.13(b)(3) of the
proposed rule imposes a documentation
requirement on all types of hedging
transactions where the banking entity
uses ownership interests in a covered
fund as the hedging instrument. This
requirement is broader than that
contained in § l.5 and is reflective of
the limited scope of positions or
exposures for which a banking entity
may acquire or retain an ownership
interest in a covered fund as a hedge.
Specifically, for any transaction that a
banking entity acquires or retains an
ownership interest in a covered fund in
reliance of the hedging exemption, the
banking entity must document the riskmitigating purposes of the transaction
and identify the risks of the individual
or aggregated positions, contracts, or
other holding of the banking entity that
the transaction is designed to reduce.
Such documentation must be
established at the time the hedging
transaction is effected, not after the fact.
This documentation requirement
establishes a contemporaneous record
that will assist the Agencies in assessing
301 See
302 See
E:\FR\FM\07NOP2.SGM
proposed rule § l.13(b).
proposed rule § l.13(b)(1)(i).
07NOP2
68910
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
the actual reasons for which the
position was established.
iv. Request for Comment
In addition to those questions raised
in connection with the proposed
implementation of the risk-mitigating
hedging exemption under § l.5 of the
proposed rule, the Agencies request
comment on the proposed
implementation of that same exemption
with respect to covered fund activities.
In particular, the Agencies request
comment on the following questions:
Question 281. Is the proposed rule’s
approach to implementing the hedging
exemption for acquiring or retaining an
ownership interest in a covered fund
effective? If not, what alternative
approach would be more effective?
Question 282. Should the approach
include other elements? If so, what
elements and why? Should any of the
proposed elements be revised or
eliminated? If so, why and how?
Question 283. What burden will the
proposed approach to implementing the
hedging exemption have on banking
entities? How can any burden be
minimized or eliminated in a manner
consistent with the language and
purpose of the statute?
Question 284. Are the criteria
included in § l.13(b)’s hedging
exemption effective? Is the application
of each criterion to potential
transactions sufficiently clear? Should
any of the criteria be changed or
eliminated? Should other requirements
be added?
Question 285. Is the requirement that
an ownership interest in a covered fund
may only be used as a hedge (i) by the
banking entity when acting as
intermediary on behalf of a customer
that is not itself a banking entity to
facilitate the exposure by the customer
to the profits and losses of the covered
fund, or (ii) to cover compensation
arrangements with an employee of the
banking entity that directly provides
investment advisory or other services to
that fund effective? If not, what other
requirements would be more effective?
Question 286. Does the proposed rule
sufficiently articulate the types of risks
and positions that a banking entity
typically would utilize an ownership
interest in a covered fund to hedge? If
not, how should the proposal be
changed?
Question 287. Is the requirement that
that the hedging transaction involve a
substantially similar offsetting exposure
to the same covered fund and in the
same amount of ownership interest to
the risk or risks the transaction is
intended to hedge or otherwise mitigate
effective? If not, how should the
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
requirement be changed? Should some
other level of correlation be required?
Should the proposal specify in greater
detail how correlation should be
measured? If not, how could it better do
so?
Question 288. Is the requirement that
the transaction not give rise, at the
inception of the hedge, to material risks
that are not themselves hedged in a
contemporaneous transaction effective?
Is the proposed materiality qualifier
appropriate and sufficiently clear? If
not, what alternative would be effective
and/or clearer?
Question 289. Is the requirement that
any transaction conducted in reliance
on the hedging exemption be subject to
continuing review, monitoring and
management after the transaction is
established effective? If not, what
alternative would be more effective?
Question 290. Is the proposed
documentation requirement effective? If
not, what alternative would be more
effective? What burden would the
proposed documentation requirement
place on covered banking entities? How
might such burden be reduced or
eliminated in a manner consistent with
the language and purpose of the statute?
c. Permitted Covered Fund Activities
and Investments Outside of the United
States
Section l.13(c) of the proposed rule,
which implements section 13(d)(1)(I) of
the BHC Act,303 permits certain foreign
banking entities to acquire or retain an
ownership interest in, or to act as
sponsor to, a covered fund so long as
such activity occurs solely outside of
the United States and the entity meets
the requirements of sections 4(c)(9) or
4(c)(13) of the BHC Act. The purpose of
this statutory exemption appears to be
to limit the extraterritorial application
of the statutory restrictions on covered
fund activities to foreign firms that, in
the course of operating outside of the
United States, engage outside the United
States in activities permitted under
relevant foreign law, while preserving
national treatment and competitive
equality among U.S. and foreign firms
303 Section
13(d)(1)(I) of the BHC Act permits a
banking entity to acquire or retain an ownership
interest in, or have certain relationships with, a
covered fund notwithstanding the prohibition on
proprietary trading and restrictions on investments
in, and relationships with, a covered fund, if: (i)
such activity or investment is conducted by a
banking entity pursuant to paragraph (9) or (13) of
section 4(c) of the BHC Act; (ii) the activity occurs
solely outside of the United States; (iii) no
ownership interest in such fund is offered for sale
or sold to a resident of the United States; and (iv)
the banking entity is not directly or indirectly
controlled by a banking entity that is organized
under the laws of the United States or of one or
more States. See 12 U.S.C. 1851(d)(1)(I).
PO 00000
Frm 00066
Fmt 4701
Sfmt 4702
within the United States.304 Consistent
with this purpose, the proposed rule
defines both the type of foreign banking
entities that are eligible for the
exemption and the circumstances in
which covered fund activities or
investments by such an entity will be
considered to have occurred solely
outside of the United States (including
clarifying when an ownership interest
will be deemed to have been offered for
sale or sold to a resident of the United
States).
i. Foreign Banking Entities Eligible for
the Exemption
Section l.13(c)(1)(i) of the proposed
rule incorporates the statutory
requirement that the banking entity not
be, directly or indirectly, controlled by
a banking entity that is organized under
the laws of the United States or of one
or more States. Consistent with the
statutory language, banking entities
organized under the laws of the United
States or of one or more States, or the
subsidiaries or branches thereof
(wherever organized or licensed), may
not rely on the exemption. Similarly,
the U.S. subsidiaries or U.S. branches of
foreign banking entities would not
qualify for the exemption.
Section l.13(c)(2) clarifies when a
banking entity would be considered to
have met the statutory requirement that
the banking entity conduct the activity
pursuant to paragraphs 4(c)(9) or
4(c)(13) of the BHC Act 305 Section
4(c)(9) of the BHC Act generally
provides that the restrictions on
nonbanking activities contained in
section 4(a) of that statute do not apply
to the ownership of shares held or
activities conducted by any company
organized under the laws of a foreign
country the greater part of whose
business is conducted outside the
United States, if the Board by regulation
or order determines that, under the
circumstances and subject to the
conditions set forth in the regulation or
order, the exemption would not be
substantially at variance with the
purposes of this Act and would be in
304 See 156 Cong. Rec. S5897 (daily ed. July 15,
2010) (statement of Sen. Merkley).
305 Section l.13(c)(2) of the proposed rule only
addresses when a transaction or activity will be
considered to have been conducted pursuant to
section 4(c)(9) of the BHC Act; although the statute
also references section 4(c)(13) of the BHC Act, the
Board has applied the authority contained in that
section only to include certain foreign activities of
U.S. banking organizations. The express language of
section 13(d)(1)(I) of the BHC Act limits its
availability to foreign banking entities that are not
controlled by a banking entity organized under the
laws of the United States or of one or more states.
A foreign banking entity may not rely on the
exemptive authority of section 4(c)(13) and, so, that
section is not addressed in the proposed rule.
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
the public interest.306 The Board has, in
part, implemented section 4(c)(9)
through subpart B of the Board’s
Regulation K, which specifies a number
of conditions and requirements that a
foreign banking organization must meet
in order to use such authority. Such
conditions and requirements include,
for example, a qualifying foreign
banking organization test that requires
the foreign banking organization to
demonstrate that more than half of its
worldwide business is banking and that
more than half of its banking business
is outside the United States.
The proposed rule makes clear that a
banking entity will qualify for the
foreign fund exemption if the entity is
a foreign banking organization subject to
subpart B of the Board’s Regulation K
and the transaction occurs solely
outside the United States. Section 13 of
the BHC Act also applies to foreign
companies that are banking entities
covered by Section 13 but are not
currently subject either to the BHC Act
generally or the Board’s Regulation K,
for example, because the foreign
company controls a savings association
or an FDIC-insured industrial loan
company but not a bank or branch in the
United States. Accordingly, the
proposed rule clarifies when such a
foreign banking entity would be
considered to have conducted a
transaction or activity ‘‘pursuant to
section 4(c)(9)’’ for purposes of the
exemption at § l.13(c) of the proposed
rule.307 In particular, the proposed rule
proposes that to qualify for the foreign
banking entity exemption, such firms
must meet at least two of three
requirements that evaluate the extent to
which the foreign entity’s business is
conducted outside the United States, as
measured by assets, revenues, and
income. This test largely mirrors the
qualifying foreign banking organization
test that is made applicable under
section 4(c)(9) and § 211.23(a) of the
Board’s Regulation K, except that the
relevant test under § l.13(c)(2)(ii) of the
proposed rule does not require such a
foreign entity to demonstrate that more
than half of its business is banking
conducted outside the United States.308
306 See
12 U.S.C. 1843(c)(9).
Board emphasizes that this clarification
would be applicable solely in the context of sections
13(d)(1)(H) and (I) of the BHC Act. The application
of section 4(c)(9) to such foreign companies in other
contexts is likely to involve different legal and
policy issues and may therefore merit different
approaches.
308 See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a);
proposed rule § l.13(c)(2). This difference reflects
the fact that foreign entities subject to section 13 of
the BHC Act but not the BHC Act are, in many
cases, predominantly commercial firms. A
requirement that a firm also demonstrate that more
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
307 The
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
ii. Transactions and Activities Solely
Outside of the United States
Section l.13(c) of the proposed rule
also clarifies when a transaction or
activity will be considered to have
occurred solely outside of the Unites
States for purposes of the exemption. In
interpreting this aspect of the statutory
language, the proposal focuses on the
extent to which material elements of the
transaction occur within, or are effected
by personnel within, the United States.
This aspect of the proposal reflects the
apparent intent of the foreign funds
exemption to avoid extraterritorial
application of the restrictions on
covered funds activities and
investments outside the United States
while preserving competitive parity
within U.S. market. The proposed rule
does not evaluate solely whether the
risk of the transaction or activity, or
management or decision-making with
respect to such transaction or activity,
rests outside the United States. Rather,
the proposal also provides that foreign
banking entities may not structure a
transaction or activity so as to be
‘‘outside of the United States’’ for risk
and booking purposes while
simultaneously engaging in transactions
within U.S. markets that are prohibited
for U.S. banking entities.
In particular, § l.13(c)(3) of the
proposed rule provides that a
transaction or activity will be
considered to have occurred solely
outside of the United States only if all
of the following three conditions are
satisfied:
• The transaction or activity is
conducted by a banking entity that is
not organized under the laws of the
United States or of one or more States;
• No subsidiary, affiliate, or employee
of the banking entity that is involved in
the offer or sale of an ownership interest
in the covered fund is incorporated or
physically located in the United States;
and
• No ownership interest in such
covered fund is offered for sale or sold
to a resident of the United States.
These three criteria reflect statutory
constraints and are intended to ensure
that a transaction or activity conducted
in reliance on the exemption does not
involve either investors that are
residents of the United States or a
relevant U.S. employee of the banking
entity, as such involvement would
appear to constitute a sufficient locus of
than half of its banking business is outside the
United States would likely make the exemption
unavailable to many such firms and subject their
global activities to the prohibition on acquiring or
retaining an ownership interest in, or acting as
sponsor to, a covered fund, a result that the statute
does not appear to have intended.
PO 00000
Frm 00067
Fmt 4701
Sfmt 4702
68911
activity in the U.S. marketplace so as to
preclude the availability of the
exemption.
A resident of the United States is
defined in § l.2(t) of the proposed rule,
and is described in detail in Part
III.B.4.d of this Supplementary
Information. The proposed rule applies
this definition in the context of the
foreign covered funds exemption
because it would appear to
appropriately capture the scope of
counterparties (including investors that
are residents of the United States) or
relevant U.S. personnel of the banking
entity, that, if involved in the
transaction or activity, would preclude
such transaction or activity from being
considered to have occurred solely
outside the United States. Under the
proposed rule, an employee or entity
engaged in the offer or sale of an
ownership interest (or booking such
transaction) must be outside of the
United States; however, an employee or
entity with no customer relationship
and involved solely in providing
administrative services or so-called
‘‘back office’’ functions to the fund as
incident to the activity permitted under
§ l.13(c) of the proposed rule (such as
clearing and settlement or maintaining
and preserving records of the fund with
respect to a transaction where no
ownership interest is offered for sale or
sold to a resident of the United States)
would not be subject to this
requirement.
iii. Request for Comment
The Agencies request comment on the
proposed rule’s approach to
implementing the foreign covered funds
activity and investment exemption. In
particular, the Agencies request
comment on the following questions:
Question 291. Is the proposed rule’s
implementation of the ‘‘foreign funds’’
exemption effective? If not, what
alternative would be more effective and/
or clearer?
Question 292. Are the proposed rule’s
provisions regarding when an activity
will be considered to be conducted
pursuant to section 4(c)(9) of the BHC
Act effective and sufficiently clear? If
not, what alternative would be more
effective and/or clearer? Does it
effectively address application of the
foreign funds exemption to foreign
banking entities not subject to the BHC
Act generally? If not, how could it better
address application of the exemption?
Question 293. Are the proposed rule’s
provisions regarding when a transaction
or activity will be considered to have
occurred solely outside the United
States effective and sufficiently clear? If
not, what alternative would be more
E:\FR\FM\07NOP2.SGM
07NOP2
68912
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
effective and/or clearer? Should
additional requirements be added? If so,
what requirements and why? Should
additional requirements be modified or
removed? If so, what requirements and
why or how?
Question 294. Is the proposed
exemption consistent with the purpose
of the statute? Is the proposed
exemption consistent with respect to
national treatment for foreign banking
organizations? Is the proposed
exemption consistent with the concept
of competitive equity?
Question 295. Does the proposed rule
effectively define a resident of the
United States for these purposes? If not,
how should the definition be altered?
What definitions of resident of the
United States are currently used by
banking entities? Would using any one
of these definitions reduce the burden of
complying with section 13 of the BHC
Act? Why or why not?
d. Sale and Securitization of Loans
Section l.13(d) of the proposed rule
permits a banking entity to acquire and
retain an ownership interest in a
covered fund that is an issuer of assetbacked securities, the assets or holdings
of which are solely comprised of: (i)
Loans; (ii) contractual rights or assets
directly arising from those loans
supporting the asset-backed securities;
and (iii) interest rate or foreign exchange
derivatives that (A) materially relate to
the terms of such loans or contractual
rights or assets and (B) are used for
hedging purposes with respect to the
securitization structure.309 The
authority contained in this section of
the proposed rule would therefore allow
a banking entity to engage in the sale
and securitization of loans by acquiring
and retaining an ownership interest in
certain securitization vehicles (which
could qualify as a covered fund for
purposes of section 13(h)(2) of the BHC
Act and the proposed rule) that the
banking entity organizes and offers, or
acts as sponsor to, in excess of and
without being subject to the limitations
contained in § l.12 of the proposed
rule. Proposed § l.13(d) is designed to
assist in implementing section 13(g)(2)
of the BHC Act, which provides that
nothing in section 13 of the BHC Act
shall be construed to limit or restrict the
ability of a banking entity or nonbank
financial company supervised by the
309 See proposed rule § l.13(d). The types of
derivatives permitted under § l.13(d)(3) of the
proposed rule are not meant to include a synthetic
securitization or a securitization of derivatives, but
rather to include those derivatives that are used to
hedge foreign exchange or interest rate risk
resulting from loans held by the issuer of assetbacked securities.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
Board to sell or securitize loans in a
manner otherwise permitted by law.310
The Agencies note that the phrase
‘‘materially relate to terms of such
loans’’ is intended to quantitatively
limit the derivatives permitted in a
‘‘securitization of loans’’ under
§ l.13(d) of the proposed rule to
include only those derivatives where
the notional amount of the derivative is
tied to the outstanding principal balance
of the loans supporting the asset-backed
securities of such issuer, either
individually or in the aggregate.
Additionally, such derivatives must be
used solely to hedge risks that result
from a mismatch between the loans and
the related asset-backed securities (e.g.,
fixed rate loans with floating rate assetbacked securities, loans tied to the
Prime Rate with LIBOR asset-backed
securities, or Euro-denominated loans
with Dollar-denominated asset-backed
securities). Therefore, § l.13(d)(3) of
the proposed rule would not allow the
use of a credit default swap by an issuer
of asset-backed securities.
The Agencies request comment on the
proposed rule’s approach to
implementing the rule of construction
related to the sale and securitization of
loans. In particular, the Agencies
request comment on the following
questions:
Question 296. Is the proposed rule’s
implementation of the statute’s ‘‘sale
and securitization of loans’’ rule of
construction effective? If not, what
alternative would be more effective and/
or clearer?
Question 297. Are there other entities
or activities that should be included in
the proposed rule’s implementation of
the rule of construction related to the
sale and securitization of loans? If so,
what entity or activity and why?
Question 298. Is the proposed rule’s
application of the rule of construction
contained in section 13(g)(2) of the BHC
Act appropriate?
Question 299. Are the proposed rule
and this Supplementary Information
sufficiently clear regarding which
derivatives would be allowed in a
‘‘securitization of loans’’ under
§ l.13(d)(3) of the proposed rule? Is
additional guidance necessary with
respect to the types of derivatives that
would be included in or excluded from
a securitization of loans for purposes of
interpreting the rule of construction
contained in section 13(g)(2) of the BHC
Act? If so, what topics should the
additional guidance discuss and why?
Question 300. Should derivatives
other than interest rate or foreign
exchange derivatives be allowed in a
310 See
PO 00000
12 U.S.C. 1851(g)(2).
Frm 00068
Fmt 4701
Sfmt 4702
‘‘securitization of loans’’ for purposes of
interpreting the rule of construction
contained in section 13(g)(2) of the BHC
Act? Why or why not? What would be
the legal and economic impact of not
allowing the use of derivatives other
than interest rate or foreign exchange
derivatives in a ‘‘securitization of loans’’
under § l.13(d)(3) of the proposed rule
for existing issuers of asset-backed
securities and for future issuers of assetbacked securities?
Question 301. Should the Agencies
consider providing additional guidance
for when a transaction with
intermediate steps constitutes one or
more securitization transactions that
each would be subject to the rule? For
example, both auto lease securitizations
and asset-backed commercial paper
conduits typically involve intermediate
securitizations. The asset-backed
securities issued to investors in such
covered funds are technically supported
by the intermediate asset-backed
securities. Should these kinds of
securitizations be viewed as a single
transaction and included within a
securitization of loans for purposes of
the proposed rule? Should each step be
viewed as a separate securitization?
5. Section l.14: Covered Fund
Activities and Investments Determined
To Be Permissible
Section l.14 of the proposed rule,
which implements section 13(d)(1)(J) of
the BHC Act,311 permits a banking
entity to engage in any covered funds
activity that the Agencies determine
promotes and protects the safety and
soundness of a banking entity and the
financial stability of the United
States.312 Any activity authorized under
§ l.14 of the proposed rule must still
comply with the prohibition and
limitations governing relationships with
covered funds contained in section 13(f)
of the BHC Act, as implemented by
§ l.16 of this proposal.313 Additionally,
311 Section 13(d)(1)(J) of the BHC Act provides the
Agencies discretion to determine that other
activities not specifically identified by sections
13(d)(1)(A)–(I) of the BHC Act are exempted from
the general prohibitions contained in section 13(a)
of that Act, and are thus permitted activities. In
order to make such a determination, the Agencies
must find that such activity or activities promote
and protect the safety and soundness of a banking
entity, as well as promote and protect the financial
stability of the United States. See 12 U.S.C.
1851(d)(1)(J).
312 See 12 U.S.C. 1851(d)(1)(J).
313 Section 13(d)(1)(J) of the BHC Act only
provides the Agencies with the ability to provide
additional exemptions from the prohibitions
contained in section 13(a)(1) of the BHC Act.
Section 13(f) of the BHC Act, which deals with
relationships and transactions with a fund that is,
directly or indirectly, organized and offered or
sponsored by a banking entity, operates as an
independent prohibition and set of limitations on
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
like other activities permissible under
section 13(d)(1) of the BHC Act and as
implemented by subpart C of the
proposed rule, activities found
permissible under § l.14 of the
proposed rule and section 13(d)(1)(J)
remain subject to other provisions of
section 13 of the BHC Act, including the
sections limiting conflicts of interest
and high-risk assets or trading strategies,
as well as the section designed to
prevent evasion of section 13 of the BHC
Act.314
The Agencies have proposed to
permit three activities at this time under
this authority. These activities involve
acquiring or retaining an ownership
interest in and sponsoring of (i) certain
BOLI separate accounts; (ii) certain
entities that, although within the
definition of covered fund are, in fact,
common corporate organizational
vehicles; and (iii) a covered fund in the
ordinary course of collecting a debt
previously contracted in good faith or
pursuant to and in compliance with the
conformance or extended transition
period provided for under the Board’s
rules issued under section 13(c)(6) of
the BHC Act.
a. Investments in Certain Bank Owned
Life Insurance Separate Accounts
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Banking entities have for many years
invested in life insurance policies that
cover key employees, in accordance
with supervisory policies established by
the Federal banking agencies.315 These
BOLI investments are typically
structured as investments in separate
accounts that are excluded from the
definition of ‘‘investment company’’
under the Investment Company Act by
virtue of section 3(c)(1) or 3(c)(7) of that
Act. By virtue of reliance on these
exclusions, these BOLI accounts would
be covered by the definition of ‘‘hedge
fund’’ or ‘‘private equity fund’’ in
section 13 of the BHC Act.316
However, when made in the normal
course, these investments do not
involve the speculative risks intended to
be addressed by section 13 of the BHC
Act. Moreover, applying the
prohibitions in section 13 to these
investments would eliminate an
investment that helps banking entities
the activities of banking entities. As such, § l.14
of the proposed rule cannot and does not provide
any exemptions from the prohibition on
relationships or transaction with a covered fund
contained in section 13(f) of the BHC Act or § l.16
of the proposed rule.
314 See 12 U.S.C. 1851(d)(2), (e)(1).
315 See, e.g., Bank Owned Life Insurance,
Interagency Statement on the Purchase and Risk
Management of Life Insurance (‘‘Interagency BOLI
Guidance’’) (Dec. 7, 2004).
316 See 12 U.S.C. 1851(h)(2).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
to reduce their costs of providing
employee benefits as well as other costs.
Section l.14(a)(1) of the proposed
rule permits a banking entity to acquire
and retain these BOLI investments, as
well as act as sponsor to a BOLI separate
account.317 The proposal includes a
number of conditions designed to
ensure that BOLI investments are not
conducted in a manner that raises the
concerns that section 13 of the BHC Act
is intended to address. In particular, in
order for a banking entity to invest in or
sponsor a BOLI separate account, the
banking entity that purchases the
insurance policy: (i) May not control the
investment decisions regarding the
underlying assets or holdings of the
separate account; and (ii) must hold its
ownership interests in the separate
account in compliance with applicable
supervisory guidance provided by the
appropriate Federal regulatory agency
regarding BOLI.318
The Agencies have structured this
exemption in the proposed rule so as to
allow a banking entity to continue to
manage and structure its risks and
obligations related to its employee
compensation or benefit plan
obligations in a manner that promotes
and protects the safety and soundness of
banking entities, which on an industrywide level has the concomitant effect of
promoting and protecting the financial
stability of the United States.
b. Investments in Certain Other Covered
Funds
As noted above, the definition of
‘‘covered fund’’ as contained in
§ l.10(b)(1) of the proposed rule
potentially includes within its scope
many entities and corporate structures
317 The proposed rule defines ‘‘separate account’’
as ‘‘an account established and maintained by an
insurance company subject to regulation by a State
insurance regulatory or a foreign insurance
regulator under which income, gains, and losses,
whether or not realized, from assets allocated to
such account, are, in accordance with the
applicable contract, credited to or charged against
such account without regard to other income, gains,
or losses of the insurance company.’’ See proposed
rule § l.2(z).
318 See proposed rule § l.14(a)(1)(i)–(ii). While
other guidance or requirements may be imposed by
the Agencies or an individual Agency for a specific
banking entity for which it serves as the primary
financial regulator, the Agencies note that, at a
minimum, investments under authority of this
section must comply with the Interagency BOLI
Guidance. This guidance requires, among other
things, that a banking entity generally: (i) Not
control the investment decisions regarding the
underlying assets or holdings of the separate
account; (ii) demonstrate to the satisfaction of the
relevant Agency that the potential returns from the
investments in such separate account are
appropriately matched to the banking entity’s
employee compensation or benefit plan obligations;
and (iii) not use such separate account to take
speculative positions or to support the general
operations of the banking entity.
PO 00000
Frm 00069
Fmt 4701
Sfmt 4702
68913
that would not usually be thought of as
a ‘‘hedge fund’’ or ‘‘private equity
fund.’’ Additionally, the Dodd-Frank
Act contains other provisions that
permit or require a banking entity to
acquire or retain an ownership interest
in or act as sponsor to a covered fund
in a manner not specifically described
under section 13 of the BHC Act.
Section l.14(a)(2) of the proposed
rule permits a banking entity to own
certain specified entities that are often
part of corporate structures and that, by
themselves and without other
extenuating circumstances or factors, do
not raise the type of concerns which
section 13 of the BHC Act was intended
to address but which nevertheless may
be captured by the definition of ‘‘hedge
fund’’ or ‘‘private equity fund’’ in
section 13(h)(2) of the BHC Act.
Specifically, § l.14(a)(2) of the
proposed rule permits a banking entity
to acquire or retain an ownership
interest in or act as sponsor to (i) a joint
venture between the banking entity and
any other person, provided that the joint
venture is an operating company and
does not engage in any activity or any
investment not permitted under the
proposed rule; (ii) an acquisition
vehicle, provided that the sole purpose
and effect of such entity is to effectuate
a transaction involving the acquisition
or merger of one entity with or into the
banking entity or one of its affiliates;
and (iii) a wholly-owned subsidiary of
the banking entity that is (A) engaged
principally in providing bona fide
liquidity management services
described under § l.3(b)(2)(iii)(C) of the
proposed rule, and (B) carried on the
balance sheet of the banking entity.319
The Agencies note that these types of
entities may meet the definition of
covered fund contained in § l.10(b)(1)
of the proposed rule (and as contained
in section 13(h)(2) of the BHC Act), to
the extent these entities rely solely on
section 3(c)(1) or 3(c)(7) of the
Investment Company Act. However,
these types of entities do not engage in
the type and scope of activities to which
Congress intended section 13 of the
BHC Act to apply.320 Additionally,
without this exemption, many entities
would be forced to alter their corporate
structure without achieving any
reduction in risk. Permitting such
investments in these entities would thus
appear to promote and protect the safety
and soundness of banking entities and
promote and protect the financial
stability of the United States.
proposed rule § l.14(a)(2).
156 Cong. Rec. H5226 (daily ed. June 30,
2010) (statement of Reps. Himes and Frank).
319 See
320 See
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68914
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Section l.14(a)(2) of the proposed
rule also permits a banking entity to
comply with section 15G of the
Exchange Act (15 U.S.C. 78o–11), added
by section 941 of the Dodd-Frank Act,
which requires a banking entity to
maintain a certain minimum interest in
certain sponsored or originated assetbacked securities.321 In order to give
effect to this separate requirement under
the Dodd-Frank Act, § l.14(a)(2)(iii) of
the proposed rule permits a banking
entity to acquire or retain an ownership
interest in or act as sponsor to an issuer
of asset-backed securities, but only with
respect to that amount or value of
economic interest in a portion of the
credit risk for an asset-backed security
that is retained by a banking entity that
is a ‘‘securitizer’’ or ‘‘originator’’ in
compliance with the minimum
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11) and
any implementing regulations issued
thereunder.322 The Agencies have
structured this exemption to recognize
that Congress imposed other
requirements on firms that are banking
entities under section 13 of the BHC
Act. Additionally, permitting a banking
entity to retain the minimum level of
economic interest will incent banking
entities to engage in more careful and
prudent underwriting and evaluation of
the risks and obligations that may
accompany asset-backed securitizations,
which would promote and protect the
safety and soundness of banking entities
and the financial stability of the United
States.
Section 14(a)(2) of the proposed rule
permits a banking entity to acquire and
retain an ownership interest in a
covered fund that is an issuer of assetbacked securities described in § 13(d) of
the proposed rule, the assets or holdings
of which are solely comprised of: (i)
Loans; (ii) contractual rights or assets
directly arising from those loans
supporting the asset-backed securities;
and (iii) interest rate or foreign exchange
derivatives that (A) materially relate to
the terms of such loans or contractual
rights or assets and (B) are used for
hedging purposes with respect to the
securitization structure. This exemption
augments the authority regarding the
sale and securitization of loans available
under § l.13(d) of the proposed rule
(which partially implements the rule of
construction under section 13(g)(2) of
the BHC Act) and permits a banking
entity to engage in the purchase, and not
321 The relevant agencies issued a proposed rule
to implement the requirements of section 15G of the
Exchange Act, as required under section 941 of the
Dodd-Frank Act. See Credit Risk Retention, 76 FR
24090 (Apr. 29, 2011).
322 See proposed rule § l.14(a)(2)(iii).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
only the sale and securitization, of loans
through authorizing the acquisition or
retention of an ownership interest in
such securitization vehicles that the
banking entity does not organize and
offer, or for which it does not act as
sponsor, provided that the assets or
holdings of such vehicles are solely
comprised of the instruments or
obligations referenced above.323
Permitting banking entities to acquire
or retain an ownership interest in these
loan securitizations will provide a
deeper and richer pool of potential
participants and a more liquid market
for the sale of such securitizations,
which in turn should result in increased
availability of funds to individuals and
small businesses, as well as provide
greater efficiency and diversification of
risk. The Agencies believe this
exemption would promote and protect
the safety and soundness of a banking
entity, and would also promote and
protect the financial stability of the
United States.324
c. Acquiring or Retaining an Ownership
Interest in or Acting a Sponsor to a
Covered Fund Under Certain Specified
Authorities
Section l.14(b) of the proposed rule
permits a banking entity to acquire or
retain an ownership interest in or act as
sponsor to a covered fund in those
instances where the ownership interest
is acquired or retained by a banking
entity (i) in the ordinary course of
collecting a debt previously contracted
in good faith, if the banking entity
divests the ownership interest within
applicable time periods provided for by
the applicable Agency, or (ii) pursuant
to and in compliance with the
Conformance or Extended Transition
Period authorities provided for under
the proposed rule.325
Allowing banking entities to rely on
these authorities for acquiring or
retaining an ownership interest in or
acting as sponsor to a covered fund will
enable banking entities to manage their
risks and structure their business in a
manner consistent with their chosen
corporate form and in a manner that
otherwise complies with applicable
laws. Thus, permitting such activities
would promote and protect the safety
and soundness of a banking entity, and
id. at § l.14(a)(2)(v).
Agencies note that proposed exemption
applies only to the covered fund-related provisions
of the proposed rule, and not to its prohibition on
proprietary trading.
325 See proposed rule § l.14(b). The
Conformance or Extended Transition period
authorities are substantially similar to those
proposed by the Board in its February 2011 final
rule governing such conformance periods under
section 13 of the BHC Act.
323 See
324 The
PO 00000
Frm 00070
Fmt 4701
Sfmt 4702
would also promote and protect the
financial stability of the United States.
d. Request for Comment
The Agencies request comment on the
proposed rule’s approach to
implementing the exemption related to
activities specifically determined to be
permissible under section 13(d)(1)(J) of
the BHC Act. In particular, the Agencies
request comment on the following
questions:
Question 302. Is the proposed rule’s
implementation of exemptions for
covered fund activities and investments
pursuant to section 13(d)(1)(J) of the
BHC Act effective? If not, what
alternative would be more effective and/
or clearer?
Question 303. Is the proposed rule’s
approach to utilizing section 13(d)(1)(J)
of the BHC Act to permit a banking
entity to acquire or retain an ownership
interest in, or act as sponsor to, certain
entities that would fall into the
definition of covered fund effective?
Why or why not? If not, what alternative
would be more effective and why? What
legal authority under the statute would
permit such an alternative?
Question 304. Are the proposed rule’s
provisions regarding when a covered
fund activity will be deemed to be
permitted under authority of section
13(d)(1)(J) of the BHC Act effective and
sufficiently clear? If not, what
alternative would be more effective and/
or clearer?
Question 305. Do the exemptions
provided for in § l.14 of the proposed
rule effectively promote and protect the
safety and soundness of banking entities
and the financial stability of the United
States? If not, why not?
Question 306. Are the proposed rule’s
provisions regarding what qualifications
must be satisfied in order to qualify for
an exemption under § l.14 of the
proposed rule effective and sufficiently
clear? If not, what alternative would be
more effective and/or clearer? Should
additional requirements be added? If so,
what requirements and why? Should
additional requirements be modified or
removed? If so, what requirements and
why or how?
Question 307. Does the proposed rule
effectively cover the scope of covered
funds activities which the Agencies
should specifically determine to be
permissible under section 13(d)(1)(J) of
the BHC Act? If not, what activity or
activities should be permitted? For
additional activities that should be
permitted, on what grounds would these
activities promote and protect the safety
and soundness of banking entities and
the financial stability of the United
States?
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Question 308. Does the proposed rule
effectively address the interplay
between the restrictions on covered
fund activities and investments in
section 13 of the BHC Act and the
requirements imposed on certain
banking entities under section 15G of
the Exchange Act? Why or why not?
Question 309. Rather than permitting
the acquisition or retentions of an
ownership interest in, or acting as
sponsor to, specific covered funds under
section 13(d)(1)(J) of the BHC Act,
should the Agencies use the authority
provided under section 13(d)(1)(J) to
permit investments in a covered fund
that display certain characteristics? If
so, what characteristics should the
Agencies consider? How would
investments with such characteristics
promote and protect the safety and
soundness of the banking entity and
promote the financial stability of the
United States?
Question 310. Should venture capital
funds be excluded from the definition of
‘‘covered fund’’? Why or why not? If so,
should the definition contained in rule
203(l)–1 under the Advisers Act be
used? Should any modification to that
definition of venture capital fund be
made? How would permitting a banking
entity to invest in such a fund meet the
standards contained in section
13(d)(1)(J) of the BHC Act?
Question 311. Should non-U.S. funds
or entities be included in the definition
of ‘‘covered fund’’? Should any non-U.S.
funds or entities be excluded from this
definition? Why or why not? How
would permitting a banking entity to
invest in such a fund meet the standards
contained in section 13(d)(1)(J) of the
BHC Act?
Question 312. Should so-called ‘‘loan
funds’’ that invest principally in loans
and not equity be excluded from the
definition of ‘‘covered fund’’? Why or
why not? What characteristics would be
most effective in determining whether a
fund invests principally in loans and
not equity? How would permitting a
banking entity to invest in such a fund
meet the standards contained in section
13(d)(1)(J) of the BHC Act?
Question 313. Are the proposed rule’s
proposed determinations that the
specified covered funds activities or
investments promote and protect the
safety and soundness of banking entities
and the financial stability of the United
States appropriate? If not, how should
the determinations be amended or
altered?
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
6. Section l.15: Internal Controls,
Reporting and Recordkeeping
Requirements Applicable to Covered
Fund Activities and Investments
Section l.15 of the proposed rule,
which implements section 13(e)(1) of
the BHC Act,326 requires a banking
entity engaged in covered fund activities
and investments to comply with (i) the
internal controls, reporting, and
recordkeeping requirements required
under § l.20 and Appendix C of the
proposed rule, as applicable and (ii)
such other reporting and recordkeeping
requirements as the relevant supervisory
Agency may deem necessary to
appropriately evaluate the banking
entity’s compliance with this subpart
C.327 These requirements are discussed
in detail in Part III.D of this
Supplementary information.
7. Section l.16: Limitations on
Relationships With a Covered Fund
Section 13(f) of the BHC Act generally
prohibits a banking entity from entering
into certain transactions with a covered
fund that would be a covered
transaction as defined in section 23A of
the FR Act.328 Section l.16 of the
proposed rule implements this
provision. Section l.16(a)(2) of the
proposed rule clarifies that, for reasons
explained in detail below, certain
transactions between a banking entity
and a covered fund remain permissible.
Section l.16(b) of the proposed rule
implements the statute’s requirement
that any transaction permitted under
section 13(f) of the BHC Act (including
a prime brokerage transaction) between
the banking entity and covered fund is
subject to section 23B of the FR Act,329
which, in general, requires that the
transaction be on market terms or on
terms at least as favorable to the banking
entity as a comparable transaction by
the banking entity with an unaffiliated
third party.
a. General Prohibition on Certain
Transactions and Relationships
Section 13(f)(1) of the BHC Act
generally prohibits a banking entity that,
directly or indirectly, serves as
investment manager, investment
adviser, commodity trading adviser, or
sponsor to a covered fund (or that
organizes and offers a covered fund
pursuant to section 13(d)(1)(G) of the
BHC Act) from engaging in any
326 Section 13(e)(1) of the BHC Act requires the
Agencies to issue regulations regarding internal
controls and recordkeeping to ensure compliance
with section 13. See 12 U.S.C. 1851(e)(1).
327 See proposed rule § l.15.
328 12 U.S.C. 371c.
329 12 U.S.C. 371c–1.
PO 00000
Frm 00071
Fmt 4701
Sfmt 4702
68915
transaction with the covered fund, or
with any covered fund that is controlled
by such fund, if the transaction would
be a ‘‘covered transaction’’ as defined in
section 23A of the FR Act, as if the
banking entity and any affiliate thereof
were a member bank and the covered
fund were an affiliate thereof.330 Section
l.16(a)(1) of the proposed rule includes
this prohibition.
Consistent with the requirements of
section 13(f)(1) of the BHC Act,
§ l.16(a)(1) of the proposed rule is
more restrictive than section 23A of the
FR Act because § l.16(a)(1) generally
prohibits a banking entity and any of its
affiliates from entering into any such
transaction, while section 23A permits
covered transactions with affiliates so
long as the transactions meet specified
quantitative and qualitative
requirements.331
b. Transactions That Would Be a
‘‘Covered Transaction’’
Section 13(f) of the BHC Act applies
to covered transactions as defined in
section 23A of the FR Act without
incorporating any of the provisions in
section 23A that provide exemptions
from the prohibitions in that section for
certain types of covered transactions.332
330 As noted above, the proposed rule implements
the definition of ‘‘banking entity’’ in a manner that
does not include covered funds for which a banking
entity acts as sponsor or organizes and offers
pursuant to section 13(d)(1)(G) of the BHC Act, or
any covered fund in which such related covered
fund invests. Accordingly, these covered funds (and
any covered fund in which such covered fund
acquired or retains a controlling investment) are not
generally subject to the prohibitions contained in
§ l.16 of the proposed rule.
331 Section 23A of the FR Act limits the aggregate
amount of covered transactions by a member bank
to no more than (i) 10 per centum of the capital
stock and surplus of the member bank in the case
of any affiliate, and (ii) 20 per centum of the capital
stock and surplus of the member bank in the case
of all affiliates. See 12 U.S.C. 371c(a). Conversely,
section 13(f) of the BHC Act operates as a general
prohibition on such transactions without providing
any similar amount of permitted transactions.
332 The term ‘‘covered transaction’’ is defined in
section 23A of the FR Act to mean, with respect to
an affiliate of a member bank: (i) A loan or
extension of credit to the affiliate, including a
purchase of assets subject to an agreement to
repurchase; (ii) a purchase of or an investment in
securities issued by the affiliate; (iii) 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; (iv)
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; (v) the issuance of a guarantee,
acceptance, or letter of credit, including an
endorsement or standby letter of credit, on behalf
of an affiliate; (vi) a transaction with an affiliate that
involves the borrowing or lending of securities, to
the extent that the transaction causes a member
bank or subsidiary to have credit exposure to the
affiliate; or (vii) a derivative transaction, as defined
in paragraph (3) of section 5200(b) of the Revised
E:\FR\FM\07NOP2.SGM
Continued
07NOP2
68916
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Section l.16 of the proposed rule
adopts the same language as the statute.
The definition of ‘‘covered transaction’’
contained in section 23A of the FR Act
itself includes an explicit exemption
from the definition of ‘‘covered
transaction’’ for ‘‘such purchase of real
and personal property as may be
specifically exempted by the Board by
order or regulation.’’ 333 Since these
transactions are, by definition, excluded
from the definition of ‘‘covered
transaction,’’ any transaction that is
specifically exempted by the Board
pursuant to this specific authority
would not be deemed to be a covered
transaction as defined in section 23A of
the FR Act.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
c. Certain Transactions and
Relationships Permitted
While section 13(f)(1) of the BHC Act
operates as a general prohibition on a
banking entity’s ability to enter into a
transaction with a related covered fund
that would be a covered transaction as
defined under section 23A of the FR
Act, other specific portions of the
statute expressly provide for, or make
reference to, a banking entity’s ability to
engage in certain transactions or
relationships with such funds.334
Section l.16(a)(2) of the proposed rule
implements and clarifies these
authorities.
i. Permitted Investments and
Ownerships Interests
Sectionl.16(a)(2) of the proposed
rule clarifies that a banking entity may
acquire or retain an ownership interest
in a covered fund in accordance with
the requirements of subpart C of the
proposed rule.335 This clarification is
proposed in order to remove any
ambiguity regarding whether the section
prohibits a banking entity from
acquiring or retaining an interest in
securities issued by a related covered
fund in accordance with the other
provisions of the rule, since the
purchase of securities of a related
covered fund would be a covered
transaction as defined by section 23A of
the FR Act. There is no evidence that
Congress intended section 13(f)(1) of the
BHC Act to override the other
provisions of section 13 with regard to
the acquisition or retention of
ownership interests specifically
Statutes of the United States (12 U.S.C. 84(b)), with
an affiliate, to 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 section 608 of the Dodd-Frank Act.
333 Id. at 371c(b)(7)(C).
334 See, e.g., 12 U.S.C. 1851(d)(1)(G), (d)(4), and
(f)(3).
335 See proposed rule § l.16(a)(2)(i).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
permitted by the section. Moreover, a
contrary reading would make these
more specific sections that permit
covered transactions between a banking
entity and a covered fund mere
surplusage.
ii. Prime Brokerage Transactions Also
Permitted
Section l.16(a)(2)(ii) of the proposed
rule implements section 13(f)(3)(A) of
the BHC Act, which provides that a
banking entity may enter into any prime
brokerage transaction with a covered
fund in which a covered fund managed,
sponsored, or advised by such banking
entity has taken an ownership interest,
so long as certain enumerated
conditions are satisfied.336 The
proposed rule defines ‘‘prime brokerage
transaction’’ to mean one or more
products or services provided by the
banking entity to a covered fund, such
as custody, clearance, securities
borrowing or lending services, trade
execution, or financing, and data,
operational, and portfolio management
support.337 To engage in a prime
brokerage transaction with a covered
fund pursuant to § l.16(a)(2)(ii) of the
proposed rule, a banking entity must be
in compliance with the limitations set
forth in § l.11 of the proposed rule
with respect to a covered fund
organized and offered by such banking
entity. In addition, as required by
statute, the chief executive officer (or
equivalent officer) of the banking entity
must certify in writing annually that the
banking entity does not, directly or
indirectly, guarantee, assume, or
otherwise insure the obligations or
performance of the covered fund or of
any covered fund in which such
covered fund invests. Finally, the Board
must not have determined that such
transaction is inconsistent with the safe
and sound operation and condition of
the banking entity.
d. Restrictions on Transactions With
Any Permitted Covered Fund
Section l.16(b) of the proposed rule
implements sections 13(f)(2) and
13(f)(3)(B) of the BHC Act and applies
section 23B of the FR Act 338 to certain
transactions and investments between a
banking entity and a covered fund as if
such banking entity were a member
bank and such covered fund were an
affiliate thereof.339 Section 23B provides
that transactions between a member
bank and an affiliate must be on terms
and under circumstances, including
proposed rule § l.16(a)(2)(ii).
proposed rule § l.10(b)(4).
338 12 U.S.C. 371c–1.
339 See proposed rule § l.16(b).
credit standards, that are substantially
the same or at least as favorable to such
banking entity as those prevailing at the
time for comparable transactions with or
involving other unaffiliated companies
or, in the absence of comparable
transactions, on terms and under
circumstances, including credit
standards, that in good faith would be
offered to, or would apply to,
nonaffiliated companies.340
Section l.16(b) applies this
requirement to transactions between a
banking entity that serves as investment
manager, investment adviser,
commodity trading adviser, or sponsor
to a covered fund and that fund and any
other fund controlled by that fund. It
also applies this condition to a
permissible prime brokerage transaction
in which a banking entity may engage
pursuant to § l.16(a)(2)(ii) of the
proposed rule.341
e. Request for Comment
The Agencies request comment on the
proposed rule’s approach to
implementing the limitations on certain
relationships with covered funds and, in
particular, the manner in which the
Agencies have proposed to apply a
banking entity’s ability to make
explicitly permitted investments for
these purposes, as described above. In
particular, the Agencies request
comment on the following questions:
Question 314. Is the proposed rule’s
approach to implementing the
limitations on certain transactions with
a covered fund effective? If not, what
alternative approach would be more
effective and why?
Question 315. Should the approach
include other elements? If so, what
elements and why? Should any of the
proposed elements be revised or
eliminated? If so, why and how?
Question 316. What types of
transactions or relationships that
currently exist between banking entities
and a covered fund (or another covered
fund in which such covered fund makes
a controlling investment) would be
prohibited under the proposed rule?
What would be the effect of the
proposed rule on banking entities’
ability to continue to meet the needs
and demands of their clients? Are there
other transactions between a banking
entity and such covered funds that are
not already covered but that should be
prohibited or limited under the
proposed rule?
Question 317. Should the Agencies
provide a different definition of ‘‘prime
336 See
337 See
PO 00000
Frm 00072
Fmt 4701
Sfmt 4702
340 12
U.S.C. 371c–1(a); 12 CFR 223.51.
12 U.S.C. 1851(f)(2), (f)(3)(B); proposed
rule § l.16(b).
341 See
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
brokerage transaction’’ under the
proposed rule? If so, what definition
would be appropriate? Are there any
transactions that should be included in
the definition of ‘‘prime brokerage
transaction’’? Are there transactions or
practices provided by banking entities
that should be excluded in order to
mitigate the burdens of complying with
section 13 of the BHC Act?
Question 318. With respect to the
CEO (or equivalent officer) certification
required under section 13(f)(3)(A)(ii) of
the BHC Act and § l.16(a)(2)(ii)(B) of
the proposed rule, what would be the
most useful, efficient method of
certification (e.g., a new stand-alone
certification, a certification incorporated
into an existing form or filing, Web site
certification, or certification filed
directly with the relevant Agency)?
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
8. Section l.17: Other Limitations on
Permitted Covered Funds Activities
Section l.17 of the proposed rule
implements section 13(d)(2) of the BHC
Act, which places certain limitations on
the permitted covered fund activities
and investments in which a banking
entity may engage. Consistent with the
statute and § l.8 of the proposed rule,
§ l.17 provides that no transaction,
class of transactions, or activity is
permissible under §§ l.11 through
l.16 of the proposed rule if the
transaction, class of transactions, or
activity would:
• Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
• Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
• Pose a threat to the safety and
soundness of the banking entity or the
financial stability of the United States.
Section l.17 of the proposed rule
further defines ‘‘material conflict of
interest,’’ ‘‘high-risk assets,’’ and ‘‘highrisk trading strategies’’ for these
purposes, which are identical to the
definitions of the same terms for
purposes of § l.8 of the proposed rule
related to proprietary trading, and are
described in detail in Part III.B.6 of this
Supplementary Information.342
342 As noted in the discussion of the definition of
‘‘material conflict of interest in Part III.B.6 of this
Supplementary Information, the proposed
disclosure provisions of that definition are provided
solely for purposes of the proposed rule’s definition
of material conflict of interest, and do not affect a
banking entity’s obligation to comply with
additional or different disclosure or other
requirements with respect to a conflict under
applicable securities, banking, or other laws (e.g.,
section 27B of the Securities Act, which governs
conflicts of interest relating to certain
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
The Agencies request comment on the
proposed limitations on permitted
covered fund activities and investments,
including with respect to the questions
in Part III.B.6 of the Supplemental
Information as they pertain to covered
fund activities and investments in
particular.
D. Subpart D (Compliance Program
Requirement) and Appendix C
(Minimum Standards for Programmatic
Compliance)
Subpart D of the proposed rule, which
implements section 13(e)(1) of the BHC
Act,343 requires certain banking entities
to develop and provide for the
continued administration of a program
reasonably designed to ensure and
monitor compliance with the
prohibitions and restrictions on covered
trading activities and covered fund
activities and investments set forth in
section 13 of the BHC Act and the
proposed rule.344 This compliance
program requirement forms a key part of
the proposal’s multi-faceted approach to
implementing section 13 of the BHC
Act, and is intended to ensure that
banking entities establish, maintain and
enforce compliance procedures and
controls to prevent violation or evasion
of the prohibitions and restrictions on
covered trading activities and covered
fund activities and investments.
1. Section l.20: Compliance Program
Mandate
The proposed rule adopts a tiered
approach to implementing the
compliance program mandate, requiring
a banking entity engaged in covered
trading activities or covered fund
activities and investments to establish a
compliance program that contains
specific elements and, if the banking
entity’s activities are significant, meet a
number of minimum standards. If a
banking entity does not engage in
covered trading activities and covered
fund activities and investments, it must
ensure that its existing compliance
policies and procedures include
measures that are designed to prevent
the banking entity from becoming
engaged in such activities and making
such investments and must develop and
provide for the required compliance
program under proposed § l.20(a) of
the proposed rule prior to engaging in
such activities or making such
securitizations; section 206 of the Investment
Advisers Act of 1940, which applies to conflicts of
interest between investment advisers and their
clients; or 12 CFR 9.12, which applies to conflicts
of interest in the context of a national bank’s
fiduciary activities).
343 See 12 U.S.C. 1851(e)(1).
344 See proposed rule § l.20.
PO 00000
Frm 00073
Fmt 4701
Sfmt 4702
68917
investments, but is not otherwise
required to meet the requirements of
subpart D of the proposed rule.345
Section l.20(a) of the proposed rule
contains the core requirement that each
banking entity engaged in covered
trading activities or covered fund
activities and investments must
establish, maintain and enforce a
program reasonably designed to ensure
and monitor compliance with the
prohibitions and restrictions on
proprietary trading activities and
covered fund activities and investments
set forth in section 13 of the BHC Act
and the proposed rule and that such
program must be suitable for the size,
scope, and complexity of activities and
business structure of the banking entity.
Section l.20(b) of the proposed rule
specifies the following six elements that
each compliance program established
under subpart D must provide for, at a
minimum:
• Internal written policies and
procedures reasonably designed to
document, describe, and monitor the
covered trading activities and covered
fund activities and investments of the
banking entity to ensure that such
activities and investments comply with
section 13 of the BHC Act and the
proposed rule;
• A system of internal controls
reasonably designed to monitor and
identify potential areas of
noncompliance with section 13 of the
BHC Act and the proposed rule in the
banking entity’s covered trading
activities and covered fund activities
and investments and to prevent the
occurrence of activities that are
prohibited by section 13 of the BHC Act
and the proposed rule;
• A management framework that
clearly delineates responsibility and
accountability for compliance with
section 13 of the BHC Act and the
proposed rule;
• Independent testing for the
effectiveness of the compliance
program, conducted by qualified
banking entity personnel or a qualified
outside party;
• Training for trading personnel and
managers, as well as other appropriate
personnel, to effectively implement and
enforce the compliance program; and
• Making and keeping records
sufficient to demonstrate compliance
with section 13 of the BHC Act and the
proposed rule, which a banking entity
must promptly provide to the relevant
supervisory Agency upon request and
retain for a period of no less than
5 years.
345 See
E:\FR\FM\07NOP2.SGM
proposed rule § l.20(d).
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68918
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
In addition, for a banking entity with
significant covered trading activities or
covered fund activities and investments,
§ l.20(c) requires the compliance
program established under subpart D to
meet a number of minimum standards,
which are specified in Appendix C of
the proposed rule. In particular, a
banking entity must comply with the
minimum standards specified in
Appendix C of the proposed rule if:
• With respect to its covered trading
activities, it engages in any covered
trading activities and has, together with
its affiliates and subsidiaries, trading
assets and liabilities the average gross
sum of which (on a worldwide
consolidated basis), as measured as of
the last day of each of the four prior
calendar quarters, (i) is equal to or
greater than
$1 billion or (ii) equals 10 percent or
more of its total assets; and
• With respect to its covered fund
activities and investments, it engages in
any covered fund activities and
investments and either (i) has, together
with its affiliates and subsidiaries,
aggregate investments in one or more
covered funds the average value of
which is, as measured as of the last day
of each of the four prior calendar
quarters, equal to or greater than
$1 billion or (ii) sponsors or advises,
together with its affiliates and
subsidiaries, one or more covered funds
the average total assets of which are, as
measured as of the last day of each of
the four prior calendar quarters, equal to
or greater than $1 billion.
The application of detailed minimum
standards to these types of banking
entities is intended to reflect the
heightened compliance risks of large
covered trading and large covered fund
activities and investments and provide
guidance to such banking entities
regarding the minimum compliance
measures that would be required under
the proposed rule.
If a banking entity does not meet the
thresholds specified in § l.20(c)(2), it
need not comply with each of the
minimum standards specified in
Appendix C. However, the proposed
rule would require such a banking
entity to establish a compliance program
that effectively implements the six
elements specified in § l.20(b).
Banking entities engaged in a relatively
small amount of covered fund activities
are encouraged to look to the minimum
standards of Appendix C for guidance.
Generally, the Agencies would expect
that the closer a banking entity is to the
thresholds specified in § l.20(c)(2), the
more its compliance program should
generally include the specific
requirements described in Appendix C.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
Within the bounds of subpart D and
Appendix C, a banking entity has
discretion to structure and manage its
program for compliance with section 13
of the BHC Act and the proposed rule
in a manner that best reflects the unique
organization and operation of the
banking entity and its affiliates and
subsidiaries, and is suitable taking
account of the size, scope, and
complexity of activities in which the
banking entity and its affiliates and
subsidiaries engage.
As described above, § l.20(d) of the
proposed rule clarifies that, if a banking
entity does not engage in covered
trading activities and/or covered fund
activities or investments, it will have
satisfied the requirements of this section
if its existing compliance policies and
procedures include measures that are
designed to prevent the banking entity
from becoming engaged in such
activities or making such investments
and which require the banking entity to
develop and provide for the compliance
program required under paragraph (a) of
this section prior to engaging in such
activities or making such investments.
2. Appendix C—Minimum Standards
for Programmatic Compliance
Appendix C of the proposed rule
specifies a variety of minimum
standards applicable to the compliance
program of a banking entity with
significant covered trading activities or
covered fund activities and
investments.346 Section I.A of proposed
Appendix C sets forth the purpose of the
required compliance program, which is
to ensure that each banking entity
establishes, maintains, and enforces an
effective compliance program,
consisting of written policies and
procedures, internal controls, a
management framework, independent
testing, training, and recordkeeping,
that:
• Is designed to clearly document,
describe, and monitor the covered
trading activities and covered fund
activities or investments and the risks of
the banking entity related to such
activities or investments, identify
potential areas of noncompliance, and
prevent activities or investments
prohibited by, or that do not comply
with, section 13 of the BHC Act and the
proposed rule;
• Specifically addresses the varying
nature of activities or investments
conducted by different units of the
banking entity’s organization, including
346 The Agencies have proposed to include these
minimum standards as part of the regulation itself,
rather than as accompanying guidance, reflecting
the compliance program’s importance within the
general implementation framework.
PO 00000
Frm 00074
Fmt 4701
Sfmt 4702
the size, scope, complexity, and risks of
the individual activity or investment;
• Subjects the effectiveness of the
compliance program to independent
review and testing;
• Makes senior management and
intermediate managers accountable for
the effective implementation of the
compliance program, and ensures that
the board of directors or chief executive
officer (‘‘CEO’’) review the effectiveness
of the compliance program; and
• Facilitate supervision of the
banking entity’s covered trading
activities and covered fund activities or
investments by the Agencies.
A banking entity’s compliance
program should not be developed
through a generic, one-size-fits-all
approach, but rather should carefully
take into account and reflect the unique
manner in which a banking entity
operates, as well as the particular
compliance risks and challenges that its
businesses present. In light of the
complexities presented in
differentiating prohibited proprietary
trading from permitted market makingrelated activities in particular, the
Agencies expect that such a dynamic,
carefully-tailored approach to internal
compliance will play an important role
in ensuring that banking entities comply
with section 13’s prohibitions and
restrictions. In addition, although this
statement of purpose appears within the
text of proposed Appendix C, the
Agencies note the statement equally
describes the general purpose of any
compliance program required under
subpart D of the proposed rule,
regardless of whether proposed
Appendix C specifically applies.
Section I.B of proposed Appendix C
provides for several definitions used
throughout the appendix, including the
definition of ‘‘trading unit’’ and ‘‘asset
management unit’’ to which the
minimum standards apply. The term
‘‘trading unit’’ is defined in the same
way as in Appendix A, as described in
Part II.B.5 of the Supplementary
Information, and is intended to identify
multiple layers of a banking entity’s
organizational structure because any
effective compliance program will need
to manage, limit and monitor covered
trading activity at each such level of
organization in order to effectively
support compliance with the
prohibition on proprietary trading. The
term ‘‘asset management unit’’ is
defined as any unit of organization of a
banking entity that makes an investment
in, acts as sponsor to, or has
relationships with, a covered fund that
the banking entity sponsors, organizes
and offers, or in which a covered fund
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
sponsored or advised by a banking
entity invests.
Section I.C of proposed Appendix C
incorporates by reference the six
elements that must be included in the
compliance program under § l.20 of
the proposed rule, and section I.D
describes the structure of a compliance
program meeting the minimum
standards. In particular, section I.D
permits a banking entity to establish a
compliance program on an enterprisewide basis to satisfy the requirements of
§ l.20 of the proposed rule and the
appendix, which program could cover
the banking entity and all of its affiliates
and subsidiaries collectively. In order to
do so, the program must (i) be clearly
applicable, both by its terms and in
operation, to all such affiliates and
subsidiaries, (ii) specifically address the
requirements set forth in proposed
Appendix C, (iii) take into account and
address the consolidated organization’s
business structure, size, and complexity,
as well as the particular activities, risks,
and applicable legal requirements of
each subsidiary and affiliate, and (iv) be
determined through periodic
independent testing to be effective for
the banking entity and its affiliates and
subsidiaries. In addition, the enterprisewide program would be subject to
supervisory review and examination by
any Agency vested with rulewriting
authority under section 13 of the BHC
Act with respect to the compliance
program and the activities of any
banking entity for which the Agency has
such authority. Further, such Agency
would have access to all records related
to the enterprise-wide compliance
program pertaining to any banking
entity that is supervised by the Agency
vested with such rulewriting authority.
a. Internal Policies and Procedures
Section II of proposed Appendix C
articulates minimum standards for the
first element of the compliance program,
internal policies and procedures, for
both covered trading activities and
covered fund activities and investments.
With respect to covered trading
activities, the proposal would require
that internal policies and procedures: (i)
Specify how the banking entity
identifies its trading accounts; (ii)
identify the trading activity in which
the banking entity is engaged and how
that activity is organized; (iii)
thoroughly articulate the mission,
strategy, risks, and compliance controls
for each trading unit; (iv) include for
each trader a mandate that describes the
scope of his or her trading activity; (v)
clearly articulate and document a
comprehensive description of the risks
associated with the trading unit’s
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
activities; (vi) document a
comprehensive explanation of how the
mission and strategy of the trading unit,
and its related risk levels, comply with
the proposed rule; and (vii) require the
banking entity to promptly address and
remedy any violation of section 13 of
the BHC Act and the proposed rule.
These internal policies and procedures
would require banking entities to have
the data and standards to prevent
prohibited proprietary trading and to
identify abnormalities and
discrepancies that may be indicative of
prohibited proprietary trading. The
internal policies and procedures should
also provide the Agencies with a clear,
comprehensive picture of a banking
entity’s covered trading activities that
can be effectively reviewed. With
respect to covered fund activities and
investments, the proposal would require
that internal policies and procedures
describe all covered fund activities in
which the banking entity engages and
the procedures used by the banking
entity to ensure that it complies with
the restrictions of section 13 of the BHC
Act and the proposed rule.
The Agencies expect that these
internal policies and procedures will be
regularly reviewed and updated to
reflect changes in business practices,
strategies, or laws and regulations,
though frequent, unexplained changes
to policies and procedures or other
aspects of the compliance program—
particularly changes to reduce their
stringency—would warrant additional
scrutiny from banking entity
management, independent testing
personnel, and Agency supervisors or
examiners.
b. Internal Controls
Section III of proposed Appendix C
articulates minimum standards for the
second element of the compliance
program, internal controls. With respect
to covered trading activities, the
proposal would require internal controls
that: (i) Are reasonably designed to
ensure that the covered trading activity
is conducted in conformance with a
trading unit’s authorized risks,
instruments and products, as
documented in the banking entity’s
written policies and procedures; (ii)
establish and enforce risk limits for each
trading unit; and (iii) perform robust
analysis and quantitative measurement
of covered trading activity for
conformance with section 13 of the BHC
Act and the proposed rule. In particular,
the banking entity must perform
analysis and quantitative measurement
that is reasonably designed to: (i) Ensure
that the activity of each trading unit is
appropriate to the mission, strategy, and
PO 00000
Frm 00075
Fmt 4701
Sfmt 4702
68919
risk of each trading unit, as documented
in the banking entity’s internal written
policies and procedures; (ii) monitor
and assist in the identification of
potential and actual prohibited trading
activity; and (iii) prevent the occurrence
of prohibited proprietary trading. This
analysis and measurement should
incorporate the quantitative
measurements calculated and reported
under Appendix A of the proposed rule,
but should also include other analysis
and measurements developed by the
banking entity that are specifically
tailored to the business, risks, practices,
and strategies of its trading units. The
Agencies expect that the thoughtful use
of these types of quantitative tools to
monitor the extent to which the
activities of a trading unit are consistent
with its stated mission, strategy, and
risk profile may help identify, for both
banking entities and Agencies,
abnormalities or discrepancies in
permitted trading activity that may be
indicative of prohibited proprietary
trading. In addition, these internal
controls must provide for regular
monitoring of the effectiveness of the
banking entity’s compliance program
and require the banking entity to take
prompt action to address and remedy
any deficiencies identified and to
provide timely notification to the
relevant Agency of any investigation
and remedial action taken.
With respect to covered fund
activities and investments, the internal
controls required under section III of
proposed Appendix C generally focus
on ensuring that a banking entity has
effective controls in place to monitor its
investments in, and relationships with,
covered funds to ensure its compliance
with the covered fund activity and
investments restrictions, including
controls that relate to implementing
remedies in the event of a violation of
the requirements of section 13 of the
BHC Act and the proposed rule.
c. Responsibility and Accountability
Section IV of proposed Appendix C
articulates minimum standards for the
third element of the compliance
program, responsibility and
accountability. These standards focus
on four key constituencies—the board of
directors, the CEO, senior management,
and managers at each trading unit and
asset management unit level. Section IV
makes clear that the board of directors,
or similar corporate body, and the CEO
are responsible for creating an
appropriate ‘‘tone at the top’’ by setting
an appropriate culture of compliance
and establishing clear policies regarding
the management of covered trading
activities and covered fund activities
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68920
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
and investments. Senior management
must be made responsible for
communicating and reinforcing the
culture of compliance established by the
board of directors and the CEO, for the
actual implementation and enforcement
of the approved compliance program,
and for taking effective corrective
action, where appropriate. Managers
with responsibility for one or more
trading units or asset management units
of the banking entity that are engaged in
covered trading activity or covered fund
activity and investments are
accountable for effective
implementation and enforcement of the
compliance program for the applicable
trading unit or asset management unit.
entity’s compliance with the proposed
rule and section 13 of the BHC Act. In
particular, any personnel with
discretionary authority to trade, in any
amount, should be appropriately trained
regarding the differentiation of
prohibited proprietary trading and
permitted trading activities and given
detailed guidance regarding what types
of trading activities are prohibited.
Similarly, personnel providing
investment management or advisory
services, or acting as general partner,
managing member, or trustee of a
covered fund, should be appropriately
trained regarding what covered fund
activities and investments are permitted
and prohibited.
d. Independent Testing
Section V of proposed Appendix C
articulates minimum standards for the
fourth element of the compliance
program, independent testing. A
banking entity subject to the appendix
must ensure that its independent testing
is conducted by a qualified independent
party, such as the banking entity’s
internal audit department, outside
auditors, consultants or other qualified
independent parties. The independent
testing must examine both the banking
entity’s compliance program and its
actual compliance with the proposed
rule. Such testing must include not only
the general adequacy and effectiveness
of the compliance program and
compliance efforts, but also the
effectiveness of each element of the
compliance program and the banking
entity’s compliance with each provision
of the proposed rule. This requirement
is intended to ensure that a banking
entity continually reviews and assesses,
in an objective manner, the strength of
its compliance efforts and promptly
identifies and remedies any weaknesses
or matters requiring attention within the
compliance framework.
f. Recordkeeping
Section VII of proposed Appendix C
articulates minimum standards for the
sixth element of the compliance
program, recordkeeping. Generally, a
banking entity must create records
sufficient to demonstrate compliance
and support the operation and
effectiveness of its compliance program
(i.e., records demonstrating the banking
entity’s compliance with the
requirements of section 13 of the BHC
Act and the proposed rule, any scrutiny
or investigation by compliance
personnel or risk managers, and any
remedies taken in the event of a
violation or non-compliance), and retain
these records for no less than five years
in a form that allows the banking entity
to promptly produce these records to
any relevant Agency upon request.
Records created and retained under the
compliance program shall include
trading records of the trading units,
including trades and positions of each
such unit.
e. Training
Section VI of proposed Appendix C
articulates minimum standards for the
fifth element of the compliance
program, training. It proposes to require
that a banking entity provide adequate
training to its trading personnel and
managers, as well as other appropriate
personnel, in order to effectively
implement and enforce the compliance
program. In particular, personnel
engaged in covered trading activities or
covered fund activities and investments
should be educated with respect to
applicable prohibitions and restrictions,
exemptions, and compliance program
elements to an extent sufficient to
permit them to make informed, day-today decisions that support the banking
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
g. Request for Comment
The Agencies request comment on the
compliance program requirement
contained in § l.20 of the proposed
rule and the minimum standards
specified in proposed Appendix C. In
particular, the Agencies request
comment on the following questions:
Question 319. Is the proposed rule’s
inclusion of a compliance program
requirement effective in light of the
purpose and language of the statute? If
not, what alternative would be more
effective?
Question 320. Is the proposed
application of § l.20’s compliance
program requirement to all banking
entities engaged in covered trading
activity or covered trading investments
and activities and the minimum
standards of proposed Appendix C to
only banking entities with significant
covered trading or covered fund
PO 00000
Frm 00076
Fmt 4701
Sfmt 4702
activities, effective? If not, what
alternative would be more effective?
Should proposed Appendix C apply to
all banking entities? If so, why? Are the
thresholds proposed for determining
whether a banking entity must comply
with proposed Appendix C appropriate?
If not, what alternative would be more
effective?
Question 321. What implementation,
operational, or other burdens or
expenses might be associated with the
compliance program requirement? How
could those burdens or expenses be
reduced or eliminated in a manner
consistent with the purpose and
language of the statute?
Question 322. Do the proposed
compliance program requirement and
minimum standards provide sufficient
guidance and clarity regarding how
compliance programs should be
structured? If not, what additional
guidance or clarity is needed? Do the
proposed compliance program
requirement and minimum standards
provide sufficient discretion to banking
entities to structure a compliance
program that appropriately reflects the
unique nature of their businesses? If not,
how could additional discretion be
provided in a manner consistent with
the purpose and language of the statute?
Question 323. Are the six proposed
elements of a required compliance
program effective? If not, what
alternative would be more effective?
Should elements be added or removed?
If so, which ones and why?
Question 324. For each of the six
proposed elements of a required
compliance program for which
minimum standards are provided in
proposed Appendix C, are the proposed
minimum standards effective? If not,
what alternative would be more
effective? Should minimum standards
be added or removed? If so, which ones
and why?
Question 325. Does the requirement
that a banking entity provide timely
notification to the relevant Agency
provide sufficient guidance as to what
activities must be reported and how and
when such reporting should be made?
Should more specific standards be
provided (e.g., regarding the timing of
reporting and the types of activities that
must be reported)? If so, what additional
criteria should be implemented? Should
the notification requirement be applied
explicitly to banking entities that are not
required to comply with the minimum
standards specified in Appendix C
because they are below the thresholds
specified in § l.20(c)(2)? Why or why
not?
Question 326. Are there specific
records that banking entities should be
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
required to make and keep to document
compliance with section 13 of the BHC
Act and the proposed rule? Please
explain.
Question 327. What process should
the Agencies use in determining
whether to require a banking entity that,
based on its size, would not be subject
to Appendix C to comply with all or
portions of the appendix under section
I.E of the proposed appendix? What
considerations should the Agencies take
into account in making such a
determination? Should this requirement
be implemented by an Agency order, by
authority delegated to Agency staff, or a
different method? Please explain.
Question 328. Should the proposed
rule permit banking entities to comply
with Appendix C of the proposed rule
on an enterprise-wide basis? If so, why?
What are the advantages and
disadvantages of an enterprise-wide
compliance program? Should the
proposed appendix provide additional
clarity or discretion regarding how such
an enterprise-wide program should be
structured? If so, how? Please include a
discussion relating to the infrastructure
of an enterprise-wide compliance
program and its management. If
enterprise-wide compliance or similar
programs are used in other contexts,
please describe your experience with
such programs and how those
experiences influence your judgment
concerning whether or not you would
choose an enterprise-wide compliance
program in this context.
Question 329. Should the proposed
rule permit banking entities to comply
with § l.20(b) of the proposed rule on
an enterprise-wide basis? If so, why?
What are the advantages and
disadvantages of an enterprise-wide
compliance program for smaller banking
entities that are not subject to Appendix
C? Please include a discussion relating
to the infrastructure of an enterprisewide compliance program and its
management in the context of smaller
banking entities. If enterprise-wide
compliance or similar programs are
used in other contexts, please describe
your experience with such programs
and how those experiences influence
your judgment concerning whether or
not you would choose an enterprisewide compliance program in this
context. Are there particular reasons
why a enterprise-wide compliance
program should be permitted for larger
banking entities subject to the
requirements of Appendix C, but not
those that are subject to § l.20(b) of the
proposed rule?
Question 330. What are the particular
challenges that should be considered in
connection with establishing a
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
compliance program on an enterprisewide basis? How will such challenges
be addressed? Can an enterprise-wide
compliance program be appropriately
tailored to each of the subsidiaries and
affiliates of a banking entity?
Question 331. Are there efficiencies
that can be gained through an
enterprise-wide compliance program? If
so, how and what efficiencies?
Question 332. Would the complexities
of various types of covered trading
activity be adequately reflected in an
enterprise-wide compliance program?
Question 333. Should only outside
parties be permitted to conduct
independent testing for the effectiveness
of the proposed compliance program to
satisfy certain minimum standards? If
so, why? Under the proposal, the
independent testing requirement may be
satisfied by testing conducted by an
internal audit department or a third
party. Should the rule specify the
minimum standards for
‘‘independence’’ as applied to internal
and/or external parties testing the
effectiveness of the compliance
program? For example, would an
internal audit be deemed to be
independent if none of the persons
involved in the testing are involved
with, or report to persons that are
involved with, activities implicated by
section 13 of the BHC Act? Why or why
not?
Question 334. Do you anticipate that
banking entities that do not meet the
thresholds specified in § l.20(c) would
voluntarily comply with the proposed
minimum standards in Appendix C in
order to effectively implement the six
elements specified in § l.20(b)? Are
there specific minimum standards that
would not be practical or would be
unattainable for a banking entity that
does not meet the § l.20(c) thresholds?
Please identify the minimum
standard(s) and explain.
Question 335. In light of the size,
scope, complexity, and risk of covered
trading activities, do commenters
anticipate the need to hire new staff
with particular expertise in order to
establish, maintain, and enforce the
proposed compliance program
requirement concerning covered trading
activities or any subset of covered
trading activities?
Question 336. With respect to the
proposed requirement that training
should occur with a frequency
appropriate to the size and risk profile
of the banking entity’s covered trading
activities and covered fund activities,
should there be a minimum requirement
that such training shall be conducted no
less than once every twelve (12)
months? If so, why?
PO 00000
Frm 00077
Fmt 4701
Sfmt 4702
68921
Question 337. Should proposed rule’s
Appendix C be revised to require a
banking entity’s CEO to annually certify
that the banking entity has in place
processes to establish, maintain,
enforce, review, test and modify the
compliance program established
pursuant to Appendix C in a manner
that is reasonably designed to achieve
compliance with section 13 of the BHC
Act and this proposal? If so, why? If so,
what would be the most useful, efficient
method of certification (e.g., a new
stand-alone certification, a certification
incorporated into an existing form or
filing, Web site certification, or
certification filed directly with the
relevant Agency)? Would a central data
repository with a CEO attestation to the
Agencies be a preferable approach?
Question 338. Do the proposed rule
requirements relating to establishment
and implementation of a compliance
program pose unique concerns or
challenges to issuers of asset-backed
securities that are banking entities, and
if so, why? Are certain asset classes
particularly impacted by the proposed
rule requirements, and if so, how?
Question 339. How would existing
issuers of asset-backed securities that
are banking entities pay for establishing
and implementing a compliance
program? Should existing issuers of
asset-backed securities that cannot
comply with the compliance program
requirements be excluded from the
proposed definition of ‘‘banking
entity’’? Should such exclusion be
limited, and if so, based on what
factors? Are the proposed thresholds
specified in § ll.20(c) of the proposed
rule and/or the allowance of an
enterprise-wide compliance program as
set forth in Appendix C of the proposed
rule sufficient to minimize these
concerns for issuers of asset-backed
securities?
Question 340. With respect to future
securitizations, what would be the
impact of the establishment and
implementation of the compliance
program related to the provisions of the
proposed rule as required by § l.20 of
the proposed rule (including Appendix
C, where applicable)? Are the proposed
thresholds specified in § l.20(c) of the
proposed rule and/or the allowance of
an enterprise-wide compliance program
as set forth in Appendix C of the
proposed rule sufficient to minimize
these concerns for issuers of assetbacked securities?
Question 341. Would existing issuers
of asset-backed securities that are
banking entities be able to establish and
implement a compliance program
related to the provisions of the proposed
rule as required by § l.20 of the
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68922
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
proposed rule (including Appendix C,
where applicable)? If amendments to
transactional documents are necessary,
are there any obstacles that would make
such amendments difficult to execute? If
existing issuers of asset-backed
securities cannot establish and
implement a compliance program, what
would be the impact on such existing
issuers of asset-backed securities and
the holders of securities issued by a
non-compliant issuer of asset-backed
securities? Is the allowance of an
enterprise-wide compliance program as
set forth in Appendix C of the proposed
rule sufficient to minimize these
concerns for issuers of asset-backed
securities?
Question 342. To rely on the
exemptions for permitted underwriting,
market making-related, and riskmitigating hedging activities, the
proposed rule requires banking entities
to establish the internal compliance
program under § l.20 and, where
applicable, Appendix C, designed to
ensure compliance with the
requirements of the applicable
exemption (e.g., policies and
procedures, internal controls and
monitoring procedures, etc.). Do these
requirements in the proposed rule
impose undue cumulative burdens,
such that the marginal benefit of a given
requirement is not justified by the cost
that the requirement imposes? If so, why
does the proposed rule impose
cumulative burdens and what are the
costs of those burdens? Please explain
the circumstances under which these
burdens may arise. Is there a way to
reduce or eliminate such burdens or
requirements in a manner consistent
with the language and purpose of the
statute? For any requirements that
impose undue burdens, are there other
requirements that could be substituted
that would more efficiently ensure
compliance with the statute? Are there
any requirements that the proposed rule
imposes that are particularly effective,
and if so, how can the Agencies make
better use of these requirements?
Question 343. Are the six elements of
the proposed compliance program
requirement mutually reinforcing and
cost effective, or are there redundancies
in the six elements? Please explain any
redundant requirements in the policies
and procedures, internal controls,
management framework, independent
testing, training, and recordkeeping
requirements in § l.20(b) of the
proposed rule or proposed Appendix C.
Why are such requirements redundant,
and how should the redundancy be
addressed and remedied in the rule?
Question 344. A banking entity that
meets the $1 billion or greater trading
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
assets and liabilities threshold would be
required under the proposed rule to
comply with both the reporting and
recordkeeping requirements in
Appendix A with respect to quantitative
measurements and the compliance
program requirement in Appendix C.
Are the requirements in these
appendices mutually reinforcing and
cost effective, or do the appendices
impose redundant requirements on
banking entities that meet the $1 billion
threshold? Please explain any
redundant requirements in the
appendices and how such redundancy
should be addressed and remedied in
the rule.
Question 345. Proposed Appendix C
incorporates the quantitative
measurements provided in proposed
Appendix A in the internal controls
requirement for banking entities that are
engaged in covered trading activity and
meet the $1 billion or greater trading
assets and liabilities threshold. Do the
requirements in proposed Appendix A
and Appendix C impose undue
cumulative burdens with respect to any
elements (e.g., quantitative
measurements), such that the marginal
benefit of a given requirement is not
justified by the cost that the requirement
imposes? Please explain why the
proposed appendices impose
cumulative burdens, the costs of those
burdens, and the circumstances under
which these burdens may arise. Is there
a way to reduce or eliminate such
burdens or requirements in a manner
consistent with the language and
purpose of the statute? For any
requirements in the appendices that
impose undue burdens, are there other
requirements that could be substituted
that would more efficiently ensure
compliance with the statute? Are there
any requirements that the proposed
appendices impose that are particularly
effective, and if so, how can the
Agencies make better use of these
requirements?
Question 346. Should the relevant
Agency prescribe any specific method
by which the board of directors or
similar corporate body reviews and
approves the compliance program? For
example, should the relevant Agency
require that: (i) A chief compliance
officer or similar officer present an
annual compliance report including, as
appropriate, recommended actions to be
taken by the banking entity to improve
compliance or correct any compliance
deficiencies; (ii) the board review any
such recommendations and determine
whether to approve them; and (iii) the
banking entity notify the relevant
Agency if the board declines to approve
such recommendations, or approves
PO 00000
Frm 00078
Fmt 4701
Sfmt 4702
different actions than those
recommended in the compliance report?
What are the advantages and
disadvantages of such an approach?
3. Section l.21: Termination of
Activities or Investments; Penalties for
Violations
Section l.21 of the proposed rule
implements section 13(e)(2) of the BHC
Act, which requires the termination of
activities or investments that violate or
function as an evasion of section 13 of
the Act.347 In particular, § l.21(a) of the
proposed rule requires any banking
entity that engages in an activity or
makes an investment in violation of
section 13 of the BHC Act or the
proposed rule or in a manner that
functions as an evasion of the
requirements of section 13 of the BHC
Act or the proposed rule, including
through an abuse of any activity or
investment permitted under subparts B
or C, or otherwise violates the
restrictions and requirements of section
13 of the BHC Act or the proposed rule,
to terminate the activity and, as
relevant, dispose of the investment.348
Section l.21(b) of the proposed rule
provides that if a relevant Agency finds
reasonable cause to believe any banking
entity has engaged in an activity or
made an investment described in
paragraph (a), the relevant Agency may,
after due notice and an opportunity for
hearing, by order, direct the banking
entity to restrict, limit, or terminate the
activity and, as relevant, dispose of the
investment.349
E. Subpart E—Conformance Provisions
Section 13(c)(6) of the BHC Act
required the Board, acting alone, to
adopt rules implementing those
provisions of section 13 of the BHC Act
that provide a banking entity or a
nonbank financial company supervised
by the Board a period of time after the
effective date of section 13 of the BHC
Act to bring the activities, investments,
and relationships of the banking entity
or company that were commenced,
acquired, or entered into before the
effective date of section 13 of the BHC
Act into compliance with that section
and the agencies’ implementing
regulations.350 The Board’s
Conformance Rule, which was required
347 See
12 U.S.C. 1851(e)(2).
proposed rule § l,21(a). The Agencies
have proposed to include § l.21(a), in addition to
the provisions of § l.21(b) of the proposed rule, to
make clear that the requirement to terminate an
activity or, as relevant, dispose of an investment
would be triggered where a banking entity discovers
a violation or evasion, regardless of whether an
Agency order has been issued.
349 See proposed rule § l,21(b).
350 See 12 U.S.C. 1851(c)(6).
348 See
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
under section 13(c)(6) of the BHC Act,
was issued on February 8, 2011.351 As
noted in its issuing release, this period
is intended to give markets and firms an
opportunity to adjust to section 13 of
the BHC Act.352
As part of the current proposal, the
Board is proposing to relocate the
Board’s Conformance Rule, which was
added as §§ 225.180–182 of the Board’s
Regulation Y, to subpart E of the Board’s
proposed rule.353 The Board is also
proposing to make certain conforming
and technical changes to the language
and defined terms of the Board’s
Conformance Rule in connection with
its proposed relocation to subpart E of
the Board’s current proposal. The Board
is not, however, proposing any
substantive changes to the Board’s
Conformance Rule as part of this
proposed rule. In particular, the Board’s
Conformance Rule defined certain terms
related to section 13 of the BHC Act,
including ‘‘banking entity,’’ ‘‘hedge
fund and private equity fund,’’ ‘‘insured
depository institution,’’ and
‘‘Board.’’ 354 For the sake of consistency,
the Board is proposing to eliminate
these definitions as they are now
defined elsewhere, and in more
comprehensive a manner, in the
proposed rule.355 These alternative or
replacement definitions are
substantially similar to those contained
in the Board’s Conformance Rule and
are discussed in further detail in Part
III.A.2 of this Supplementary
Information.
In connection with incorporating
provisions of the existing Board’s
Conformance Rule into the current
proposal, the Board notes that the
conformance period and extended
transition period provided by section
13(c) of the BHC Act and the Board’s
Conformance Rule do not permit a
banking entity to engage in any new
activity or make any new investment in
a covered fund without complying with
the restrictions and prohibitions of
section 13 of the BHC Act and
implementing rules thereunder. The
conformance period and extended
transition period provided by the
Board’s Conformance Rule permit a
banking entity to bring those of its
existing activities and investments that
351 See Conformance Period for Entities Engaged
in Prohibited Proprietary Trading or Private Equity
Fund or Hedge Fund Activities, 76 FR 8265 (Feb.
14, 2011).
352 See id. (citing 156 Cong. Rec. S5898 (daily ed.
July 15, 2010) (statement of Sen. Merkley)).
353 See Board proposed rule §§ l.30 to l.32.
354 See Board’s Conformance Rule §§ 225.180(a)–
(c), (e).
355 See proposed rule §§ l.2(e), (f), (p);
l.10(b)(1).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
do not conform to the requirements of
section 13 of the BHC Act and the
proposed rule into conformance. The
Board’s Conformance Rule does not
authorize a banking entity to engage in
new or additional prohibited activities
or investments, and this restriction
would continue to apply under the
current proposed rule.
With respect to proprietary trading,
the Board expects that each banking
entity will identify those trading units
of the banking entity that are engaged in
prohibited proprietary trading as of or
after the effective date of section 13 of
the BHC Act and the type of proprietary
trading in which they are engaged. A
banking entity is expected to bring the
prohibited proprietary trading activity
of a trading unit into compliance with
the requirements of the proposed rule as
soon as practicable within the
conformance period. A trading unit may
not expand its activity to include
prohibited proprietary trading after the
effective date of the proposed rule.
Similarly, a trading unit that is not
identified as engaging in proprietary
trading as of the effective date may not
begin engaging in such activity after the
effective date.
With respect to a covered fund
activity or investment, the conformance
period (or, in the case of an illiquid
fund for which a banking entity has
received Board approval, the extended
transition period) generally permits a
banking entity to retain an existing
investment in a covered fund, make
additional capital contributions to a
covered fund if contractually obligated
to do so, or continue certain existing
relationships with a covered fund.356
However, pursuant to the conformance
period or extended transition period, a
banking entity may not make a new
investment or capital contribution that
it is not contractually obligated to make
in, or establish a new relationship with,
a covered fund after the effective date of
the proposed rule.357
356 For instance, under the Board’s Conformance
Rule and the current proposed rule, a banking
entity may retain an existing ownership interest in
a covered fund under authority of the conformance
period or extended transition period without regard
to the per-fund or aggregate fund limitations
contained in § l.12 of the proposed rule.
Additionally, a banking entity may continue to
serve as sponsor to a covered fund under authority
of the conformance period, but only if the banking
entity acted as sponsor to such fund as of the
effective date of section 13 of the BHC Act and the
nature of the relationship was continuous. A
banking entity may also serve as sponsor of an
illiquid fund pursuant to the extended transition
period, but only to the extent such service is related
to the banking entity’s retention of its permitted
ownership interest in such fund.
357 In the case of a covered fund that a banking
entity organizes and offers, or begins to act as
PO 00000
Frm 00079
Fmt 4701
Sfmt 4702
68923
Request for Comment
In light of the interplay between the
Board’s Conformance Rule and the
current proposed rule, the Board is
requesting comment on whether any of
the conformance provisions should be
revised. In particular, the Board requests
comment on the following question:
Question 347. Should any portion of
the Board’s Conformance Rule be
revised in light of other elements of the
current proposed rule? If so, why and
how?
IV. Request for Comments
The Agencies are interested in
receiving comments on all aspects of the
proposed rule.
V. Solicitation of Comments on Use of
Plain Language
Section 722 of the Gramm-LeachBliley Act, Public Law 106–102, sec.
722, 113 Stat. 1338, 1471 (Nov. 12,
1999), requires the OCC, Board and
FDIC to use plain language in all
proposed and final rules published after
January 1, 2000. The OCC, Board and
FDIC invite public comments on how to
make this proposal easier to understand.
For example:
• Have we organized the material to
suit your needs? If not, how could this
material be better organized?
• Are the requirements in the
proposed regulation clearly stated? If
not, how could the regulation be more
clearly stated?
• Does the proposed regulation
contain language or jargon that is not
clear? If so, which language requires
clarification?
• Would a different format (grouping
and order of sections, use of headings,
paragraphing) make the regulation
easier to understand? If so, what
changes to the format would make the
regulation easier to understand?
• What else could we do to make the
regulation easier to understand?
sponsor to, after the effective date of section 13 of
the BHC Act, the banking entity must comply with
the requirements of the proposed rule with respect
to its relationships with, and acquisition and
retention of an ownership interest in, such covered
fund. For instance, after the effective date of section
13 of the BHC Act, a banking entity may only
acquire and retain an ownership interest in that
covered fund as a permitted investment only (i) if
the banking entity organizes and offers or acts as
sponsor to that fund, and (ii) in compliance with
the per-fund limitation and aggregate fund
limitation of the proposed rule. Similarly, a banking
entity’s relationship with such covered fund would
be subject to the limitations contained in the
proposed rule.
E:\FR\FM\07NOP2.SGM
07NOP2
68924
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
VI. The Economic Impact of the
Proposed Rule Under Section 13 of the
BHC Act—Request for Comment
Section 13 of the BHC Act imposes on
all banking entities prohibitions and
restrictions on proprietary trading and
certain interests in, and relationships
with, a covered fund,358 which apply to
banking entities whether or not the
Agencies adopt implementing rules. In
formulating the proposed rule to
implement these provisions, which is
required by statute, the Agencies have
chosen a multi-faceted approach to
establish a regulatory framework that
provides for clear, robust, and effective
implementation of the statute’s
provisions in a consistent manner,
while also not unduly constraining the
ability of banking entities to engage in
permitted activities and investments.359
The Agencies have proposed this
approach after considering the Council’s
findings and recommendations
regarding how to implement section 13
of the BHC Act and a variety of
alternatives described throughout this
Supplemental Information.360 The
Agencies seek comment, in particular,
on the potential costs and benefits of
those aspects of the proposed rule that
involve choices made, or the exercise of
discretion, by the Agencies in
implementing section 13 of the BHC
Act.
The Agencies recognize that there are
economic impacts that may arise from
the proposed rule and its
implementation of section 13 of the
BHC Act and invite comment on the
manner in which the proposed rule
implements section 13 of the BHC Act,
including commenters’ views on the
potential economic impacts discussed
in this Part of the Supplemental
Information. In addition, the Agencies
seek comment on whether the proposed
rule represents a balanced and effective
approach to implementing section 13 of
the BHC Act or whether alternative
approaches to implementing section 13
358 As noted above in connection with the
conformance and extended transition periods, the
proposed rule would not require an immediate
application of these restrictions for any activity or
investment entered into prior to the effective date
of section 13 of the BHC Act (July 21, 2012).
However, any activity or investment entered into
after the effective date would be required to comply
with section 13 of the BHC Act and the proposed
rule, if adopted. See Supplemental Information Part
III.E.
359 See Supplemental Information Part II.A.
360 See 12 U.S.C. 1851(b)(2)(A); see also Financial
Stability Oversight Council, Study &
Recommendations on Prohibitions on Proprietary
Trading & Certain Relationships with Hedge Funds
& Private Equity Funds (Jan. 2011), available at
http://www.treasury.gov/initiatives/Documents/
Volcker%20sec%20%20619%20study%20
final%201%2018%2011%20rg.pdf.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
of the BHC Act exist that would provide
greater benefits or involve fewer costs,
consistent with the statutory purpose.
We also request comment on the
potential competitive effects of the
manner in which the proposed rule
implements the statute.361
In addition to the questions posed
throughout Part II of the Supplemental
Information with respect to the potential
costs and benefits of particular aspects
of the statute and proposed rule, in
order to assist in the analysis of the
economic impacts associated with the
final rule and any alternatives the
Agencies may evaluate, the Agencies
encourage commenters to provide
quantitative information about the rule’s
impact on banking entities, their clients,
customers, and counterparties, specific
markets or asset classes, and any other
entities potentially affected by the
proposed rule with respect to:
1. The direct and indirect costs and
benefits of compliance with section 13
of the BHC Act, as proposed to be
implemented;
2. The effect of section 13 of the BHC
Act, as proposed to be implemented, on
competition; and
3. Any other economic impacts of the
proposal.
In addition, to assist with potential
estimates of the proposed rule’s
quantitative impacts, we request
specific comment on: (i) The extent to
which banking entities currently engage
in proprietary trading activity or
covered funds activities or investments
that are prohibited or restricted by the
statute, or have otherwise divested or
conformed such activities; and (ii) the
potential costs and benefits or other
quantitative impacts of various aspects
of the proposed rule, such as the
compliance program requirement, the
required reporting of quantitative
measurements, and the conditions and
requirements for relying on the
proposed exemptions.
To further facilitate public comment
on the economic effects of the manner
in which the proposed rule implements
the statute, the Agencies have identified
below a number of significant aspects of
the proposed rule and potential
economic impacts that may result from
section 13 of the BHC Act’s
requirements, as proposed to be
implemented. We seek commenters’
views on the likelihood of the potential
economic impacts identified in this Part
and whether there are additional costs,
361 For example, implementation of section
13(d)(1)(H) of the BHC Act may result in a
competitive advantage for foreign-controlled
banking entities over U.S.-controlled banking
entities with respect to activities that occur solely
outside of the United States.
PO 00000
Frm 00080
Fmt 4701
Sfmt 4702
benefits, or other impacts that may arise
from the proposed rule. To the extent
that such costs, benefits, or other
impacts are quantifiable, commenters
are encouraged to identify, discuss,
analyze, and supply relevant data,
information, or statistics related to such
costs, benefits, and other impacts and
the quantification of such costs,
benefits, and other impacts. In addition,
commenters are asked to identify or
estimate start-up, or non-recurring, costs
separately from costs or effects they
believe would be ongoing.
A. Proprietary Trading Provisions
1. Definition of Trading Account
Section l.3 of the proposed rule,
which implements the statutory
definition of ‘‘trading account,’’
provides a multi-pronged definition of
that term that is intended to ensure that
banking entities do not engage in
‘‘hidden’’ proprietary trading by
characterizing trading activity as being
conducted outside a trading account. In
addition to positions taken principally
for the purpose of short-term resale,
benefitting from short-term price
movements, realizing short-term
arbitrage profits, or hedging another
trading account position, the proposed
definition also includes: (i) With respect
to a banking entity subject to the Federal
banking agencies’ Market Risk Capital
Rules, all positions in financial
instruments subject to the prohibition
on proprietary trading that are treated as
‘‘covered positions’’ under those capital
rules, other than certain foreign
exchange and commodities positions;
and (ii) all positions acquired or taken
by certain registered securities and
derivatives dealers (or, in the case of
financial institutions that are
government securities dealers, that have
filed notice with an appropriate
regulatory agency) in connection with
their activities that require such
registration or notice. Although these
prongs of the definition are proposed to
prevent evasion of the statutory
requirements, we seek comment on the
extent to which either of these two
prongs may create a competitive
disadvantage for certain banking entities
vis-a`-vis competitors that are either not
subject to section 13 of the BHC Act
and/or competitors subject to different
prongs of the proposed definition.
2. Exemption for Underwriting
Activities
Section 13(d)(1)(B) of the BHC Act
provides an exemption from the
prohibition on proprietary trading for
purchases and sales in connection with
underwriting activities, to the extent
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
that such activities are designed not to
exceed the reasonably expected near
term demands of clients, customers, or
counterparties. In implementing this
exemption in § l.4(a) of the proposed
rule, the Agencies have endeavored to
establish a regime that clearly sets forth
the requirements for relying on the
underwriting exemption established in
the statute to facilitate banking entities’
compliance with the statutory
requirements. In considering potential
requirements for the underwriting
exemption, and assessing the potential
economic impacts of each such
requirement, the Agencies strived to
propose an appropriate balance between
considerations related to: (i) The
potential for evasion of the statutory
prohibition on proprietary trading
through misuse of the underwriting
exemption; and (ii) the potential costs
that may arise from constraints on
legitimate underwriting activities.
The Agencies have proposed to use,
wherever practicable, common terms
from existing laws and regulations in
the context of underwriting to facilitate
market participants’ understanding and
use of the exemption and to promote
consistency across laws and regulations.
Specifically, the proposed definitions of
‘‘distribution’’ and ‘‘underwriter’’
established in the proposed rule largely
mirror the definitions provided for these
terms in the SEC’s Regulation M.
Because the proposed rule uses a
modified version of the Regulation M
definition of ‘‘underwriter’’ to include
selling group members, the proposed
definition would permit the current
market practice of members of the
underwriting syndicate entering into an
agreement with other selling group
members to collectively distribute the
securities, rather than requiring all
members of a distribution to join the
underwriting syndicate.
In addition, the definition of
‘‘distribution’’ from Regulation M that
the Agencies have proposed in § l.4(a)
of the proposed rule is intended to
ensure that the underwriting exemption
does not unduly constrain banking
entities from providing underwriting
services, while at the same time
preventing banking entities from relying
on the underwriting exemption to evade
the proposed rule and the statutory
prohibition on proprietary trading. The
Agencies anticipate that the proposed
approach to implementing the
underwriting exemption should permit
legitimate forms of underwriting in
which market participants currently
engage and, thus, should not unduly
burden capital formation. In addition,
the proposed rule would permit
underwriters to continue to employ
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
existing practices to stabilize a
distribution of securities, which
stabilization promotes confidence
among issuers, selling security holders,
and investors and further supports
capital formation.
Under the proposed rule, the
underwriting activities of a banking
entity must be designed to generate
revenues primarily from fees,
commissions, underwriting spreads or
other income, not from appreciation in
value of covered financial positions that
the banking entity holds related to such
activities or the hedging of such covered
financial positions. This proposed
requirement should promote investor
confidence by ensuring that the
activities conducted in reliance on the
underwriting exemption are designed to
benefit the interests of clients seeking to
bring their securities to market, not the
interests of the underwriters themselves.
The proposed requirement should also
help prevent evasion of the statutory
prohibition on proprietary trading, as
trading activity designed to generate
revenues from appreciation in the value
of positions held by the banking entity
would be indicative of prohibited
proprietary trading, not underwriting
activity. We seek comment on whether
this approach of identifying
underwriting activity by reference to
revenue source could also make
underwriting less profitable to the
extent that it precludes or discourages
certain types of profitability for bona
fide underwriting services.
In addition to commenters’ views on
the potential economic impacts
identified above, we request comment
on whether the proposed rule may cause
some banking entities to choose to
decrease the supply of underwriting
services in response to potential costs of
the proposed rule and whether this
result would adversely affect
competition among underwriters or
have a harmful impact on capital
formation. In addition, if banking
entities were to pass the increased costs
of complying with the proposed
exemption on to issuers, selling security
holders, or their customers, we seek
comment on whether the effect would
be to increase the cost of raising capital
and whether this would harm capital
formation to the extent that such cost
increases were sufficient to preclude
issuers from accessing the capital
markets. As described above, the
Agencies have designed the proposal to
balance such potential costs with
provisions intended to permit banking
entities’ legitimate underwriting
activities to continue as provided by the
statute, while also establishing
sufficient requirements to prevent
PO 00000
Frm 00081
Fmt 4701
Sfmt 4702
68925
evasion of the statutory goals through
misuse of the underwriting exemption.
3. Exemption for Market Making-Related
Activities
Section 13(d)(1)(B) of the BHC Act
provides an exemption from the
prohibition on proprietary trading for
purchases and sales in connection with
market making-related activities, to the
extent that such activities are designed
not to exceed the reasonably expected
near term demands of clients,
customers, or counterparties. In setting
forth the requirements for eligibility for
this exemption in § l.4(b) of the
proposed rule, the Agencies have
endeavored to establish a regime that
clearly sets forth the requirements for
relying on the exemption for market
making-related activity established in
the statute to facilitate banking entities’
compliance with the statutory
requirements. In considering potential
requirements for the market-making
exemption, and assessing the potential
economic impacts of each such
requirement, the Agencies tried to strike
an appropriate balance between
considerations related to: (i) The
potential for evasion of the statutory
prohibition on proprietary trading
through misuse of the exemption for
market making-related activity; (ii) the
potential difficulties related to
distinguishing market making-related
activity from prohibited proprietary
trading; and (iii) potential costs that
may arise from constraints on legitimate
market making-related activities.
The Agencies have proposed to use,
where practicable, terms and concepts
used in current laws and regulations in
the context of market making to promote
clarity and consistency. Recognizing
that there are differences in market
making activities between different
types of asset classes (e.g., liquid and
illiquid instruments) and market
structures (e.g., organized trading
facilities and the over-the-counter
markets), the Agencies have proposed to
implement the market-making
exemption in a manner that accounts for
these distinctions and permits market
making activities in different asset
classes and market structures.
Permitting legitimate market making in
its different forms should promote
market liquidity and efficiency by
allowing banking entities to continue to
provide customer intermediation and
liquidity services in both liquid and
illiquid instruments. The Agencies also
recognize, however, that market makingrelated activities in the over-the-counter
markets or activities involving less
liquid instruments are sometimes less
transparent than similar activities on
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68926
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
organized trading facilities or in liquid
markets. We seek comment on whether,
in order to comply with the statutory
prohibition on proprietary trading, some
banking entities may be inclined to
abstain from some market-making
activities in an effort to reduce the risk
of noncompliance. We also request
comment on whether, if banking entities
did so, this could result in reduced
liquidity for certain types of trades or
for certain less liquid instruments.
In addition, the proposed exemption
permits anticipatory market making,
block positioning, and hedging of
market making positions under certain
circumstances, which should further
facilitate customer intermediation and
market liquidity and efficiency.
However, certain conditions are placed
on such market making-related activities
in the proposal in an effort to ensure
that such activities are, in fact, market
making-related activities, and are not
hidden proprietary trading activities
subject to the statutory prohibition.
The proposal requires that the market
making-related activities be designed to
generate revenues primarily from fees,
commissions, bid/ask spreads or other
income not attributable to appreciation
in the value of covered financial
positions a banking entity holds in
trading accounts or the hedging of such
positions. This proposed requirement
should promote investor confidence by
helping to ensure that market making
serves customer needs. The proposed
requirement should also help prevent
evasion of the statutory prohibition on
proprietary trading, as trading activity
designed to generate revenues from
appreciation in the value of positions
held by the banking entity would be
indicative of prohibited proprietary
trading, not market making-related
activity. The Agencies request comment
on whether this approach of identifying
market making activity by reference to
a market making trading unit’s revenue
source would also make market making
activity less profitable and whether it
would preclude or discourage certain
types of profitability for bona fide
market making services. Commenters
should also address whether this
requirement would reduce the
willingness of some banking entities to
continue to provide market makingrelated services and whether this could
reduce liquidity, harm capital
formation, or make market makingrelated services more expensive. The
Agencies note that, in order to balance
the potential for such effects with the
statutory purpose, the proposed rule
does not expressly prohibit all types of
non-client income, and recognizes that
the precise type and source of revenues
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
generated by bona fide market making
services can and will vary depending on
the relevant market, asset, and facts and
circumstances.
4. Exemption for Risk-Mitigating
Hedging Activities
Section 13(d)(1)(C) provides an
exemption from the prohibition on
proprietary trading for risk-mitigating
hedging activities in connection with
and related to individual or aggregated
positions, contracts, or other holdings of
a banking entity that are designed to
reduce the specific risks to the banking
entity in connection with and related to
such positions, contracts, or other
holdings. The proposed exemption
requires that the hedging transaction be
reasonably correlated to these risks that
the transaction is intended to hedge or
otherwise mitigate. This proposed
requirement is intended to address the
potential for misuse of the exemption
where a transaction is not closely tied
to risk mitigation, while also providing
some flexibility in the degree of
correlation that is required in order to
promote consistency with the statutory
goals and requirements.
In addition, the proposed exemption
requires that the hedging transaction: (i)
Not give rise, at the inception of the
hedge, to significant exposures that are
not themselves hedged in a
contemporaneous transaction; and (ii)
be subject to continuing review,
monitoring, and management. Together,
these proposed requirements are
designed to ensure that a banking entity
does not use the hedging exemption to
conduct prohibited proprietary trading
in the guise of hedging activity and to
prevent evasion of the proprietary
trading prohibition contained in section
13 of the BHC Act and the proposed
rule. These proposed requirements are
intended to ensure that an exempt
hedging transaction will mitigate, not
amplify, risk. Moreover, such
requirements should further the goals of
compliance with the statutory
requirements and reducing banking
entities’ risks.
We seek comment on whether the
proposed requirements for relying on
the hedging exemption are more
restrictive than necessary to implement
the statutory language and purpose, and
to prevent evasion of the statutory
provisions, and whether a banking
entity’s hedging activities could be
unduly constrained by the proposed
rule. Further, commenters should
address the extent to which a banking
entity may be unable or unwilling to
execute certain hedges and whether, as
a result, a banking entity could be
limited in its means to reduce its risk.
PO 00000
Frm 00082
Fmt 4701
Sfmt 4702
In addition, would banking entities be
dissuaded from engaging in other
permitted activities or activities outside
the scope of the statute (e.g., long-term
investments) if the requirements of the
proposed hedging exemption unduly
limits or prevents them from mitigating
the risks associated with such activities?
We request comment on whether a
reduction in efficiency could result from
a reduced ability of covered banking
entities to transfer risks to those more
willing to bear them. Commenters
should also address whether the
proposed rule would reduce a banking
entity’s willingness to engage in
permitted risk-mitigating hedging
activities in order to avoid costs related
to ensuring compliance with the
exemption’s requirements and whether
this would increase the banking entity’s
risk exposure. In order to balance the
potential for such effects with the
statutory purpose, the proposed rule
attempts to implement the riskmitigating hedging exemption in a
manner that recognizes that the precise
nature and execution of risk mitigation
through hedging transactions can and
will vary depending on the relevant
market, asset, and facts and
circumstances, while also establishing
requirements designed to ensure that
transactions relying on the hedging
exemption are, in fact, hedges and not
hidden proprietary trading prohibited
by the statute.
The proposed exemption would
require documentation with respect to
hedges established at a different level of
organization than that responsible for
the underlying positions or risks that are
being hedged. This proposed
documentation requirement is intended
to facilitate review by banking entities
and Agency supervisors and examiners
in assessing whether the hedge position
was established to hedge or otherwise
mitigate another unit’s risks. Without
such documentation, there could be an
increased risk of evasion of the statute’s
prohibition on proprietary trading, as it
would be difficult to assess whether a
purported hedging transaction was
established to mitigate another level of
organization’s risk or solely to profit
from price appreciation of the position
established by the purported hedge. We
seek comment on the costs of the
proposed documentation requirement
for certain hedging transactions, such as
the costs related to systems changes and
maintenance, employee resources and
time, and recordkeeping.362 The
362 The Agencies note that, for some costs of the
proposed rule, hour burden estimates are provided
in Part [internal cite to PRA] of this Supplementary
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Agencies also request comment on the
extent to which the proposed
documentation requirement would
reduce the speed in which a banking
entity could execute a hedge at a
different level within the entity and
whether this could reduce efficiency or
result in a banking entity being exposed
to a greater amount of risk. Further, we
seek commenters’ views on whether
potentially slower execution times
could also reduce profitability
associated with the position as it
remains unhedged (or, alternatively,
increase profitability, depending on
whether the value of the unhedged
position is increasing or decreasing in
the market). To balance the potential for
such consequences with the statutory
purpose, the Agencies have proposed to
apply the documentation requirement to
only a subset of hedging transactions
that pose the greatest compliance risk
(i.e., hedges that are established at a
different level of organization than that
establishing or responsible for the
underlying positions or risks that are
being hedged). In addition, the Agencies
expect that the preparation of required
documentation would become less
burdensome and more efficient over
time as systems are developed and
personnel become more accustomed to
the proposed requirement.
5. Compensation Related to Permitted
Activities
The proposed rule would require that
the compensation arrangements of
persons performing underwriting,
market making-related, and riskmitigating hedging activities be
designed not to reward proprietary risktaking. These proposed requirements are
intended to reduce incentives for
personnel of the banking entity to
violate the statutory prohibition on
proprietary trading and expose the
banking entity to risks arising from
prohibited proprietary trading. We
request comment on whether the
proposed rule’s requirements regarding
compensation arrangements would
reduce the banking entity’s ability to
attract talented and experienced trading
personnel or would harm the banking
entity’s ability to compete with entities
that are not subject to section 13 of the
BHC Act and the proposed rule. In order
to balance the potential for such effects
with the statutory goals, the proposed
rule does not expressly prescribe how a
banking entity must compensate its
personnel or prohibit all types of
compensation incentives related to nonclient income, but instead proposes an
Information for purposes of the Agencies’
compliance with the Paperwork Reduction Act.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
approach that leaves banking entities
with a degree of flexibility to
compensate their personnel as they
deem appropriate.
6. Exemption for Trading on Behalf of
Customers
Section l.6(b) of the proposed rule
implements section 13(d)(1)(D) of the
BHC Act, which permits a banking
entity, notwithstanding the prohibition
on proprietary trading, to purchase or
sell a covered financial position on
behalf of customers. Because the statute
does not define when a transaction
would be conducted on behalf of
customers, the proposed rule identifies
three categories of transactions that
would qualify under this exemption. By
providing that only transactions meeting
the terms of the three categories would
be considered to be on behalf of
customers for purposes of the
exemption, the proposed rule addresses
the potential for evasion of the statutory
prohibition. At the same time, the
proposed rule also would not permit
banking entities to rely on the
exemption with respect to other,
unanticipated transactions that banking
entities may undertake on behalf of
customers. The Agencies seek comment
on whether banking entities currently
engage in principal transactions on
behalf of customers that are not covered
by the proposed exemption or other
permitted activities and whether the
lack of an exemption in the proposed
rule for such activities would impact
beneficial customer facilitation, market
liquidity, efficiency, or capital
formation.
7. Exemption for Trading Outside of the
United States
Section l.6(d) of the proposed rule
implements section 13(d)(1)(H) of the
BHC Act, which permits certain foreign
banking entities to engage in proprietary
trading that occurs ‘‘solely outside of
the United States.’’ The proposed
exemption provides a number of
specific criteria for determining when
trading will be considered to have
occurred solely outside of the United
States to help prevent evasion of the
statutory restriction. The proposed
exemption also provides a definition of
‘‘resident of the United States’’ that is
similar to the SEC’s definition of ‘‘U.S.
person’’ in Regulation S, which should
promote consistency and understanding
among market participants that have
experience with the concept from the
SEC’s Regulation S. In addition, the
proposed exemption clarifies when a
foreign banking entity will be
considered to engage in such trading
pursuant to sections 4(c)(9) and 4(c)(13)
PO 00000
Frm 00083
Fmt 4701
Sfmt 4702
68927
of the BHC Act, as required by the
statute, including with respect to a
foreign banking entity that is not a
‘‘foreign banking organization’’ under
the Board’s Regulation K. This
implementation of section 13(d)(1)(H) of
the BHC Act would permit certain
foreign banking entities that are not
‘‘qualifying foreign banking
organizations’’ under the Board’s
Regulation K to also rely on the
exemption, notwithstanding the fact
such foreign banking entities are not
currently subject to the BHC Act
generally or the Board’s Regulation K.
As a result, such foreign banking
entities should encounter fewer costs
related to complying with the
proprietary trading prohibitions than if
they were unable to rely on the
exemption in section 13(d)(1)(H) of the
BHC Act.
Despite the reference to section
4(c)(13) of the BHC Act, the statute
provides that the exemption for trading
outside of the United States is only
available to banking entities that are not
directly or indirectly controlled by U.S.
banking entities (i.e., not any U.S.
banking entities or their foreign
subsidiaries and affiliates). Under the
statute, the prohibition on proprietary
trading applies to the consolidated,
worldwide operations of U.S. firms. As
required by statute, the proposal
prohibits U.S. banking entities from
engaging in proprietary trading unless
the requirements of one or more
relevant exemptions (other than the
exemption for trading by foreign
banking entities) are satisfied. As a
result, the statute creates a competitive
difference between the foreign activities
of U.S. banking entities, which must
monitor and limit their foreign activities
in accordance with the requirements of
section 13 of the BHC Act, relative to
the foreign activities of foreign-based
banking entities, which may not be
subject to restrictions similar to those in
section 13 of BHC Act. The Agencies
seek commenters’ views on whether the
proposed rule’s implementation of
section 13(d)(1)(H) of the BHC Act
imposes additional competitive
differences, beyond those recognized
above, and the potential economic
impact of such competitive differences.
8. Quantitative Measurements
Section l.7 of the proposed rule,
which implements in part section
13(e)(1) of the BHC Act,363 requires
363 Section 13(e)(1) of the BHC Act requires the
Agencies to issue regulations regarding internal
controls and recordkeeping to ensure compliance
with section 13. See 12 U.S.C. 1851(e)(1). Section
E:\FR\FM\07NOP2.SGM
Continued
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68928
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
certain banking entities to comply with
the reporting and recordkeeping
requirements specified in Appendix A
of the proposed rule. Proposed
Appendix A requires a banking entity
with significant trading activities to
furnish periodic reports to the relevant
Agency regarding various quantitative
measurements of its trading activities
and create and retain records
documenting the preparation and
content of these reports. The proposed
measurements would vary depending
on the scope, type, and size of trading
activities. In addition, proposed
Appendix B contains a detailed
commentary regarding the
characteristics of permitted market
making-related activities and how such
activities may be distinguished from
trading activities that, even if conducted
in the context of banking entity’s market
making operations, would constitute
prohibited proprietary trading. These
proposed requirements are intended, in
particular, to address some of the
difficulties associated with (i)
identifying permitted market makingrelated activities and distinguishing
such activities from prohibited
proprietary trading and (ii) identifying
certain trading activities resulting in
material exposure to high-risk assets or
high-risk strategies. In combination,
§ l.7 and Appendix A of the proposed
rule provide a quantitative overlay
designed to help banking entities and
the Agencies identify trading activities
that warrant further analysis or review
in a variety of levels and contexts.
The various quantitative
measurements that would be required to
be reported focus on assessing banking
entities’ risk management, sources of
revenue, revenues in relation to risk,
customer servicing, and fee generation.
Aberrant patterns among the
measurements with respect to these
areas would warrant further review to
determine whether trading activities
have occurred that are proprietary in
nature and whether such activities may
be exposing banking entities to
disproportionate risk. For example,
quantitative measurements should
provide banking entities with a useful
starting point for assessing whether
their trading activities are consistent
with the proposed rule and whether
traders are exposing the entity to
disproportionate risks. In addition,
proposed Appendix A applies a
standardized description and general
method of calculating each quantitative
measurement that, while taking into
account the potential variation among
l.20 and Appendix C of the proposed rule also
implement section 13(e)(1) of the BHC Act.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
trading practices and asset classes, is
intended to facilitate reporting of
sufficiently uniform information across
different banking entities so as to permit
horizontal reviews and comparisons of
the quantitative profile of trading units
across firms. This proposed approach,
which recognizes that quantitative
measurements must be applied with
respect to differences within a banking
entity’s structure, business lines, and
trading desks, should facilitate efficient
application within firms and efficient
examination across firms. The proposed
use of a suite of quantitative
measurements for these purposes may
also limit erroneous indications of
potential violations or erroneous
indications of compliance (i.e., false
positives and false negatives), thus
allowing banking entities and examiners
and supervisors to focus upon the
measurements that may be most
relevant in identifying prohibited
conduct. The uniformity of the
proposed measurements across different
types of banking entities is also
intended to ensure that banking entities
are calculating comparable
measurements consistently and that
comparable measurements are being
evaluated consistently by Agencies. The
Agencies expect that as the
implementation of quantitative
measurements and the internal
compliance and external oversight
processes become more efficient over
time, banking entities will find
compliance efforts less burdensome.
The Agencies seek comment on the
extent to which banking entities will
incur costs associated with
implementing, monitoring, and
attributing financial and personnel
resources for purposes of complying
with the requirements of proposed
Appendix A. Specifically, please
discuss the extent to which banking
entities are unlikely to currently
calculate certain quantitative
measurements in the manner required
under the proposal (e.g., Spread Profit
and Loss or Customer-facing Trade
Ratio) and whether this may result in
significant start-up costs associated with
developing these measurements. Under
the proposal, banking entities would
also need to dedicate personnel and
supervisory staff to review for potential
aberrant patterns of activity that warrant
further review, as well as maintain
appropriate records of that review. In
order to limit these calculation and
surveillance costs to the greatest extent
practicable, the Agencies have proposed
measurements that, in many cases, are
already calculated by many banking
entities to measure and manage trading
PO 00000
Frm 00084
Fmt 4701
Sfmt 4702
risks and activities. The costs to banking
entities associated with calculating the
proposed quantitative metrics should
also be mitigated by the tiered
application of Appendix A, which
would require banking entities with the
most extensive trading activities to
report the largest number of quantitative
measurements, while imposing fewer or
no reporting requirements on banking
entities with smaller trading activities.
By limiting the application of aspects of
Appendix A to firms with greater than
$1 billion in trading assets and
liabilities, and all aspects of the
appendix only to entities with greater
than $5 billion in trading assets and
liabilities, the costs imposed should be
proportional to the market reach and
complexity of a banking entity’s trading
activities.
B. Covered Fund Activities
Subpart C implements the statutory
provisions of section 13(a)(1)(B) of the
BHC Act, which prohibit banking
entities from acquiring or retaining any
equity, partnership, or other ownership
interest in, or sponsoring, a covered
fund, and other provisions of section 13
of the BHC Act which provide
exemptions from, or otherwise relate to,
that prohibition. In implementing the
covered funds provisions of section 13
of the BHC Act, the Agencies have
proposed to define and interpret several
terms used in implementing these
provisions and the goals of section 13.
We seek comment on whether the
proposed rule represents a balanced and
effective approach to implementing the
covered fund provisions of the statute.
1. General Scope
For banking entities that invest in,
sponsor or have relationships with one
or more covered funds, the economic
impact of complying with the statute
and the implementing rule will vary,
depending on the size, scope and
complexity of their respective business,
operations and relationships with
clients, customers and counterparties.
Moreover, the types of covered funds
advised or sponsored by an adviser, the
types of business and other
relationships that an adviser may
conduct with such funds and the
adviser’s other business activities,
including relationships with other third
party advised covered funds, will affect
whether a covered fund activity would
be subject to the statutory prohibition,
eligible for a particular exemption or
subject to particular internal control
requirements as specified by the
proposed rule.
For example, with respect to a
banking entity that does not ‘‘sponsor,’’
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
invest in, or otherwise provide ‘‘prime
brokerage transactions’’ to, a ‘‘covered
fund,’’ the statute, as implemented by
the proposed rule, would not
substantively restrict the banking
entity’s activity; instead, the proposed
rule would only require the minimum
internal controls reasonably designed to
prevent the entity from engaging in the
prohibited activities. As a result, we do
not expect that the proposed rule would
have a significant effect on most
banking entities, such as investment
advisers, that are primarily engaged in
providing bona fide trust, fiduciary, or
advisory services to unrelated parties.
Although such advisers may incur some
incremental costs to develop and
implement a compliance program
reasonably designed to ensure that they
do not engage in otherwise prohibited
activities, there should be no significant
costs associated with modifying existing
business practices and procedures. We
request comment on the extent to which
such banking entities would be required
to modify their existing business
practices and procedures to comply
with the proposed rule. For instance,
would a registered investment adviser
that only advises registered investment
companies and that does not trade for
its own account incur costs, benefits or
other impacts in addition to costs to
implement the minimum internal
controls reasonably designed to prevent
it from engaging in prohibited activities?
Would an adviser that trades on behalf
of itself incur, with respect to such
trading activities, additional costs,
benefits or other impacts described
above relating to the proposed
restrictions on proprietary trading?
In contrast, a banking entity that seeks
to invest in a covered fund could only
do so in reliance on an exemption
specified in the statute or the proposed
rule, such as the exemption for
organizing and offering certain covered
funds provided in section 13(d)(1)(G), as
implemented in § l.11 of the proposed
rule. Similarly, a banking entity that
seeks to enter into ‘‘prime brokerage
transactions’’ with a covered fund could
only do so by meeting certain
requirements under the proposed rule.
Accordingly, the economic impact of
the proposed rule will depend on
whether an adviser’s activities fall
within the scope of the terms as
proposed such that the banking entity
would be subject to the limitations on
covered fund activities. To the extent
that these terms or exemptions would
result in more, or fewer, activities being
captured by the proposed rule, what are
the attendant costs and benefits that a
covered banking may incur? We request
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
commenters provide empirical data
where possible.
Definition of Covered Fund. The
proposed rule’s definition of ‘‘covered
fund’’ includes hedge funds and private
equity funds as defined by statute, but
also identifies two types of similar
funds—commodity pools and certain
non-U.S. funds—that are subject to the
covered fund restrictions and
prohibitions of section 13 of the BHC
Act, as implemented by the proposed
rule. The Agencies have proposed to
include these funds since they are
generally managed and structured
similar to a covered fund, but are not
generally subject to the Federal
securities laws due to the instruments in
which they invest or the fact that they
are not organized in the United States or
one or more States. We request
comment on whether applying the
definition of covered fund in this way
as proposed would increase the number
of investment vehicles or similar
entities that would be subject to the
limitations under the proposed rule.
Would this approach increase
compliance costs for banking entities
that sponsor, invest in, or have certain
relationships with these types of funds?
The proposed rule also excludes
certain types of investments in covered
funds, pursuant to section 13(d)(1)(J) of
the BHC Act, which authorizes the
Agencies to exclude from the general
covered fund activity prohibition those
activities that would promote the safety
and soundness of a banking entity.
Section l.14 of the proposed rule
would exclude from the prohibition,
among other things, a banking entity’s
investments in covered funds related to
bank owned life insurance, certain joint
ventures and interests in securitization
vehicles retained in compliance with
the minimum credit risk retention
requirements of section 15G of the
Exchange Act. We request comment on
the potential economic impact of the
proposal to exclude these types of
investments from the general
prohibition. For banking entities whose
only covered fund activities are those
described in § l.14, what economic
impact would be attributed to
complying with this provision of the
proposed rule? Would these costs and
benefits differ from those of banking
entities that conduct covered fund
activities as well as engage in activities
described in § l.14? As described in the
Supplementary Information, a banking
entity that generally does not engage in
any prohibited activities is only
required to adopt and implement a
compliance program reasonably
designed to ensure that the entity does
not engage in prohibited activities. To
PO 00000
Frm 00085
Fmt 4701
Sfmt 4702
68929
what extent will the proposed
provisions in § l.14 increase or
mitigate any costs, benefits or other
impacts associated with the foregoing
minimum internal controls
requirement?
Definition of Sponsor. Under the
proposed rule, the term ‘‘sponsor’’ is
defined by incorporating the definition
set forth in section 13(h)(5) of the BHC
Act, but the Agencies have proposed to
clarify that the term trustee, as used in
the definition of sponsor, does not
include a trustee that does not provide
discretionary investment services to a
covered fund. This exception
distinguishes a trustee providing nondiscretionary advisory services from
trustees providing services similar to
those associated with entities serving as
general partner, managing member,
commodity pool operator or investment
adviser of a covered fund. We request
comment on the economic impact
associated with the proposed definition
of ‘‘sponsor.’’ Will the economic impact
differ depending on the scope of a
banking entity’s covered fund activities?
For example, a banking entity whose
only relationship with a covered fund
involves the provision of nondiscretionary investment services would
not be a sponsor under the proposed
rule. We request comment on whether
such a banking entity would benefit
from this exception. We also request
comment on whether a covered fund’s
investors and counterparties would bear
any costs associated with a banking
entity’s modification of its business
practices or its relationship to the
covered fund.
Other Definitions. The covered fund
provisions also define, among other
things, ‘‘director’’ and ‘‘prime brokerage
transaction.’’ What are the costs,
benefits or other impacts associated
with the way the proposed rule defines
these terms? For example, would the
proposed definition of ‘‘prime brokerage
transaction’’ enable a banking entity to
provide services to a covered fund that
would not ordinarily be understood to
be prime brokerage as long as it met
certain conditions? What costs, or
benefits, for banking entities, clients,
customers or counterparties may be
associated with this approach to
defining prime brokerage transaction?
2. Exemptions
In implementing the covered funds
provisions of section 13 of the BHC Act,
the Agencies also have interpreted or
defined terms contained in the three
principal exemptions related to covered
fund activities by a banking entity:
(i) The exemption for organizing and
offering covered funds; (ii) the
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68930
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
exemption for investment in a covered
fund in the case of risk-mitigating
hedging; and (iii) the exemption for
covered fund activities outside of the
United States. We request comment
generally on the potential impact of
these statutory exemptions, as
implemented by the proposed rule. The
Agencies note that there are multiple
factors that could affect the impact of
the statute and the proposed rule on a
banking entity’s covered fund activities,
including other conditions set forth in
the statute or the proposed rule that
could mitigate costs or enhance benefits
associated with a particular element or
condition of an exemption.
Organize and Offer Exemption.
Section l.11 of the proposed rule
implements the exemption set forth in
section 13(d)(1)(G) of the BHC Act and
generally incorporates all of the
conditions specified in the statute. As
required by the statute, the exemption
for organizing and offering covered
funds is available only to banking
entities that provide bona fide trust,
fiduciary, commodity trading or
investment advisory services, which
must meet certain requirements. As a
result, the exemption should not
preclude banking entities, such as
registered advisers or other advisers,
from providing trust or advisory
services to their clients. We request
comment on whether the proposed
requirements of the exemption would
result in a banking entity modifying its
business practices or bearing higher
costs to comply with the limitations and
requirements applicable to this statutory
exemption, as implemented by the
proposed rule. These costs may include,
for example, developing a credible plan
that documents how advisory services
would be provided to banking entity
customers through organizing and
offering covered funds and making the
specified disclosures required by the
exemption. We also request comment on
whether the banking entity will pass
these costs on to covered fund investors
and counterparties.
In implementing this statutory
exemption, the Agencies have defined
or clarified several key terms or
requirements, including (i) the
definition of ownership interest and (ii)
the method for calculating the 3%
ownership interest limit. The proposed
definition of ownership interest is
designed to describe the typical types of
relationships through which an investor
has exposure to the profits and losses of
a covered fund. Consistent with this
approach, carried interest is not
included within the proposed definition
of ownership interest. As discussed in
the Supplementary Information above,
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
carried interest generally entitles service
providers, such as banking entities that
provide advisory services, to receive
compensation for such services
determined as a share of a covered
fund’s profits. As a result, the proposed
rule does not treat carried interest as an
ownership interest, which could have
costs and benefits. To help discern these
costs and benefits, we request comment
on whether this is consistent with how
providers of advisory services view the
receipt of such ‘‘carried interest’’ (i.e., as
compensation for services rather than as
an ‘‘ownership interest’’ equivalent to
an investor’s interest that shares in a
fund’s profits and losses). The proposed
definition of carried interest has
limitations designed to prevent a
banking entity from circumscribing the
proposed rule’s limitations on
ownership. For instance, among other
things, the proposed definition requires
that the ‘‘sole purpose and effect of the
interest is to allow banking entity * * *
to share in the profits of the covered
fund.’’ 364 For banking entities receiving
compensation that would satisfy all of
the elements of the proposed definition,
there should be no burden associated
with modifying existing business
practices. For other banking entities,
however, the conditions specified in the
proposed definition could result in
more banking entities being deemed to
hold ‘‘ownership interests’’ and hence
subject to the limitations under the
statute and the proposed rule, including
the limitations on material conflicts of
interest, high-risk trading activities and
exposure to high-risk assets. We request
comment on whether these banking
entities would need to modify their
existing practices and develop
alternatives, and, if so, whether these
modifications will impose costs and
benefits. For example, costs associated
with modifying business practices could
include developing and implementing a
compliance program in accordance with
the proposed rule; benefits that may
arise as a result of modifying business
practices could include limiting the
extent to which material conflicts of
interest may arise between clients,
customer and counterparties of banking
entities. We also request comment on
whether such costs, if any, are likely to
be passed on to fund investors, clients
and counterparties.
As required by statute, a banking
entity that seeks to invest in a covered
fund under the exemption for
organizing and offering covered funds
could not, after the expiration of an
initial one-year period (plus any
applicable extensions), hold more than
364 Proposed
PO 00000
Frm 00086
rule § l.10(b)(3)(i).
Fmt 4701
Sfmt 4702
3% of the total outstanding ownership
interests of such fund. The proposed
rule would require that a banking entity
calculate the per-fund limit whenever
the covered fund calculates its value or
permits investor investments or
redemptions, but in no case less
frequently than quarterly. We request
comment on whether this approach will
limit any additional burden associated
with calculating the per-fund limit for
banking entities that invest in covered
funds that determine their value on at
least a quarterly basis. We also request
comment on whether such banking
entities will incur any additional
significant costs in determining their
compliance with the 3% ownership
limitation.
Risk-mitigating Hedging Exemption.
The proposed rule specifies an
exemption from the general prohibition
on covered fund activities in the case of
risk-mitigating hedging. Similar to the
hedging exemption in the case of
proprietary trading (discussed above),
the hedging exemption for covered fund
activities specifies a number of
conditions that are identical except for
two conditions. In the case of the
hedging exemption for covered fund
activities, the hedging must generally
‘‘offset’’ the exposure of the banking
entity to the liabilities associated with
(i) the facilitation of customer
transactions or (ii) compensation
arrangements for certain employees.
Consistent with the statute, the
proposed exemption would enable a
banking entity to invest in a covered
fund without limit if the investment is
for risk-mitigating hedging purposes.
We request comment on whether the
proposed requirements will have
benefits of furthering the goals of
compliance with the statute and
reducing banking entities’ risks. We also
request comment on whether the
proposed requirements are more
restrictive than necessary to implement
the statute and whether they could
unnecessarily limit a banking entity’s
hedging activities and ability to reduce
risk. Commenters should also address
whether the proposed requirements will
dissuade banking entities from engaging
in other permitted activities (e.g.,
organizing and offering covered funds)
or those activities outside the scope of
the statute to the extent that the
exemption prevents them from
mitigating the risks associated with such
activities. We request comment on
whether a reduction in efficiency could
result from a reduced ability of covered
banking entities to transfer risks to those
more willing to bear them.
Commentators should also address
whether the proposed rule could reduce
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
a banking entity’s willingness to engage
in permitted risk-mitigating hedging
activities in order to avoid costs related
to ensuring compliance with the
exemption’s requirements, and whether
this would increase the banking entity’s
risk exposure.
Exemption for Covered Fund
Activities Outside of the United States.
Section l.13(c) of the proposed rule
implements section 13(d)(1)(I) of the
BHC Act, which permits certain foreign
banking entities to sponsor or invest in
covered funds ‘‘solely outside of the
United States,’’ so long as the covered
fund is not offered or sold to a resident
of the United States. The proposed
exemption provides a number of
specific criteria for determining when a
banking entity will be considered to
have invested or sponsored a covered
fund solely outside of the United States.
The proposed exemption provides a
definition of ‘‘resident of the United
States’’ that is similar, but not identical,
to the SEC’s definition of ‘‘U.S. person’’
in Regulation S, which should promote
consistency and understanding among
market participants that have
experience with the concept from the
SEC’s Regulation S. In addition, the
proposed exemption clarifies when a
foreign banking entity will be
considered to engage in such trading
pursuant to sections 4(c)(9) and 4(c)(13)
of the BHC Act, as required by the
statute, including with respect to a
foreign banking entity that is not a
‘‘foreign banking organization’’ under
the Board’s Regulation K. This
implementation of section 13(d)(1)(I) of
the BHC Act would permit certain
foreign banking entities that are not
‘‘qualifying foreign banking
organizations’’ under the Board’s
Regulation K to also rely on the
exemption, notwithstanding the fact
such foreign banking entities are not
currently subject to the BHC Act
generally or the Board’s Regulation K.
As a result, such foreign banking
entities should encounter fewer costs
related to complying with the covered
fund activity prohibitions than if they
were unable to rely on the exemption in
section 13(d)(1)(I) of the BHC Act.
Despite the reference to section
4(c)(13) of the BHC Act, the statute
provides that the exemption for covered
fund activities outside of the United
States is only available to banking
entities that are not directly or
indirectly controlled by U.S. banking
entities (i.e., not any U.S. banking
entities or their foreign subsidiaries and
affiliates). Under the statute, the
prohibition and restrictions on covered
fund activities apply to the
consolidated, worldwide operations of
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
U.S. firms. As required by statute, the
proposal prohibits U.S. banking entities
from investing in or sponsoring covered
funds unless the requirements of one or
more relevant exemptions (other than
the exemption for trading by foreign
banking entities) are satisfied. As a
result, the statute creates a competitive
difference between the foreign activities
of U.S. banking entities, which must
monitor and limit their foreign activities
in accordance with the requirements of
section 13 of the BHC Act, relative to
the foreign activities of foreign-based
banking entities, which may not be
subject to restrictions similar to those in
section 13 of BHC Act. The Agencies
seek commenters’ views on whether the
proposed rule’s implementation of
section 13(d)(1)(I) of the BHC Act
imposes additional competitive
differences, beyond those discussed
above, and the potential economic
impact of such competitive differences.
3. Securitizations
The Agencies recognize that by
defining ‘‘covered fund’’ and ‘‘banking
entity’’ broadly, securitization vehicles
may be affected by the restrictions and
requirements of the proposed rule, and
this may give rise to various economic
effects. The Agencies preliminarily
believe that the proposed rule should
mitigate the impact of securitization
market participants and investors in
some non-loan asset classes (including,
for example, banking entities that are
participants in a securitization that may
acquire or retain ownership interests in
a securitization vehicle that falls within
the definition of covered fund) by
excluding loan securitizations from the
restrictions on sponsoring or acquiring
and retaining ownership interests in
covered funds.
Costs may be incurred to establish
internal compliance programs to track
compliance for any securitization
vehicle that falls within the definition of
banking entity. These costs may be
minimized for future securitization
vehicles, however, because such
securitizations may be able both to
incorporate any internal compliance
program requirements into their
documentation prior to execution, and
to minimize (or eliminate) any activities
that may trigger greater compliance
costs. The proposed rule should further
minimize the costs of the internal
compliance programs by (i) allowing for
enterprise-wide compliance programs
and minimal requirements for banking
entities that do not engage in covered
trading activities and/or covered fund
activities or investments (each as
described below), and (ii) allowing for
reduced compliance program
PO 00000
Frm 00087
Fmt 4701
Sfmt 4702
68931
requirements by establishing financial
thresholds for ‘‘significant’’ covered
trading activities or covered fund
activities or investments (as described
below).
There could be initial costs both for
banking entities that have an ownership
interest in a securitization vehicle and
for other securitization participants to
determine if a particular vehicle falls
within the definition of covered fund.
Additional costs could be incurred to
the extent that banking entities divest
their ownership interests in any
securitization vehicle that is a covered
fund and is not otherwise eligible for
one of the exceptions allowed under the
proposed rule. This divestment could
result in selling pressure that may have
a negative impact on the market prices
for the vehicles that fall within the
definition of covered fund, which in
turn could impact all investors in those
securitization vehicles. Additionally,
under the proposed rule banking
entities would no longer be allowed to
acquire and retain such ownership
interests, which may result in fewer
potential investors and reduced
liquidity in the market for ownership
interests in these covered funds.
For example, the proposed rule could
lead to significant potential market
impacts if, with respect to an issuance
of asset-backed securities secured by
assets which are not loans, the market
requires credit risk retention in excess
of the minimum requirements to be
adopted pursuant to Section 941 of the
Dodd-Frank Act (i.e., the market
believes that 5% credit risk retention is
insufficient to address potential
misalignment of incentives in a
particular transaction). In such
circumstances, the proposed rule could
reduce potential investors’ demand for
such securitizations and could make
such securitizations more expensive.
C. Limitations on Permitted Activities
for Material Conflicts of Interest and
High-Risk Assets and High-Risk Trading
Strategies
Section 13(d)(2)(A)(i) of the BHC Act
provides that an otherwise-permitted
activity would not qualify for a statutory
exemption if it would involve or result
in a material conflict of interest. The
proposed rule’s definition of material
conflict of interest, as discussed in more
detail in Part II of the SUPPLEMENTARY
INFORMATION, would provide flexibility
to banking entities and their clients,
customers, and counterparties with
respect to how transactions are
structured, while also establishing a
structure to prevent banking entities
from engaging in transactions and
activities in reliance on a statutory
E:\FR\FM\07NOP2.SGM
07NOP2
68932
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
exemption when the transaction or
activity would have a materially adverse
effect on the clients, customers, or
counterparties of the banking entity.
Specifically, the proposed definition
would permit the use of timely and
effective disclosure and/or information
barriers in certain circumstances to
address and mitigate conflicts of
interest, while prohibiting transactions
or activities where such a conflict of
interest cannot be addressed or
mitigated in the specified manner. The
Agencies have endeavored to establish a
workable definition that sets forth when
a banking entity may not rely on an
exemption because it would involve or
result in a material conflict of interest,
consistent with the statutory goals, to
facilitate banking entities’ compliance
with the statutory requirements. We
seek comment on whether the statutory
prohibition, as implemented by the
proposal, may impose costs on banking
entities or their clients, customers, or
counterparties. For instance, by
permitting a client, customer or
counterparty the option of negating or
mitigating the conflict after the banking
entity has disclosed the conflict, would
the banking entity incur certain costs
related to terminating the transaction,
providing compensation or other means
of mitigating the conflict, or
administrative costs associated with
negotiating the extent of any such
compensation or other means of
mitigating the conflict, depending on
the actions of the client, customer, or
counterparty in response to the
disclosure?
In addition, section 13(d)(2)(A)(ii) of
the BHC Act provides that an otherwisepermitted activity would not qualify for
a statutory exemption if it would result,
directly or indirectly, in a material
exposure by the banking entity to highrisk assets or high-risk trading strategies.
This statutory limitation, as
implemented in the proposed rule,
would prevent a banking entity from
engaging in certain high-risk activity.
The Agencies request comment on
whether the proposed definitions of
high-risk asset and high-risk trading
strategy would potentially reduce
liquidity or create a reduction in
efficiency for assets or markets related
to that high-risk activity.
D. Compliance Program
Under § l.20 of the proposed rule, all
covered banking entities that are
engaged in covered trading activities or
covered fund activities or investments
would be required to have a compliance
program that provides for the following
six elements, at a minimum: (i) Internal
written policies and procedures; (ii)
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
internal controls; (iii) a management
framework; (iv) independent testing; (v)
training; and (vi) recordkeeping. For
those banking entities with significant
covered trading activities or covered
fund activities or investments under
§ l.20(c) of the proposed rule,
additional standards in proposed
Appendix C must be met with respect
to these six elements.365 Collectively,
the six proposed requirements would
facilitate a banking entity’s review and
assessment of its compliance with
section 13 of the BHC Act and the
proposed rule, including identifying
potential areas of deficiency in a
banking entity’s compliance program
and providing the banking entity the
opportunity to take appropriate
corrective or disciplinary action, where
warranted. The proposed compliance
program would also facilitate Agency
examination and supervision for
compliance with the requirements of the
statute and the proposed rule. By
requiring that a banking entity have in
place specific, documented elements
(e.g., written policies and procedures
and internal controls, recordkeeping
requirements), the proposed rule would
ensure that Agency examiners and
supervisors can effectively review a
banking entity’s activities and
investments to assess compliance and,
where a banking entity is not in
compliance with the proposed rule, take
appropriate action.
Beyond the benefits recognized above,
the individual elements of the proposed
compliance program should also
provide certain benefits. For example,
the proposed management framework
requirement is designed to give
management a greater incentive to
comply with the proposed rule and to
ascertain that the employees they are
responsible for overseeing are also
complying with the proposed rule.
Further, by establishing a management
framework for compliance, the banking
entity would be required to set a strong
compliance tone at the top of the
banking entity’s organization and signal
to its employees that management is
serious about compliance, which should
foster a strong culture of compliance
throughout the banking entity.
Similarly, the proposed independent
testing requirement would provide a
third-party assessment of a banking
entity’s compliance with the proposed
rule, which should provide assurances
to the banking entity, its clients,
365 Proposed rule § l.20 and Appendix C
implement section 13(e) of the BHC Act, which
requires the Agencies to issue regulations regarding
internal controls and recordkeeping to ensure
compliance with section 13.
PO 00000
Frm 00088
Fmt 4701
Sfmt 4702
customers, and counterparties, and
current or prospective investors that the
banking entity is in compliance with the
proposed rule. In addition, the proposed
training requirement should help the
various employees of a banking entity
that have responsibilities and
obligations under the proposed rule
(e.g., complying with the requirements
for permitted market making-related
activity) understand such
responsibilities and obligations and
facilitate the banking entity’s
compliance with the proposed rule.
This proposed requirement may also
promote market confidence by assuring
that trading personnel, and other
appropriate personnel of the banking
entity, are familiar with their regulatory
responsibilities and are complying with
the applicable laws and regulations in
their interactions with clients,
customers, and counterparties.
Because the six elements would be
required to be established by all banking
entities, other than those that are not
engaged in covered trading activities or
covered fund activities or investments,
the proposed compliance program
requirement should promote
consistency across banking entities.
However, the proposed elements are
also intended to give a banking entity a
degree of flexibility in establishing and
maintaining its compliance program in
order to address the varying nature of
activities or investments conducted by
different units of the banking entity’s
organization, including the size, scope,
complexity, and risks of the activity or
investment.
We seek comment on whether
developing and providing for the
continued administration of a
compliance program under § l.20 of
the proposed rule is likely to impose
material costs on banking entities. Costs
related to the proposed compliance
program requirement are likely to be
higher for those banking entities that are
engaged in significant covered trading
or covered fund activities or
investments and, as a result, are
required to comply with the more
detailed, specific requirements of
proposed Appendix C. Potential costs
related to implementation of a
compliance program under the proposal
include those associated with: Hiring
additional personnel or other personnel
modifications, new or additional
systems (including computer hardware
or software), developing exception
reports, and consultation with outside
experts (e.g., attorneys, accountants).
The proposed compliance program
requirement would also impose ongoing
costs related to maintenance and
enforcement of the compliance program
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
elements, which may include those
associated with: Ongoing system
maintenance, surveillance (e.g.,
reviewing and monitoring exception
reports), recordkeeping, independent
testing, and training. For example, the
independent testing requirement in the
proposal may necessitate that additional
resources be provided to the internal
audit department of the covered banking
entity that is a registered broker-dealer
or security-based swap dealer, if such
testing is conducted by a qualified
internal tester. Alternatively, if an
outside party is used to conduct the
independent testing, the covered
banking entity would incur costs
associated with paying the qualified
outside party’s for its services. The
Agencies do not anticipate significant
costs related to the proposed
management framework requirement, as
banking entities should already have
relevant management structures in
place.
The tiered approach with which the
proposal applies the proposed
compliance program requirement to
banking entities of varying size should
reduce the costs associated with
developing and providing for the
continued administration of a
compliance program. In setting forth the
proposed compliance program
requirement in § l.20 of the proposed
rule and Appendix C, the Agencies have
taken into consideration the size, scope,
and complexity of a banking entity’s
covered trading activities and covered
fund activities and investments in
developing requirements targeted to the
compliance risks of large and small
banking entities. Specifically, banking
entities that do not meet the thresholds
established in § l.20(c) of the proposed
rule would not be required to comply
with the more detailed and burdensome
requirements set forth in Appendix C. In
addition, banking entities that do not
engage in covered trading activities and
covered fund activities and investments
would not be required to establish a
compliance program under the
proposed rule, and therefore should
incur only minimal costs associated
with adding measures to their existing
compliance policies and procedures to
prevent the banking entity from
becoming engaged in such activities or
making such investments. Together,
these provisions have been proposed in
order to permit a banking entity to tailor
its compliance program to its activities
and investments and, where possible,
leverage its existing compliance
structures, all of which should
minimize the incremental costs
associated with establishing a
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
compliance program under the
proposed rule. However, banking
entities that are engaged in significant
covered trading and covered fund
activities and investments and thereby
present a heightened compliance risk
due to the size and nature of their
activities and investments would be
required to comply with the additional
standards set forth in proposed
Appendix C.
Costs associated with the
requirements of proposed Appendix C
should also be reduced by aspects of the
proposed rule that would permit a
banking entity to establish an
enterprise-wide compliance program
under certain circumstances. An
enterprise-wide compliance program
would generally permit one compliance
program to be established for a banking
entity and all of its affiliates and
subsidiaries collectively, rather than
each legal entity being required to
establish its own separate compliance
program. The Agencies expect that an
enterprise-wide compliance program
should promote efficiencies and
economies of scale, and reduce costs,
associated with establishing separate
compliance programs.
E. Additional Request for Comment
In addition to the requests for
comment discussed above, we seek
commenters’ views on the following
additional questions related to the
potential economic impacts of the
proposed framework for implementing
section 13 of the BHC Act:
Question 348. What are the expected
costs and benefits of complying with the
requirements of the proposed rule? We
seek commenters’ estimates of the
aggregate cost or benefit that would be
incurred or received by banking entities
subject to section 13 of the BHC Act to
comply. We also ask commenters to
break out the costs or benefits of
compliance to banking entities with
each individual aspect of the proposed
rule. Please provide an explanation of
how cost or benefit estimates were
derived. Please also identify any costs or
benefits that would occur on a one time
basis and costs that would recur. Would
particular costs or benefits decrease or
increase over time? If certain costs or
benefits cannot be estimated, please
discuss why such costs or benefits
cannot be estimated.
Question 349. Please identify any
costs or benefits that would occur on a
one-time basis and costs or benefits that
would recur (e.g., training and
compliance monitoring). Please identify
any costs or benefits that you believe
would decrease over time. Please
identify any costs or benefits that you
PO 00000
Frm 00089
Fmt 4701
Sfmt 4702
68933
believe may increase over time or
remain static.
Question 350. Are there
circumstances in which registered
dealers, security-based swap dealers,
and/or swap dealers (i) hold accounts
other than trading accounts or (ii) hold
investment positions for activities for
which they are required to be
registered? If so, would including all
such dealer positions within the trading
account definition create competitive
burdens as well as additional burdens
on the operations of such dealers that
may not be consistent with the language
and purpose of the statute? Please
describe how this may occur, and to
what extent it may occur.
Question 351. Please identify the
ways, if any, that banking entities might
alter the ways they currently conduct
business as a result of the costs that
could be incurred to comply with the
requirements of the proposed rule. Do
you anticipate that banking entities will
terminate any services or products
currently offered to clients, customers,
or counterparties due to the proposed
rule, if adopted? Please explain.
Question 352. How would trading
systems and practices used in today’s
marketplace be impacted by the
proposed rule? What would be the costs
and/or benefits of such changes in
trading practices and systems?
Question 353. Would the proposed
rule create any additional
implementation or operational costs or
benefits associated with systems
(including computer hardware and
software), surveillance, procedural,
recordkeeping, or personnel
modifications, beyond those discussed
in the above analysis? Would smaller
banking entities be disproportionately
impacted by any of these additional
implementation or operational costs?
Question 354. We seek specific
comments on the costs and benefits
associated with systems changes on
banking entities with respect to the
proposed rule, including the type of
systems changes necessary and
quantification of costs associated with
changing the systems, including both
start-up and maintenance costs. We
request comments on the types of jobs
and staff that would be affected by
systems modifications and training with
respect to the proposed rule, the number
of labor hours that would be required to
accomplish these matters, and the
compensation rates of these staff
members.
Question 355. Please discuss any
human resources costs associated with
the proposed rule, along with any
associated overhead costs.
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68934
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Question 356. What are the benefits
and costs associated with the
requirements for relying on the
underwriting exemption? What impact
will these requirements have on capital
formation, efficiency, competition,
liquidity, price efficiency, if any? Please
estimate any resulting benefits and costs
or discuss why such benefits and costs
cannot be estimated. What alternatives,
if any, may be more cost-effective while
still being consistent with the purpose
and language of the statute?
Question 357. What are the benefits
and costs associated with the
requirements for relying on the
exemption for market making-related
activity, including the requirement that
such activity be consistent with the
commentary in Appendix B? What
impact will these requirements have on
liquidity, price efficiency, capital
formation, efficiency, and competition,
if any? Please estimate any resulting
benefits and costs or discuss why such
benefits and costs cannot be estimated.
What alternatives, if any, may be more
cost-effective while still being
consistent with the purpose and
language of the statute?
Question 358. What are the benefits
and costs associated with the
requirements for relying on the
exemption for risk-mitigating hedging
activity, including the requirement that
certain hedge transactions be
documented? What impact will these
requirements have on liquidity, price
efficiency, capital formation, efficiency,
and competition, if any? Please estimate
any resulting benefits and costs or
discuss why such benefits and costs
cannot be estimated. What alternatives,
if any, may be more cost-effective while
still being consistent with the purpose
and language of the statute?
Question 359. Are there traditional
risk management activities of banking
entities that are not covered by the
liquidity management and riskmitigating hedging exemptions as
currently proposed? What risks do
banking entities face that go beyond
market, counterparty/credit, currency/
foreign exchange, interest rate, and basis
risk? Could the proposed construction
of the liquidity management and riskmitigating hedging exemptions increase
the costs of management or impede the
ability of banking entities to effectively
manage risk?
Question 360. To rely on the
exemptions from the proposed rule for
permitted underwriting, market makingrelated activity, and risk-mitigating
hedging, banking entities must
establish, maintain, and enforce a
compliance program, including written
policies and procedures and internal
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
controls. Please discuss how the costs
incurred, or benefits received, by
banking entities related to initial
implementation and ongoing
maintenance of the compliance program
would impact their customers and their
businesses with respect to underwriting,
market making, and hedging activity.
Question 361. Please discuss benefits
and costs related to the limitations on
permitted activities for material
conflicts of interest, high-risk assets and
trading strategies, and threats to the
safety and soundness of banking entities
or to the financial stability of the U.S.
in the proposed rule. Are there
particular benefits and costs related to
the proposed definitions of material
conflict of interest, high-risk asset, and
high-risk trading strategy in the
proposed rule? Would these definitions
have any unintended costs, such as
creating undue burdens and limitations
on permitted underwriting, market
making-related, or hedging activity?
Please explain. What alternatives, if any,
may be more cost-effective while still
being consistent with the purpose and
language of the statute?
Question 362. Please discuss the
benefits and costs related to the
definition of derivative in the proposed
rule and the application of the
restrictions on proprietary trading to
transactions in the different types of
derivatives covered by the definition.
What alternatives, if any, may be more
cost-effective while still being
consistent with the purpose and
language of the statute?
Question 363. What costs and benefits
would be associated with calculating,
reviewing, and analyzing the proposed
quantitative measurements? What costs
and benefits would be associated with
reporting the proposed quantitative
measurements to an Agency? Please
identify any of the proposed
quantitative measurements that are
already reported to an Agency and
discuss whether the current reporting
regime would mitigate costs associated
with the proposed rule. With respect to
any quantitative measurement that is
not already reported to an Agency, what
are the costs and benefits of beginning
to report the measurement? Would
banking entities have to create or
purchase new systems or implement
changes to existing systems in order to
report these quantitative measurements?
Please discuss the costs and benefits
associated with such systems changes.
Question 364. How much of the data
necessary to calculate the quantitative
measurements in Appendix A is
currently captured, retained, and
utilized by banking entities? If the
applicable data is not currently used by
PO 00000
Frm 00090
Fmt 4701
Sfmt 4702
banking entities, is it readily available?
Is it possible to collect all of the data
that is necessary for calculating the
required measurements? Please identify
any data that banking entities do not
currently utilize that would need to be
captured and retained for purposes of
proposed Appendix A and discuss the
costs and benefits of capturing and
retaining such data.
Question 365. Do the costs and
benefits of calculating, analyzing, and
reporting certain or all quantitative
measurements differ between trading
units and their trading activities,
including trading strategies, asset
classes, market structure, experience
and market share, and market
competitiveness? Are any quantitative
measurements particularly costly to
calculate or analyze for specific trading
activities or, alternatively, particularly
beneficial? If so, which quantitative
measurement, what type of trading
activity, and what factor(s) of that
trading activity makes the quantitative
measurement particularly costly or
beneficial? Please discuss how these
costs, if any, could be mitigated or
benefits, if any, could be enhanced.
Question 366. The proposed
definition of trading unit would require
a tiered approach to calculating and
reporting quantitative measurements,
such that the measurements would be
calculated and reported for different
levels within the banking entity, with
higher levels encompassing smaller
units (e.g., trading desks, business lines,
and all trading operations). What are the
costs and benefits of calculating the
quantitative measurements for each
level within the definition of trading
unit? Can the higher level calculations
incorporate the lower level calculations
such that the higher level calculations
result in small, incremental costs? Why
or why not? Are there particular costs or
benefits associated with calculating,
analyzing, and reporting a quantitative
measurement at one of the levels within
the definition of trading unit that would
not be experienced at the other levels?
Please explain. What are the costs, if
any, of ‘‘noise,’’ ‘‘false positives,’’ or
‘‘false negatives’’ with respect to the
quantitative measurements and
calculations at different levels? Can
these costs be mitigated and, if so, how?
What alternatives, if any, may be more
cost-effective while still being
consistent with the purpose and
language of the statute?
Question 367. We seek comment on
whether the requirement that banking
entities employ a suite of quantitative
measurements may lead to
redundancies and/or inefficiencies in
the application of the measurements for
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
some types of trading units within some
banking entities. Despite the flexibility
of Appendix A via recognition that
quantitative measurements will be
applied with respect to differences
within a banking entity’s structure,
business lines, and trading desks, we
seek comment on whether the
requirement of a mandatory suite of
quantitative measurements may prove
burdensome. For instance, is the
application of certain quantitative
measurements not efficient, appropriate,
or calculable for certain asset classes or
trading units or would the benefits of
applying such quantitative
measurements be negligible in relation
to the costs of applying such
measurements? In addition, would the
overlay divert a banking entity from
allocating resources toward
quantitative—or other—measurements
that might prove more useful and better
tailored to its specific and unique
trading practices?
Question 368. What are the benefits
and costs of the recordkeeping
requirement in proposed Appendix A?
Please explain and quantify, to the
extent possible. To what extent would
the proposed recordkeeping
requirement impose new or additional
costs and benefits beyond the current
recordkeeping obligations of different
types of banking entities (e.g., affiliated
broker-dealers, affiliated investment
advisers, insured depository
institutions, etc.)? What alternatives, if
any, may be more cost-effective while
still being consistent with the purpose
and language of the statute?
Question 369. Please identify any cost
savings that would be achieved through
the use of an enterprise-wide
compliance program. Alternatively,
would you expect certain costs to
increase when using an enterprise-wide
compliance program? Please explain.
Please identify any benefits that might
be amplified or reduced when using an
enterprise-wide compliance program.
Question 370. Are there tools or
elements in the contents of the
compliance program set forth in
§ l.20(b) for which the costs may be
negligible because banking entities use
the same or similar elements for other
purposes (e.g., satisfying other
regulatory requirements, risk
management, etc.) and could utilize
existing infrastructure for purposes of
the proposed rule? For example, could
existing trader mandates or an existing
training program be expanded to meet
the requirements of the proposed rule,
rather than developing an entirely new
infrastructure? Alternatively, would the
proposed rule require redundancies or
duplications within a banking entity’s
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
infrastructure (e.g., the trader mandates
currently used for one purpose do not
conform to the requirements of the
proposed rule, so a banking entity
would have to utilize both in different
circumstances)? Please identify and
explain any such redundancies and how
the rule could be modified to reduce or
eliminate such redundancies, if
possible.
Question 371. How would the
proposed rule affect compliance costs
(e.g., personnel or system changes) or
benefits for each category of banking
entity: Small, medium, and large? Please
discuss any differences between the
costs and benefits of the compliance
program required under § l.20(b) for
smaller banking entities and the
compliance program requirements of
Appendix C for larger banking entities.
Are the differences between these
benefits and costs justified due to the
differences in size and complexity of
smaller and larger banking entities?
Question 372. The definition of
trading unit in proposed Appendix C
covers different levels of a banking
entity and, as a result, requires a tiered
approach to establishing, maintaining,
and enforcing the compliance program
requirements with respect to covered
trading activities. What are the costs and
benefits of applying the compliance
program requirements at several levels
within the banking entity? To what
extent does the ability to incorporate
written policies and procedures of
lower-level units by reference, rather
than establishing separate written
policies and procedures, mitigate the
costs of the proposed requirements? Are
there other ways that the proposed
requirements could be made more costeffective for the different levels within
the banking entity?
Question 373. How will the proposed
definition of ‘‘covered fund’’ affect a
banking entity’s investment advisory
activities, in particular activities and
relationships with investment funds
that would be treated as ‘‘covered
funds’’? Please estimate any resulting
costs or benefits or discuss why such
costs or benefits cannot be estimated.
Question 374. How have banking
entities traditionally organized and
offered covered funds? What are the
benefits and costs associated with the
proposed requirements for relying on
the exception for organizing and
offering covered funds? Please estimate
any resulting costs or benefits or discuss
why such costs or benefits cannot be
estimated.
Question 375. What are the costs and
benefits associated with the way the
proposed rule implements the
‘‘customers of such services’’
PO 00000
Frm 00091
Fmt 4701
Sfmt 4702
68935
requirement in the exception for
organizing and offering covered funds?
What alternative, if any, may be more
cost-effective while still being
consistent with the language and
purpose of the statute?
Question 376. Is it common for a
banking entity to share a name with the
covered funds that it invests in or
sponsors? If yes, what entity in the
banking structure typically shares a
name with such covered funds? What
costs and benefits will result from the
proposed rule’s implementation of the
name sharing requirement in exception
for organizing and offering a covered
fund? What alternatives, if any, may be
more cost-effective while still being
consistent with the purpose of the
statute?
Question 377. Under what
circumstances do directors and
employees of a banking entity invest in
covered funds? What are the benefits
and costs associated with the proposed
provisions regarding director and
employee investments in covered
funds? What alternatives, if any, may be
more cost-effective while still being
consistent with the purpose of the
statute?
Question 378. Do banking entities
currently invest in or sponsor SBICs and
public welfare and qualified
rehabilitation investments? If yes, to
what extent? What are the benefits and
costs associated with the proposed
rule’s implementation of the exception
for investment in SBICs and public
welfare and qualified rehabilitation
investments?
Question 379. Do banking entities
currently invest in or sponsor each of
the vehicles that the proposed rule
permits banking entities to continue to
invest in and sponsor under section
12(d)(1)(J) of the BHC Act? If yes, to
what extent? What are the benefits and
costs associated with the proposed
rule’s implementation of these
exceptions?
Question 380. For banking entities
that are affiliated investment advisers,
are there additional costs or benefits to
complying with section 13 of the BHC
Act and the proposed rule? For
example, do affiliated investment
advisers typically maintain records that
would enable them to demonstrate
compliance with the 3% ownership
limits or restrictions on transactions that
would be subject to sections 23A and
23B of the FR Act?
Question 381. Would complying with
section 13 of the BHC Act and the
proposed rule affect an affiliated
investment adviser’s other business
activities (benefit or burden) that are not
subject to restrictions on proprietary
E:\FR\FM\07NOP2.SGM
07NOP2
68936
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
trading or other covered fund activities?
For example, would advisers incur
additional burdens to distinguish
covered fund activities from noncovered fund activities?
Question 382. For banking entities
that are affiliated investment advisers,
are there particular costs or benefits to
complying with the portions of
Appendix C that are applicable to each
asset management unit of the adviser?
Do these costs and benefits differ
depending on whether the adviser
complies with Appendix C individually
or on an enterprise basis? Does the rule
provide sufficient clarify for how
Appendix C applies to unregistered
affiliates of an affiliated investment
adviser?
Question 383. To the extent
applicable, please address each of the
questions above with respect to
securitization vehicles that would be
included in the proposed definition of
covered fund.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
VII. Administrative Law Matters
A. Paperwork Reduction Act Analysis
Request for Comment on Proposed
Information Collection
In accordance with section 3512 of
the Paperwork Reduction Act of 1995
(44 U.S.C. 3501–3521) (‘‘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 OCC,
FDIC, and Board will obtain OMB
control numbers. The information
collection requirements contained in
this joint notice of proposed
rulemaking, to the extent they apply to
insured financial institutions that are
not under a holding company, have
been submitted by the OCC and FDIC to
OMB for review and approval under
section 3506 of the PRA and section
1320.11 of OMB’s implementing
regulations (5 CFR 1320). The Board
reviewed the proposed rule under the
authority delegated to the Board by
OMB. The Board will submit to OMB
once the final rule is published and the
submission will include burden for
Federal Reserve-supervised institutions,
as well as burden for OCC-, FDIC-,
SEC-, and CFTC-supervised institutions
under a holding company. The OCC and
the FDIC will take burden for banking
entities that are not under a holding
company. The CFTC has stated that it
will be publishing a separate proposed
rulemaking in the near future. The
burden estimates for CFTC-supervised
institutions, published in this proposed
rule, are based on the requirements set
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
forth below and the assumption that the
CFTC’s proposed rulemaking would
contain substantively similar
requirements.
The proposed rule contains
requirements subject to the PRA. The
reporting requirements are found in
sections l.7(a) and l.12(d); the
recordkeeping requirements are found
in sections l.3(b)(2)(iii)(C), l.5(c),
l.7(a), l.11(b), l.13(b)(3), l.20(b),
l.20(c), and l.20(d); and the
disclosure requirement is found in
section l.11(h)(1). The recordkeeping
and disclosure burden for the following
sections is accounted for in the l.20(b)
burden: l.4(a)(2)(i), l.4(b)(2)(i),
l.5(b)(1), l.5(b)(2)(i), l.5(b)(2)(v),
l.13(b)(2)(i), l.13(b)(2)(ii)(A),
l.13(b)(2)(ii)(D), l.15(a)(1), and
l.17(b)(1). These information collection
requirements would implement section
619 of the Dodd-Frank Act, as
mentioned in the Abstract below. The
respondent/recordkeepers 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
[Agency] on request.
Comments are invited on:
(a) Whether the collections of
information are necessary for the proper
performance of the Agencies’ functions,
including whether the information has
practical utility;
(b) The accuracy of the estimates of
the burden of the information
collections, including the validity of the
methodology and assumptions used;
(c) Ways to enhance the quality,
utility, and clarity of the information to
be collected;
(d) Ways to minimize the burden of
the information collections on
respondents, including through the use
of automated collection techniques or
other forms of information technology;
and
(e) Estimates of capital or start up
costs and costs of operation,
maintenance, and purchase of services
to provide information.
All comments will become a matter of
public record. Comments on aspects of
this notice that may affect reporting,
recordkeeping, or disclosure
requirements and burden estimates
should be sent to the addresses listed in
the ADDRESSES section of this
Supplementary Information. A copy of
the comments may also be submitted to
the OMB desk officer for the Agencies:
By mail to U.S. Office of Management
and Budget, 725 17th Street NW.,
#10235, Washington, DC 20503 or by
facsimile to (202) 395–5806, Attention,
PO 00000
Frm 00092
Fmt 4701
Sfmt 4702
Commission and Federal Banking
Agency Desk Officer.
Proposed Information Collection
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 of Response: Annual,
monthly, and on occasion.
Affected Public: Businesses or other
for-profit.
Respondents
Board: State member banks, bank
holding companies, savings and loan
holding companies, mutual holding
companies, foreign banking
organizations, and other holding
companies that control an insured
depository institution. 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.
OCC: National banks, federal savings
associations, and federal savings banks
not under a holding company, and their
respective subsidiaries, and their
affiliates not under a holding company.
The OCC will take the burden with
respect to registered investment advisers
and commodity trading advisers and
commodity pool operators that are
subsidiaries of national banks, federal
savings associations, and federal savings
banks not under a bank holding
company.
FDIC: State nonmember banks not
under a holding company; state savings
associations and state savings banks not
under a holding company; subsidiaries
of state nonmember banks, state savings
associations and state savings banks not
under a holding company; and foreign
banks having an insured branch.
Abstract: Section 619 of the DoddFrank Act added a new section 13 to the
BHC Act (to be codified at 12 U.S.C.
1851) that generally prohibits any
banking entity from engaging in
proprietary trading or from investing in,
sponsoring, or having certain
relationships with a hedge fund or
private equity fund, subject to certain
exemptions. New section 13 of the BHC
Act also provides for nonbank financial
companies supervised by the Board that
engage in such activities or have such
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
investments or relationships to be
subject to additional capital
requirements, quantitative limits, or
other restrictions.
Section l.3(b)(2)(iii)(C) would
require a covered banking entity to
establish a documented liquidity
management plan in order to rely on an
exclusion from the definition of
‘‘trading account’’ for certain positions
taken for the bona fide purpose of
liquidity management.
Section l.5(c) would require that,
with respect to any purchase, sale, or
series of purchases or sales conducted
by a covered banking entity pursuant to
section l.5 for risk-mitigating hedging
purposes that is established at a level of
organization that is different than the
level of organization establishing the
positions, contracts, or other holdings
the risks of which the purchase, sale, or
series of purchases or sales are designed
to reduce, the covered banking entity
document, at the time the purchase,
sale, or series of purchases or sales are
conducted:
(1) The risk-mitigating purpose of the
purchase, sale, or series of purchases or
sales;
(2) The risks of the individual or
aggregated positions, contracts, or other
holdings of a covered banking entity
that the purchase, sale, or series of
purchases or sales are designed to
reduce; and
(3) The level of organization that is
establishing the hedge.
Section l.7(a) would require a
covered banking entity engaged in any
proprietary trading activity pursuant to
sections l.4 through l.6 to comply
with the reporting and recordkeeping
requirements described in Appendix A
if the covered banking entity has,
together with its affiliates and
subsidiaries, trading assets and
liabilities the average gross sum of
which (on a worldwide consolidated
basis) is, as measured as of the last day
of each of the four prior calendar
quarters, equal to or greater than $1
billion, as well as such other reporting
and recordkeeping requirements as a
relevant Agency may impose to evaluate
the covered banking entity’s compliance
with this subpart.
Section l.11(b) would require that,
with respect to any covered fund that is
organized and offered by a covered
banking entity in connection with the
provision of bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services and to persons
that are customers of such services of
the covered banking entity, the covered
banking entity document how the
covered banking entity intends to
provide advisory or similar services to
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
its customers through organizing and
offering such fund.
Section l.11(h)(1) would require
that, with respect to any covered fund
that is organized and offered by a
covered banking entity in connection
with the provision of bona fide trust,
fiduciary, investment advisory, or
commodity trading advisory services
and to persons that are customers of
such services of the covered banking
entity, the covered banking entity
clearly and conspicuously disclose, in
writing, to any prospective and actual
investor in the covered fund (such as
through disclosure in the covered fund’s
offering documents):
(1) That ‘‘any losses in [such covered
fund] will be borne solely by investors
in [the covered fund] and not by [the
covered banking entity and its affiliates
or subsidiaries]; therefore, [the covered
banking entity’s and its affiliates’ or
subsidiaries’] losses in [such covered
fund] will be limited to losses
attributable to the ownership interests
in the covered fund held by the [covered
banking entity and its affiliates or
subsidiaries] in their capacity as
investors in the [covered fund]’’;
(2) That such investor should read the
fund offering documents before
investing in the covered fund;
(3) That the ‘‘ownership interests in
the covered fund are not insured by the
FDIC, and are not deposits, obligations
of, or endorsed or guaranteed in any
way, by any banking entity’’ (unless that
happens to be the case); and
(4) The role of the covered banking
entity and its affiliates, subsidiaries and
employees in sponsoring or providing
any services to the covered fund.
Section l.12(d) would extend the
time to divest an ownership interest in
a covered fund. Upon receipt of an
application from a covered banking
entity, the Board may extend the period
of time to meet the requirements under
paragraphs (a)(2)(i)(A) and (B) of that
section for up to 2 additional years, if
the Board finds that an extension would
be consistent with safety and soundness
and not detrimental to the public
interest. An application for extension
must:
(1) Be submitted to the Board at least
90 days prior to the expiration of the
applicable time period;
(2) Provide the reasons for
application, including information that
addresses the factors in paragraph (e)(2)
of that section; and
(3) Explain the covered 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)(i) of that section.
PO 00000
Frm 00093
Fmt 4701
Sfmt 4702
68937
Section l.13(b)(3) would require that,
with respect to any acquisition or
retention of an ownership interest in a
covered fund by a covered banking
entity pursuant to § l.13(b), the
covered banking entity must document,
at the time the transaction is conducted:
(1) The risk-mitigating purpose of the
acquisition or retention of an ownership
interest in a covered fund;
(2) The risks of the individual or
aggregated obligation or liability of a
covered banking entity that the
acquisition or retention of an ownership
interest in a covered fund is designed to
reduce; and
(3) The level of organization that is
establishing the hedge.
Section l.20(b) would require a
compliance program with respect to
covered fund activities and investments
that shall, at a minimum, include:
(1) Internal written policies and
procedures reasonably designed to
document, describe, and monitor the
covered trading and covered fund
activities and investments of the
covered banking entity to ensure that
such activities and investments are
compliant with section 13 of the BHC
Act and this part;
(2) A system of internal controls
reasonably designed to monitor and
identify potential areas of
noncompliance with section 13 of the
BHC Act and this part in the covered
banking entity’s covered trading and
covered fund activities and investments
and to prevent the occurrence of
activities or investments that are
prohibited by section 13 of the BHC Act
and this part;
(3) A management framework that
clearly delineates responsibility and
accountability for compliance with
section 13 of the BHC Act and this part;
(4) Independent testing for the
effectiveness of the compliance program
conducted by qualified personnel of the
covered banking entity or by a qualified
outside party;
(5) Training for trading personnel and
managers, as well as other appropriate
personnel, to effectively implement and
enforce the compliance program; and
(6) Maintenance of records sufficient
to demonstrate compliance with section
13 of the BHC Act and this part, which
a covered banking entity must promptly
provide to the Agency upon request and
retain for a period of no less than
5 years.
Section l.20(c) would require the
compliance program of a covered
banking entity to also comply with the
requirements and other standards
contained in Appendix C if the covered
banking entity: (i) Engages in
proprietary trading and has, together
E:\FR\FM\07NOP2.SGM
07NOP2
68938
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
with its affiliates and subsidiaries,
trading assets and liabilities the average
gross sum of which (on a worldwide
consolidated basis), as measured as of
the last day of each of the four prior
calendar quarters (A) is equal to or
greater than $1 billion, or (B) equals 10
percent or more of its total assets; or (ii)
invests in, or has relationships with, a
covered fund and (A) the covered
banking entity has, together with its
affiliates and subsidiaries, aggregate
investments in one or more covered
funds, the average value of which is, as
measured as of the last day of each of
the four prior calendar quarters, equal to
or greater than $1 billion, or (B)
sponsors and advises, together with its
affiliates and subsidiaries, one or more
covered funds, the average total assets of
which are, as measured as of the last
day of each of the four prior calendar
quarters, equal to or greater than $1
billion.
Section l.20(d) would require a
covered banking entity that does not
engage in activities or investments
prohibited or restricted in subpart B or
subpart C of the proposed rule, in order
to be deemed to have satisfied the
requirements of § l.20, to ensure that
its existing compliance policies and
procedures include measures that are
designed to prevent the covered banking
entity from becoming engaged in such
activities or making such investments
and which require the covered banking
entity to develop and provide for
establishment of the compliance
program required under § l.20(a) of the
proposed rule prior to engaging in such
activities or making such investments.
Estimated Paperwork Burden
In determining the method for
estimating the paperwork burden the
Agencies made the assumption that
affiliated entities under a holding
company would act in concert with one
another to take advantage of efficiencies
that may exist. The Agencies invite
comment on whether it is reasonable to
assume that affiliated entities would act
jointly to implement a firm-wide
program or whether they would act
independently to implement programs
tailored to each entity. In addition, the
Agencies invite comment as to the
accuracy of our estimates of the burdens
concerning the proposed collections of
information and whether all banking
entities subject to the rule are
appropriately accounted for by the
Agencies.
Estimated Burden Per Response
Section l.3(b)(2)(iii)(C)
recordkeeping—1 hour (Initial setup 3
hours).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
Section l.5(c) recordkeeping—6
hours for entities with $1 billion or
more in trading assets/liabilities, 35
hours for entities with $5 billion or
more in trading assets/liabilities.
Section l.7(a) reporting—2 hours for
entities with $1 billion or more in
trading assets/liabilities, 2 hours for
entities with $5 billion or more in
trading assets/liabilities (Initial setup 6
hours for entities with $1 billion or
more in trading assets/liabilities, 6
hours for entities with $5 billion or
more in trading assets/liabilities).
Section l.7(a) recordkeeping—350
hours for entities with $1 billion or
more in trading assets/liabilities, 440
hours for entities with $5 billion or
more in trading assets/liabilities.
Section l.11(b) recordkeeping—10
hours.
Section l.11(h)(1) disclosure—0.10
hours.
Section l.12(d) reporting—20 hours
(Initial setup 50 hours).
Section l.13(b)(3) recordkeeping—10
hours.
Section l.20(b) recordkeeping—265
hours (Initial setup 795 hours).366
Section l.20(c) recordkeeping—1,200
hours (Initial setup 3,600 hours).
Section l.20(d) recordkeeping—8
hours.
B. Initial Regulatory Flexibility Act
Analysis
The Regulatory Flexibility Act
(‘‘RFA’’), 5 U.S.C. 601 et seq., requires
an agency to consider whether the rules
it proposes will have a significant
economic impact on a substantial
number of small entities.367 If so, the
agency must prepare an initial and final
regulatory flexibility analysis respecting
the significant economic impact.
Pursuant to section 605(b) of the RFA,
the regulatory flexibility analysis
otherwise required under sections 603
and 604 of the RFA is not required if an
agency certifies that the rule will not
have a significant economic impact on
a substantial number of small entities.
The Agencies have considered the
potential impact of the proposed rule on
small entities in accordance with the
RFA. The proposed rule would not
appear to have a significant economic
impact on small entities for several
reasons.
First, while the proposed rule will
affect all banking organizations,
including those that have been defined
to be ‘‘small businesses’’ under the RFA,
only certain limited requirements would
be imposed on entities that engage in
little or no covered trading activities or
covered fund activities and investments.
Significantly, the reporting and
recordkeeping requirements of § l.7
and Appendix A of the proposed rule
apply only to banking entities with
average trading assets and liabilities on
a consolidated, worldwide basis equal
to or greater than $1 billion for the
preceding year. This is a threshold that
a small banking entity typically would
not meet.
Second, the scope and size of the
compliance program requirements set
forth in subpart D and Appendix C of
the proposed rule would vary based on
the size and activities of each covered
banking entity. Only banking entities
with average trading assets and
liabilities on a worldwide consolidated
basis equal to or greater than $1 billion
or 10 percent or more of their total
assets, or that have aggregate
investments in, or sponsor or advise,
covered funds with aggregate total assets
of more than $1 billion must establish,
maintain and enforce a full compliance
program under the proposed rule.
Banking entities that engage in trading
activities or covered fund activities and
investments under these thresholds
must adopt, at a minimum, only the six
core compliance requirements set forth
in § l.20 of the proposed rule. Banking
entities that do not engage in any
covered trading or fund activities,
typical of small banking entities, must
ensure only that their compliance
programs include measures designed to
366 For the Board, the section l.20(b) burden
hours are 266 hours (ongoing) and 796 hours (initial
setup) because the Board is accounting for the 1
hour disclosure burden for certain SEC- and CFTCsupervised entities.
367 A banking organization is generally
considered to be a small banking entity for the
purposes of the RFA if it has assets less than or
equal to $175 million. See also 13 CFR
121.1302(a)(6) (noting factors that the Small
Business Administration considers in determining
whether an entity qualifies as a small business,
including receipts, employees, and other measures
of its domestic and foreign affiliates).
Board
Number of respondents: 10,000.
Total estimated annual burden:
6,283,620 hours (4,541,070 hours for
initial setup and 1,742,550 hours for
ongoing compliance).
FDIC
Number of respondents: 1,139.
Total estimated annual burden:
46,428 hours (29,934 hours for initial
setup and 16,494 hours for ongoing
compliance).
OCC
Number of respondents: 469.
Total estimated annual burden:
253,796 hours (187,643 hours for initial
setup and 66,153 hours for ongoing
compliance).
PO 00000
Frm 00094
Fmt 4701
Sfmt 4702
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
prevent the entities from becoming
engaged in covered activities unless
they first adopt a compliance program.
These compliance requirements would
not appear to have a significant
economic impact on a substantial
number of small entities.
OCC, FDIC, and SEC: For the reasons
stated above, the head of the OCC, FDIC,
and the SEC certifies, for the covered
banking entities subject to each such
Agency’s jurisdiction, that the proposed
rule would not result in a significant
economic impact on a substantial
number of small entities. The OCC,
FDIC, and SEC encourage written
comments regarding this certification,
and request that commenters describe
the nature of any impact on small
entities and provide empirical data to
illustrate and support the extent of the
impact.
Board: For the reasons stated above,
the proposed rules would not appear to
have a significant economic impact on
small entities subject to the Board’s
jurisdiction. The Board welcomes
written comments regarding this initial
regulatory flexibility analysis, and
requests that commenters describe the
nature of any impact on small entities
and provide empirical data to illustrate
and support the extent of the impact. A
final regulatory flexibility analysis will
be conducted after consideration of
comment received during the public
comment period.
C. OCC Unfunded Mandates Reform Act
of 1995 Determination
Section 202 of the Unfunded
Mandates Reform Act of 1995, Public
Law 104–4 (2 U.S.C. 1532) (‘‘Unfunded
Mandates Act’’), requires that an agency
prepare a budgetary impact statement
before promulgating any rule likely to
result in 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, as adjusted by inflation, in any
one year. If a budgetary impact
statement is required, Section 205 of the
Unfunded Mandates Act also requires
an agency to identify and consider a
reasonable number of regulatory
alternatives before promulgating a rule.
The OCC has completed an
assessment whether any mandates
imposed by the proposed rule may
result in expenditures of $100 million or
more annually, as adjusted by inflation,
by state, local, and tribal governments,
or by the private sector as required by
the Unfunded Mandates Act. The OCC
focused its analysis on the impact of the
various compliance, recordkeeping,
reporting, disclosure, and training
requirements in the proposed rule and,
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
as provided for under section 201 of the
Unfunded Mandates Act (2 U.S.C.
1531), excluded the cost of requirements
specifically set forth in the statute.
Overall, the OCC determined that this
proposed rule will not result in
expenditures by state, local, and tribal
governments, or by the private sector, of
$100 million or more in any one year.
Accordingly, this proposal is not subject
to Section 202 of the Unfunded
Mandates Act.
The OCC also will need to prepare an
impact statement for the final rule, for
purposes of the Unfunded Mandates Act
and the Congressional Review Act,
Public Law 104–121 (5 U.S.C. 801–808).
Comments provided on the costs and
benefits of the proposed rule, in
response to the analysis and questions
posed in the Supplemental Information
Part VII.D, will help to inform this
assessment.
D. SEC: Small Business Regulatory
Enforcement Fairness Act
Under the Small Business Regulatory
Enforcement Fairness Act of 1996,368 a
rule is ‘‘major’’ if it has resulted, or is
likely to result, in:
• An annual effect on the U.S.
economy of $100 million or more;
• A major increase in costs or prices
for consumers or individual industries;
or
• Significant adverse effects on
competition, investment, or innovation.
The SEC requests comment on
whether its proposed rule would be a
‘‘major’’ rule for purposes of the Small
Business Regulatory Enforcement
Fairness Act. In addition, the SEC
solicits comment and empirical data on:
• The potential effect on the U.S.
economy on an annual basis;
• Any potential increase in costs or
prices for consumer or individual
industries; and
• Any potential effect on competition,
investment, or innovation.
VIII. SEC: Additional Matters
A. Statutory Authority and ‘‘Covered
Banking Entity’’ Definition
1. Statutory authority
Section l.1 of the proposed rule
implementing section 13 of the BHC Act
cites section 13 of the BHC Act,
pursuant to which the SEC is adopting
the entirety of the proposed rule with
respect to ‘‘covered banking entities,’’ as
that term is defined in the SEC’s
proposed rule.369 Section l.1 also cites
368 Public Law 104–121, Title II, 110 Stat. 857
(1996).
369 The SEC notes that the SEC is only proposing
rules as they would be applicable to the banking
PO 00000
Frm 00095
Fmt 4701
Sfmt 4702
68939
the SEC’s independent authority under
certain sections of the Exchange Act to
adopt §§ l.5(c), l.7(a), l.20, and
Appendices A and C of the proposed
rule.370 Compliance with such
provisions, if adopted, will be subject to
examination and enforcement under the
Exchange Act for certain covered
banking entities.
2. ‘‘Covered Banking Entity’’ Definition
The proprietary trading and covered
fund activity prohibition set forth in
section 13 of the BHC Act, as proposed
to be implemented in § l.3(a) and
§ l.10(a) of the proposed rule, would
apply to any ‘‘covered banking
entity.’’371 The term ‘‘banking entity’’ is
generally defined under section 13 of
the BHC Act to include any insured
depository institution, any company
that controls an insured depository
institution, any company that is treated
as a bank holding company for purposes
of section 8 of the International Banking
Act of 1978, and any affiliates and
subsidiaries of these entities.372 Section
l.2(j) of the proposed rule
implementing section 13 of BHC Act
would define the term ‘‘covered banking
entity.’’ This term is used in each
Agency’s proposed rule to describe the
specific types of banking entities to
which that Agency’s rule would apply.
As discussed in Part I of the
Supplementary Information, the
authority for adopting regulations to
implement section 13 of the BHC Act is
divided between the Agencies in the
manner provided in section 13(b)(2).373
entities for which the SEC has regulatory authority,
as set forth in section 13(b)(2)(B)(IV) of the BHC
Act, e.g., registered broker-dealers. Accordingly, the
SEC proposal should be read in the context of these
regulated entities and comments to the SEC should
focus on these entities. For instance, the SEC is
particularly interested in the impact of the
proposed rules on the activities of such entities.
370 15 U.S.C. 78o(c)(3)(A), 78o–10(f), (j), 78q(a),
78w.
371 Proposed rule § l.3(a) provides ‘‘Except as
otherwise provided in this subpart, a covered
banking entity may not engage in proprietary
trading.’’ Proposed rule § l.10(a) provides ‘‘Except
as otherwise provided in this subpart, a covered
banking entity may not, as principal, directly or
indirectly, acquire or retain any ownership interest
in or sponsor a covered fund.’’
372 See 12 U.S.C. 1851(h)(1); proposed rule
§ l.2(e).
373 See 12 U.S.C. 1851(b)(2). Under section
13(b)(2)(B) of the BHC Act, rules implementing
section 13’s prohibitions and restrictions must be
issued by: (i) The appropriate Federal banking
agencies (i.e., the Board, the OCC, and the FDIC),
jointly, with respect to insured depository
institutions; (ii) the Board, with respect to any
company that controls an insured depository
institution, or that is treated as a bank holding
company for purposes of section 8 of the
International Banking Act, any nonbank financial
company supervised by the Board, and any
subsidiary of any of the foregoing (other than a
E:\FR\FM\07NOP2.SGM
Continued
07NOP2
68940
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Section 13 of the BHC Act generally
prohibits a banking entity from engaging
in proprietary trading or investing in or
sponsoring a hedge fund or private
equity fund, and section
13(b)(2)(B)(i)(IV) of the BHC Act directs
the SEC to issue rules implementing
that section with respect to any entity
for which the SEC is the primary
financial regulatory agency, as that term
is defined in section 2 of the DoddFrank Act.374 The SEC has proposed to
restate that statutory provision in
defining ‘‘covered banking entity’’ for
purposes of the SEC’s proposed rule.375
The SEC recognizes that some entities
that would be included in the SEC’s
proposed definition of ‘‘covered banking
entity’’ generally do not engage in
subsidiary for which an appropriate Federal
banking agency, the SEC, or the CFTC is the
primary financial regulatory agency); (iii) the CFTC
with respect to any entity for which it is the
primary financial regulatory agency, as defined in
section 2 of the Dodd-Frank Act; and (iv) the SEC
with respect to any entity for which it is the
primary financial regulatory agency, as defined in
section 2 of the Dodd-Frank Act. See id.
374 Under section 2(12)(B) of the Dodd-Frank Act,
the term ‘‘primary financial regulatory agency’’
means the SEC with respect to (i) SEC-registered
brokers and dealers, with respect to the activities
of the broker or dealer that require the broker or
dealer to be registered as such under the Exchange
Act; (ii) SEC-registered investment companies, with
respect to the activities of the investment company
that require the investment company to be
registered under the Investment Company Act; (iii)
SEC-registered investment advisers, with respect to
the investment advisory activities of such company
and activities that are incidental to such advisory
activities; (iv) SEC-registered clearing agencies,
with respect to the activities of the clearing agency
that require the agency to be registered under the
Exchange Act; (v) SEC-registered nationally
recognized statistical rating organizations; (vi) SECregistered transfer agents; (vii) national securities
exchanges registered with the SEC; (viii) national
securities associations registered with the SEC; (ix)
SEC-registered securities information processors; (x)
the Municipal Securities Rulemaking Board; (xi) the
Public Company Accounting Oversight Board; (xii)
the Securities Investor Protection Corporation; and
(xiii) SEC-registered security-based swap execution
facilities, security-based swap data repositories,
security-based swap dealers, and major securitybased swap participants, with respect to the
security-based swap activities of the person that
require such person to be registered under the
Exchange Act. See section 2(12)(B) of the DoddFrank Act. The SEC notes that, with respect to SECregistered clearing agencies, to the extent a clearing
agency acquires or takes a position in one or more
covered financial positions in connection with
clearing securities transactions, such positions
would be excluded from the definition of trading
account under the proposal. See proposed rule
§ l.3(b)(2)(iii)(D). As a result of this proposed
exclusion, clearing agencies’ positions taken in
connection with clearing securities transactions
would not involve proprietary trading, as defined
under the proposal, and would not be subject to the
prohibition on proprietary trading in § l.3(a) of the
proposed rule. As discussed further below, the
proposal is designed to reduce any burdens on
covered banking entities that do not engage in
proprietary trading and covered fund activities and
investments.
375 See SEC proposed rule § l.2(j).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
covered trading activities and covered
fund activities and investments. The
SEC notes that, to the extent the covered
banking entity does not engage in
activities and investments covered by
section 13 of the BHC Act and the
proposed rule, the proposal is
reasonably designed to reduce and
alleviate any burdens on such a covered
banking entity, while also preventing
evasion of the proposed rule.
Specifically, a covered banking entity
that does not engage in activities and
investments prohibited or restricted by
section 13 of the BHC Act and the
proposed rule would only be required to
include measures in its existing
compliance policies and procedures that
are reasonably designed to prevent the
covered banking entity from becoming
engaged in such activities and making
such investments under the proposed
rule.376
The SEC requests comment on the
proposed definition of ‘‘covered banking
entity.’’ In particular, the SEC requests
comment on the following questions:
Question SEC–1. Is the SEC’s
proposed definition of the term
‘‘covered banking entity’’ sufficiently
clear? If not, why not? Please suggest an
alternative definition.
Question SEC–2. Is the SEC’s
proposed definition of the term
‘‘covered banking entity’’ appropriate,
or is it over- or under-inclusive? Please
explain.
Question SEC–3. Should any of the
covered banking entities included in the
SEC’s proposed definition of ‘‘covered
banking entity’’ be excluded? If so,
which entities, why, and on what basis?
Should the SEC’s proposed rule provide
specific guidance or exemptions for any
such entities?
Question SEC–4. Would particular
types of entities incur costs or burdens
that are greater than other types of
entities that are included in the SEC’s
proposed definition of ‘‘covered banking
entity’’? If so, should any such
difference be addressed or mitigated?
How?
Question SEC–5. Are all of the
provisions in the proposed rule relevant
to the business conducted by SEC
covered banking entities? If not, which
provisions are not relevant and how
should this be addressed in the rule?
Are there differences between the SEC’s
covered banking entities and other types
of banking entities subject to the rules
of the Federal banking agencies or the
376 See proposed rule § l.20(d). However, to the
extent that the covered banking entity becomes
engaged in such activities or investments, it would
be required to develop a more detailed compliance
program, as set forth in § l.20(b) of the proposed
rule.
PO 00000
Frm 00096
Fmt 4701
Sfmt 4702
CFTC that have not been sufficiently
accounted for in the proposed rule? If
so, what are these differences and how
should the SEC’s rule account for such
differences in a manner that is
consistent with the statutory
requirement that the Agencies’ rules be
consistent and comparable, to the extent
possible?
B. Consideration of the Impact of
Reporting and Recordkeeping and
Compliance Program Proposed Rules on
Competition and on the Promotion of
Efficiency, Competition, and Capital
Formation
Section 3(f) of the Exchange Act
requires the SEC, whenever it engages in
rulemaking and is required to consider
or determine whether an action is
necessary or appropriate in the public
interest, to consider, in addition to the
protection of investors, whether the
action would promote efficiency,
competition, and capital formation.377
In addition, section 23(a)(2) of the
Exchange Act requires the SEC, when
adopting rules under the Exchange Act,
to consider the impact such rules would
have on competition.378 Section 23(a)(2)
of the Exchange Act also prohibits the
SEC from adopting any rule that would
impose a burden on competition not
necessary or appropriate in furtherance
of the purposes of the Exchange Act.
The SEC’s consideration of the factors
specified in Exchange Act sections 3(f)
and 23(a)(2) is limited to those portions
of the proposal that, in addition to being
proposed under section 13 of the BHC
Act, are also being proposed pursuant to
the SEC’s authority under the Exchange
Act with respect to covered banking
entities that are registered brokerdealers and security-based swap dealers.
The remaining portions of the joint
proposed rule are being proposed
exclusively under the authority set forth
in Section 13 of the BHC Act, which
does not require consideration of the
factors specified in Exchange Act
sections 3(f) and 23(a)(2).
As discussed above in Part III.B.5 of
the Supplementary Information,
§ l.7(a) of the proposed rule and
proposed Appendix A require covered
banking entities that meet, together with
their affiliates and subsidiaries, the $1
billion gross trading assets and
liabilities threshold to: (i) Calculate and
report certain quantitative
measurements, and (ii) create and retain
records related to such quantitative
measurements. Further, under § l.7(a)
of the proposed rule and proposed
Appendix A, a larger number of
377 15
378 15
E:\FR\FM\07NOP2.SGM
U.S.C. 78c(f).
U.S.C. 78w(a)(2).
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
quantitative measurements are required
to be calculated and reported by covered
banking entities that, together with their
affiliates and subsidiaries, have over $5
billion gross trading assets and
liabilities. In addition, such
measurements are required to be
calculated and reported for a broader
scope of trading activities if a covered
banking entity meets the $5 billion
threshold.
The reporting and recordkeeping
requirements in § l.7(a) and Appendix
A of the proposed rule are likely to
impose certain costs on covered banking
entities that meet the $1 billion gross
trading assets and liabilities threshold,
including costs associated with
implementing, monitoring, and
attributing financial and personnel
resources for purposes of complying
with the reporting and recordkeeping
requirements. Moreover, such costs will
likely be greater for covered banking
entities that meet the $5 billion
threshold. Incurring these costs may
marginally reduce the ability of covered
banking entities that are registered
broker-dealers and security-based swap
dealers to compete with their nonbanking entity counterparts or with
banking entities that do not meet the $1
billion threshold. Further, as a result of
these costs, the proposal may impose
additional competitive burdens on
registered broker-dealers and securitybased swap dealers that, together with
their affiliates and subsidiaries, meet the
$5 billion threshold, and may affect
their ability to compete with: (i)
Banking entities with $1 to $5 billion
gross trading assets and liabilities; (ii)
banking entities below the $1 billion
threshold; and (iii) non-banking entities.
In addition, registered broker-dealers
and security-based swap dealers that are
covered banking entities meeting the $1
billion threshold may need to redirect
resources from other functions of the
broker-dealer or security-based swap
dealer in order to comply with the
reporting and recordkeeping
requirements. Reallocating available
resources within the registered brokerdealer or security-based swap dealer
may reduce efficiency within the
covered banking entity and may have a
marginal negative impact on the extent
to which the registered broker-dealer or
security-based swap dealer continues to
perform certain functions, which may
include those that serve customers or
provide other market benefits. If this
were to occur, registered broker-dealers
and security-based swap dealers that are
covered banking entities meeting the $5
billion threshold may face greater
efficiency effects because they will
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
likely need to devote more time and
resources to the enhanced reporting and
recordkeeping requirements set forth in
the proposal for such covered banking
entities. The increased cost of doing
business that may result from the
proposed reporting and recordkeeping
requirements could also cause a
registered broker-dealer or securitybased swap dealer that is a covered
banking entity to pass some of the costs
along to customers and clients of their
services, such as market making or
underwriting. On the other hand, the
reporting and recordkeeping
requirements in § l.7(a) and Appendix
A could have positive efficiency effects
because these measures generally may
improve compliance within covered
banking entities and thereby reduce the
potential consequences associated with
noncompliance.
The reporting and recordkeeping
requirements may create an incentive
for covered banking entities that are
registered broker-dealers and securitybased swap dealers to reduce their
average gross sum of trading assets and
liabilities, together with their affiliates
and subsidiaries, below the $5 billion
threshold or $1 billion in order to avoid
the costs of complying with some or all
of the requirements in § l.7(a) of the
proposed rule and Appendix A. To the
extent the proposed rule creates such an
incentive, a covered banking entity that
is a registered broker-dealer or securitybased swap dealer may reduce the
amount of its trading activities to be
below the applicable threshold. If a
registered broker-dealer or securitybased swap dealer that is a covered
banking entity decreased the extent to
which it engaged in trading activities,
the resulting effects could be decreased
competitiveness of the registered brokerdealer or security-based swap dealer in
the broader market and reduced market
efficiency and liquidity. Whether there
will be a competitive impact will
depend on the way in which a
registered broker-dealer or securitybased swap dealer that is a covered
banking entity chooses to reduce its
trading activities. For example, if the
reporting and recordkeeping
requirement lead a covered banking
entity to minimize its trading in a
particular product, this may lead to a
decreased competitiveness in the
trading of that particular product. The
reporting and recordkeeping
requirements, however, could enhance
efficiency by improving covered
banking entities’ compliance and
thereby reduce the potential
consequences associated with
noncompliance.
PO 00000
Frm 00097
Fmt 4701
Sfmt 4702
68941
Further, a majority of the quantitative
measurements in proposed Appendix A
would only be required to be calculated
and reported for trading units engaged
in market making-related activity under
§ l.4(b) of the proposed rule. To the
extent that the costs associated with the
requirements in Appendix A create a
disincentive for covered banking
entities that are registered brokerdealers or security-based swap dealers
to engage in the full range of market
making-related activity that is permitted
under the rule, such covered banking
entities may reduce the size or scope of
their market making activities. If this
were to occur to a significant extent, the
overall reduction in market making
activities would likely have a negative
impact on market efficiency and
liquidity and, as a related matter, capital
formation by causing certain banking
entities to provide fewer market makingrelated services. This potential
reduction in market making on the part
of certain registered broker-dealers or
security-based swap dealers that are
covered banking entities may cause
some demand for market making-related
services to migrate to smaller banking
entities not meeting the $1 billion
threshold and non-banking entities. At
the same time, the quantitative
measurements required under Appendix
A could have positive efficiency effects
by generally improving compliance and
thereby reduce the potential
consequences associated with
noncompliance.
The documentation requirements of
§ l.5(c) of the proposed rule, which
provides that risk-mitigating hedging
transactions must be documented in a
specified manner if the hedging
transaction is established at a level of
organization that is different than the
level of organization establishing or
responsible for the position, contract, or
other holding that is being hedged, may
have a negative impact on efficiency by
reducing the speed with which a
covered banking entity could execute a
hedge at a different level within the
entity. To the extent that the proposed
documentation requirement makes it
more costly or difficult for a covered
banking entity that is a registered
broker-dealer or security-based swap
dealer to establish hedges at a different
level within the entity, this requirement
may result in increased risks or reduced
profitability of the broker-dealer or
security-based swap dealer, which
could negatively affect the
competitiveness of the broker-dealer or
security-based swap dealer. Further,
greater difficulties or increased costs,
such as those related to potential
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68942
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
systems changes and maintenance,
employee resources and time, and
recordkeeping, related to establishing a
hedge at a different level within the
covered banking entity may cause the
registered broker-dealer or securitybased swap dealer to reduce its
underwriting or market making-related
activities under the proposed rule in
order to avoid costs related to hedging
underwriting or market making
positions, which could likewise harm
efficiency and capital formation.
Alternatively, such costs could be
passed through to clients or customers
of the registered broker-dealer or
security-based swap dealer which, in
turn, could harm capital formation.
As discussed above in Part III.D of the
Supplemental Information, § l.20 of
the proposed rule requires all covered
banking entities to develop and provide
for the continued administration of a
program reasonably designed to ensure
and monitor compliance with the
prohibitions and restrictions of section
13 of the BHC Act and the proposed
rule, unless such covered banking entity
does not engage in activities or
investments prohibited or restricted by
subpart B or subpart C of the proposed
rule.379 In addition, covered banking
entities that meet the thresholds in
§ l.20(c) of the proposed rule are
required to satisfy the additional
standards and requirements in proposed
Appendix C with respect to their
compliance program.
The SEC recognizes that the
compliance program requirements in
the proposal are likely to impose certain
costs, including implementation and
ongoing maintenance costs associated
with hiring additional personnel or
other personnel modifications, new or
additional systems (including computer
hardware or software), ongoing system
maintenance, developing exception
reports, surveillance (e.g., reviewing and
monitoring exception reports),
consultation with outside experts (e.g.,
attorneys, accountants), recordkeeping,
independent testing, and training. These
costs may increase competitive burdens
on registered broker-dealers and
security-based swap dealers that are
covered banking entities. For example,
the increased compliance costs related
to implementation and ongoing
maintenance of the six elements of the
compliance program (i.e., written
policies and procedures, internal
controls, a management framework,
independent testing, training, and
recordkeeping), as part of the overall
cost of doing business, may make it
more difficult for covered banking
379 See
proposed rule §§ l.20(a), (d).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
entities that are registered brokerdealers and security-based swap dealers
to compete with non-banking entity
broker-dealers and security-based swap
dealers. Further, there may be
additional competitive burdens for
covered banking entities that are
registered broker-dealers and securitybased swap dealers that, together with
their affiliates and subsidiaries, meet the
thresholds in § l.20(c), which
determines the covered banking entities
that must comply with the minimum
standards in proposed Appendix C, as
there are likely to be increased
compliance costs related to the more
specific requirements for the
compliance program requirements set
forth in Appendix C. Since the
thresholds in § l.20(c) are based on the
size of the registered broker-dealer or
security-based swap dealer, together
with its affiliates and subsidiaries, and
the size of their collective covered
trading activities and covered fund
activities and investments, the demand
for these trading activities may migrate
to smaller banking entities or nonbanking entities.
In addition, the costs associated with
implementation and ongoing
maintenance of the compliance program
requirements in § l.20 of the proposed
rule and Appendix C, where applicable,
could cause the covered banking entity
to redirect resources from other business
activities that are generally beneficial to
market efficiency, such as market
making and other customer-related
services. This potential reallocation of
resources could have a marginal
negative effect on competition,
efficiency, and capital formation. For
example, the independent testing
requirement in the proposal may
necessitate that additional resources be
provided to the internal audit
department of the covered banking
entity that is a registered broker-dealer
or security-based swap dealer, if such
testing is conducted by a qualified
internal tester. Alternatively, if an
outside party is used to conduct the
independent testing, the covered
banking entity would incur costs
associated with paying the qualified
outside party for its services, which
would reduce the resources available for
other activities of the covered banking
entity.
Further, §§ l.4(a), l.4(b), and l.5 of
the proposed rule, which permit
underwriting, market making-related,
and risk-mitigating hedging activities,
require a covered banking entity to
establish the compliance program
required in the proposed rule in order
to rely on the exemptions. To the extent
that the burdens associated with the
PO 00000
Frm 00098
Fmt 4701
Sfmt 4702
compliance program requirements in
the proposed rule create an incentive for
registered broker-dealers and securitybased swap dealers that are covered
banking entities to forgo these permitted
activities, rather than incur the costs
related to establishing and maintaining
a compliance program, there would
likely be a negative impact on
efficiency, competition, and capital
formation as a result of reduced market
making and underwriting services
available to customers and clients of
such services.
The SEC requests comment on the
competitive or anticompetitive effects of
the elements of the proposed rule that
are proposed under Exchange Act
authority with respect to covered
banking entities that are registered
broker-dealers and security-based swap
dealers. The SEC also seeks comment on
the efficiency and capital formation
effects of these components of the
proposal, if adopted. The SEC
encourages commenters to identify,
discuss, analyze, and supply relevant
data, information, or statistics regarding
any such effects.
C. Registered Investment Advisers
As discussed above, under the
proposed rule, a covered banking entity
as defined in § l.2(j) would generally
be subject to the substantive
requirements contained in the SEC’s
rule. These substantive requirements
implement the provisions on
proprietary trading and covered fund
activities under section 13 of the BHC
Act. Thus for example, a covered
banking entity that is a registered dealer
would be required to comply with
subparts A through D of the SEC’s
proposed rule, including Appendices A,
B and C, where applicable. With respect
to covered fund activities, investments
or relationships set forth in subpart C
and § l.20 of subpart D (‘‘covered fund
restrictions’’), however, the SEC’s
proposed rule would require that a
covered banking entity that is a covered
banking entity because it is an
investment adviser for which the SEC is
the primary financial regulatory agency
under section 2(12)(B)(iii) of the DoddFrank Act (a ‘‘registered adviser’’)
comply with the covered fund
restrictions issued by the appropriate
Federal banking agency that regulates
the banking entity specified in
§ l.2(e)(1), (2) and (3) with which the
registered adviser is affiliated.380 Under
380 A registered adviser would, however, be
required to comply with the provisions that
implement the proprietary trading restrictions set
forth in subparts A, B and § l.20 of subpart D of
the proposed rule as promulgated by the SEC,
including Appendix C, where applicable.
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
this approach, a registered adviser
would be required to comply with the
rules and related guidance issued by the
appropriate Federal banking agency.
The SEC would, however, retain
enforcement authority over all activities
of registered advisers (i.e., both
proprietary trading and covered fund
restrictions).
The covered fund restrictions of
section 13 of the BHC Act and the
proposed implementing rules make
reference to or incorporate a number of
banking law and supervision concepts
that traditionally appear in Federal
banking law and are interpreted and
applied by the Federal banking
agencies. For example, as discussed in
greater detail in the Supplementary
Information, the limitations on
ownership interests in a covered fund
set forth in the statute and the proposed
rule generally reference the tier 1 capital
of the affiliated insured depository
institution or the affiliated holding
company. Similarly, capital deductions
under the proposed rule refer to the tier
1 capital of the affiliated insured
depository institution or the affiliated
holding company. In addition, the
covered fund restrictions of the statute
and the proposed rule incorporate by
reference sections 23A and 23B of the
FR Act and are administered by the
Federal banking agencies. These
sections of the FR Act restrict and limit
transactions between certain banking
organizations and their affiliates, some
of which are based on a percentage of
bank capital. Further, other covered
fund restrictions, including for example
exemptions for investments involving
the public welfare and bank-owned life
insurance and the extension of time to
divest of investments after the seeding
period, reference other banking laws or
regulations that are administered by the
Federal banking agencies.
In light of these considerations, the
SEC’s proposed rule would require a
registered adviser to comply with the
covered fund restrictions contained in
subpart C and § .l20 of subpart D of
rules implementing section 13 of the
BHC that are issued by the appropriate
Federal banking agency that regulates
the banking entity with which the
registered adviser is affiliated. Under
the proposed approach, a registered
adviser complying with the SEC’s rule
would do so by complying with the rule
issued by the appropriate Federal
banking agency, including any related
interpretations or guidance regarding
such requirements. Similarly, under the
proposed approach, the foregoing
determinations regarding capital or
other banking law requirements that
may be applicable to a registered adviser
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
would be made by the appropriate
Federal banking agency that regulates
the banking entity with which the
registered adviser is affiliated. This
approach would mitigate the burdens of
complying with the covered fund
restrictions for registered advisers and
would avoid creating incentives for
covered fund activities to be moved
from a registered adviser to a bank.381
The SEC’s proposed rule specifies that
a registered adviser must comply with
the covered fund restrictions contained
in subpart C and § l.20 of subpart D
that are issued by the appropriate
Federal banking agency that regulates
the banking entity with which the
registered adviser is affiliated. Subpart
C, which uses terms defined in subpart
A, specifies the covered fund
restrictions. Subpart D § l.20 requires
the establishment of a compliance
program when engaging in covered fund
activities. A registered adviser
complying with subpart C and § l.20 of
subpart D, as issued by the appropriate
Federal banking agency, would also rely
on interpretative guidance issued by the
appropriate Federal banking agency
with respect to those subparts of the
proposed rule. Because § l.20 of
subpart D relates to both the
prohibitions and restrictions on
proprietary trading activity as well as
the prohibitions and restrictions on
covered fund activities and investments,
a registered adviser would be required
to comply with the relevant covered
fund provisions issued by the
appropriate Federal banking agency. A
registered adviser, however, would be
subject to the provisions set forth in
subpart D of the SEC’s proposed rule,
including § l.20, that relate to covered
trading activities.
Nothing set forth in the discussion
above, or in § l.10(a)(2) of the SEC’s
proposed rule, however, is intended, or
shall be deemed, to limit the SEC’s
authority under any other provision of
law, including pursuant to section 13 of
the BHC Act.
The SEC request comment on its
proposed approach to implementing
section 13 of the BHC Act as it applies
to registered advisers with respect to the
covered fund restrictions. In particular,
the SEC requests comment on the
following:
381 Unless it advises a registered investment
company, a bank (as defined in section 202(a)(2) of
the Advisers Act) that relies on the exclusion from
the definition of investment adviser under section
202(a)(11)(A) of the Advisers Act would not be
required to register under the Advisers Act. If such
a bank provided advisory services, the bank would
not be a ‘‘covered banking entity’’ under the SEC’s
proposed rules because its primary financial
regulatory agency would not be the SEC.
PO 00000
Frm 00099
Fmt 4701
Sfmt 4702
68943
Question SEC–5. Should the SEC
instead require registered advisers to
comply with the covered fund
restrictions proposed by the SEC,
instead of those issued the appropriate
Federal banking agency? If so, could this
create incentives to move the advisory
business between the registered adviser
and its affiliated bank? Are there
benefits to this alternate approach? If so,
please explain.
Question SEC–6. Are there other
alternative approaches to the proposed
rule that would be more effective? If yes,
what alternatives and why?
Question SEC–7. Would registered
advisers affiliated with insured
depository institutions benefit from the
proposed approach? Why or why not?
Question SEC–8. Would a registered
adviser that is affiliated with insured
depository institutions that are
regulated by multiple Federal banking
agencies encounter additional burdens
in implementing the proposed
approach? With respect to these
registered advisers, which Federal
banking agency’s rules should be
applicable to the registered adviser? For
example, should the registered adviser
be subject to the rules applicable to the
registered adviser’s immediate parent
that is an insured depository
institution?
Question SEC–9. Is the proposed
requirement that registered advisers
comply with the covered fund
restrictions in § l.20 issued by the
Federal banking agency that regulates
the banking entity specified in
§ l.2(e)(1), (2) and (3) of the proposed
rule with which the registered adviser is
affiliated sufficiently clear? Are there
particular compliance program
requirements in § l.20 with respect to
the covered fund restrictions that
overlap with the proprietary trading
restrictions, such that it would be
difficult to identify which requirements
are related to the covered fund
restrictions and which requirements are
related to the proprietary trading
restrictions? If so, which requirements
and how should this overlap be
addressed? Should registered advisers
be required to comply with § l.20 of
the SEC’s rule in its entirety? Why or
why not?
Question SEC–10. Will the SEC’s
proposed approach limit the potential
for inconsistent application of the
proposed rules with respect to affiliates
of entities specified in § l.2(e)(1), (2)
and (3)? Why or why not?
Question SEC–11. Will the SEC’s
proposed approach be effective in
avoiding the creation of incentives for
covered fund activities to move from a
E:\FR\FM\07NOP2.SGM
07NOP2
68944
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
registered adviser to a bank? Why or
why not?
Subpart A—Authority and Definitions
§ l.1 Authority, purpose, scope, and
relationship to other authorities. [Reserved]
Text of the Proposed Common Rules
(All Agencies)
The text of the proposed common
rules appears below:
§ l.2
PART [ ]—PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS
Subpart A—Authority and Definitions
Sec.
l.1 Authority, purpose, scope, and
relationship to other authorities.
[Reserved]
l.2 Definitions.
Subpart B—Proprietary Trading
l.3 Prohibition on proprietary trading.
l.4 Permitted underwriting and market
making-related activities.
l.5 Permitted risk-mitigating hedging
activities.
l.6 Other permitted proprietary trading
activities.
l.7 Reporting and recordkeeping
requirements applicable to trading
activities.
l.8 Limitations on permitted proprietary
trading activities.
l.9 [Reserved]
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Subpart C—Covered Fund Activities and
Investments
l.10 Prohibition on acquiring or retaining
an ownership interest in and having
certain relationships with a covered
fund.
l.11 Permitted organizing and offering of a
covered fund.
l.12 Permitted investment in a covered
fund.
l.13 Other permitted covered fund
activities and investments.
l.14 Covered fund activities and
investments determined to be
permissible.
l.15 Internal controls, reporting and
recordkeeping requirements applicable
to covered fund activities and
investments.
l.16 Limitations on relationships with a
covered fund.
l.17 Other limitations on permitted
covered fund activities and investments.
l.18 [Reserved]
l.19 [Reserved]
Subpart D—Compliance Program
Requirement; Violations
l.20 Program for monitoring compliance;
enforcement.
l.21 Termination of activities or
investments; penalties for violations.
Appendix A to Part [ ]—Reporting and
Recordkeeping Requirements for
Covered Trading Activities
Appendix B to Part [ ]—Commentary
Regarding Identification of Permitted
Market Making-Related Activities
Appendix C to Part [ ]—Minimum
Standards for Programmatic Compliance
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
Definitions.
Unless otherwise specified, for
purposes of this part:
(a) Affiliate has the same meaning as
in section 2(k) of the BHC Act (12 U.S.C.
1841(k)).
(b) Applicable accounting standards
means U.S. generally accepted
accounting principles or such other
accounting standards applicable to a
covered banking entity that [Agency]
determines are appropriate, that the
covered banking entity uses in the
ordinary course of its business in
preparing its consolidated financial
statements.
(c) BHC Act means the Bank Holding
Company Act of 1956 (12 U.S.C. 1841 et
seq.).
(d) Bank holding company has the
same meaning as in section 2 of the BHC
Act (12 U.S.C. 1841).
(e) Banking entity means:
(1) Any insured depository
institution;
(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 (12 U.S.C. 3106); and
(4) Any affiliate or subsidiary of any
entity described in paragraphs (e)(1), (2),
or (3) of this section, other than an
affiliate or subsidiary that is:
(i) A covered fund that is organized,
offered and held by a banking entity
pursuant to § l.11 and in accordance
with the provisions of subpart C of this
part, including the provisions governing
relationships between a covered fund
and a banking entity; or
(ii) An entity that is controlled by a
covered fund described in paragraph
(e)(4)(i) of this section.
(f) Board means the Board of
Governors of the Federal Reserve
System.
(g) Buy and purchase each include
any contract to buy, purchase, or
otherwise acquire. For security futures
products, such terms include any
contract, agreement, or transaction for
future delivery. With respect to a
commodity future, such terms include
any contract, agreement, or transaction
for future delivery. With respect to a
derivative, such terms include the
execution, termination (prior to its
scheduled maturity date), assignment,
exchange, or similar transfer or
conveyance of, or extinguishing of rights
or obligations under, a derivative, as the
context may require.
PO 00000
Frm 00100
Fmt 4701
Sfmt 4702
(h) CFTC means the Commodity
Futures Trading Commission.
(i) Commodity Exchange Act means
the Commodity Exchange Act (7 U.S.C.
1 et seq.).
(j) [Reserved]
(k) Depository institution has the same
meaning as in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)).
(l) (i) Derivative means:
(A) Any swap, as that term is defined
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)), or
security-based swap, as that term is
defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)), and
as those terms are further jointly defined
by the CFTC and SEC by joint
regulation, interpretation, guidance, or
other action, in consultation with the
Board pursuant to section 712(d) of the
Dodd-Frank Wall Street Reform and
Consumer Protection Act (15 U.S.C.
8302(d));
(B) Any purchase or sale of a
nonfinancial commodity for deferred
shipment or delivery that is intended to
be physically settled;
(C) Any foreign exchange forward (as
that term is defined in section 1a(24) of
the Commodity Exchange Act (7 U.S.C.
1a(24)) or foreign exchange swap (as
that term is defined in section 1a(25) of
the Commodity Exchange Act (7 U.S.C.
1a(25));
(D) Any agreement, contract, or
transaction in foreign currency
described in section 2(c)(2)(C)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(C)(i));
(E) Any agreement, contract, or
transactions in a commodity other than
foreign currency described in section
2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and
(F) Any transaction authorized under
section 19 of the Commodity Exchange
Act (7 U.S.C. 23(a) or (b));
(ii) A derivative does not include:
(A) Any consumer, commercial, or
other agreement, contract, or transaction
that the CFTC and SEC have further
defined by joint regulation,
interpretation, guidance, or other action
as not within the definition of swap, as
that term is defined in section 1a(47) of
the Commodity Exchange Act (7 U.S.C.
1a(47)), or security-based swap, as that
term is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68));
(B) Any identified banking product, as
defined in section 402(b) of the Legal
Certainty for Bank Products Act of 2000
(7 U.S.C. 27(b)), that is subject to section
403(a) of that Act (7 U.S.C. 27a(a)).
(m) Exchange Act means the
Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
(n) Federal banking agencies means
the Board, the Office of the Comptroller
of the Currency, and the Federal Deposit
Insurance Corporation.
(o) Foreign banking organization has
the same meaning as in § 211.21(o) of
the Board’s Regulation K (12 CFR
211.21(o)).
(p) Insured depository institution has
the same meaning as in section 3(c) of
the Federal Deposit Insurance Act (12
U.S.C. 1813(c)), but does not include
any insured depository institution that
is described in section 2(c)(2)(D) of the
BHC Act (12 U.S.C. 1841(c)(2)(D)).
(q) Loan means any loan, lease,
extension of credit, or secured or
unsecured receivable.
(r) Nonbank financial company
supervised by the Board has the
meaning specified in section 102 of the
Financial Stability Act of 2010 (12
U.S.C. 5311).
(s) Qualifying foreign banking
organization means a foreign banking
organization that qualifies as such under
§ 211.23(a) of the Board’s Regulation K
(12 CFR 211.23(a)).
(t) Resident of the United States
means:
(1) Any natural person resident in the
United States;
(2) Any partnership, corporation or
other business entity organized or
incorporated under the laws of the
United States or any State;
(3) Any estate of which any executor
or administrator is a resident of the
United States;
(4) Any trust of which any trustee,
beneficiary or, if the trust is revocable,
any settlor is a resident of the United
States;
(5) Any agency or branch of a foreign
entity located in the United States;
(6) Any discretionary or nondiscretionary account or similar account
(other than an estate or trust) held by a
dealer or fiduciary for the benefit or
account of a resident of the United
States;
(7) Any discretionary account or
similar account (other than an estate or
trust) held by a dealer or fiduciary
organized or incorporated in the United
States, or (if an individual) a resident of
the United States; or
(8) Any person organized or
incorporated under the laws of any
foreign jurisdiction formed by or for a
resident of the United States principally
for the purpose of engaging in one or
more transactions described in
§ l.6(d)(1) or § l.13(c)(1).
(u) SEC means the Securities and
Exchange Commission.
(v) Sale and sell each include any
contract to sell or otherwise dispose of.
For security futures products, such
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
terms include any contract, agreement,
or transaction for future delivery. With
respect to a commodity future, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a derivative, such terms
include the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(w) Security has the meaning
specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(x) Security future has the meaning
specified in section 3(a)(55) of the
Exchange Act (15 U.S.C. 78c(a)(55)).
(y) Securities Act means the Securities
Act of 1933 (15 U.S.C. 77a et seq.).
(z) Separate account means an
account established and maintained by
an insurance company subject to
regulation by a State insurance regulator
or a foreign insurance regulator under
which income, gains, and losses,
whether or not realized, from assets
allocated to such account, are, in
accordance with the applicable contract,
credited to or charged against such
account without regard to other income,
gains, or losses of the insurance
company.
(aa) State means any State, territory or
possession of the United States, and the
District of Columbia.
(bb) Subsidiary has the same meaning
as in section 2(d) of the BHC Act (12
U.S.C. 1841(d)).
Subpart B—Proprietary Trading
§ l.3
Prohibition on proprietary trading.
(a) Prohibition. Except as otherwise
provided in this subpart, a covered
banking entity may not engage in
proprietary trading.
(b) Definition of ‘‘proprietary trading’’
and related terms. For purposes of this
subpart:
(1) Proprietary trading means
engaging as principal for the trading
account of the covered banking entity in
any purchase or sale of one or more
covered financial positions. Proprietary
trading does not include acting solely as
agent, broker, or custodian for an
unaffiliated third party.
(2) Trading account.
(i) Trading account means any
account that is used by a covered
banking entity to:
(A) Acquire or take one or more
covered financial positions principally
for the purpose of:
(1) Short-term resale;
(2) Benefitting from actual or expected
short-term price movements;
PO 00000
Frm 00101
Fmt 4701
Sfmt 4702
68945
(3) Realizing short-term arbitrage
profits; or
(4) Hedging one or more positions
described in paragraphs (b)(2)(i)(A)(1),
(2), or (3) of this section;
(B) Acquire or take one or more
covered financial positions, other than
positions that are foreign exchange
derivatives, commodity derivatives, or
contracts of sale of a commodity for
future delivery, that are market risk
capital rule covered positions, if the
covered banking entity, or any affiliate
of the covered banking entity that is a
bank holding company, calculates riskbased capital ratios under the market
risk capital rule as defined in paragraph
(c)(8) of this section; or
(C) Acquire or take one or more
covered financial position for any
purpose, if the covered banking entity
is:
(1) A dealer or municipal securities
dealer that is registered with the SEC
under the Exchange Act, to the extent
the position is acquired or taken in
connection with the activities of the
dealer or municipal securities dealer
that require it to be registered under that
Act;
(2) A government securities dealer
that is registered, or that has filed
notice, with an appropriate regulatory
agency (as that term is defined in
section 3(a)(34) of the Exchange Act (15
U.S.C. 78c(a)(34)), to the extent the
position is acquired or taken in
connection with the activities of the
government securities dealer that
require it to be registered, or to file
notice, under that Act;
(3) A swap dealer that is registered
with the CFTC under the Commodity
Exchange Act, to the extent the position
is acquired or taken in connection with
the activities of the swap dealer that
require it to be registered under that
Act;
(4) A security-based swap dealer that
is registered with the SEC under the
Exchange Act, to the extent the position
is acquired or taken in connection with
the activities of the security-based swap
dealer that require it to be registered
under that Act; or
(5) Engaged in the business of a
dealer, swap dealer, or security-based
swap dealer outside of the United States
to the extent the position is acquired or
taken in connection with the activities
of such business.
(ii) Rebuttable presumption for
certain positions. An account shall be
presumed to be a trading account if it is
used to acquire or take a covered
financial position, other than a covered
financial position described in
paragraph (b)(2)(i)(B) or (C) of this
section, that the covered banking entity
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68946
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
holds for a period of sixty days or less,
unless the covered banking entity can
demonstrate, based on all the facts and
circumstances, that the covered
financial position, either individually or
as a category, was not acquired or taken
principally for any of the purposes
described in paragraph (b)(2)(i)(A) of
this section.
(iii) An account shall not be deemed
a trading account for purposes of
paragraph (b)(2)(i) of this section to the
extent that such account is used to
acquire or take a position in one or more
covered financial positions:
(A) That arise under a repurchase or
reverse repurchase agreement pursuant
to which the covered banking entity has
simultaneously agreed, in writing, to
both purchase and sell a stated asset, at
stated prices, and on stated dates or on
demand with the same counterparty;
(B) That arise under a transaction in
which the covered banking entity lends
or borrows a security temporarily to or
from another party pursuant to a written
securities lending agreement under
which the lender retains the economic
interests of an owner of such security,
and has the right to terminate the
transaction and to recall the loaned
security on terms agreed by the parties;
(C) For the bona fide purpose of
liquidity management and in
accordance with a documented liquidity
management plan of the covered
banking entity that:
(1) Specifically contemplates and
authorizes the particular instrument to
be used for liquidity management
purposes, its profile with respect to
market, credit and other risks, and the
liquidity circumstances in which the
particular instrument may or must be
used;
(2) Requires that any transaction
contemplated and authorized by the
plan be principally for the purpose of
managing the liquidity of the covered
banking entity, and not for the purpose
of short-term resale, benefitting from
actual or expected short-term price
movements, realizing short-term
arbitrage profits, or hedging a position
taken for such short-term purposes;
(3) Requires that any position taken
for liquidity management purposes be
highly liquid and limited to financial
instruments the market, credit and other
risks of which the covered banking
entity does not expect to give rise to
appreciable profits or losses as a result
of short-term price movements;
(4) Limits any position taken for
liquidity management purposes,
together with any other positions taken
for such purposes, to an amount that is
consistent with the banking entity’s
near-term funding needs, including
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
deviations from normal operations, as
estimated and documented pursuant to
methods specified in the plan; and
(5) Is consistent with [Agency]’s
supervisory requirements, guidance and
expectations regarding liquidity
management; or
(D) That are acquired or taken by a
covered banking entity that is a
derivatives clearing organization
registered under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1) or a clearing agency registered with
the SEC under section 17A of the
Exchange Act (15 U.S.C. 78q–1) in
connection with clearing derivatives or
securities transactions.
(3) Covered financial position.
(i) Covered financial position means
any position, including any long, short,
synthetic or other position, in:
(A) A security, including an option on
a security;
(B) A derivative, including an option
on a derivative; or
(C) A contract of sale of a commodity
for future delivery, or option on a
contract of sale of a commodity for
future delivery.
(ii) A covered financial position does
not include any position that is:
(A) A loan;
(B) A commodity; or
(C) Foreign exchange or currency.
(c) Definition of other terms related to
proprietary trading. For purposes of this
subpart:
(1) Commodity has the same meaning
as in section 1a(9) of the Commodity
Exchange Act (7 U.S.C. 1a(9)), except
that a commodity does not include any
security;
(2) Contract of sale of a commodity
for future delivery means a contract of
sale (as that term is defined in section
1a(13) of the Commodity Exchange Act
(7 U.S.C. 1a(13)) for future delivery (as
that term is defined in section 1a(27) of
the Commodity Exchange Act (7 U.S.C.
1a(27)).
(3) Exempted security has the same
meaning as in section 3(a)(12)(A) of the
Exchange Act (15 U.S.C. 78c(a)(12)(A)).
(4) Foreign insurance regulator means
the insurance commission, or a similar
official or agency, of one or more
countries other than the United States
that is engaged in the supervision of
insurance companies under foreign
insurance law.
(5) General account means, with
respect to an insurance company, all of
the assets of the insurance company that
are not legally segregated and allocated
to separate accounts under applicable
State or foreign law.
(6) Government securities has the
same meaning as in section 3(a)(42) of
the Exchange Act (15 U.S.C. 78c(a)(42)).
PO 00000
Frm 00102
Fmt 4701
Sfmt 4702
(7) Market risk capital rule covered
position means a covered position as
that term is defined for purposes of:
(i) In the case of a covered banking
entity that is a bank holding company
or insured depository institution, the
market risk capital rule that is
applicable to the covered banking
entity; and
(ii) In the case of a covered banking
entity that is affiliated with a bank
holding company, other than a covered
banking entity to which a market risk
capital rule is applicable, the market
risk capital rule that is applicable to the
affiliated bank holding company.
(8) Market risk capital rule means 12
CFR 3, Appendix B, 12 CFR 208,
Appendix E, 12 CFR 225, Appendix E,
and 12 CFR 325, Appendix C, as
applicable.
(9) Municipal securities has the same
meaning as in section 3(a)(29) of the
Exchange Act (15 U.S.C. 78c(a)(29)).
(10) Security-based swap has the
meaning specified in section 3(a)(68) of
the Exchange Act (15 U.S.C. 78c(a)(68)).
(11) Swap has the meaning specified
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)).
(12) State insurance regulator means
the insurance commission, or a similar
official or agency, of a State that is
engaged in the supervision of insurance
companies under State insurance law.
§ l.4 Permitted underwriting and market
making-related activities.
(a) Underwriting activities.
(1) Permitted underwriting activities.
The prohibition on proprietary trading
contained in § ll.3(a) does not apply
to the purchase or sale of a covered
financial position by a covered banking
entity that is made in connection with
the covered banking entity’s
underwriting activities.
(2) Requirements. For purposes of
paragraph (a)(1) of this section, a
purchase or sale of a covered financial
position shall be deemed to be made in
connection with a covered banking
entity’s underwriting activities only if:
(i) The covered banking entity has
established the internal compliance
program required by subpart D of this
part that is designed to ensure the
covered banking entity’s compliance
with the requirements of paragraph
(a)(2) of this section, including
reasonably designed written policies
and procedures, internal controls, and
independent testing;
(ii) The covered financial position is
a security;
(iii) The purchase or sale is effected
solely in connection with a distribution
of securities for which the covered
banking entity is acting as underwriter;
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
(iv) The covered banking entity is:
(A) With respect to a purchase or sale
effected in connection with a
distribution of one or more covered
financial positions that are securities,
other than exempted securities,
security-based swaps, commercial
paper, bankers’ acceptances, or
commercial bills:
(1) A dealer that is registered with the
SEC under section 15 of the Exchange
Act (15 U.S.C. 78o), or a person that is
exempt from registration or excluded
from regulation as a dealer thereunder;
or
(2) Engaged in the business of a dealer
outside of the United States and subject
to substantive regulation of such
business in the jurisdiction where the
business is located;
(B) With respect to a purchase or sale
effected as part of a distribution of one
or more covered financial positions that
are municipal securities, a municipal
securities dealer that is registered under
section 15B of the Exchange Act (15
U.S.C. 78o–4) or exempt from
registration thereunder; or
(C) With respect to a purchase or sale
effected as part of a distribution of one
or more covered financial positions that
are government securities, a government
securities dealer that is registered, or
that has filed notice, under section 15C
of the Exchange Act (15 U.S.C. 78o–5)
or exempt from registration thereunder;
(v) The underwriting activities of the
covered banking entity with respect to
the covered financial position are
designed not to exceed the reasonably
expected near term demands of clients,
customers, or counterparties;
(vi) The underwriting activities of the
covered banking entity are designed to
generate revenues primarily from fees,
commissions, underwriting spreads or
other income not attributable to:
(A) Appreciation in the value of
covered financial positions related to
such activities; or
(B) The hedging of covered financial
positions related to such activities; and
(vii) The compensation arrangements
of persons performing underwriting
activities are designed not to reward
proprietary risk-taking.
(3) Definition of distribution. For
purposes of paragraph (a) of this section,
a distribution of securities means an
offering of securities, whether or not
subject to registration under the
Securities Act, that is distinguished
from ordinary trading transactions by
the magnitude of the offering and the
presence of special selling efforts and
selling methods.
(4) Definition of underwriter. For
purposes of paragraph (a) of this section,
underwriter means:
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
(i) A person who has agreed with an
issuer of securities or selling security
holder:
(A) To purchase securities for
distribution;
(B) To engage in a distribution of
securities for or on behalf of such issuer
or selling security holder; or
(C) To manage a distribution of
securities for or on behalf of such issuer
or selling security holder; and
(ii) A person who has an agreement
with another person described in
paragraph (a)(4)(i) of this section to
engage in a distribution of such
securities for or on behalf of the issuer
or selling security holder.
(b) Market making-related activities.
(1) Permitted market making-related
activities. The prohibition on
proprietary trading contained in
§ ll.3(a) does not apply to the
purchase or sale of a covered financial
position by a covered banking entity
that is made in connection with the
covered banking entity’s market makingrelated activities.
(2) Requirements. For purposes of
paragraph (b)(1) of this section, a
purchase or sale of a covered financial
position shall be deemed to be made in
connection with a covered banking
entity’s market making-related activities
only if:
(i) The covered banking entity has
established the internal compliance
program required by subpart D that is
designed to ensure the covered banking
entity’s compliance with the
requirements of paragraph (b)(2) of this
section, including reasonably designed
written policies and procedures,
internal controls, and independent
testing;
(ii) The trading desk or other
organizational unit that conducts the
purchase or sale holds itself out as being
willing to buy and sell, including
through entering into long and short
positions in, the covered financial
position for its own account on a regular
or continuous basis;
(iii) The market making-related
activities of the trading desk or other
organizational unit that conducts the
purchase or sale are, with respect to the
covered financial position, designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties;
(iv) The covered banking entity is:
(A) With respect to a purchase or sale
of one or more covered financial
positions that are securities, other than
exempted securities, security-based
swaps, commercial paper, bankers’
acceptances, or commercial bills:
(1) A dealer that is registered with the
SEC under section 15 of the Exchange
PO 00000
Frm 00103
Fmt 4701
Sfmt 4702
68947
Act (15 U.S.C. 78o), or a person that is
exempt from registration or excluded
from regulation as a dealer thereunder;
or
(2) Engaged in the business of a dealer
outside of the United States and subject
to substantive regulation of such
business in the jurisdiction where the
business is located;
(B) With respect to a purchase or sale
of one or more covered financial
positions that are swaps:
(1) A swap dealer that is registered
with the CFTC under the Commodity
Exchange Act (7 U.S.C. 1a) or a person
that is exempt from registration
thereunder; or
(2) Engaged in the business of a swap
dealer outside the United States and
subject to substantive regulation of such
business in the jurisdiction where the
business is located;
(C) With respect to a purchase or sale
of one or more covered financial
positions that are security-based swaps:
(1) A security-based swap dealer that
is registered with the SEC under section
15F of the Exchange Act (15 U.S.C. 78o–
10) or a person that is exempt from
registration thereunder; or
(2) Engaged in the business of a
security-based swap dealer outside of
the United States and subject to
substantive regulation of such business
in the jurisdiction where the business is
located;
(D) With respect to a purchase or sale
of one or more covered financial
positions that are municipal securities,
a municipal securities dealer that is
registered under section 15B of the
Exchange Act (15 U.S.C. 78o–4) or a
person that is exempt from registration
thereunder; or
(E) With respect to a purchase or sale
of one or more covered financial
positions that are government securities,
a government securities dealer that is
registered, or that has filed notice, under
section 15C of the Exchange Act (15
U.S.C. 78o–5) or a person that is exempt
from registration thereunder;
(v) The market making-related
activities of the trading desk or other
organizational unit that conducts the
purchase or sale are designed to
generate revenues primarily from fees,
commissions, bid/ask spreads or other
income not attributable to:
(A) Appreciation in the value of
covered financial positions it holds in
trading accounts; or
(B) The hedging of covered financial
positions it holds in trading accounts;
(vi) The market making-related
activities of the trading desk or other
organizational unit that conducts the
purchase or sale are consistent with the
E:\FR\FM\07NOP2.SGM
07NOP2
68948
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
commentary provided in Appendix B;
and
(vii) The compensation arrangements
of persons performing the market
making-related activities are designed
not to reward proprietary risk-taking.
(3) Market making-related hedging.
For purposes of paragraph (b)(1) of this
section, a purchase or sale of a covered
financial position shall also be deemed
to be made in connection with a covered
banking entity’s market making-related
activities if:
(i) The covered financial position is
purchased or sold to reduce the specific
risks to the covered banking entity in
connection with and related to
individual or aggregated positions,
contracts, or other holdings acquired
pursuant to paragraph (b) of this section;
and
(ii) The purchase or sale meets all of
the requirements described in § l.5(b)
and, if applicable, § l.5(c).
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
§ ll.5 Permitted risk-mitigating hedging
activities.
(a) Permitted risk-mitigating hedging
activities. The prohibition on
proprietary trading contained in
§ ll.3(a) does not apply to the
purchase or sale of a covered financial
position by a covered banking entity
that is made in connection with and
related to individual or aggregated
positions, contracts, or other holdings of
a covered banking entity and is
designed to reduce the specific risks to
the covered banking entity in
connection with and related to such
positions, contracts, or other holdings.
(b) Requirements. For purposes of
paragraph (a) of this section, a purchase
or sale of a covered financial position
shall be deemed to be in connection
with and related to individual or
aggregated positions, contracts, or other
holdings of a covered banking entity
and designed to reduce the specific risks
to the covered banking entity in
connection with and related to such
positions, contracts, or other holdings
only if:
(1) The covered banking entity has
established the internal compliance
program required by subpart D designed
to ensure the covered banking entity’s
compliance with the requirements of
paragraph (b) of this section, including
reasonably designed written policies
and procedures regarding the
instruments, techniques and strategies
that may be used for hedging, internal
controls and monitoring procedures,
and independent testing;
(2) The purchase or sale:
(i) Is made in accordance with the
written policies, procedures and
internal controls established by the
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
covered banking entity pursuant to
subpart D of this part;
(ii) Hedges or otherwise mitigates one
or more specific risks, including market
risk, counterparty or other credit risk,
currency or foreign exchange risk,
interest rate risk, basis risk, or similar
risks, arising in connection with and
related to individual or aggregated
positions, contracts, or other holdings of
a covered banking entity;
(iii) Is reasonably correlated, based
upon the facts and circumstances of the
underlying and hedging positions and
the risks and liquidity of those
positions, to the risk or risks the
purchase or sale is intended to hedge or
otherwise mitigate;
(iv) Does not give rise, at the
inception of the hedge, to significant
exposures that were not already present
in the individual or aggregated
positions, contracts, or other holdings of
a covered banking entity and that are
not hedged contemporaneously;
(v) Is subject to continuing review,
monitoring and management by the
covered banking entity that:
(A) Is consistent with the written
hedging policies and procedures
required under paragraph (b)(1) of this
section; and
(B) Maintains a reasonable level of
correlation, based upon the facts and
circumstances of the underlying and
hedging positions and the risks and
liquidity of those positions, to the risk
or risks the purchase or sale is intended
to hedge or otherwise mitigate; and
(C) Mitigates any significant exposure
arising out of the hedge after inception;
and
(vi) The compensation arrangements
of persons performing the riskmitigating hedging activities are
designed not to reward proprietary risktaking.
(c) Documentation. With respect to
any purchase, sale, or series of
purchases or sales conducted by a
covered banking entity pursuant to this
§ l.5 for risk-mitigating hedging
purposes that is established at a level of
organization that is different than the
level of organization establishing or
responsible for the positions, contracts,
or other holdings the risks of which the
purchase, sale, or series of purchases or
sales are designed to reduce, the
covered banking entity must, at a
minimum, document, at the time the
purchase, sale, or series of purchases or
sales are conducted:
(1) The risk-mitigating purpose of the
purchase, sale, or series of purchases or
sales;
(2) The risks of the individual or
aggregated positions, contracts, or other
holdings of a covered banking entity
PO 00000
Frm 00104
Fmt 4701
Sfmt 4702
that the purchase, sale, or series of
purchases or sales are designed to
reduce; and
(3) The level of organization that is
establishing the hedge.
§ l.6 Other permitted proprietary trading
activities.
(a) Permitted trading in government
obligations.
(1) The prohibition on proprietary
trading contained in § l.3(a) does not
apply to the purchase or sale by a
covered banking entity of a covered
financial position that is:
(i) An obligation of the United States
or any agency thereof;
(ii) An obligation, participation, or
other instrument of or issued by the
Government National Mortgage
Association, the Federal National
Mortgage Association, the Federal Home
Loan Mortgage Corporation, a Federal
Home Loan Bank, the Federal
Agricultural Mortgage Corporation or a
Farm Credit System institution
chartered under and subject to the
provisions of the Farm Credit Act of
1971 (12 U.S.C. 2001 et seq.); or
(iii) An obligation of any State or any
political subdivision thereof.
(2) An obligation or other instrument
described in paragraphs (a)(1)(i), (ii) or
(iii) of this section shall include both
general obligations and limited
obligations, such as revenue bonds.
(b) Permitted trading on behalf of
customers. (1) The prohibition on
proprietary trading contained in
§ l.3(a) does not apply to the purchase
or sale of a covered financial position by
a covered banking entity on behalf of
customers.
(2) For purposes of paragraph (b)(1) of
this section, a purchase or sale of a
covered financial position by a covered
banking entity shall be considered to be
on behalf of customers if:
(i) The purchase or sale:
(A) Is conducted by a covered banking
entity acting as investment adviser,
commodity trading advisor, trustee, or
in a similar fiduciary capacity for a
customer;
(B) Is conducted for the account of the
customer; and
(C) Involves solely covered financial
positions of which the customer, and
not the covered banking entity or any
subsidiary or affiliate of the covered
banking entity, is beneficial owner
(including as a result of having long or
short exposure under the relevant
covered financial position);
(ii) The covered banking entity is
acting as riskless principal in a
transaction in which the covered
banking entity, after receiving an order
to purchase (or sell) a covered financial
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
position from a customer, purchases (or
sells) the covered financial position for
its own account to offset a
contemporaneous sale to (or purchase
from) the customer; or
(iii) The covered banking entity is an
insurance company that purchases or
sells a covered financial position for a
separate account, if:
(A) The insurance company is directly
engaged in the business of insurance
and subject to regulation by a State
insurance regulator or foreign insurance
regulator;
(B) The insurance company purchases
or sells the covered financial position
solely for a separate account established
by the insurance company in
connection with one or more insurance
policies issued by that insurance
company;
(C) All profits and losses arising from
the purchase or sale of a covered
financial position are allocated to the
separate account and inure to the
benefit or detriment of the owners of the
insurance policies supported by the
separate account, and not the insurance
company; and
(D) The purchase or sale is conducted
in compliance with, and subject to, the
insurance company investment and
other laws, regulations, and written
guidance of the State or jurisdiction in
which such insurance company is
domiciled.
(c) Permitted trading by a regulated
insurance company. The prohibition on
proprietary trading contained in
§ l.3(a) does not apply to the purchase
or sale of a covered financial position by
an insurance company or any affiliate of
an insurance company if:
(1) The insurance company is directly
engaged in the business of insurance
and subject to regulation by a State
insurance regulator or foreign insurance
regulator;
(2) The insurance company or its
affiliate purchases or sells the covered
financial position solely for the general
account of the insurance company;
(3) The purchase or sale is conducted
in compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
(4) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (c)(3) of this
section is insufficient to protect the
safety and soundness of the covered
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
banking entity, or of the financial
stability of the United States.
(d) Permitted trading outside of the
United States.
(1) The prohibition on proprietary
trading contained in § l.3(a) does not
apply to the purchase or sale of a
covered financial position by a covered
banking entity if:
(i) The covered banking entity is not
directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of one
or more States;
(ii) The purchase or sale is conducted
pursuant to paragraph (9) or (13) of
section 4(c) of the BHC Act; and
(iii) The purchase or sale occurs
solely outside of the United States.
(2) A purchase or sale shall be
deemed to be conducted pursuant to
paragraph (9) or (13) of section 4(c) of
the BHC Act only if:
(i) With respect to a covered banking
entity that is a foreign banking
organization, the banking entity is a
qualifying foreign banking organization
and is conducting the purchase or sale
in compliance with subpart B of the
Board’s Regulation K (12 CFR 211.20
through 211.30); or
(ii) With respect to a covered banking
entity that is not a foreign banking
organization, the covered banking entity
meets at least two of the following
requirements:
(A) Total assets of the covered
banking entity held outside of the
United States exceed total assets of the
covered banking entity held in the
United States;
(B) Total revenues derived from the
business of the covered banking entity
outside of the United States exceed total
revenues derived from the business of
the covered banking entity in the United
States; or
(C) Total net income derived from the
business of the covered banking entity
outside of the United States exceeds
total net income derived from the
business of the covered banking entity
in the United States.
(3) A purchase or sale shall be
deemed to have occurred solely outside
of the United States only if:
(i) The covered banking entity
conducting the purchase or sale is not
organized under the laws of the United
States or of one or more States;
(ii) No party to the purchase or sale
is a resident of the United States;
(iii) No personnel of the covered
banking entity who is directly involved
in the purchase or sale is physically
located in the United States; and
(iv) The purchase or sale is executed
wholly outside of the United States.
PO 00000
Frm 00105
Fmt 4701
Sfmt 4702
68949
§ l.7 Reporting and recordkeeping
requirements applicable to trading
activities.
A covered banking entity engaged in
any proprietary trading activity
permitted under §§ l.4 through l.6
shall comply with:
(a) The reporting and recordkeeping
requirements described in Appendix A
to this part, if the covered banking
entity has, together with its affiliates
and subsidiaries, trading assets and
liabilities the average gross sum of
which (on a worldwide consolidated
basis) is, as measured as of the last day
of each of the four prior calendar
quarters, equal to or greater than $1
billion;
(b) The recordkeeping requirements
required under § l.20 and appendix C
to this part, as applicable; and
(c) Such other reporting and
recordkeeping requirements as [Agency]
may impose to evaluate the covered
banking entity’s compliance with this
subpart.
§ l.8 Limitations on permitted proprietary
trading activities.
(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ l.4 through l.6 if
the transaction, class of transactions, or
activity would:
(1) Involve or result in a material
conflict of interest between the covered
banking entity and its clients,
customers, or counterparties;
(2) Result, directly or indirectly, in a
material exposure by the covered
banking entity to a high-risk asset or a
high-risk trading strategy; or
(3) Pose a threat to the safety and
soundness of the covered banking entity
or to the financial stability of the United
States.
(b) Definition of material conflict of
interest. For purposes of this section, a
material conflict of interest between a
covered banking entity and its clients,
customers, or counterparties exists if the
covered banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the covered banking entity’s interests
being materially adverse to the interests
of its client, customer, or counterparty
with respect to such transaction, class of
transactions, or activity, unless:
(1) Timely and effective disclosure
and opportunity to negate or
substantially mitigate. Prior to effecting
the specific transaction or class or type
of transactions, or engaging in the
specific activity, for which a conflict of
interest may arise, the covered banking
entity:
(i) Makes clear, timely, and effective
disclosure of the conflict of interest,
E:\FR\FM\07NOP2.SGM
07NOP2
68950
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest; and
(ii) Makes such disclosure explicitly
and effectively, and in a manner that
provides the client, customer, or
counterparty the opportunity to negate,
or substantially mitigate, any materially
adverse effect on the client, customer, or
counterparty created by the conflict of
interest; or
(2) Information barriers. The covered
banking entity has established,
maintained, and enforced information
barriers that are memorialized in written
policies and procedures, such as
physical separation of personnel, or
functions, or limitations on types of
activity, that are reasonably designed,
taking into consideration the nature of
the covered banking entity’s business, to
prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A covered banking entity
may not rely on such information
barriers if, in the case of any specific
transaction, class or type of transactions
or activity, the banking entity knows or
should reasonably know that,
notwithstanding the covered banking
entity’s establishment of information
barriers, the conflict of interest may
involve or result in a materially adverse
effect on a client, customer, or
counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a covered banking entity,
significantly increase the likelihood that
the covered banking entity would incur
a substantial financial loss or would fail.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a covered banking entity,
significantly increase the likelihood that
the covered banking entity would incur
a substantial financial loss or would fail.
§ l.9
[Reserved]
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Subpart C—Covered Funds Activities
and Investments
§ l.10 Prohibition on acquiring or
retaining an ownership interest in and
having certain relationships with a covered
fund.
(a) Prohibition. Except as otherwise
provided in this subpart, a covered
banking entity may not, as principal,
directly or indirectly, acquire or retain
any ownership interest in or sponsor a
covered fund.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
(b) Definitions. For purposes of this
part:
(1) Covered fund means:
(i) An issuer that would be an
investment company, as defined in the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.), but for section
3(c)(1) or 3(c)(7) of that Act (15 U.S.C.
80a–3(c)(1) or (7));
(ii) A commodity pool, as defined in
section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10));
(iii) Any issuer, as defined in section
2(a)(22) of the Investment Company Act
of 1940 (15 U.S.C. 80a–2(a)(22)), that is
organized or offered outside of the
United States that would be a covered
fund as defined in paragraphs (b)(1)(i),
(ii), or (iv) of this section, were it
organized or offered under the laws, or
offered to one or more residents, of the
United States or of one or more States;
and
(iv) Any such similar fund as the
appropriate Federal banking agencies,
the SEC, and the CFTC may determine,
by rule, as provided in section 13(b)(2)
of the BHC Act.
(2) Director has the same meaning as
provided in § 215.2(d)(1) of the Board’s
Regulation O (12 CFR 215.2(d)(1)).
(3) Ownership interest.
(i) Ownership interest means any
equity, partnership, or other similar
interest (including, without limitation, a
share, equity security, warrant, option,
general partnership interest, limited
partnership interest, membership
interest, trust certificate, or other similar
instrument) in a covered fund, whether
voting or nonvoting, or any derivative of
such interest.
(ii) Ownership interest does not
include, with respect to a covered fund:
(A) Carried interest. An interest held
by a covered banking entity (or an
affiliate, subsidiary or employee thereof)
in a covered fund for which the covered
banking entity (or an affiliate, subsidiary
or employee thereof) serves as
investment manager, investment adviser
or commodity trading adviser, so long
as:
(1) The sole purpose and effect of the
interest is to allow the covered banking
entity (or the affiliate, subsidiary or
employee thereof) to share in the profits
of the covered fund as performance
compensation for services provided to
the covered fund by the covered
banking entity (or the affiliate,
subsidiary or employee thereof),
provided that the covered banking
entity (or the affiliate, subsidiary or
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 covered banking
PO 00000
Frm 00106
Fmt 4701
Sfmt 4702
entity (or the affiliate, subsidiary or
employee thereof) promptly after being
earned or, if not so distributed, the
reinvested profit of the covered banking
entity (or the affiliate, subsidiary or
employee thereof) does not share in the
subsequent profits and losses of the
covered fund;
(3) The covered banking entity (or the
affiliate, subsidiary or employee thereof)
does not provide funds to the covered
fund in connection with acquiring or
retaining this interest; and
(4) The interest is not transferable by
the covered banking entity (or the
affiliate, subsidiary or employee thereof)
except to another affiliate or subsidiary
thereof.
(4) Prime brokerage transaction means
one or more products or services
provided by a covered banking entity to
a covered fund, such as custody,
clearance, securities borrowing or
lending services, trade execution, or
financing, data, operational, and
portfolio management support.
(5) Sponsor, with respect to a covered
fund, means:
(i) To serve as a general partner,
managing member, trustee, or
commodity pool operator of a covered
fund;
(ii) In any manner to select or to
control (or to have employees, officers,
or directors, or agents who constitute) a
majority of the directors, trustees, or
management of a covered fund; or
(iii) To share with a covered fund, for
corporate, marketing, promotional, or
other purposes, the same name or a
variation of the same name.
(6) Trustee. (i) For purposes of this
subpart, a trustee does not include a
trustee that does not exercise
investment discretion with respect to a
covered fund, including a directed
trustee, as that term is used in section
403(a)(1) of the Employee’s Retirement
Income Security Act (29 U.S.C.
1103(a)(1)).
(ii) Any covered banking entity that
directs a person identified in paragraph
(b)(6)(i) of this section, or that possesses
authority and discretion to manage and
control the assets of a covered fund for
which such person identified in
paragraph (b)(6)(i) of this section serves
as trustee, shall be considered a trustee
of such covered fund.
§ l.11 Permitted organizing and offering
of a covered fund.
Section l.10(a) does not prohibit a
covered banking entity from, directly or
indirectly, organizing and offering a
covered fund, including serving as a
general partner, managing member,
trustee, or commodity pool operator of
the covered fund and in any manner
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
selecting or controlling (or having
employees, officers, directors, or agents
who constitute) a majority of the
directors, trustees, or management of the
covered fund, including any necessary
expenses for the foregoing, only if:
(a) The covered banking entity
provides bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services;
(b) The covered fund is organized and
offered only in connection with the
provision of bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services and only to
persons that are customers of such
services of the covered banking entity,
pursuant to a credible plan or similar
documentation outlining how the
covered banking entity intends to
provide advisory or similar services to
its customers through organizing and
offering such fund;
(c) The covered banking entity does
not acquire or retain an ownership
interest in the covered fund except as
permitted under this subpart;
(d) The covered banking entity
complies with the restrictions under
§ l.16 of this subpart;
(e) The covered banking entity does
not, directly or indirectly, guarantee,
assume, or otherwise insure the
obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests;
(f) The covered fund, for corporate,
marketing, promotional, or other
purposes:
(1) Does not share the same name or
a variation of the same name with the
covered banking entity (or an affiliate or
subsidiary thereof); and
(2) Does not use the word ‘‘bank’’ in
its name;
(g) No director or employee of the
covered banking entity takes or retains
an ownership interest in the covered
fund, except for any director or
employee of the covered banking entity
who is directly engaged in providing
investment advisory or other services to
the covered fund; and
(h) The covered banking entity:
(1) Clearly and conspicuously
discloses, in writing, to any prospective
and actual investor in the covered fund
(such as through disclosure in the
covered fund’s offering documents):
(i) That ‘‘any losses in [such covered
fund] will be borne solely by investors
in [the covered fund] and not by [the
covered banking entity and its affiliates
or subsidiaries]; therefore, [the covered
banking entity’s and its affiliates’ or
subsidiaries’] losses in [such covered
fund] will be limited to losses
attributable to the ownership interests
in the covered fund held by the [covered
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
banking entity and its affiliates or
subsidiaries] in their capacity as
investors in the [covered fund]’’;
(ii) That such investor should read the
fund offering documents before
investing in the covered fund;
(iii) That the ‘‘ownership interests in
the covered fund are not insured by the
FDIC, and are not deposits, obligations
of, or endorsed or guaranteed in any
way, by any banking entity’’ (unless that
happens to be the case);
(iv) The role of the covered banking
entity and its affiliates, subsidiaries and
employees in sponsoring or providing
any services to the covered fund; and
(2) Complies with any additional
rules of the appropriate Federal banking
agencies, the SEC, or the CFTC, as
provided in section 13(b)(2) of the BHC
Act, designed to ensure that losses in
such covered fund are borne solely by
investors in the covered fund and not by
the covered banking entity and its
affiliates or subsidiaries.
§ l.12
fund.
Permitted investment in a covered
(a) Authority and limitations on
permitted investments in covered funds.
(1) The prohibition contained in
§ l.10(a) does not apply with respect to
a covered banking entity acquiring and
retaining any ownership interest in a
covered fund that the covered banking
entity or an affiliate or subsidiary
thereof organizes and offers, for the
purposes of:
(i) Establishment. Establishing the
covered fund and providing the fund
with sufficient initial equity for
investment to permit the fund to attract
unaffiliated investors as required by
paragraph (a)(2)(i) of this section; or
(ii) De minimis investment. Making
and retaining an investment in the
covered fund that does not exceed 3
percent of the total outstanding
ownership interests in the fund.
(2) Ownership limits.
(i) With respect to an investment in
any covered fund pursuant to paragraph
(a)(1)(i) of this section, the covered
banking entity:
(A) Must actively seek unaffiliated
investors to reduce through redemption,
sale, dilution, or other methods the
aggregate amount of all ownership
interests of the covered banking entity
in any covered fund under § l.12 to the
amount permitted in paragraph
(a)(2)(i)(B) of this section; and
(B) May not exceed 3 percent of the
total amount or value of outstanding
ownership interests of the fund not later
than 1 year after the date of
establishment of the fund (or such
longer period as may be provided by the
PO 00000
Frm 00107
Fmt 4701
Sfmt 4702
68951
Board pursuant to paragraph (e) of this
section); and
(ii) The aggregate value of all
ownership interests of the covered
banking entity in all covered funds
under § l.12 may not exceed 3 percent
of the tier 1 capital of the covered
banking entity, as provided under
paragraph (c) of this section.
(b) Limitations on investments in a
single covered fund. For purposes of
determining whether a covered banking
entity is in compliance with the
limitations and restrictions on permitted
investments in covered funds contained
in paragraph (a) of this section, a
covered banking entity shall calculate
its amount and value of a permitted
investment in a single covered fund as
follows:
(1) Attribution of ownership interests
to a covered banking entity. The amount
and value of a banking entity’s
permitted investment in any single
covered fund shall include:
(i) Controlled investments. Any
ownership interest held under § l.12
by any entity that is controlled, directly
or indirectly, by the covered banking
entity for purposes of this part; and
(ii) Noncontrolled investments. The
pro rata share of any ownership interest
held under § l.12 by any covered fund
that is not controlled by the covered
banking entity but in which the covered
banking entity owns, controls, or holds
with the power to vote more than 5
percent of the voting shares.
(2) Calculation of amount of
ownership interests in a single covered
fund. For purposes of determining
whether an investment in a single
covered fund does not exceed 3 percent
of the total outstanding ownership
interests of the fund under paragraph
(a)(2)(i)(B) of this section:
(i) The aggregate amount of all
ownership interests of the covered
banking entity shall be the greater of
(without regard to committed funds not
yet called for investment):
(A) The value of any investment or
capital contribution made with respect
to all ownership interests held under
§ l.12 by the covered banking entity in
the covered fund, divided by the value
of all investments or capital
contributions, respectively, made by all
persons in that covered fund; or
(B) The total number of ownership
interests held under § l.12 by the
covered banking entity in a covered
fund divided by the total number of
ownership interests held by all persons
in that covered fund.
(ii) Inclusion of certain parallel
investments. To the extent that a
covered banking entity is contractually
obligated to directly invest in, or is
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68952
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
found to be acting in concert through
knowing participation in a joint activity
or parallel action toward a common goal
of investing in, one or more investments
with a covered fund that is organized
and offered by the covered banking
entity, whether or not pursuant to an
express agreement, such investments
shall be included in any calculation
required under paragraph (a)(2) of this
section.
(3) Timing of single covered fund
investment calculation. The aggregate
amount of all ownership interests of a
covered banking entity in a single
covered fund may at no time exceed the
limits in this paragraph after the
conclusion of the period provided in
paragraph (a)(2)(i)(B) of this section.
(4) Methodology and standards for
calculation. For purposes of
determining the amount or value of its
investment in a covered fund under this
paragraph (b), a covered banking entity
must calculate its investment in the
same manner and according to the same
standards utilized by the covered fund
for determining the aggregate value of
the fund’s assets and ownership
interests.
(c) Aggregate permitted investments
in all covered funds. (1) For purposes of
determining the aggregate value of all
permitted investments in all covered
funds by a covered banking entity under
paragraph (a)(2)(ii) of this section, the
aggregate value of all ownership
interests held by that covered banking
entity shall be the sum of the value of
each investment in a covered fund held
under § l.12, as determined in
accordance with applicable accounting
standards.
(2) Calculation of tier 1 capital. For
purposes of determining compliance
with paragraph (a)(2)(ii) of this section:
(i) Entities that are required to hold
and report tier 1 capital. If a covered
banking entity is required to calculate
and report tier 1 capital, the covered
banking entity’s tier 1 capital shall be
equal to the amount of tier 1 capital
calculated by that covered banking
entity as of the last day of the most
recent calendar quarter that has ended,
as reported to its primary financial
regulatory agency, as defined in section
2(12) of the Dodd-Frank Wall Street
Reform and Consumer Protection Act;
and
(ii) If a covered banking entity is not
required to calculate and report tier 1
capital, the covered banking entity’s tier
1 capital shall be determined to be equal
to:
(A) In the case of a covered banking
entity that is controlled, directly or
indirectly, by a depository institution
that calculates and reports tier 1 capital,
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
the amount of tier 1 capital reported by
such controlling depository institution
pursuant to paragraph (c)(2)(i) of this
section;
(B) In the case of a covered banking
entity that is not controlled, directly or
indirectly, by a depository institution
that calculates and reports tier 1 capital:
(1) Bank holding company
subsidiaries. If the covered banking
entity is a subsidiary of a bank holding
company or company that is treated as
a bank holding company, the amount of
tier 1 capital reported by the top-tier
affiliate of such covered banking entity
that calculates and reports tier 1 capital,
pursuant to paragraph (c)(2)(i) of this
section; and
(2) Other holding companies and any
subsidiary or affiliate thereof. If the
covered banking entity is not a
subsidiary of a bank holding company
or a company that is treated as a bank
holding company, the total amount of
shareholders’ equity of the top-tier
affiliate within such organization as of
the last day of the most recent calendar
quarter that has ended, as determined
under applicable accounting standards.
(3) A covered banking entity’s
aggregate permitted investment in all
covered funds shall be calculated as of
the last day of each calendar quarter.
(d) Capital treatment for a permitted
investment in a covered fund. For
purposes of calculating capital pursuant
to the applicable capital rules, a covered
banking entity shall deduct the
aggregate value of all permitted
investments in all covered funds made
or retained by a covered banking entity
pursuant to this section (as determined
under paragraph (c)(1) of this section)
from the banking entity’s tier 1 capital
(as determined under paragraph (c)(2) of
this section).
(e) Extension of time to divest an
ownership interest. (1) Upon application
by a covered banking entity, the Board
may extend the period of time to meet
the requirements under paragraphs
(a)(2)(i)(A) and (B) of this section for up
to 2 additional years, if the Board finds
that an extension would be consistent
with safety and soundness and not
detrimental to the public interest. An
application for extension must:
(i) Be submitted to the Board at least
90 days prior to the expiration of the
applicable time period;
(ii) Provide the reasons for
application, including information that
addresses the factors in paragraph (e)(2)
of this section; and
(iii) Explain the covered banking
entity’s plan for reducing the permitted
investment in a covered fund through
redemption, sale, dilution or other
PO 00000
Frm 00108
Fmt 4701
Sfmt 4702
methods as required in paragraph
(a)(2)(i) of this section.
(2) Factors governing Board
determinations. In reviewing any
application under paragraph (e)(1) of
this section, the Board may consider all
the facts and circumstances related to
the permitted investment in a covered
fund, including:
(i) Whether the investment would:
(A) Involve or result in material
conflicts of interest between the covered
banking entity and its clients, customers
or counterparties;
(B) Result, directly or indirectly, in a
material exposure by the covered
banking entity to high-risk assets or
high-risk trading strategies;
(C) Pose a threat to the safety and
soundness of the covered banking
entity; or
(D) Pose a threat to the financial
stability of the United States;
(ii) Market conditions;
(iii) The contractual terms governing
the covered banking entity’s interest in
the covered fund;
(iv) The date on which the covered
fund is expected to have attracted
sufficient investments from investors
unaffiliated with the covered banking
entity to enable the covered banking
entity to comply with the limitations in
paragraph (a)(2)(i) of this section;
(v) 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 covered banking entity and
the financial stability of the United
States;
(vi) The cost to the covered banking
entity of divesting or disposing of the
investment within the applicable
period;
(vii) Whether the divestiture or
conformance of the investment would
involve or result in a material conflict
of interest between the covered banking
entity and unaffiliated clients,
customers or counterparties to which it
owes a duty;
(viii) The covered 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; and
(ix) Any other factor that the Board
believes appropriate.
(3) Consultation. In the case of a
covered 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
approval of an application by the
covered banking entity for an extension
under paragraph (e)(1) of this section.
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
(4) Authority to impose restrictions on
activities or investment during any
extension period. (i) 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 covered 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 (12 U.S.C.
1851) and this part.
(ii) Consultation. In the case of a
covered 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
imposing conditions on the approval of
a request by the covered banking entity
for an extension under paragraph (e)(1)
of this section.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
§ l.13 Other permitted covered fund
activities and investments.
(a) Permitted investments in SBICs
and related investments. The
prohibition contained in § l.10(a) does
not apply with respect to acquiring or
retaining an ownership interest in, or
acting as sponsor to, a covered fund by
a covered banking entity or an affiliate
or subsidiary thereof:
(1) In one or more small business
investment companies, as defined in
section 102 of the Small Business
Investment Act of 1958 (15 U.S.C. 662);
(2) That is designed primarily to
promote the public welfare, of the type
permitted under paragraph (11) of
section 5136 of the Revised Statutes of
the United States (12 U.S.C. 24),
including the welfare of low- and
moderate-income communities or
families (such as providing housing,
services, or jobs); or
(3) That is a qualified rehabilitation
expenditure with respect to a qualified
rehabilitation 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.
(b) Permitted risk-mitigating hedging
activities.
(1) The prohibition contained in
§ l.10(a) does not apply with respect to
an ownership interest in a covered fund
by a covered banking entity, provided
that the acquisition or retention of the
ownership interest is:
(i) Made in connection with and
related to individual or aggregated
obligations or liabilities of the covered
banking entity that are:
(A) Taken by the covered banking
entity when acting as intermediary on
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
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, or
(B) Directly connected to a
compensation arrangement with an
employee that directly provides
investment advisory or other services to
the covered fund; and
(ii) Designed to reduce the specific
risks to the covered banking entity in
connection with and related to such
obligations or liabilities.
(2) Requirements. For purposes of
paragraph (b)(1) of this section,
acquiring or retaining an ownership
interest in a covered fund by a covered
banking entity shall be a permissible
risk-mitigating hedging activity under
this section only if:
(i) The covered banking entity has
established the internal compliance
program required by subpart D designed
to ensure the covered banking entity’s
compliance with the requirements of
this paragraph (b)(2) of this section
including reasonably designed written
policies and procedures regarding the
instruments, techniques and strategies
that may be used for hedging, internal
controls and monitoring procedures,
and independent testing;
(ii) The acquisition or retention of an
ownership interest in a covered fund:
(A) Is made in accordance with the
written policies, procedures and
internal controls established by the
covered banking entity pursuant to
subpart D;
(B) Hedges or otherwise mitigates an
exposure to a covered fund through an
offsetting exposure to the same covered
fund and in the same amount of
ownership interest in that covered fund
that:
(1) Arises out of a transaction
conducted solely to accommodate a
specific customer request with respect
to, or
(2) Is directly connected to its
compensation arrangement with an
employee that directly provides
investment advisory or other services to,
that covered fund;
(C) Does not give rise, at the inception
of the hedge, to significant exposures
that were not already present in
individual or aggregated positions,
contracts, or other holdings of a covered
banking entity and that are not hedged
contemporaneously; and
(D) Is subject to continuing review,
monitoring and management by the
covered banking entity that:
(1) Is consistent with its written
hedging policies and procedures;
(2) Maintains a substantially similar
offsetting exposure to the same amount
and type of ownership interest, based
PO 00000
Frm 00109
Fmt 4701
Sfmt 4702
68953
upon the facts and circumstances of the
underlying and hedging positions and
the risks and liquidity of those
positions, to the risk or risks the
purchase or sale is intended to hedge or
otherwise mitigate; and
(3) Mitigates any significant exposure
arising out of the hedge after inception;
and
(iii) The compensation arrangements
of persons performing the riskmitigating hedging activities are
designed not to reward proprietary risktaking.
(3) Documentation. With respect to
any acquisition or retention of an
ownership interest in a covered fund by
a covered banking entity pursuant to
this paragraph (b), the covered banking
entity must document, at the time the
transaction is conducted:
(i) The risk-mitigating purpose of the
acquisition or retention of an ownership
interest in a covered fund;
(ii) The risks of the individual or
aggregated obligation or liability of a
covered banking entity that the
acquisition or retention of an ownership
interest in a covered fund is designed to
reduce; and
(iii) The level of organization that is
establishing the hedge.
(c) Certain permitted covered fund
activities and investments outside of the
United States.
(1) The prohibition contained in
§ l.10(a) does not apply to the
acquisition or retention of any
ownership interest in, or the
sponsorship of, a covered fund by a
covered banking entity if:
(i) The covered banking entity is not
directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of one
or more States;
(ii) The activity is conducted pursuant
to paragraph (9) or (13) of section 4(c)
of the BHC Act;
(iii) No ownership interest in such
covered fund is offered for sale or sold
to a resident of the United States; and
(iv) The activity occurs solely outside
of the United States.
(2) An activity shall be considered to
be conducted pursuant to paragraph (9)
or (13) of section 4(c) of the BHC Act
only if:
(i) With respect to a covered banking
entity that is a foreign banking
organization, the covered banking entity
is a qualifying foreign banking
organization and is conducting the
activity in compliance with subpart B of
the Board’s Regulation K (12 CFR 211.20
et seq.); or
(ii) With respect to a covered banking
entity that is not a foreign banking
organization, the covered banking entity
E:\FR\FM\07NOP2.SGM
07NOP2
68954
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
meets at least two of the following
requirements:
(A) Total assets of the covered
banking entity held outside of the
United States exceed total assets of the
covered banking entity held in the
United States;
(B) Total revenues derived from the
business of the covered banking entity
outside of the United States exceed total
revenues derived from the business of
the covered banking entity in the United
States; or
(C) Total net income derived from the
business of the covered banking entity
outside of the United States exceeds
total net income derived from the
business of the covered banking entity
in the United States.
(3) An activity shall be considered to
have occurred solely outside of the
United States only if:
(i) The covered banking entity
engaging in the activity is not organized
under the laws of the United States or
of one or more States;
(ii) No subsidiary, affiliate, or
employee of the covered banking entity
that is involved in the offer or sale of an
ownership interest in the covered fund
is incorporated or physically located in
the United States or in one or more
States; and
(iii) No ownership interest in such
covered fund is offered for sale or sold
to a resident of the United States.
(d) Loan securitizations. The
prohibition contained in § l.10(a) does
not apply with respect to the acquisition
or retention by a covered banking entity
of any ownership interest in, or acting
as sponsor to, a covered fund that is an
issuer of asset-backed securities, the
assets or holdings of which are solely
comprised of:
(1) Loans;
(2) Contractual rights or assets
directly arising from those loans
supporting the asset-backed securities;
and
(3) Interest rate or foreign exchange
derivatives that:
(i) Materially relate to the terms of
such loans or contractual rights or
assets; and
(ii) Are used for hedging purposes
with respect to the securitization
structure.
§ l.14 Covered fund activities determined
to be permissible.
(a) The prohibition contained in
§ l.10(a) does not apply to the
acquisition or retention by a covered
banking entity of any ownership interest
in or acting as sponsor to:
(1) Bank owned life insurance. A
separate account which is used solely
for the purpose of allowing a covered
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
banking entity to purchase an insurance
policy for which the covered banking
entity is the beneficiary, provided that
the covered banking entity that
purchases the insurance policy:
(i) Does not control the investment
decisions regarding the underlying
assets or holdings of the separate
account; and
(ii) Holds its ownership interest in the
separate account in compliance with
applicable supervisory guidance
regarding bank owned life insurance.
(2) Certain other covered funds. Any
of the following entities that would
otherwise qualify as a covered fund:
(i) A joint venture between the
covered banking entity or one of its
affiliates and any other person, provided
that the joint venture:
(A) Is an operating company; and
(B) Does not engage in any activity or
make any investment that is prohibited
under this part;
(ii) An acquisition vehicle, provided
that the sole purpose and effect of such
entity is to effectuate a transaction
involving the acquisition or merger of
one entity with or into the covered
banking entity or one of its affiliates;
(iii) An issuer of an asset-backed
security, but only with respect to that
amount or value of economic interest in
a portion of the credit risk for an assetbacked security that is retained by a
covered banking entity that is a
‘‘securitizer’’ or ‘‘originator’’ in
compliance with the minimum
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11) and
any implementing regulations issued
thereunder;
(iv) A wholly-owned subsidiary of the
covered banking entity that is:
(A) Engaged principally in performing
bona fide liquidity management
activities described in § l.3(b)(2)(iii)(C);
and
(B) Carried on the balance sheet of the
covered banking entity; and
(v) A covered fund that is an issuer of
asset-backed securities described in
§ l.13(d), the assets or holdings of
which are solely comprised of:
(A) Loans;
(B) Contractual rights or assets
directly arising from those loans
supporting the asset-backed securities;
and
(C) Interest rate or foreign exchange
derivatives that:
(1) Materially relate to the terms of
such loans or contractual rights or
assets, and
(2) Are used for hedging purposes
with respect to the securitization
structure.
(b) The prohibition contained in
§ l.10(a) does not apply to the
PO 00000
Frm 00110
Fmt 4701
Sfmt 4702
acquisition or retention by a covered
banking entity of any ownership interest
in, or acting as sponsor to, a covered
fund, but only if such ownership
interest is acquired or retained by a
covered banking entity (or an affiliate or
subsidiary thereof):
(1) In the ordinary course of collecting
a debt previously contracted in good
faith, if the covered banking entity
divests the ownership interest within
applicable time periods provided for by
[Agency]; or
(2) Pursuant to and in compliance
with the conformance or extended
transition period authorities provided
for in subpart E of the Board’s rules
implementing section 13 of the BHC Act
(12 CFR 248.30 through 248.35).
§ l.15 Internal controls, reporting and
recordkeeping requirements applicable to
covered fund activities and investments.
A covered banking entity engaged in
any covered fund activity or making or
holding any investment permitted under
this subpart shall comply with:
(a) The internal controls, reporting,
and recordkeeping requirements
required under § l.20 and appendix C
to this part, as applicable; and
(b) Such other reporting and
recordkeeping requirements as [Agency]
may deem necessary to appropriately
evaluate the covered banking entity’s
compliance with this subpart.
§ l.16 Limitations on relationships with a
covered fund.
(a) Relationships with a covered fund.
(1) Except as provided for in
paragraph (a)(2) of this section, no
covered banking entity that serves,
directly or indirectly, as the investment
manager, investment adviser,
commodity trading advisor, or sponsor
to a covered fund, or that organizes and
offers a covered fund pursuant to
§ l.11, and no affiliate of such entity,
may enter into a transaction with the
covered fund, or with any other covered
fund that is controlled by such covered
fund, that would be a covered
transaction as defined in section 23A of
the Federal Reserve Act (12 U.S.C.
371c), as if such covered banking entity
and the affiliate thereof were a member
bank and the covered fund were an
affiliate thereof.
(2) Notwithstanding paragraph (a)(1)
of this section, a covered banking entity
may:
(i) Acquire and retain any ownership
interest in a covered fund in accordance
with the requirements of this subpart;
and
(ii) Enter into any prime brokerage
transaction with any covered fund in
which a covered fund managed,
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
sponsored, or advised by such covered
banking entity (or an affiliate or
subsidiary thereof) has taken an
ownership interest, if:
(A) The covered banking entity is in
compliance with each of the limitations
set forth in § l.11 with respect to a
covered fund organized and offered by
such covered banking entity (or an
affiliate or subsidiary thereof);
(B) The chief executive officer (or
equivalent officer) of the top-tier
affiliate of the covered banking entity
certifies in writing annually (with a
duty to update the certification if the
information in the certification
materially changes) that the covered
banking entity does not, directly or
indirectly, guarantee, assume, or
otherwise insure the obligations or
performance of the covered fund or of
any covered fund in which such
covered fund invests; and
(C) The Board has not determined that
such transaction is inconsistent with the
safe and sound operation and condition
of the covered banking entity.
(b) Restrictions on transactions with
covered funds. A covered banking entity
that serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, or that
organizes and offers a covered fund
pursuant to § l.11, shall be subject to
section 23B of the Federal Reserve Act
(12 U.S.C. 371c–1), as if such covered
banking entity were a member bank and
such covered fund were an affiliate
thereof.
(c) Restrictions on prime brokerage
transactions. A prime brokerage
transaction permitted under paragraph
(a)(2)(ii) of this section shall be subject
to section 23B of the Federal Reserve
Act (12 U.S.C. 371c–1) as if the
counterparty were an affiliate of the
covered banking entity.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
§ l.17 Other limitations on permitted
covered fund activities.
(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ l.11 through
l.14 and § l.16 if the transaction, class
of transactions, or activity would:
(1) Involve or result in a material
conflict of interest between the covered
banking entity and its clients,
customers, or counterparties;
(2) Result, directly or indirectly, in a
material exposure by the covered
banking entity to a high-risk asset or a
high-risk trading strategy; or
(3) Pose a threat to the safety and
soundness of the covered banking entity
or the financial stability of the United
States.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
(b) Definition of material conflict of
interest. For purposes of this section, a
material conflict of interest between a
covered banking entity and its clients,
customers, or counterparties exists if the
covered banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the covered banking entity’s interests
being materially adverse to the interests
of its client, customer, or counterparty
with respect to such transaction, class of
transactions, or activity, unless:
(1) Timely and effective disclosure
and opportunity to negate or
substantially mitigate. Prior to effecting
the specific transaction or class or type
of transactions, or engaging in the
specific activity, for which a conflict of
interest may arise, the covered banking
entity:
(i) Makes clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest; and
(ii) Makes such disclosure explicitly
and effectively, and in a manner that
provides the client, customer, or
counterparty the opportunity to negate,
or substantially mitigate, any materially
adverse effect on the client, customer, or
counterparty created by the conflict of
interest; or
(2) Information barriers. The covered
banking entity has established,
maintained, and enforced information
barriers that are memorialized in written
policies and procedures, such as
physical separation of personnel, or
functions, or limitations on types of
activity, that are reasonably designed,
taking into consideration the nature of
the covered banking entity’s business, to
prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A covered banking entity
may not rely on such information
barriers if, in the case of any specific
transaction, class or type of transactions
or activity, the banking entity knows or
should reasonably know that,
notwithstanding the covered banking
entity’s establishment of information
barriers, the conflict of interest may
involve or result in a materially adverse
effect on a client, customer, or
counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a covered banking entity,
significantly increase the likelihood that
PO 00000
Frm 00111
Fmt 4701
Sfmt 4702
68955
the covered banking entity would incur
a substantial financial loss or would fail.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a covered banking entity,
significantly increase the likelihood that
the covered banking entity would incur
a substantial financial loss or would fail.
§ l.18
[Reserved]
§ l.19
[Reserved]
Subpart D—Compliance Program
Requirement; Violations
§ l.20 Program for monitoring
compliance; enforcement.
(a) Program requirement. Except as
provided in paragraph (d) of this
section, each covered banking entity
shall develop and provide for the
continued administration of a 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,
and such program shall be appropriate
for the size, scope and complexity of
activities and business structure of the
covered banking entity.
(b) Contents of compliance program.
The compliance program required by
paragraph (a) of this section, at a
minimum, shall include:
(1) Internal written policies and
procedures reasonably designed to
document, describe, and monitor
trading activities subject to subpart B of
this part and activities and investments
with respect to a covered fund subject
to subpart C of this part (including those
permitted under §§ l.4 through l.6 or
§§ l.11 through l.16) to ensure that
such activities and investments comply
with section 13 of the BHC Act and this
part;
(2) A system of internal controls
reasonably designed to monitor and
identify potential areas of
noncompliance with section 13 of the
BHC Act and this part in the covered
banking entity’s trading activities
subject to subpart B of this part and
activities and investments with respect
to a covered fund subject to subpart C
of this part (including those permitted
under §§ l.4 through l.6 or §§ l.11
through l.16) and to prevent the
occurrence of activities or investments
that are prohibited by section 13 of the
BHC Act and this part;
(3) A management framework that
clearly delineates responsibility and
accountability for compliance with
section 13 of the BHC Act and this part;
(4) Independent testing for the
effectiveness of the compliance program
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68956
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
conducted by qualified personnel of the
covered banking entity or by a qualified
outside party;
(5) Training for trading personnel and
managers, as well as other appropriate
personnel, to effectively implement and
enforce the compliance program; and
(6) Making and keeping records
sufficient to demonstrate compliance
with section 13 of the BHC Act and this
part, which a covered banking entity
must promptly provide to [Agency]
upon request and retain for a period of
no less than 5 years.
(c) Additional standards. (1) In the
case of any covered banking entity
described in paragraph (c)(2) of this
section, the compliance program
required by paragraph (a) of this section
shall also satisfy the requirements and
other standards contained in Appendix
C to this part.
(2) A covered banking entity is subject
to paragraph (c)(1) of this section if:
(i) The covered banking entity engages
in proprietary trading and has, together
with its affiliates and subsidiaries,
trading assets and liabilities the average
gross sum of which (on a worldwide
consolidated basis), as measured as of
the last day of each of the four prior
calendar quarters:
(A) Is equal to or greater than $1
billion; or
(B) Equals 10 percent or more of its
total assets;
(ii) The covered banking entity invests
in, or has relationships with, a covered
fund and:
(A) The covered banking entity has,
together with its affiliates and
subsidiaries, aggregate investments in
one or more covered funds, the average
value of which is, as measured as of the
last day of each of the four prior
calendar quarters, equal to or greater
than $1 billion; or
(B) Sponsors or advises, together with
its affiliates and subsidiaries, one or
more covered funds, the average total
assets of which are, as measured as of
the last day of each of the four prior
calendar quarters, equal to or greater
than $1 billion; or
(iii) [The Agency] deems it
appropriate.
(d) No program required for certain
banking entities. To the extent that a
covered banking entity does not engage
in activities or investments prohibited
or restricted by subpart B or subpart C
of this part, a covered banking entity
will have satisfied the requirements of
this section if its existing compliance
policies and procedures include
measures that are designed to prevent
the covered banking entity from
becoming engaged in such activities or
making such investments and which
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
require the covered banking entity to
develop and provide for the compliance
program required under paragraph (a) of
this section prior to engaging in such
activities or making such investments.
§ l.21 Termination of activities or
investments; penalties for violations.
(a) Any covered banking entity that
engages in an activity or makes an
investment in violation of section 13 of
the BHC Act or this part or in a manner
that functions as an evasion of the
requirements of section 13 of the BHC
Act or this part, including through an
abuse of any activity or investment
permitted under subparts B or C, or
otherwise violates the restrictions and
requirements of section 13 of the BHC
Act or this part, shall terminate the
activity and, as relevant, dispose of the
investment.
(b) After due notice and an
opportunity for hearing, if [Agency]
finds reasonable cause to believe any
covered banking entity has engaged in
an activity or made an investment
described in paragraph (a), the [Agency]
may, by order, direct the banking entity
to restrict, limit, or terminate the
activity and, as relevant, dispose of the
investment.
(c) [Reserved]
Appendix A to Part [ ]—Reporting and
Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
This appendix sets forth reporting and
recordkeeping requirements that certain
covered banking entities must satisfy in
connection with the restrictions on
proprietary trading set forth in subpart B of
this part (‘‘proprietary trading restrictions’’).
Pursuant to § l.7, this appendix generally
applies to a covered banking entity that has,
together with its affiliates and subsidiaries,
trading assets and liabilities the average gross
sum of which (on a worldwide consolidated
basis) is, as measured as of the last day of
each of the four prior calendar quarters, equal
to or greater than $1 billion. These entities
are required to furnish periodic reports to
[Agency] regarding a variety of quantitative
measurements of their covered trading
activities, which vary depending on the
scope and size of covered trading activities,
and create and maintain records
documenting the preparation and content of
these reports. The requirements of this
appendix should be incorporated into the
covered banking entity’s internal compliance
program under § l.20 and appendix C to this
part.
The purpose of this appendix is to assist
covered banking entities and [Agency] in:
(i) Better understanding and evaluating the
scope, type, and profile of the covered
banking entity’s trading activities;
(ii) Monitoring the covered banking entity’s
trading activities;
(iii) Identifying trading activities that
warrant further review or examination by the
PO 00000
Frm 00112
Fmt 4701
Sfmt 4702
covered banking entity to verify compliance
with the proprietary trading restrictions;
(iv) Evaluating whether the trading
activities of trading units engaged in market
making-related activities subject to § l.4(b)
are consistent with the requirements
governing permitted market making-related
activities;
(v) Evaluating whether the covered trading
activities of trading units that are engaged in
permitted trading activity subject to §§ l.4,
l.5, or l.6(a) (i.e., underwriting and market
making-related related activity, riskmitigating hedging, or trading in certain
government obligations) are consistent with
the requirement that such activity not result,
directly or indirectly, in a material exposure
to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular
trading activities of the covered banking
entity, and the individual trading units of the
banking entity, to help establish the
appropriate frequency and scope of
examination by [Agency] of such activities;
and
(vii) Assessing and addressing the risks
associated with the covered banking entity’s
covered trading activities.
The quantitative measurements that must
be furnished pursuant to this appendix are
not intended to serve as a dispositive tool for
the identification of permissible or
impermissible activities.
In addition to the quantitative
measurements required in this appendix, a
covered banking entity may need to develop
and implement other quantitative
measurements in order to effectively monitor
its covered trading activities for compliance
with section 13 of the BHC Act and this part
and to have an effective compliance program,
as required by § l.20 and appendix C to this
part. The effectiveness of particular
quantitative measurements may differ based
on the profile of the banking entity’s
businesses in general and, more specifically,
of the particular trading unit, including types
of instruments traded, trading activities and
strategies, and history and experience (e.g.,
whether the trading desk is an established,
successful market maker or a new entrant to
a competitive market). In all cases, covered
banking entities must ensure that they have
robust measures in place to identify and
monitor the risks taken in their trading
activities, to ensure that the activities are
within risk tolerances established by the
covered banking entity, and to monitor and
examine for compliance with the proprietary
trading restrictions in this part.
On an ongoing basis, covered banking
entities should carefully monitor, review,
and evaluate all furnished quantitative
measurements, as well as any others that they
choose to utilize in order to maintain
compliance with section 13 of the BHC Act
and this part. All measurement results that
indicate a heightened risk of impermissible
proprietary trading, including with respect to
otherwise-permitted activities under §§ l.4
through l.6 that result in a material
exposure to high-risk assets or high-risk
trading strategies, should be escalated within
the banking entity for review, further
analysis, explanation to [Agency], and
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
remediation, where appropriate. Many of the
quantitative measurements discussed in this
appendix will also be helpful to covered
banking entities in identifying and managing
the risks related to their covered trading
activities.
II. Definitions
The terms used in this appendix have the
same meanings as set forth in §§ l.2 and
l.3. In addition, for purposes of this
appendix, the following definitions apply:
Covered trading activity means proprietary
trading, as defined in paragraph (b)(1) of
§ l.3.
Trading unit means each of the following
units of organization of a covered banking
entity:
(i) Each discrete unit that is engaged in the
coordinated implementation of a revenuegeneration strategy and that participates in
the execution of any covered trading
activity; 1
(ii) Each organizational unit that is used to
structure and control the aggregate risktaking activities and employees of one or
more trading units described in paragraph
(i); 2
(iii) All trading operations, collectively;
and
(iv) Any other unit of organization
specified by [Agency] with respect to a
particular banking entity.
Calculation period means the period of
time for which a particular quantitative
measurement must be calculated.
III. Reporting and Recordkeeping of
Quantitative Measurements
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
A. Scope of Required Reporting
General scope. The quantitative
measurements that must be furnished by a
covered banking entity depend on the
aggregate size of the covered banking entity’s
trading activities and the activities in which
its trading units engage, as follows:
(i) With respect to any covered banking
entity that is engaged in any covered trading
activity, and has trading assets and liabilities
the average gross sum of which (on a
worldwide consolidated basis) is, as
measured as of the last day of each of the four
prior calendar quarters, equal to or greater
than $5 billion:
(a) Each trading unit of the covered
banking entity that is engaged in market
making-related activities subject to § l.4(b)
must furnish the following quantitative
measurements, calculated in accordance with
this appendix:
• Value-at-Risk and Stress VaR;
• VaR Exceedance;
• Risk Factor Sensitivities;
1 [The Agency] expects that this will generally be
the smallest unit of organization used by the
covered banking entity to structure and control its
risk-taking activities and employees, and will
include each unit generally understood to be a
single ‘‘trading desk.’’
2 [The Agency] expects that this will generally
include management or reporting divisions, groups,
sub-groups, or other intermediate units of
organization used by the covered banking entity to
manage one or more discrete trading units (e.g.,
‘‘North American Credit Trading,’’ ‘‘Global Credit
Trading,’’ etc.).
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
• Risk and Position Limits;
• Comprehensive Profit and Loss;
• Portfolio Profit and Loss;
• Fee Income and Expense;
• Spread Profit and Loss;
• Comprehensive Profit and Loss
Attribution;
• Pay-to-Receive Spread Ratio;
• Unprofitable Trading Days Based on
Comprehensive Profit and Loss and
Unprofitable Trading Days Based on Portfolio
Profit and Loss;
• Skewness of Portfolio Profit and Loss
and Kurtosis of Portfolio Profit and Loss;
• Volatility of Comprehensive Profit and
Loss and Volatility of Portfolio Profit and
Loss;
• Comprehensive Profit and Loss to
Volatility Ratio and Portfolio Profit and Loss
to Volatility Ratio;
• Inventory Risk Turnover;
• Inventory Aging; and
• Customer-facing Trade Ratio; and
(b) Each trading unit of the covered
banking entity that is engaged in permitted
trading activity subject to §§ l.4(a), l.5, or
l.6(a) must furnish the following
quantitative measurements, calculated in
accordance with this appendix:
• Value-at-Risk and Stress VaR;
• Risk Factor Sensitivities;
• Risk and Position Limits;
• Comprehensive Profit and Loss; and
• Comprehensive Profit and Loss
Attribution; and
(ii) With respect to any covered banking
entity that is engaged in any covered trading
activity, and has trading assets and liabilities
the average gross sum of which (on a
worldwide consolidated basis) is, as
measured as of the last day of each of the four
prior calendar quarters, equal to or greater
than $1 billion and less than $5 billion, each
trading unit of the covered banking entity
that is engaged in market making-related
activities under § l.4(b) must furnish the
following quantitative measurement,
calculated in accordance with this appendix:
• Comprehensive Profit and Loss;
• Portfolio Profit and Loss;
• Fee Income and Expense;
• Spread Profit and Loss;
• Value-at-Risk;
• Comprehensive Profit and Loss
Attribution;
• Volatility of Comprehensive Profit and
Loss and Volatility of Portfolio Profit and
Loss; and
• Comprehensive Profit and Loss to
Volatility Ratio and Portfolio Profit and Loss
to Volatility Ratio.
B. Frequency of Required Calculation and
Reporting
A covered banking entity must calculate
any applicable quantitative measurement for
each trading day. A covered banking entity
must report each applicable quantitative
measurement to [Agency] on a monthly basis,
or on any other reporting schedule requested
by [Agency]. All quantitative measurements
for any calendar month must be reported to
[Agency] no later than 30 days after the end
PO 00000
Frm 00113
Fmt 4701
Sfmt 4702
68957
of that calendar month or on any other time
basis requested by [Agency].3
C. Recordkeeping
A covered banking entity must, for any
quantitative measurement furnished to
[Agency] pursuant to this appendix and
§ l.7, create and maintain records
documenting the preparation and content of
these reports, as well as such information as
is necessary to permit [Agency] to verify the
accuracy of such reports, for a period of 5
years.
IV. Quantitative Measurements
A. Risk-Management Measurements
1. Value-at-Risk and Stress Value-at-Risk
Description: For purposes of this appendix,
Value-at-Risk (‘‘VaR’’) is the commonly used
percentile measurement of the risk of future
financial loss in the value of a given portfolio
over a specified period of time, based on
current market conditions. For purposes of
this appendix, Stress Value-at-Risk (‘‘Stress
VaR’’) is the percentile measurement of the
risk of future financial loss in the value of a
given portfolio over a specified period of
time, based on market conditions during a
period of significant financial stress.
General Calculation Guidance: Banking
entities should compute and report VaR and
Stress VaR by employing generally accepted
standards and methods of calculation. VaR
should reflect a loss in a trading unit that is
expected to be exceeded less than one
percent of the time over a one-day period.
For those banking entities that are subject to
regulatory capital requirements imposed by a
Federal banking agency, VaR and Stress VaR
should be computed and reported in a
manner that is consistent with such
regulatory capital requirements. In cases
where a trading unit does not have a
standalone VaR or Stress VaR calculation but
is part of a larger portfolio for which a VaR
or Stress VaR calculation is performed, a VaR
or Stress VaR calculation that includes only
the trading unit’s holdings should be
performed consistent with the VaR or Stress
VaR model and methodology used by the
larger portfolio.
Calculation Period: One trading day.
2. VaR Exceedance
Description: For purposes of this appendix,
VaR Exceedance is the difference between
VaR and Portfolio Profit and Loss, exclusive
of Spread Profit and Loss, for a trading unit
for any given calculation period.
Calculation Period: One trading day.
3. Risk Factor Sensitivities
Description: For purposes of this appendix,
Risk Factor Sensitivities are changes in a
trading unit’s Portfolio Profit and Loss,
exclusive of Spread Profit and Loss, that are
expected to occur in the event of a change
in a trading unit’s ‘‘risk factors’’ (i.e., one or
more underlying market variables that are
3 For example, under section IV.B.1 of this
appendix, a banking entity is required to report to
[Agency] the Comprehensive Profit and Loss
quantitative measurement, as calculated for all
trading days in June of any year, no later than July
30 of that year.
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68958
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
significant sources of the trading unit’s
profitability and risk).
General Calculation Guidance: A covered
banking entity should report the Risk Factor
Sensitivities that are monitored and managed
as part of the trading unit’s overall risk
management policy. The underlying data and
methods used to compute a trading unit’s
Risk Factor Sensitivities should depend on
the specific function of the trading unit and
the internal risk management models
employed. The number and type of Risk
Factor Sensitivities that are monitored and
managed by a trading unit, and furnished to
[Agency], should depend on the explicit risks
assumed by the trading unit. In general,
however, reported Risk Factor Sensitivities
should be sufficient to account for a
preponderance of the price variation in the
trading unit’s holdings.
Trading units should take into account any
relevant factors in calculating Risk Factor
Sensitivities, including, for example, the
following with respect to particular asset
classes:
• Commodity derivative positions:
sensitivities with respect to the related
commodity type (e.g., precious metals, oil
and petroleum or agricultural products), the
maturity of the positions, volatility and/or
correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), and the maturity profile of
the positions;
• Credit positions: sensitivities with
respect to credit spread factors that are
sufficiently granular to account for specific
credit sectors and market segments, the
maturity profile of the positions, and
sensitivities to interest rates at all relevant
maturities;
• Credit-related derivative positions: credit
positions sensitivities and volatility and/or
correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), and the maturity profile of
the positions;
• Equity positions: sensitivity to equity
prices and sensitivities that differentiate
between important equity market sectors and
segments, such as a small capitalization
equities and international equities;
• Equity derivative positions: equity
position sensitivities and volatility and/or
correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), and the maturity profile of
the positions;
• Foreign exchange derivative positions:
sensitivities with respect to major currency
pairs and maturities, sensitivity to interest
rates at relevant maturities, and volatility
and/or correlation sensitivities (expressed in
a manner that demonstrates any significant
non-linearities), as well as the maturity
profile of the positions; and
• Interest rate positions, including interest
rate derivative positions: sensitivities with
respect to major interest rate categories and
maturities and volatility and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
as well as the maturity profile of the
positions.
The methods used by a covered banking
entity to calculate sensitivities to a common
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
factor shared by multiple trading units, such
as an equity price factor, should be applied
consistently across its trading units so that
the sensitivities can be compared from one
trading unit to another.
Calculation Period: One trading day.
4. Risk and Position Limits
Description: For purposes of this appendix,
Risk and Position Limits are the constraints
that define the amount of risk that a trading
unit is permitted to take at a point in time,
as defined by the covered banking entity for
a specific trading unit.
General Calculation Guidance: Risk and
Position Limits should be reported in the
format used by the covered banking entity for
the purposes of risk management of each
trading unit. Risk and Position Limits are
often expressed in terms of risk measures,
such as VaR and Risk Factor Sensitivities, but
may also be expressed in terms of other
observable criteria, such as net open
positions. When criteria other than VaR or
Risk Factor Sensitivities are used to define
the Risk and Position Limits, both the value
of the Risk and Position Limits and the value
of the variables used to assess whether these
limits have been reached should be reported.
Calculation Period: One trading day.
B. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss
Description: For purposes of this appendix,
Comprehensive Profit and Loss is the net
profit or loss of a trading unit’s material
sources of trading revenue, including, for
example, dividend and interest income and
expense, over a specific period of time. A
trading unit’s Comprehensive Profit and Loss
for any given calculation period should
generally equal the sum of the trading unit’s
(i) Portfolio Profit and Loss and (ii) Fee
Income.
General Calculation Guidance:
Comprehensive Profit and Loss generally
should be computed using data on the value
of a trading unit’s underlying holdings, the
prices at which those holdings were bought
and sold, and the value of any fees,
commissions, sales credits, spreads,
dividends, interest income and expense, or
other sources of income from trading
activities, whether realized or unrealized.
Comprehensive Profit and Loss should not
include: (i) compensation costs or other costs
required to operate the unit, such as
information technology costs; or (ii) charges
and adjustments made for internal reporting
and management purposes, such as
accounting reserves.
Calculation Period: One trading day.
2. Portfolio Profit and Loss
Description: For purposes of this appendix,
Portfolio Profit and Loss is a trading unit’s
net profit or loss on its underlying holdings
over a specific period of time, whether
realized or unrealized. Portfolio Profit and
Loss should generally include any increase or
decrease in the market value of a trading
unit’s holdings, including, for example, any
dividend, interest income, or expense of a
trading unit’s holdings. Portfolio Profit and
Loss should not include direct fees,
commissions, sales credits, or other sources
of trading revenue that are not directly
PO 00000
Frm 00114
Fmt 4701
Sfmt 4702
related to the market value of the trading
unit’s holdings.
General Calculation Guidance: In general,
Portfolio Profit and Loss should be computed
using data on a trading unit’s underlying
holdings and the prices at which those
holdings are marked for valuation purposes.
Portfolio Profit and Loss should not include:
compensation costs or other costs required to
operate the trading unit, such as information
technology costs; or charges and adjustments
made for internal reporting and management
purposes, such as accounting reserves.
Calculation Period: One trading day.
3. Fee Income and Expense
Description: For purposes of this appendix,
Fee Income and Expense generally includes
direct fees, commissions and other distinct
income for services provided by or to a
trading unit over a specific period of time.
General Calculation Guidance: Fee Income
and Expense should be computed using data
on direct fees that are earned by the trading
unit for services it provides to clients,
customers, or counterparties, such as fees
earned for structured transactions or sales
commissions and credits earned for fulfilling
a customer request, whether realized or
unrealized, and similar fees paid by the
trading unit to other service providers.
Calculation Period: One trading day.
4. Spread Profit and Loss
Description: For purposes of this appendix,
Spread Profit and Loss is the portion of
Portfolio Profit and Loss that generally
includes revenue generated by a trading unit
from charging higher prices to buyers than
the trading unit pays to sellers of comparable
instruments over the same period of time
(i.e., charging a ‘‘spread,’’ such as the bid-ask
spread).
General Calculation Guidance: Spread
Profit and Loss generally should be
computed using data on the prices at which
comparable instruments are either bought or
sold by the trading unit, as well as the
turnover of these instruments. Spread Profit
and Loss should be measured with respect to
both the purchase and the sale of any
position, and should include both (i) the
spreads that are earned by the trading unit to
execute transactions (expressed as positive
amounts), and (ii) the spreads that are paid
by the trading unit to initiate transactions
(expressed as negative amounts). Spread
Profit and Loss should be computed by
calculating the difference between the bid
price or the ask price (whichever is paid or
received) and the mid-market price. The midmarket price is the average of bid and ask.
For some asset classes in which a trading
unit is engaged in market making-related
activities, bid-ask or similar spreads are
widely disseminated, constantly updated,
and readily available, or otherwise
reasonably ascertainable. For purposes of
calculating the Spread Profit and Loss
attributable to a transaction in such asset
classes, the trading unit should utilize the
prevailing bid-ask or similar spread on the
relevant position at the time the purchase or
sale is completed.
For other asset classes in which a trading
unit is engaged in market making-related
activities, bid-ask or similar spreads may not
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
be widely disseminated on a consistent basis
or otherwise reasonably ascertainable. A
covered banking entity must identify any
trading unit engaged in market makingrelated activities in an asset class for which
the covered banking entity believes bid-ask
or similar spreads are not widely
disseminated on a consistent basis or are not
otherwise reasonably ascertainable and must
be able to demonstrate that bid-ask or similar
spreads for the asset class are not reasonably
ascertainable. In such cases, the trading unit
should calculate the Spread Profit and Loss
for the relevant purchase or sale of a position
in a particular asset class by using whichever
of the following three alternatives the
banking entity believes more accurately
reflects prevailing bid-ask or similar spreads
for transactions in that asset class:
(i) End of Day Spread Proxy: A proxy based
on the bid-ask or similar spread that is used
to estimate, or is otherwise implied by, the
market price at which the trading entity
marks (or in the case of a sale, would have
marked) the position for accounting purposes
at the close of business on the day it executes
the purchase or sale (‘‘End of Day Spread
Proxy’’);
(ii) Historical Data Spread Proxy: A proxy
based on historical bid-ask or similar spread
data in similar market conditions (‘‘Historical
Data Spread Proxy’’); or
(iii) Any other proxy that the banking
entity can demonstrate accurately reflects
prevailing bid-ask or similar spreads for
transactions in the specific asset class.
A covered banking entity selecting any of
these alternatives should be able to
demonstrate that the alternative it has chosen
most accurately reflects prevailing bid-ask or
similar spreads for the relevant asset class. If
a covered banking entity chooses to calculate
Spread Profit and Loss for a particular
trading unit using the End of Day Spread
Proxy, then the banking entity should
separately identify the portion of Spread
Profit and Loss that is attributable to
positions acquired and disposed of on the
same trading day. If a banking entity chooses
to calculate Spread Profit and Loss for a
particular trading unit using the Historical
Data Spread Proxy, the covered banking
entity should be able to demonstrate that the
Historical Data Proxy is appropriate and
continually monitor market conditions and
adjust, as necessary, the Historical Data
Proxy to reflect any changes.
Calculation Period: One trading day.
5. Comprehensive Profit and Loss Attribution
Description: For purposes of this appendix,
Comprehensive Profit and Loss Attribution is
an attribution analysis that divides the
trading unit’s Comprehensive Profit and Loss
into the separate sources of risk and revenue
that have caused any observed variation in
Comprehensive Profit and Loss. This
attribution analysis should attribute
Comprehensive Profit and Loss to specific
market and risk factors that can be accurately
and consistently measured over time. Any
component of Comprehensive Profit and Loss
that cannot be specifically identified in the
attribution analysis should be identified as
an unexplained portion of the
Comprehensive Profit and Loss.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
General Calculation Guidance: The
specific market and risk factors used by a
trading unit in the attribution analysis should
be tailored to the trading activities
undertaken by the unit. These factors should
be measured consistently over time to
facilitate historical comparisons. The
attribution analysis should also identify any
significant factors that have a consistent and
regular influence on Comprehensive Profit
and Loss, such as Risk Factor Sensitivities
that have a significant influence on portfolio
income, customer spreads, bid-ask spreads,
or commissions that are earned. Factors that
influence Comprehensive Profit and Loss
across different trading units should be
measured and included in the attribution
analysis in a comparable fashion.
Calculation Period: One trading day.
C. Revenue-Relative-to-Risk Measurements
1. Volatility of Comprehensive Profit and
Loss and Volatility of Portfolio Profit and
Loss
Description: For purposes of this appendix,
Volatility of Comprehensive Profit and Loss
generally is the standard deviation of the
trading unit’s Comprehensive Profit and Loss
estimated over a given calculation period.
For purposes of this appendix, Volatility of
Portfolio Profit and Loss generally is the
standard deviation of the trading unit’s
Portfolio Profit and Loss, exclusive of Spread
Profit and Loss, estimated over a given
calculation period.
Calculation Period: 30 days, 60 days, and
90 days.
2. Comprehensive Profit and Loss to
Volatility Ratio and Portfolio Profit and Loss
to Volatility Ratio
Description: For purposes of this appendix,
Comprehensive Profit and Loss to Volatility
Ratio is a ratio of Comprehensive Profit and
Loss to the Volatility of Comprehensive Profit
and Loss for a trading unit over a given
calculation period. For purposes of this
appendix, Portfolio Profit and Loss to
Volatility Ratio is a ratio of Portfolio Profit
and Loss, exclusive of Spread Profit and
Loss, to the Volatility of Portfolio Profit and
Loss, exclusive of Spread Profit and Loss, for
a trading unit over a given calculation period.
Calculation Period: 30 days, 60 days, and
90 days.
3. Unprofitable Trading Days Based on
Comprehensive Profit and Loss and
Unprofitable Trading Days Based on Portfolio
Profit and Loss
Description: For purposes of this appendix,
Unprofitable Trading Days Based on
Comprehensive Profit and Loss is the number
or proportion of trading days on which a
trading unit’s Comprehensive Profit and Loss
is less than zero over a given calculation
period. For purposes of this appendix,
Unprofitable Trading Days Based on Portfolio
Profit and Loss, exclusive of Spread Profit
and Loss, is the number or proportion of
trading days on which a trading unit’s
Portfolio Profit and Loss, exclusive of Spread
Profit and Loss, is less than zero over a given
calculation period.
Calculation Period: 30 days, 90 days, and
360 days.
PO 00000
Frm 00115
Fmt 4701
Sfmt 4702
68959
4. Skewness of Portfolio Profit and Loss and
Kurtosis of Portfolio Profit and Loss
Description: Skewness of Portfolio Profit
and Loss and Kurtosis of Portfolio Profit and
Loss should be calculated using standard
statistical methods with respect to Portfolio
Profit and Loss, exclusive of Spread Profit
and Loss.
Calculation Period: 30 days, 60 days, and
90 days.
D. Customer-Facing Activity Measurements
1. Inventory Risk Turnover
Description: For purposes of this appendix,
Inventory Risk Turnover is a ratio that
measures the amount of risk associated with
a trading unit’s inventory, as measured by
Risk Factor Sensitivities, that is turned over
by the trading unit over a specific period of
time. For each Risk Factor Sensitivity, the
numerator of the Inventory Risk Turnover
ratio generally should be the absolute value
of the Risk Factor Sensitivity associated with
each transaction over the calculation period.
The denominator of the Inventory Risk
Turnover ratio generally should be the value
of each Risk Factor Sensitivity for all of the
trading unit’s holdings at the beginning of the
calculation period.
General Calculation Guidance: As a
general matter, a trading unit should measure
and report the Inventory Risk Turnover ratio
for each of the Risk Factor Sensitivities
calculated and furnished for that trading
unit.
Calculation Period: 30 days, 60 days, and
90 days.
2. Inventory Aging
Description: For purposes of this appendix,
Inventory Aging generally describes the
trading unit’s aggregate assets and liabilities
and the amount of time that those assets and
liabilities have been held for the following
periods: 0–30 days; 30–60 days; 60–90 days;
90–180 days; 80–360 days; and greater than
360 days. Inventory Aging should measure
the age profile of the trading unit’s assets and
liabilities.
General Calculation Guidance: In general,
Inventory Aging should be computed using a
trading unit’s trading activity data and
should identify the trading unit’s aggregate
assets and liabilities. In addition, Inventory
Aging should include two schedules, an
asset-aging schedule and a liability-aging
schedule. The asset-aging schedule should
record the value of the trading unit’s assets
that have been held for: 0–30 days; 30–60
days; 60–90 days; 90–180 days; 180–360
days; and greater than 360 days. The liabilityaging schedule should record the value of the
trading unit’s liabilities that have been held
for: 0–30 days; 30–60 days; 60–90 days; 90–
180 days; 180–360 days; and more than 360
days.
Calculation Period: 30 days, 60 days, and
90 days.
3. Customer-Facing Trade Ratio
Description: For purposes of this appendix,
the Customer-Facing Trade Ratio is a ratio
comparing the number of transactions
involving a counterparty that is a customer
of the trading unit to the number of
transactions involving a counterparty that is
E:\FR\FM\07NOP2.SGM
07NOP2
68960
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
not a customer of the trading unit. For
purposes of calculating the Customer-Facing
Trade Ratio, a counterparty is considered to
be a customer of the trading unit if the
counterparty is neither a counterparty to a
transaction executed on a designated contract
market registered under the Commodity
Exchange Act or national securities exchange
registered under the Exchange Act, nor a
broker-dealer, swap dealer, security-based
swap dealer, any other entity engaged in
market making-related activities, or any
affiliate thereof. A broker-dealer, swap
dealer, or security-based swap dealer, any
other entity engaged in market makingrelated activities, or any affiliate thereof may
be considered a customer of the trading unit
for these purposes if the covered banking
entity treats that entity as a customer and has
documented how and why the entity is
treated as such.
Calculation Period: 30 days, 60 days, and
90 days.
E. Payment of Fees, Commissions, and
Spreads Measurement
1. Pay-to-Receive Spread Ratio
Description: For purposes of this appendix,
the Pay-to-Receive Spread Ratio is a ratio
comparing the amount of Spread Profit and
Loss and Fee Income that is earned by a
trading unit to the amount of Spread Profit
and Loss and Fee Income that is paid by the
trading unit.
General Calculation Guidance: The Pay-toReceive Spread Ratio will depend on the
amount of Spread Profit and Loss and Fee
Income that is earned by the trading unit for
facilitating buy and sell orders and the
amount of Spread Profit and Loss that is paid
by a trading unit as it initiates buy and sell
orders. The Pay-to-Receive Spread Ratio
generally should be computed using the
calculation of Spread Profit and Loss
described in this appendix, except that
spread paid should include the aggregate
Spread Profit and Loss of all transactions
producing a negative Spread Profit and Loss,
and spread received should include the
aggregate Spread Profit and Loss of all
transactions producing a positive Spread
Profit and Loss.
Calculation Period: One trading day.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Appendix B: Commentary Regarding
Identification of Permitted Market
Making-Related Activities
I. Purpose
This appendix provides commentary
describing the features of permitted market
making-related activities and distinctions
between permitted market making-related
activities and prohibited proprietary trading.
The appendix applies to all covered banking
entities that are engaged in market makingrelated activities in reliance on § l.4(b). The
following commentary must be incorporated
into the covered banking entity’s internal
compliance program under § l.20, as
applicable.
II. Definitions
The terms used in this appendix have the
same meanings as those set forth in §§ l.2
and l.3 and Appendix A.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
III. Commentary
Section 13 of the BHC Act and § l.3
prohibit any covered banking entity from
engaging in proprietary trading, which is
generally defined as engaging as principal for
the trading account of the covered banking
entity in any transaction to purchase or sell
a covered financial position. However,
section 13(d)(1)(B) of the BHC Act and
§ l.4(b) permit a covered banking entity to
engage in proprietary trading that would
otherwise be prohibited if the activity is
conducted in connection with the covered
banking entity’s market making-related
activities, to the extent that such activities
are designed not to exceed the reasonably
expected near term demands of clients,
customers, and counterparties. This
commentary is intended to assist covered
banking entities in identifying permitted
market making-related activities and
distinguishing such activities from trading
activities that, even if conducted in the
context of the covered banking entity’s
market making operations, would constitute
prohibited proprietary trading.
A. Overview of Market Making-Related
Activities
In the context of trading activities in which
a covered banking entity acts as principal,
market making-related activities generally
involve the covered banking entity either (i)
in the case of market making in a security
that is executed on an organized trading
facility or exchange, passively providing
liquidity by submitting resting orders that
interact with the orders of others on an
organized trading facility or exchange and
acting as a registered market maker, where
such exchange or organized trading facility
provides the ability to register as a market
maker,1 or (ii) in other cases, providing an
intermediation service to its customers by
assuming the role of a counterparty that
stands ready to buy or sell a position that the
customer wishes to sell or buy. A market
maker’s ‘‘customers’’ generally vary
depending on the asset class and market in
which the market maker is providing
intermediation services. In the context of
market making in a security that is executed
on an organized trading facility or an
exchange, a ‘‘customer’’ is any person on
behalf of whom a buy or sell order has been
submitted by a broker-dealer or any other
market participant. In the context of market
making in a covered financial position in an
over-the-counter market, a ‘‘customer’’
generally would be a market participant that
makes use of the market maker’s
intermediation services, either by requesting
such services or entering into a continuing
1 The status of being a registered market maker is
not, on its own, a sufficient basis for relying on the
exemption for market making-related activity
contained in § l.4(b). Registration as a market
maker generally involves filing a prescribed form
with an exchange or organized trading facility, in
accordance with its rules and procedures, and
complying with the applicable requirements for
market makers set forth in the rules of that
exchange or organized trading facility. See, e.g.,
Nasdaq Rule 4612, New York Stock Exchange Rule
104, CBOE Futures Exchange Rule 515, BATS
Exchange Rule 11.5.
PO 00000
Frm 00116
Fmt 4701
Sfmt 4702
relationship with the market maker with
respect to such services.2
The primary purpose of market makingrelated activities is to intermediate between
buyers and sellers of similar positions, for
which service market makers are
compensated, resulting in more liquid
markets and less volatile prices. The purpose
of such activities is not to earn profits as a
result of movements in the price of positions
and risks acquired or retained; rather, a
market maker generally manages and limits
the extent to which it is exposed to
movements in the price of principal positions
and risks that it acquires or retains, or in the
price of one or more material elements of
those positions. To the extent that it can, a
market maker will eliminate some or all of
the price risks to which it is exposed.
However, in some cases, the risks posed by
one or more positions may be sufficiently
complex or specific that the risk cannot be
fully hedged. In other cases, although it may
be possible to hedge the risks posed by one
or more positions, the cost of doing so may
be so high as to effectively make market
making in those positions uneconomic if
complete hedges were acquired. In such
cases, in order to provide effective
intermediation services, market makers are
required to retain at least some risk for at
least some period of time with respect to
price movements of retained principal
positions and risks. The size and type of risk
that must be retained in such cases may vary
widely depending on the type and size of the
positions, the liquidity of the specific market,
and the market’s structure. As the liquidity
of positions increases, the frequency with
which a market maker must take or retain
risk in order to make a market in those
positions generally decreases.
The profitability of market making-related
activities relies on forms of revenue that
reflect the value of the intermediation
services that are provided to the market
maker’s customers. These revenues typically
take the form of explicit fees and
commissions or, in markets where no such
fees or commission are charged, a bid-ask or
similar spread that is generated by charging
higher prices to buyers than is paid to sellers
of comparable instruments. In the case of a
derivative contract, these revenues reflect the
difference between the cost of entering into
the derivative contract and the cost of
hedging incremental, residual risks arising
from the contract. These types of ‘‘customer
revenues’’ provide the primary source of a
market maker’s profitability. Typically, a
market maker holds at least some risk with
respect to price movements of retained
principal positions and risks. As a result, the
market maker also incurs losses or generates
profits as price movements actually occur,
but such losses or profits are incidental to
customer revenues and significantly limited
by the banking entity’s hedging activities.
Customer revenues, not revenues from price
movements, predominate. The appropriate
proportion of ‘‘customer revenues’’ to profits
2 In certain cases, depending on the conventions
of the relevant market (e.g., the over-the-counter
derivatives market), such a ‘‘customer’’ may
consider itself or refer to itself more generally as a
‘‘counterparty.’’
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
and losses resulting from price movements of
retained principal positions and risks varies
depending on the type of positions involved,
the typical fees, commissions, and spreads
payable for transactions in those positions,
and the risks of those positions. As a general
matter, the proportion of ‘‘customer
revenues’’ generated when making a market
in certain positions increases as the fees,
commissions, or spreads payable for those
positions increase, the volatility of those
positions’ prices decrease, and the prices for
those positions are less transparent.
Because a market maker’s business model
entails managing and limiting the extent to
which it is exposed to movements in the
prices of retained principal positions and
risks while generating customer revenues
that are earned, regardless of movements in
the price of retained principal positions and
risks, a market maker typically generates
significant revenue relative to the risks that
it retains. Accordingly, a market maker will
typically demonstrate consistent profitability
and low earnings volatility under normal
market conditions. The appropriate extent to
which a market maker will demonstrate
consistent profitability and low earnings
volatility varies depending on the type of
positions involved, the liquidity of the
positions, the price transparency of the
positions, and the volatility of the positions’
prices. As a general matter, consistent
profitability will decrease and earnings
volatility will increase as the liquidity of the
positions decrease, the volatility of the
positions’ prices increase, and the prices for
the positions are less transparent.
As the primary purpose of market makingrelated activities is to provide intermediation
services to its customers, market makers
focus their activities on servicing customer
demands and typically only engage in
transactions with non-customers to the extent
that these transactions directly facilitate or
support customer transactions. In particular,
a market maker generally only transacts with
non-customers to the extent necessary to
hedge or otherwise manage the risks of its
market making-related activities, including
managing its risk with respect to movements
of the price of retained principal positions
and risks, to acquire positions in amounts
consistent with reasonably expected near
term demand of its customers, or to sell
positions acquired from its customers. The
appropriate proportion of a market maker’s
transactions that are with customers versus
non-customers varies depending on the type
of positions involved and the extent to which
the positions are typically hedged in noncustomer transactions. In the case of a
derivatives market maker that engages in
dynamic hedging, the number of noncustomer transactions significantly
outweighs the number of customer
transactions, as the derivatives market maker
must constantly enter into transactions to
appropriately manage its retained principal
positions and risks as market prices for the
positions and risks move and additional
transactions with customers change the risk
profile of the market maker’s retained
principal positions.
Because a market maker generates revenues
primarily by transacting with, and providing
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
intermediation services to, customers, a
market maker typically engages in
transactions that earn fees, commissions, or
spreads as payment for its services.
Transactions in which the market maker pays
fees, commissions, or spreads—i.e., where it
pays another market maker for providing it
with liquidity services—are much less
frequent, although in some cases obtaining
liquidity services from another market maker
and paying fees, commissions, or spreads
may be necessary to prudently manage its
risk with respect to price movements of
retained principal positions and risks. The
appropriate proportion of a market maker’s
transactions that earn, rather than pay, fees,
commissions or spreads varies depending on
the type of positions involved, the liquidity
of the positions, and the extent to which
market trends increase the volatility of its
risk with respect to price movements of
retained principal positions and risks. As a
general matter, the proportion of a market
maker’s transactions that earn rather than pay
fees, commissions or spreads decreases as the
liquidity of the positions decreases, and the
extent to which the price volatility of
retained principal positions and risks
increases.
Finally, because the primary purpose of
market making-related activities is to provide
intermediation services to its customers, a
market maker does not provide compensation
incentives to its personnel that primarily
reward proprietary risk-taking. Although a
market maker may take into account
revenues resulting from movements in the
price of retained principal positions and risks
to the extent that such revenues reflect the
effectiveness with which personnel have
effectively managed the risk of movements in
the price of retained principal positions and
risks, a market maker that provides
compensation incentives relating to revenues
generally does so through incentives that
primarily reward customer revenues and
effective customer service.
B. Overview of Prohibited Proprietary
Trading Activities
Like permitted market making-related
activities, prohibited proprietary trading
involves the taking of principal positions by
a covered banking entity. Unlike permitted
market making-related activities, the purpose
of prohibited proprietary trading is to
generate profits as a result of, or otherwise
benefit from, changes in the price of
positions and risks taken. Whereas a market
maker attempts to eliminate some or all of
the price risks inherent in its retained
principal positions and risks by hedging or
otherwise managing those risks in a
reasonable period of time after positions are
acquired or risks arise, a proprietary trader
seeks to capitalize on those risks, and
generally only hedges or manages a portion
of those risks when doing so would improve
the potential profitability of the risk it
retains. A proprietary trader does not have
‘‘customers’’ because a proprietary trader
simply seeks to obtain the best price and
execution in purchasing or selling its
proprietary positions. A proprietary trader
generates few if any fees, commissions, or
spreads from its trading activities because it
PO 00000
Frm 00117
Fmt 4701
Sfmt 4702
68961
is not providing an intermediation service to
any customer or other third party. Instead, a
proprietary trader is likely to pay fees,
commissions, or spreads to other market
makers when obtaining their liquidity
services is beneficial to execution of its
trading strategy. Because a proprietary trader
seeks to generate profits from changes in the
price of positions taken, a proprietary trader
typically provides compensation incentives
to its personnel that primarily reward
successful proprietary risk taking.
C. Distinguishing Permitted Market MakingRelated Activities From Prohibited
Proprietary Trading
Because both permitted market makingrelated activities and prohibited proprietary
trading involve the taking of principal
positions, certain challenges arise in
distinguishing permitted market makingrelated activities and prohibited proprietary
trading, particularly in cases where both of
these activities occur in the context of a
market making operation. Particularly during
periods of significant market disruption, it
may be difficult to distinguish between
retained principal positions and risks that
appropriately support market making-related
activities and positions taken, or positions or
risks not hedged, for proprietary purposes.
In connection with these challenges,
[Agency] will apply the following factors in
distinguishing permitted market makingrelated activities from trading activities that,
even if conducted in the context of the
covered banking entity’s market making
operations, would constitute prohibited
proprietary trading. The particular types of
trading activity described in this appendix
may involve the aggregate trading activities
of a single trading unit, a significant number
or series of transactions occurring at one or
more trading units, or a single significant
transaction, among other potential scenarios.
In addition to meeting the terms of this
appendix, any transaction or activity for
which a covered banking entity intends to
rely on the market making exemption in
§ l.4(b) must also satisfy all the
requirements specified in § l.4(b), as well as
the other applicable requirements and
conditions of this part.
1. Risk Management
Absent explanatory facts and
circumstances, particular trading activity in
which a trading unit retains risk in excess of
the size and type required to provide
intermediation services to customers will be
considered to be prohibited proprietary
trading, and not permitted market makingrelated activity.
[The Agency] will base a determination of
whether a trading unit retains risk in excess
of the size and type required for these
purposes on all available facts and
circumstances, including a comparison of
retained principal risk to: The amount of risk
that is generally required to execute a
particular market making function; hedging
options that are available in the market and
permissible under the covered banking
entity’s hedging policy at the time the
particular trading activity occurred; the
trading unit’s prior levels of retained risk and
its hedging practices with respect to similar
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68962
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
positions; and the levels of retained risk and
the hedging practices of other trading units
with respect to similar positions.
To help assess the extent to which a
trading unit’s risks are potentially being
retained in excess of amounts required to
provide intermediation services to customers,
[Agency] will utilize the VaR and Stress VaR,
VaR Exceedance, and Risk Factor
Sensitivities quantitative measurements, as
applicable, among other risk measurements
described in appendix A to this part and any
other relevant factor. This assessment will
focus primarily on the risk measurements
relative to: The risk required for conducting
market making-related activities, and any
significant changes in the risk over time and
across similarly situated trading units and
banking entities.
Explanatory facts and circumstances might
include, among other things, market-wide
changes in risk, changes in the specific
composition of market making-related
activities, temporary market disruptions, or
other market changes that result in
previously used hedging or other risk
management techniques no longer being
possible or cost-effective.
2. Source of Revenues
Absent explanatory facts and
circumstances, particular trading activity in
which a trading unit primarily generates
revenues from price movements of retained
principal positions and risks, rather than
customer revenues, will be considered to be
prohibited proprietary trading, and not
permitted market making-related activity.
[The Agency] will base a determination of
whether a trading activity primarily generates
revenues from price movements of retained
principal positions and risks, rather than
customer revenues, on all available facts and
circumstances, including: an evaluation of
the revenues derived from price movements
of retained principal positions and risks
relative to its customer revenues; and a
comparison of these revenue figures to the
trading unit’s prior revenues with respect to
similar positions, and the revenues of other
covered banking entities’ trading units with
respect to similar positions.
To help assess the extent to which a
trading unit’s revenues are potentially
derived from movements in the price of
retained principal positions and risks,
[Agency] will utilize the Comprehensive
Profit and Loss, Portfolio Profit and Loss, Fee
Income and Expense, and Spread Profit and
Loss quantitative measurements, as
applicable, both individually and in
combination with one another (e.g., by
comparing the ratio of Spread Profit and Loss
to Portfolio Profit and Loss), and any other
relevant factor.
Explanatory facts and circumstances might
include, among other things: general upward
or downward price trends in the broader
markets in which the trading unit is making
a market, provided revenues from price
movements in retained principal positions
and risks are consistent; sudden market
disruptions or other changes causing
significant, unanticipated alterations in the
price of retained principal positions and
risks; sudden and/or temporary changes in
the market (e.g., narrowing of bid/ask
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
spreads) that cause significant, unanticipated
reductions in customer revenues; or efforts to
expand or contract a trading unit’s market
share.
3. Revenues Relative to Risk
Absent explanatory facts and
circumstances, particular trading activity will
be considered to be prohibited proprietary
trading, and not permitted market makingrelated activity, if the trading unit: generates
only very small or very large amounts of
revenue per unit of risk taken; does not
demonstrate consistent profitability; or
demonstrates high earnings volatility.
[The Agency] will base such a
determination on all available facts and
circumstances, including: an evaluation of
the amount of revenue per unit of risk taken,
earnings volatility, profitability, exposure to
risks, and overall level of risk taking for the
particular trading activities; and a
comparison of these figures to the trading
unit’s prior results with respect to similar
positions, and the results of other covered
banking entities’ trading units with respect to
similar positions.
To help assess the riskiness of revenues
and the amount of revenue per unit of risk
taken, [Agency] will utilize the Volatility of
Comprehensive Profit and Loss and Volatility
of Portfolio Profit and Loss, Comprehensive
Profit and Loss to Volatility Ratio and
Portfolio Profit and Loss to Volatility Ratio,
and Comprehensive Profit and Loss
Attribution quantitative measurements, as
applicable, and any other relevant factor.
To help assess the extent to which a
trading unit demonstrates consistent
profitability, [Agency] will utilize the
Unprofitable Trading Days Based on
Comprehensive Profit and Loss and
Unprofitable Trading Days Based on Portfolio
Profit and Loss quantitative measurements,
as applicable, and any other relevant factor.
To help assess the extent to which a
trading unit is exposed to outsized risk,
[Agency] will utilize the Skewness of
Portfolio Profit and Loss and Kurtosis of
Profit and Loss quantitative measurements,
as applicable, and any other relevant factor.
Explanatory facts and circumstances might
include, among other things: market
disruptions or other changes causing
significant, unanticipated increases in a
trading unit’s risk with respect to movements
in the price of retained principal positions
and risks; market disruptions or other
changes causing significant, unanticipated
increases in the volatility of positions in
which the trading unit makes a market;
sudden and/or temporary changes in the
market (e.g., narrowing of bid-ask spreads)
that cause significant, unanticipated
reductions in customer revenues and
decrease overall profitability; or efforts to
expand or contract a trading unit’s market
share.
4. Customer-Facing Activity
Absent explanatory facts and
circumstances, particular trading activity will
be considered to be prohibited proprietary
trading, and not permitted market makingrelated activity, if the trading unit: does not
transact through a trading system that
interacts with orders of others or primarily
PO 00000
Frm 00118
Fmt 4701
Sfmt 4702
with customers of the banking entity’s market
making desk to provide liquidity services; or
retains principal positions and risks in excess
of reasonably expected near term customer
demands.
[The Agency] will base such a
determination on all available facts and
circumstances, including, among other
things: An evaluation of the extent to which
a trading unit’s transactions are with
customers versus non-customers and the
frequency with which the trading unit’s
retained principal positions and risks turn
over; and a comparison of these figures to the
trading unit’s prior results with respect to
similar positions and market situations, and
the results of other covered banking entities’
trading units with respect to similar
positions.
To help assess the extent to which a
trading unit’s transactions are with customers
versus non-customers, [Agency] will utilize
the Customer-Facing Trade Ratio quantitative
measurement, as applicable, and any other
relevant factor. To help assess the frequency
with which the trading unit’s retained
principal positions and risks turn over,
[Agency] will utilize the Inventory Risk
Turnover and Inventory Aging quantitative
measurements, as applicable, and any other
relevant factor.
With respect to a particular trading activity
in which a trading unit either does not
transact through a trading system that
interacts with orders of others or primarily
with customers of the banking entity’s market
making desk to provide liquidity services,
explanatory facts and circumstances might
include, among other things: sudden market
disruptions or other changes causing
significant increases in a trading unit’s
hedging transactions with non-customers; or
substantial intermediary trading required to
satisfy customer demands and hedging
management. With respect to particular
trading activity in which a trading unit
retains principal positions and risks in excess
of reasonably expected near term customer
demands, explanatory facts and
circumstances might include, among other
things: sudden market disruptions or other
changes causing a significant reduction in
actual customer demand relative to expected
customer demand; documented and
reasonable expectations for temporary
increases in customer demand in the near
term; and sudden market disruptions or other
changes causing a significant reduction in the
value of retained principal positions and
risks, such that it would be imprudent for the
trading unit to dispose of the positions in the
near term.
5. Payment of Fees, Commissions, and
Spreads
Absent explanatory facts and
circumstances, particular trading activity in
which a trading unit routinely pays rather
than earns fees, commissions, or spreads will
be considered to be prohibited proprietary
trading, and not permitted market makingrelated activity.
[The Agency] will base such a
determination on all available facts and
circumstances, including, among other
things: An evaluation of the frequency with
which the trading unit pay fees,
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
commissions, or spreads and the relative
amount of fees, commissions, or spreads that
is paid versus earned; and a comparison of
these figures to the trading unit’s prior results
with respect to similar positions, and the
results of other covered banking entities’
trading units with respect to similar
positions.
To help assess the extent to which a
trading unit is paying versus earning fees,
commissions, and spreads, [Agency] will
utilize the Pay-to-Receive Spread Ratio
quantitative measurement, as applicable, and
any other relevant factor.
Explanatory facts and circumstances might
include, among other things, sudden market
disruptions or other changes causing
significant, increases in a trading unit’s
hedging transactions with non-customers for
which it must pay fees, commissions, or
spreads, sudden, unanticipated customer
demand for liquidity that requires the trading
unit itself to pay fees, commissions, or
spreads to other market makers for liquidity
services to obtain the inventory needed to
meet that customer demand, or significant,
unanticipated reductions in fees,
commissions, or spreads earned by the
trading unit. Explanatory facts and
circumstances might also include a trading
unit’s efforts to expand or contract its market
share.
6. Compensation Incentives
Absent explanatory facts and
circumstances, the trading activity of a
trading unit that provides compensation
incentives to employees that primarily
reward proprietary risk taking will be
considered to be prohibited proprietary
trading, and not permitted market makingrelated activity.
[The Agency] will base such a
determination on all available facts and
circumstances, including, among other
things, an evaluation of: the extent to which
compensation incentives are provided to
trading unit personnel that reward revenues
from movements in the price of retained
principal positions and risks; the extent to
which compensation incentives are provided
to trading unit personnel that reward
customer revenues; and the compensation
incentives provided by other covered
banking entities to similarly-situated
personnel.
*
*
*
*
*
Appendix C: Minimum Standards for
Programmatic Compliance
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
I. Overview
A. Purpose
This appendix sets forth the minimum
standards with respect to the establishment,
maintenance, and enforcement by banking
entities of internal compliance programs for
ensuring and monitoring compliance with
the prohibitions and restrictions on
proprietary trading and covered fund
activities or investments set forth in section
13 of the BHC Act and this part.
This appendix requires that banking
entities establish, maintain, and enforce an
effective compliance program, consisting of
written policies and procedures, internal
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
controls, a management framework,
independent testing, training, and
recordkeeping, that:
• Is reasonably designed to clearly
document, describe, and monitor the covered
trading and covered fund activities or
investments and the risks of the covered
banking entity related to such activities or
investments, identify potential areas of
noncompliance, and prevent activities or
investments prohibited by, or that do not
comply with, section 13 of the BHC Act and
this part;
• Specifically addresses the varying nature
of activities or investments conducted by
different units of the covered banking entity’s
organization, including the size, scope,
complexity, and risks of the individual
activities or investments;
• Subjects the effectiveness of the
compliance program to independent review
and testing;
• Makes senior management and
intermediate managers accountable for the
effective implementation of the compliance
program, and ensures that the board of
directors and CEO review the effectiveness of
the compliance program; and
• Facilitates supervision and examination
of the covered banking entity’s covered
trading and covered fund activities or
investments by the Agencies.
B. Definitions
The terms used in this Appendix have the
same meanings as set forth in §§ l.2, l.3,
and l.10. In addition, for purposes of this
appendix, the following definitions apply:
Asset management unit means any unit of
organization of a covered banking entity that
makes investments in, or acts as sponsor to,
covered funds, or has relationships with
covered funds, that the covered banking
entity (or an affiliate of subsidiary thereof)
has sponsored, organized and offered, or in
which a covered fund sponsored or advised
by the covered banking entity invests.
Compliance program means the internal
compliance program established by a covered
banking entity in accordance with § l.20
and this appendix.
Covered fund activity or investment means
sponsoring any covered fund or making
investments in, or otherwise having
relationships with, any covered fund for
which the covered banking entity (or an
affiliate or subsidiary thereof) acts as sponsor
or organizes and offers.
Covered fund restrictions means the
restrictions on covered fund activities or
investments set forth in subpart C.
Covered trading activity means proprietary
trading, as defined in § l.3(b)(1).
Trading unit means each of the following
units of organization of a covered banking
entity:
(i) Each discrete unit that is engaged in the
coordinated implementation of a revenuegeneration strategy and that participates in
the execution of any covered trading
activity; 1
1 [The
Agency] expects that this will generally be
the smallest unit of organization used by the
covered banking entity to structure and control its
risk-taking activities and employees, and will
include each unit generally understood to be a
single ‘‘trading desk.’’
PO 00000
Frm 00119
Fmt 4701
Sfmt 4702
68963
(ii) Each organizational unit that is used to
structure and control the aggregate risktaking activities and employees of one or
more trading units described in paragraph
(i); 2
(iii) All trading operations, collectively;
and
(iv) Any other unit of organization
specified by [Agency] with respect to a
particular banking entity.
C. Required Elements
Section l.20 requires that covered banking
entities establish, maintain, and enforce a
compliance program reasonably designed to
ensure and monitor compliance with the
prohibitions and restrictions on proprietary
trading and covered fund activities or
investments that effectively implements, at a
minimum, the six elements required under
paragraph (b) of § l.20.
D. Compliance Program Structure
Each covered banking entity subject to
§ l.20(c) must be governed by a compliance
program meeting the requirements of this
appendix. A covered banking entity may
establish a compliance program on an
enterprise-wide basis to satisfy the
requirements of § l.20 and this appendix
with respect to the covered banking entity
and all of its affiliates and subsidiaries
collectively, provided that: the program is
clearly applicable, both by its terms and in
operation, to all such affiliates and
subsidiaries; the program specifically
addresses the requirements set forth in this
appendix; the program takes into account
and addresses the consolidated
organization’s business structure, size, and
complexity, as well as the particular
activities, risks, and applicable legal
requirements of each subsidiary and affiliate;
and the program is determined through
periodic independent testing to be effective
for the covered banking entity and all of its
subsidiaries and affiliates. An enterprisewide program established pursuant to this
Appendix will be subject to supervisory
review and examination by any Agency
vested with rulewriting authority under
section 13 of the BHC Act with respect to the
compliance program and the activities or
investments of any banking entity for which
the Agency has such authority. Further, such
Agency will have access to all records related
to the enterprise-wide compliance program
pertaining to any banking entity that is
supervised by the Agency vested with such
rulewriting authority.
E. Applicability
This appendix applies only to covered
banking entities described in § l.20(c)(2). In
addition, [Agency] may require any covered
banking entity to comply with all or portions
of this appendix if [Agency] deems it
appropriate for purposes the covered banking
entity’s compliance with this part.
2 [The Agency] expects that this will generally
include management or reporting divisions, groups,
sub-groups, or other intermediate units of
organization used by the covered banking entity to
manage one or more discrete trading units (e.g.,
‘‘North American Credit Trading,’’ ‘‘Global Credit
Trading,’’ etc.).
E:\FR\FM\07NOP2.SGM
07NOP2
68964
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Nothing in this appendix limits the
authority of [Agency] under any other
provision of law or regulation to take
supervisory, examination, or enforcement
action, including action to address unsafe or
unsound practices or conditions, deficient
capital levels, or violations of law.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
II. Internal Policies and Procedures
A. Covered Trading Activities
A covered banking entity must establish,
maintain, and enforce written policies and
procedures reasonably designed to
document, describe, and monitor the covered
banking entity’s covered trading activities
and the risks taken in these activities, as
follows:3
Identification of trading account: The
covered banking entity’s policies and
procedures must specify how the banking
entity evaluates the covered financial
positions it acquires or takes and determines
which of its accounts are trading accounts for
purposes of subpart B of this part.
Identification of trading units and
organization structure: The covered banking
entity’s written policies and procedures must
identify and document each trading unit
within the organization and map each trading
unit to the division, business line, or other
organizational structure that the covered
banking entity uses to manage or oversee the
trading unit’s activities.
Description of missions and strategies: The
covered banking entity’s written policies and
procedures for each trading unit must clearly
articulate and document a comprehensive
description of the mission (i.e., the nature of
the business conducted) and strategy (i.e.,
business model for the generation of
revenues) of the trading unit, and include a
description of:
• How revenues are intended to be
generated by the trading unit;
• The activities that the trading unit is
authorized to conduct, including (i)
authorized instruments and products and (ii)
authorized hedging strategies and
instruments;
• The expected holding period of, and the
market risk associated with, covered
financial positions in its trading account;
• The types of clients, customers, and
counterparties with whom trading is
conducted by the trading unit;
• How the trading unit, if engaged in
market making-related activity under
§ l.4(b) of this part, identifies its customers
for purposes of computing the CustomerFacing Trade Ratio, if applicable, including
documentation explaining when, how, and
why a broker-dealer, swap dealer, securitybased swap dealer, any other entity engaged
in market making-related activities, or any
affiliate thereof is considered to be a
customer of the trading unit for those
purposes; and
• The compensation structure of the
employees associated with the trading unit.
Trader mandates: The covered banking
entity must establish, maintain, document,
3 These policies and procedures must be updated
with a frequency sufficient for the covered banking
entity to adequately control the applicable trading
unit for purposes of this part.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
and enforce trader mandates for each trading
unit. At a minimum, trader mandates must:
• Clearly inform each trader of the
prohibitions and requirements set forth in
section 13 of the BHC Act and this part and
his or her responsibilities for compliance
with such requirements;
• Set forth appropriate parameters for each
trader engaged in covered trading activities,
including:
Æ The conditions for relying on the
applicable exemptions in §§ l.4 through
l.6;
Æ The financial contracts, products, and
underlying assets that the trader is permitted
to trade pursuant to the covered banking
entity’s internal controls;
Æ The risk limits of the trader’s trading
unit, and the types and levels of risk that may
be taken; and
Æ The applicable trading unit’s hedging
policy.
Description of risks and risk management
processes: The written policies and
procedures for each trading unit must clearly
articulate and document a comprehensive
description of the risks associated with the
trading unit. Such descriptions must include,
at a minimum, the following elements:
• A description of the supervisory and risk
management structure governing the trading
units, including a description of processes for
initial and senior-level review of new
products and new strategies;
• A description of the types of risks that
may be taken to implement the mission and
strategy of the trading unit, including an
enumeration of material risks resulting from
the activities in which the trading unit is
engaged (including but not limited to all
significant price risks, such as basis,
volatility and correlation risks, as well as any
significant counterparty credit risk associated
with the trading activity);
• An articulation of the amount of risk
allocated by the covered banking entity to
such trading unit to implement the
documented mission and strategy of the
trading unit;
• An explanation of how the risks
allocated to such trading unit will be
measured; and
• An explanation of why the allocated risk
levels are appropriate to the mission and
strategy of the trading unit.
Hedging policies and procedures. The
covered banking entity must establish,
maintain, and enforce policies and
procedures for all of its trading units
regarding the use of risk-mitigating hedging
instruments and strategies. At a minimum,
these hedging policies and procedures must
articulate the following:
• The manner in which the covered
banking entity will determine that the risks
generated by each trading unit have been
properly and effectively hedged;
• The instruments, techniques and
strategies the covered entity will use to hedge
the risk of the positions or portfolios;
• The level of the organization at which
hedging activity and management will occur;
• The manner in which hedging strategies
will be monitored;
• The risk management processes used to
control unhedged or residual risks; and
PO 00000
Frm 00120
Fmt 4701
Sfmt 4702
• The independent testing of hedging
techniques and strategies.
Explanation of compliance. The covered
banking entity’s written policies and
procedures must clearly articulate and
document a comprehensive explanation of
how the mission and strategy of each trading
unit, and its related risk levels, comply with
this part. Such explanation must:
• Identify which portions of the risk-taking
activity of the trading unit would or would
not constitute covered trading activity;
• Identify activities of the trading unit that
will be conducted in reliance on exemptions
contained in §§ l.4 through l.6, including
an explanation of:
o How and where the activity occurs; and
o Which exemption is being relied on and
how the activity meets the specific
requirements for reliance on the applicable
exemption.
• Describe how the covered banking entity
monitors for and prohibits potential or actual
material exposure to high-risk assets or highrisk trading strategies presented by each
trading unit, which must take into account
potential or actual exposure to:
Æ Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
Æ Assets whose changes in values cannot
be adequately mitigated by effective hedging;
Æ New products with rapid growth,
including those that do not have a market
history;
Æ Assets or strategies that include
significant embedded leverage;
Æ Assets or strategies that have
demonstrated significant historical volatility;
Æ Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
Æ Assets or strategies that result in large
and significant concentrations to sectors, risk
factors, or counterparties;
• Explain how each trading unit will
comply with the reporting and recordkeeping
requirements of § l.7 and Appendix A ;
• Describe how the covered banking entity
monitors for and prohibits potential or actual
material conflicts of interest between the
covered banking entity and its clients,
customers, or counterparties present in each
trading unit; and
• Describe how the covered banking entity
monitors for and prohibits potential or actual
transactions or activities that may threaten
the safety and soundness of the covered
banking entity.
Remediation of violations. The covered
banking entity’s written policies and
procedures must require the covered banking
entity to promptly document, address and
remedy any violation of section 13 of the
BHC Act or this part, and document all
proposed and actual remediation efforts.
Further, such policies and procedures must
include specific procedures that are
reasonably designed to implement and
monitor any required remediation and that
assess the extent to which any violation
indicates that modification to the covered
banking entity’s compliance program is
warranted.
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
With respect to any trading unit that is
either used by the covered banking entity to
structure and control the aggregate risktaking activities and employees of one or
more other trading units, or comprised of the
entire trading operation of the covered
banking entity, the description of missions
and strategies, description of risks and risk
management processes, and explanation of
compliance for such trading units may
incorporate by reference the policies and
procedures of the underlying trading units
that the trading unit oversees and manages in
the aggregate.
B. Covered Fund Activities or Investments
A covered banking entity must establish,
maintain, and enforce written policies and
procedures that are reasonably designed to
document, describe, and monitor the covered
banking entity’s covered fund activities or
investments and the risks taken in these
activities or investments, as follows.
Identification of covered funds: The
covered banking entity’s policies and
procedures must specify how the covered
banking entity identifies covered funds that
the covered banking entity sponsors,
organizes and offers, or in which covered
banking entity invests.
Identification of asset management units
and organization structure: The covered
banking entity’s written policies and
procedures must identify and document each
asset management unit within the
organization and map each asset management
unit to the division, business line, or other
organizational structure that the covered
banking entity uses to manage or oversee the
asset management unit’s activities or
investments.
Description of sponsorship activities
related to covered funds: The covered
banking entity’s written policies and
procedures for each asset management unit
must clearly articulate and document a
comprehensive description of the mission
(i.e., the nature of the business conducted)
and strategy (i.e., business model for the
generation of revenues) of the asset
management unit related to its sponsorship
or organizing and offering of covered funds,
including a description of how such
activities comply with this part and, in
particular:
• The activities that the asset management
unit is authorized to conduct, including the
nature of any trust, fiduciary, investment
advisory, or commodity trading advisory
services offered to customers of the covered
banking entity;
• The types of customers to whom the
asset management unit provides such
services and to whom ownership interests in
covered funds are sold;
• The extent of any co-investment
activities of the covered banking entity
(including its directors or employees) in
covered funds offered to such customers; and
• How the asset management unit
complies with the requirements of subpart C
of this part.
Description of investment activities of
covered funds: The covered banking entity’s
written policies and procedures for each
asset management unit must clearly
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
articulate and document a comprehensive
description of the mission (i.e., the nature of
the business conducted) and strategy (i.e.,
business model for the generation of
revenues) of the asset management unit
related to its investments in covered funds,
including a description of how such
activities comply with this part and, in
particular:
• The asset management unit’s practices
with respect to seed capital investments in
covered funds, including how the asset
management unit reduces its investments in
covered funds to amounts that are permitted
de minimis investments within the required
period of time;
• The asset management unit’s practices
with respect to co-investments in covered
funds, including certain parallel investments
as identified in § l.12;
• How the asset management unit
complies with the requirements of § l.12
with respect to individual and aggregate
investments in covered funds;
• With respect to other permitted covered
fund activities or investment, how the asset
management unit complies with the
requirements of §§ l.13 and l.14;
• How the asset management unit
complies with the limitations on
relationships with a covered fund under
§ l.16;
• How the covered banking entity
monitors for and prohibits potential or actual
material conflicts of interest between the
covered banking entity and its clients,
customers, or counterparties related to the
asset management unit;
• How the covered banking entity
monitors for and prohibits potential or actual
transactions or activities that may threaten
the safety and soundness of the covered
banking entity related to the asset
management unit; and
• How the covered banking entity
monitors for and prohibits potential or actual
material exposure to high-risk assets or highrisk trading strategies presented by each asset
management unit.
Remediation of violations. The covered
banking entity’s written policies and
procedures must require the covered banking
entity to promptly document, address and
remedy any violation of section 13 of the
BHC Act or this part, and document all
proposed and actual remediation efforts.
Further, such policies and procedures must
include specific procedures that are designed
to implement, monitor, and enforce any
required remediation and that assess the
extent to which any violation indicates that
modification to the covered banking entity’s
compliance program is warranted.
III. Internal Controls
A. Covered Trading Activities
A covered banking entity must establish,
maintain, and enforce written internal
controls that are reasonably designed to
ensure that the trading activity of each
trading unit is appropriate and consistent
with the description of mission, strategy, and
risk mitigation for each trading unit
contained in its written policies and
procedures. These written internal controls
must also be reasonably designed and
PO 00000
Frm 00121
Fmt 4701
Sfmt 4702
68965
established to effectively monitor and
identify for further analysis any covered
trading activity that may indicate potential
violations of section 13 of the BHC Act and
this part and to prevent actual violations of
section 13 of the BHC Act and this part.
Further, the internal controls must describe
procedures for remedying violations of
section 13 of the BHC Act and this part. The
written internal controls must include, at a
minimum, the following.
Authorized risks, instruments, and
products. The covered banking entity must
implement and enforce internal controls for
each trading unit that are reasonably
designed to ensure that trading activity is
conducted in conformance with the trading
unit’s authorized risks, instruments, and
products, as documented in the covered
banking entity’s written policies and
procedures and trader mandates. At a
minimum, these internal controls must
monitor and govern:
• The types and levels of risks that may be
taken by each trading unit, consistent with
the covered banking entity’s written policies
and procedures;
• The type of hedging instruments used,
hedging strategies employed, and the amount
of risk effectively hedged, consistent with the
covered banking entity’s written policies and
procedures; and
• The financial contracts, products and
underlying assets that the trading unit may
trade, consistent with covered banking
entity’s written policies and procedures.
Risk limits. The covered banking entity
must establish and enforce risk limits
appropriate for each trading unit, which shall
include limits based on probabilistic and
non-probabilistic measures of potential loss
(e.g., Value-at-Risk and notional exposure,
respectively), measured under normal and
stress market conditions.
Analysis and quantitative measurements.
The covered banking entity must perform
robust analysis and quantitative
measurement of its covered trading activities
that is reasonably designed to ensure that the
trading activity of each trading unit is
consistent with its mission, strategy and risk
management process, as documented in the
covered banking entity’s written policies and
procedures; monitor and assist in the
identification of potential and actual
prohibited proprietary trading activity; and
prevent the occurrence of prohibited
proprietary trading. In addition to the
quantitative measurements reported by the
covered banking entity to [Agency] pursuant
to appendix A to this part, each covered
banking must develop and implement, to the
extent necessary to facilitate compliance with
this part, additional quantitative
measurements specifically tailored to the
particular risks, practices, and strategies of its
trading units. The covered banking entity’s
analysis and quantitative measurement must
incorporate the quantitative measurements
reported by the covered banking entity to
[Agency] pursuant to Appendix A and
include, at minimum, the following:
• Internal controls and written policies
and procedures reasonably designed to
ensure the accuracy and integrity of
quantitative measurements;
E:\FR\FM\07NOP2.SGM
07NOP2
68966
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
• Ongoing, timely monitoring and review
of calculated quantitative measurements;
• Heightened review of a quantitative
measurement when such quantitative
measurement raises any question regarding
compliance with section 13 of the BHC Act
and this part, which shall include in-depth
analysis, appropriate escalation procedures,
and documentation related to the review,
including the establishment of numerical
thresholds for each trading unit for purposes
of triggering such heightened review; and
• Immediate review and compliance
investigation of the trading unit’s activities,
escalation to senior management with
oversight responsibilities for the applicable
trading unit, timely notification to [Agency],
appropriate remedial action (e.g., divesting of
impermissible positions, cessation of
impermissible activity, disciplinary actions),
and documentation of the investigation
findings and remedial action taken when the
quantitative measurement, considered
together with the facts and circumstances,
suggests a reasonable likelihood that the
trading unit has violated any part of section
13 of the BHC Act and this part.
Surveillance of compliance program
effectiveness. The covered banking entity
must regularly monitor the effectiveness of
its compliance program and take prompt
action to address and remedy any
deficiencies identified. Any actions taken to
remedy deficiencies and violations shall be
documented and maintained as a record of
the banking entity.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
B. Covered Fund Activities
A covered banking entity must establish,
maintain, and enforce internal controls that
are reasonably designed to ensure that the
covered fund activities or investments of its
asset management units are appropriate and
consistent with the description of the asset
management unit’s mission, strategy, and risk
management process contained in the
covered banking entity’s written policies and
procedures. The internal controls must, at a
minimum, be designed to ensure that the
covered banking entity complies with the
requirements of § l.11 for any covered fund
in which it invests, acts as sponsor, or
organizes and offers, as well as the following:
Monitoring investments in a covered fund.
The covered banking entity must implement
and enforce internal controls in a way that
monitors and limits the covered banking
entity’s individual and aggregate investments
in covered funds. At a minimum, the covered
banking entity shall establish, maintain, and
enforce internal controls reasonably designed
to ensure that such investments are in
compliance with section 13 of the BHC Act
and this part at all times, including:
• Monitoring the amount and timing of
seed capital investments for compliance with
the limitations (including but not limited to
the redemption, sale or disposition
requirements of § l.12);
• Calculating the individual and aggregate
levels of ownership interests in covered
funds required by § l.12;
• Describing procedures for remedying
violations of section 13 of the BHC Act and
this part;
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
• Attributing the appropriate instruments
to the individual and aggregate ownership
interest calculations above; and
• Making the appropriate required
disclosures, in writing, to prospective and
actual investors in any covered fund
organized and offered or sponsored by the
covered banking entity, as provided under
§ l.11(h).
Monitoring relationships with a covered
fund. The covered banking entity must
implement and enforce internal controls in a
way that monitors and limits the covered
banking entity’s sponsorship of, and
relationships with, covered funds. At a
minimum, the covered banking entity shall
establish, maintain, and enforce internal
controls reasonably designed to ensure that
such activities and relationships are in
compliance with section 13 of the BHC Act
and this part at all times, including
monitoring for and preventing any
relationship or transaction between the
covered banking entity and a covered fund
that is prohibited under § l.16.
Surveillance of compliance program
effectiveness. The covered banking entity
must regularly monitor the effectiveness of
its compliance program and take prompt
action to address and remedy any
deficiencies identified. Any actions taken to
remedy deficiencies and violations shall be
documented and maintained as a record of
the covered banking entity.
IV. Responsibility and Accountability for the
Compliance Program
A covered banking entity must establish,
maintain, and enforce a management
framework to manage its business and
employees with a view to preventing
violations of section 13 of the BHC Act and
this part. A covered banking entity must have
an appropriate management framework
reasonably designed to ensure that:
appropriate personnel are made responsible
and accountable for the effective
implementation and enforcement of the
compliance program; a clear reporting line
with a chain of responsibility is delineated;
and the board of directors, or similar
corporate body, and CEO reviews and
approves the compliance program. This
management framework must include, at a
minimum:
Corporate governance. The covered
banking entity must ensure that its
compliance program is reduced to writing,
approved by the board of directors or similar
corporate body, and noted in the minutes.
Trader mandates. The covered banking
entity must establish, maintain, and enforce
the trader mandates required by this
appendix to clearly inform each trader within
a trading unit of his or her responsibilities for
compliance with section 13 of the BHC Act
and this part.
Management procedures. The covered
banking entity must establish, maintain, and
enforce management procedures that are
reasonably designed to achieve compliance
with section 13 of the BHC Act and this part,
which, at a minimum, provide for:
• The designation of at least one person
with authority to carry out the management
responsibilities of the covered banking entity
for each trading unit;
PO 00000
Frm 00122
Fmt 4701
Sfmt 4702
• Written procedures addressing the
management of the activities of the covered
banking entity that are reasonably designed
to achieve compliance with section 13 of the
BHC Act and this part, including:
Æ Procedures for the review by a manager
of activities of the trading unit and the
quantitative measurements pursuant to
appendix A and any other quantitative
measurements developed and tailored to the
particular risks, practices, and strategies of
the covered banking entity’s trading units;
Æ A description of the management
system, including the titles, qualifications,
and locations of managers and the specific
responsibilities of each person with respect
to the covered banking entity’s trading units;
and
Æ Procedures for determining
compensation arrangements for traders
engaged in underwriting or market makingrelated activities under § l.4 or riskmitigating hedging activities under § l.5 so
that such compensation arrangements are
designed not to reward proprietary risk
taking.
Business line managers. Managers with
responsibility for one or more trading units
or asset management units of the covered
banking entity engaged in covered trading
activities or covered fund activities or
investments are accountable for the effective
implementation and enforcement of the
compliance program with respect to the
applicable trading unit or asset management
unit.
Senior management. Senior management is
responsible for communicating and
reinforcing the culture of compliance with
section 13 of the BHC Act and this part, as
established by the board of directors or
similar corporate body, and implementing
and enforcing the approved compliance
program. Senior management must also
ensure that effective corrective action is
taken when failures in compliance with
section 13 of the BHC Act and this part are
identified.4 Senior management and control
personnel charged with overseeing
compliance with section 13 of the BHC Act
and this part should report to the board, or
an appropriate committee thereof, on the
effectiveness of the compliance program and
compliance matters with a frequency
appropriate to the size, scope, and risk
profile of the covered banking entity’s
covered trading activities and covered fund
activities or investments, which shall be at
least once every twelve months.
Board of directors, or similar corporate
body, and CEO. The board of directors, or
similar corporate body, and CEO are
responsible for setting an appropriate culture
of compliance with this part and establishing
clear policies regarding the management of
covered trading activities and covered fund
activities or investments in compliance with
section 13 of the BHC Act and this part. The
board of directors or similar corporate body
must ensure that senior management is fully
capable, qualified, and properly motivated to
manage compliance with this part in light of
4 Such corrective action may include, among
other things divesture of the position, cessation of
the activity, or disciplinary measures.
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
the organization’s business activities. The
board of directors or similar corporate body
must also ensure that senior management has
established appropriate incentives to support
compliance with this part, including the
implementation of a compliance program
meeting the requirements of this appendix
into management goals and compensation
structures across the covered banking entity.
END OF COMMON RULE
V. Independent Testing
A covered banking entity must ensure that
independent testing is conducted by a
qualified independent party, such as the
covered banking entity’s internal audit
department, outside auditors, consultants, or
other qualified independent parties,
regarding the effectiveness of the covered
banking entity’s compliance program
established pursuant to this appendix and
§ l.20 and the covered banking entity’s
compliance with this part. A banking entity
must take appropriate action to remedy any
concerns identified by the independent
testing (e.g., remedying deficiencies in its
written policies and procedures and internal
controls, etc.).
The required independent testing must
occur with a frequency appropriate to the
size, scope, and risk profile of the covered
banking entity’s covered trading and covered
fund activities or investments, which shall be
no less than once every twelve months. This
independent testing must include an
evaluation of:
• The overall adequacy and effectiveness
of the covered banking entity’s compliance
program, including an analysis of the extent
to which the program contains all the
required elements of this appendix;
• The effectiveness of the covered banking
entity’s written policies and procedures;
• The effectiveness of the covered banking
entity’s internal controls, including an
analysis and documentation of instances in
which such internal controls have been
breached, and how such breaches were
addressed and resolved; and
• The effectiveness of the covered banking
entity’s management procedures.
DEPARTMENT OF THE TREASURY
VI. Training
Covered banking entities must provide
adequate training to trading personnel and
managers of the covered banking entity, as
well as other appropriate personnel, as
determined by the covered banking entity, in
order to effectively implement and enforce
the compliance program. This training
should occur with a frequency appropriate to
the size and the risk profile of the covered
banking entity’s covered trading activities
and covered fund activities or investments.
The training may be conducted by internal
personnel or independent parties deemed
appropriate by the covered banking entity
based on its size and risk profile.
VII. Recordkeeping
Covered banking entities must create and
retain records sufficient to demonstrate
compliance and support the operations and
effectiveness of the compliance program. A
covered banking 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 [Agency] on request.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
[END OF COMMON TEXT]
Adoption of the Common Rule Text
The proposed adoption of the
common rules by the agencies, as
modified by agency-specific text, is set
forth below:
Office of the Comptroller of the
Currency
12 CFR Chapter I
List of Subjects in 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 and Issuance
For the reasons stated in the Common
Preamble, the Office of the Comptroller
of the Currency proposes to amend
chapter I of Title 12, Code of Federal
Regulations as follows:
PART 44—PROPRIETARY TRADING
AND CERTAIN INTEREST IN AND
RELATIONSHIPS WITH COVERED
FUNDS
1. The authority citation for part 44 is
added to read as follows:
Authority: 7 U.S.C. 27 et seq., 12 U.S.C. 1,
24, 92a, 93a, 161, 1461, 1462a, 1463, 1464,
1813(q), 1818, 1851, 3101 3102, 3108, 5412.
2. Part 44 is added as set forth at the
end of the Common Preamble.
3. Part 44 is amended by
a. Removing ‘‘[Agency]’’ wherever it
appears and adding in its place ‘‘the
OCC’’; and
b. Removing ‘‘[The Agency]’’
wherever it appears and adding in its
place ‘‘The OCC’’.
4. Section 44.1 is added to read as
follows:
§ 44.1
Authority, purpose, and scope.
(a) Authority. This part is issued by
[Agency] under section 13 of the Bank
Holding Company Act of 1956, as
amended (12 U.S.C. 1851).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes
prohibitions and restrictions on
proprietary trading and investments in
or relationships with covered funds by
certain banking entities, including
national banks, Federal branches and
agencies of foreign banks, Federal
savings associations, and certain
subsidiaries thereof. This part
implements section 13 of the Bank
Holding Company Act by defining terms
PO 00000
Frm 00123
Fmt 4701
Sfmt 4702
68967
used in the statute and related terms,
establishing prohibitions and
restrictions on proprietary trading and
investments in or relationships with
covered funds, and explaining the
statute’s requirements.
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to covered
banking entities described in § 44.2(j).
This part takes effect on July 21, 2012.
(d) Relationship to other authorities.
Except as otherwise provided under
section 13 of the Bank Holding
Company Act, and notwithstanding any
other provision of law, the prohibitions
and restrictions under section 13 of
Bank Holding Company Act shall apply
to the activities of a covered banking
entity, even if such activities are
authorized for a covered banking entity
under other applicable provisions of
law.
(e) Preservation of authority. Nothing
in this part limits in any way the
authority of the OCC to impose
penalties for violation of this part by
any covered banking entity provided
under any other applicable statute.
5. Paragraph (j) of § 44.2 is added to
read as follows:
§ 44.2
Definitions.
*
*
*
*
*
(j) Covered banking entity means any
banking entity that is:
(1) A national bank;
(2) A Federal branch or agency of a
foreign bank;
(3) A Federal savings association or a
Federal savings bank; and
(4) Any subsidiary of a company
described in paragraph (j)(1) through (3)
of this section, other than a subsidiary
for which the CFTC or SEC is the
primary financial regulatory agency as
defined in section 2(12) of the DoddFrank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 5301(12)).
*
*
*
*
*
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE
12 CFR Chapter II
List of Subjects in 12 CFR Part 248
Administrative practice and
procedure, Banks and banking, Capital,
Compensation, Conflict of interests,
Credit, Derivatives, Foreign banking,
Government securities, Holding
companies, Insurance, Insurance
companies, Investments, Penalties,
Reporting and recordkeeping
requirements, Risk, Risk retention,
Securities, Trusts and trustees.
E:\FR\FM\07NOP2.SGM
07NOP2
68968
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Authority and Issuance
For the reasons set forth in the
Supplementary Information, the Board
of Governors of the Federal Reserve
System proposes to add the text of the
common rule as set forth at the end of
the Supplementary Information as Part
248 to 12 CFR Chapter II as follows:
PART 248—PROPRIETARY TRADING
AND RELATIONSHIPS WITH COVERED
FUNDS (REGULATION VV)
6. The authority citation for part 248
is added 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.
7. Part 248 is added as set forth at the
end of the Common Preamble.
8. Part 248 is amended by:
A. Removing ‘‘[Agency]’’ wherever it
appears and adding in its place ‘‘the
Board’’; and
B. Removing ‘‘[The Agency]’’
wherever it appears and adding in its
place ‘‘The Board’’.
9. Section 248.1 is added to read as
follows:
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
§ 248.1 Authority, purpose, scope, and
relationship to other authorities.
(a) Authority. This part 1 (Regulation
VV) is issued by the Board under
section 13 of the Bank Holding
Company Act of 1956, as amended (12
U.S.C. 1851), as well as under the
Federal Reserve Act, as amended (12
U.S.C. 221 et seq.); section 8 of the
Federal Deposit Insurance Act, as
amended (12 U.S.C. 1818); the Bank
Holding Company Act of 1956, as
amended (12 U.S.C. 1841 et seq.); and
the International Banking Act of 1978,
as amended (12 U.S.C. 3101 et seq.).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes
prohibitions and restrictions on
proprietary trading and investments in
or relationships with covered funds by
certain banking entities, including state
members banks, bank holding
companies, savings and loan holding
companies, other companies that
control an insured depository, foreign
banking organizations, and certain
subsidiaries thereof. This part
implements section 13 of the Bank
Holding Company Act by defining terms
used in the statute and related terms,
establishing prohibitions and
restrictions on proprietary trading and
investments in or relationships with
covered funds, and explaining the
statute’s requirements.
1 Code of Federal Regulations, title 12, chapter II,
part 248.
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to covered
banking entities described in § 248.2(j).
This part takes effect on July 21, 2012.
(d) Relationship to other authorities.
Except as otherwise provided in under
section 13 of the Bank Holding
Company Act, and notwithstanding any
other provision of law, the prohibitions
and restrictions under section 13 of
Bank Holding Company Act shall apply
to the activities of a covered banking
entity, even if such activities are
authorized for a covered banking entity
under other applicable provisions of
law.
10. In § 248.2, paragraph (c) is revised,
and paragraph (j) is added to read as
follows:
§ 248.2
Definitions.
*
*
*
*
*
(c) Nothing in this part limits in any
way the authority of the Board, under
the BHC Act (including section 8 of
such Act) and other provisions of law,
to impose penalties for violation by any
company or individual.
*
*
*
*
*
(j) Covered banking entity means any
banking entity that is:
(1) A state member bank (as defined
in 12 CFR 208.2(g));
(2) A bank holding company;
(3) A savings and loan holding
company (as defined in 12 U.S.C.
1467a);
(4) A foreign banking organization (as
defined in 12 CFR 211.21(o));
(5) Any company that controls an
insured depository institution; and
(6) Any subsidiary of a company
described in paragraph (j)(1) through (5)
of this section, other than a subsidiary
for which the OCC, FDIC, CFTC, or SEC
is the primary financial regulatory
agency (as defined in section 2(12) of
the Dodd-Frank Wall Street Reform and
Consumer Protection Act (12 U.S.C.
5301(12)).
11–12. Add subpart E to read as
follows:
Subpart E—Conformance Period and
Extended Transition Period Authorities
Sec.
248.30 Definitions.
248.31 Conformance periods for banking
entities engaged in prohibited
proprietary trading or covered fund
activities or investments.
248.32 Conformance period for nonbank
financial companies supervised by the
Board engaged in prohibited proprietary
trading or covered fund activities and
investments.
PO 00000
Frm 00124
Fmt 4701
Sfmt 4702
Subpart E—Conformance Period and
Extended Transition Period Authorities
§ 248.30
Definitions.
For purposes of this subpart:
(a) Illiquid fund means a covered fund
that:
(1) As of May 1, 2010:
(i) Was principally invested in
illiquid assets; or
(ii) Was invested in, and contractually
committed to principally invest in,
illiquid assets; and
(2) Makes all investments pursuant to,
and consistent with, an investment
strategy to principally invest in illiquid
assets.
(b) Illiquid assets means any real
property, security, obligation, or other
asset that:
(1) Is not a liquid asset;
(2) Because of statutory or regulatory
restrictions applicable to the covered
fund or asset, cannot be offered, sold, or
otherwise transferred by covered fund to
a person that is unaffiliated with the
relevant banking entity; or
(3) Because of contractual restrictions
applicable to the covered fund or asset,
cannot be offered, sold, or otherwise
transferred by the covered fund for a
period of 3 years or more to a person
that is unaffiliated with the relevant
banking entity.
(c) Liquid asset means:
(1) Cash or cash equivalents;
(2) An asset that is traded on a
recognized, established exchange,
trading facility or other market on
which there exist independent, bona
fide offers to buy and sell so that a price
reasonably related to the last sales price
or current bona fide competitive bid and
offer quotations can be determined for
the particular asset almost
instantaneously;
(3) An asset for which there are bona
fide, competitive bid and offer
quotations in a recognized inter-dealer
quotation system or similar system or
for which multiple dealers furnish bona
fide, competitive bid and offer
quotations to other brokers and dealers
on request;
(4) An asset the price of which is
quoted routinely in a widely
disseminated publication that is readily
available to the general public or
through an electronic service that
provides indicative data from real-time
financial networks;
(5) An asset with an initial term of
one year or less and the payments on
which at maturity may be settled,
closed-out, or paid in cash or one or
more other liquid assets described in
paragraphs (c)(1), (2), (3), or (4) of this
section; and
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
(6) Any other asset that the Board
determines, based on all the facts and
circumstances, is a liquid asset.
(d) Principally invested and related
definitions.—A covered fund:
(1) Is principally invested in illiquid
assets if at least 75 percent of the fund’s
consolidated total assets are—
(i) Illiquid assets; or
(ii) Risk-mitigating hedges entered
into in connection with and related to
individual or aggregated positions in, or
holdings of, illiquid assets;
(2) Is contractually committed to
principally invest in illiquid assets if the
fund’s organizational documents, other
documents that constitute a contractual
obligation of the fund, or written
representations contained in the fund’s
offering materials distributed to
potential investors provide for the fund
to be principally invested in assets
described in paragraph (d)(1) of this
section at all times other than during
temporary periods, such as the period
prior to the initial receipt of capital
contributions from investors or the
period during which the fund’s
investments are being liquidated and
capital and profits are being returned to
investors; and
(3) Has an investment strategy to
principally invest in illiquid assets if the
fund:
(i) Markets or holds itself out to
investors as intending to principally
invest in assets described in paragraph
(d)(1) of this section; or
(ii) Has a documented investment
policy of principally investing in assets
described in paragraph (d)(1) of this
section.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
§ 248.31 Conformance periods for banking
entities engaged in prohibited proprietary
trading or covered fund activities or
investments.
(a) Conformance Period. (1) In
general.—Except as provided in
paragraph (a)(2) or (3) of this section, a
banking entity shall bring its activities
and investments into compliance with
the requirements of section 13 of the
BHC Act (12 U.S.C. 1851) and this part
no later than 2 years after July 21, 2012.
(2) New banking entities.—A
company that was not a banking entity,
or a subsidiary or affiliate of a banking
entity, as of July 21, 2010, and becomes
a banking entity, or a subsidiary or
affiliate of a banking entity, after that
date shall bring its activities and
investments into compliance with the
requirements of section 13 of the BHC
Act (12 U.S.C. 1851) and this part before
the later of:
(i) The conformance date determined
in accordance with paragraph (a)(1) of
this section; or
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
(ii) 2 years after the date on which the
company becomes a banking entity or a
subsidiary or affiliate of a banking
entity.
(3) Extended conformance period.
The Board may extend the two-year
period under paragraph (a) (1) or (2) of
this section by not more than three
separate one-year periods, if, in the
judgment of the Board, each such oneyear extension is consistent with the
purposes of section 13 of the BHC Act
(12 U.S.C. 1851) and this part and
would not be detrimental to the public
interest.
(b) Illiquid funds. (1) Extended
transition period. The Board may
further extend the period provided by
paragraph (a) of this section during
which a banking entity may acquire or
retain an ownership interest in, or
otherwise provide additional capital to,
a covered fund if:
(i) The fund is an illiquid fund; and
(ii) The acquisition or retention of
such interest, or provision of additional
capital, is necessary to fulfill a
contractual obligation of the banking
entity that was in effect on May 1, 2010.
(2) Duration limited. The Board may
grant a banking entity only one
extension under paragraph (b)(1) of this
section and such extension:
(i) May not exceed 5 years beyond any
conformance period granted under
paragraph (a)(3) of this section; and
(ii) Shall terminate automatically on
the date during any such extension on
which the banking entity is no longer
under a contractual obligation described
in paragraph (b)(1)(ii) of this section.
(3) Contractual obligation. For
purposes of this paragraph (b):
(i) A banking entity has a contractual
obligation to take or retain an ownership
interest in an illiquid fund if the
banking entity is prohibited from
redeeming all of its ownership interests
in the fund, and from selling or
otherwise transferring all such
ownership interests to a person that is
not an affiliate of the banking entity—
(A) Under the terms of the banking
entity’s ownership interest in the fund
or the banking entity’s other contractual
arrangements with the fund or
unaffiliated investors in the fund; or
(B) If the banking entity is the sponsor
of the fund, under the terms of a written
representation made by the banking
entity in the fund’s offering materials
distributed to potential investors;
(ii) A banking entity has a contractual
obligation to provide additional capital
to an illiquid fund if the banking entity
is required to provide additional capital
to such fund—
(A) Under the terms of its ownership
interest in the fund or the banking
PO 00000
Frm 00125
Fmt 4701
Sfmt 4702
68969
entity’s other contractual arrangements
with the fund or unaffiliated investors
in the fund; or
(B) If the banking entity is the sponsor
of the fund, under the terms of a written
representation made by the banking
entity in the fund’s offering materials
distributed to potential investors; and
(iii) A banking entity shall be
considered to have a contractual
obligation for purposes of paragraph
(b)(3)(i) or (ii) of this section only if:
(A) The obligation may not be
terminated by the banking entity or any
of its subsidiaries or affiliates under the
terms of its agreement with the fund;
and
(B) In the case of an obligation that
may be terminated with the consent of
other persons, the banking entity and its
subsidiaries and affiliates have used
their reasonable best efforts to obtain
such consent and such consent has been
denied.
(c) Approval Required to Hold
Interests in Excess of Time Limit. The
conformance period in paragraph (a) of
this section may be extended in
accordance with paragraph (a)(3) or (b)
only with the approval of the Board. A
banking entity that seeks the Board’s
approval for an extension of the
conformance period under paragraph
(a)(3) or for an extended transition
period under paragraph (b)(1) must:
(1) Submit a request in writing to the
Board at least 180 days prior to the
expiration of the applicable time period;
(2) Provide the reasons why the
banking entity believes the extension
should be granted, including
information that addresses the factors in
paragraph (d)(1) of this section; and
(3) Provide a detailed explanation of
the banking entity’s plan for divesting or
conforming the activity or
investment(s).
(d) Factors governing Board
determinations.
(1) Extension requests generally.—In
reviewing any application by a specific
company for an extension under
paragraph (a)(3) or (b)(1) of this section,
the Board may consider all the facts and
circumstances related to the activity,
investment, or fund, including, to the
extent relevant:
(i) Whether the activity or investment:
(A) Involves or results in material
conflicts of interest between the banking
entity and its clients, customers or
counterparties;
(B) Would result, directly or
indirectly, in a material exposure by the
banking entity to high-risk assets or
high-risk trading strategies;
(C) Would pose a threat to the safety
and soundness of the banking entity; or
E:\FR\FM\07NOP2.SGM
07NOP2
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
68970
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
(D) Would pose a threat to the
financial stability of the United States;
(ii) Market conditions;
(iii) The nature of the activity or
investment;
(iv) The date that the banking entity’s
contractual obligation to make or retain
an investment in the fund was incurred
and when it expires;
(v) The contractual terms governing
the banking entity’s interest in the fund;
(vi) The degree of control held by the
banking entity over investment
decisions of the fund;
(vii) The types of assets held by the
fund, including whether any assets that
were illiquid when first acquired by the
fund have become liquid assets, such as,
for example, because any statutory,
regulatory, or contractual restrictions on
the offer, sale, or transfer of such assets
have expired;
(viii) The date on which the fund is
expected to wind up its activities and
liquidate, or its investments may be
redeemed or sold;
(ix) The total exposure of the banking
entity to the activity or investment and
the risks that disposing of, or
maintaining, the investment or activity
may pose to the banking entity or the
financial stability of the United States;
(x) The cost to the banking entity of
divesting or disposing of the activity or
investment within the applicable
period;
(xi) Whether the divestiture or
conformance of the activity or
investment would involve or result in a
material conflict of interest between the
banking entity and unaffiliated clients,
customers or counterparties to which it
owes a duty;
(xii) The banking entity’s prior efforts
to divest or conform the activity or
investment(s), including, with respect to
an illiquid fund, the extent to which the
banking entity has made efforts to
terminate or obtain a waiver of its
contractual obligation to take or retain
an equity, partnership, or other
ownership interest in, or provide
additional capital to, the illiquid fund;
and
(xiii) Any other factor that the Board
believes appropriate.
(2) Timing of Board review. The Board
will seek to act on any request for an
extension under paragraph (a)(3) or
(b)(1) of this section no later than 90
calendar days after the receipt of a
complete record with respect to such
request.
(3) Consultation. In the case of a
banking entity that is primarily
supervised by another Federal banking
agency, the SEC, or the CFTC, the Board
will consult with such agency prior to
the approval of a request by the banking
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
entity for an extension under paragraph
(a)(3) or (b)(1) of this section.
(e) Authority to impose restrictions on
activities or investments during any
extension period.
(1) In general. The Board may impose
such conditions on any extension
approved under paragraph (a)(3) or
(b)(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 (12 U.S.C. 1851) and this part.
(2) Consultation. In the case of a
banking entity that is primarily
supervised by another Federal banking
agency, the SEC, or the CFTC, the Board
will consult with such agency prior to
imposing conditions on the approval of
a request by the banking entity for an
extension under paragraph (a)(3) or
(b)(1) of this section.
§ 248.32 Conformance period for nonbank
financial companies supervised by the
Board engaged in prohibited proprietary
trading or covered fund activities and
investments.
(a) Divestiture requirement. A
nonbank financial company supervised
by the Board shall come into
compliance with all applicable
requirements of section 13 of the Bank
Holding Company Act (12 U.S.C. 1851)
and this subpart, including any capital
requirements or quantitative limitations
adopted thereunder and applicable to
the company, not later than 2 years after
the date the company becomes a
nonbank financial company supervised
by the Board.
(b) Extensions. The Board may, by
rule or order, extend the two-year
period under paragraph (a) of this
section by not more than three separate
one-year periods, if, in the judgment of
the Board, each such one-year extension
is consistent with the purposes of
section 13 of the BHC Act (12 U.S.C.
1851) and this part and would not be
detrimental to the public interest.
(c) Approval required to hold interests
in excess of time limit. A nonbank
financial company supervised by the
Board that seeks the Board’s approval
for an extension of the conformance
period under paragraph (b) of this
section must:
(1) Submit a request in writing to the
Board at least 180 days prior to the
expiration of the applicable time period;
(2) Provide the reasons why the
nonbank financial company supervised
by the Board believes the extension
should be granted; and
PO 00000
Frm 00126
Fmt 4701
Sfmt 4702
(3) Provide a detailed explanation of
the company’s plan for conforming the
activity or investment(s) to any
applicable requirements established
under section 13(a)(2) or (f)(4) of the
Bank Holding Company Act (12 U.S.C.
1851(a)(2) and (f)(4)).
(d) Factors governing Board
determinations.
(1) In general. In reviewing any
application for an extension under
paragraph (b) of this section, the Board
may consider all the facts and
circumstances related to the nonbank
financial company and the request
including, to the extent determined
relevant by the Board, the factors
described in § 225.181(d)(1) of this
chapter.
(2) Timing. The Board will seek to act
on any request for an extension under
paragraph (b) of this section no later
than 90 calendar days after the receipt
of a complete record with respect to
such request.
(e) Authority to impose restrictions on
activities or investments during any
extension period. The Board may
impose conditions on any extension
approved under paragraph (b) of this
section as the Board determines are
necessary or appropriate to protect the
safety and soundness of the nonbank
financial company or the financial
stability of the United States, address
material conflicts of interest or other
unsound practices, or otherwise further
the purposes of section 13 of the BHC
Act (12 U.S.C. 1851) and this part.
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Chapter III
List of Subjects in 12 CFR Part 351
Banks, banking, Capital,
Compensation, Conflict of interests,
Credit, Derivatives, Government
securities, Insurance, Insurance
companies, Investments, Penalties,
Reporting and recordkeeping
requirements, Risk, Risk retention,
Securities, State nonmember banks,
State savings associations, Trusts and
trustees.
Authority and Issuance
For the reasons set forth in the
Supplementary Information, the Federal
Deposit Insurance Corporation proposes
to add the text of the common rule as
set forth at the end of the
Supplementary Information as Part 351
to chapter III of Title 12, Code of Federal
Regulations, modified as follows:
E:\FR\FM\07NOP2.SGM
07NOP2
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
PART 351—PROPRIETARY TRADING
AND RELATIONSHIPS WITH COVERED
FUNDS
13. The authority citation for part 351
is added to read as follows:
Authority: 12 U.S.C. 1851; 12 U.S.C. 1801
et seq., and 3103 et seq.
14. Part 351 is added as set forth at
the end of the Common Preamble.
15. Part 351 is amended by:
a. Removing ‘‘[Agency]’’ wherever it
appears and adding in its place ‘‘the
FDIC’’; and
b. Removing ‘‘[The Agency]’’
wherever it appears and adding in its
place ‘‘The FDIC’’.
16. Section 351.1 is added to read as
follows:
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
§ 351.1 Authority, purpose, scope, and
relationship to other authorities.
(a) Authority. This part is issued by
the FDIC under section 13 of the Bank
Holding Company Act of 1956, as
amended (12 U.S.C. 1851).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes
prohibitions and restrictions on
proprietary trading and investments in
or relationships with covered funds by
certain banking entities, including any
insured depository institution for which
the FDIC is the appropriate Federal
banking agency. This part implements
section 13 of the Bank Holding
Company Act by defining terms used in
the statute and related terms,
establishing prohibitions and
restrictions on proprietary trading and
investments in or relationships with
covered funds, and explaining the
statute’s requirements.
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to any
insured depository institution for which
the FDIC is the appropriate Federal
banking agency. This part takes effect on
July 21, 2012.
(d) Relationship to other authorities.
Except as otherwise provided in under
section 13 of the Bank Holding
Company Act, and notwithstanding any
other provision of law, the prohibitions
and restrictions under section 13 of
Bank Holding Company Act shall apply
to the activities of a covered banking
entity, even if such activities are
authorized for a covered banking entity
under other applicable provisions of
law.
17. Paragraph (j) of § 351.2 is added to
read as follows:
§ 351.2
Definitions.
*
*
*
*
*
(j) Covered banking entity means any
banking entity that is an insured
VerDate Mar<15>2010
18:20 Nov 04, 2011
Jkt 226001
depository institution for which the
FDIC is the appropriate Federal banking
agency, as that term is defined in
section 3(q) of the Federal Deposit
Insurance Act (12 U.S.C. 1813(q)).
*
*
*
*
*
SECURITIES AND EXCHANGE
COMMISSION
List of Subjects in 17 CFR Part 255
Banks, Brokers, Dealers, Investment
advisers, Recordkeeping, Reporting,
Securities.
Authority and Issuance
For the reasons set forth in the
Supplementary Information, the
Securities and Exchange Commission
proposes to add the text of the common
rule as set forth at the end of the
Supplementary Information as Part 255
to chapter II of Title 17, Code of Federal
Regulations, modified as follows:
PART 255—PROPRIETARY TRADING
AND RELATIONSHIPS WITH COVERED
FUNDS
18. The authority for part 255 is
added to read as follows:
Authority: 12 U.S.C. 1851, 15 U.S.C.
78o(c)(3)(A), 78o–10(f), (j), 78q(a), 78w.
19. Part 255 is added as set forth at
the end of the Common Preamble.
20. Part 255 is amended by:
a. Removing ‘‘[Agency]’’ wherever it
appears and adding in its place ‘‘SEC’’;
and
b. Removing ‘‘[The Agency]’’
wherever it appears and adding in its
place ‘‘The SEC.’’
21. Section 255.1 is added to read as
follows:
§ 255.1 Authority, purpose, scope, and
relationship to other authorities.
(a) Authority. This part 1 is issued by
the SEC under section 13 of the Bank
Holding Company Act of 1956, as
amended (12 U.S.C. 1851) and sections
15(c)(3)(A), 15F(f), 15F(j), 17(a), and 23
of the Securities Exchange Act of 1934
(15 U.S.C. 78o(c)(3)(A), 78o-10(f), (j),
78q(a), 78w.).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes
prohibitions and restrictions on
proprietary trading and investments in
or relationships with covered funds by
certain banking entities, including
registered broker-dealers, registered
investment advisers, and registered
security-based swap dealers, among
others identified in section 2(12)(B) of
the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (12
1 Code of Federal Regulations, title 17, chapter II,
part 255.
PO 00000
Frm 00127
Fmt 4701
Sfmt 4702
68971
U.S.C. 5301(12)(B)). This part
implements section 13 of the Bank
Holding Company Act by defining terms
used in the statute and related terms,
establishing prohibitions and
restrictions on proprietary trading and
investments in or relationships with
covered funds, and explaining the
statute’s requirements.
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to covered
banking entities described in § 255.2(j).
This part takes effect on July 21, 2012.
(d) Relationship to other authorities.
Except as otherwise provided in under
section 13 of the BHC Act, and
notwithstanding any other provision of
law, the prohibitions and restrictions
under section 13 of BHC Act shall apply
to the activities of a covered banking
entity, even if such activities are
authorized for a covered banking entity
under other applicable provisions of
law.
22. Paragraph (j) of § 255.2 is added to
read as follows:
§ 225.2
Definitions.
*
*
*
*
*
(j) Covered banking entity means any
entity described in paragraph (e) of this
section for which the SEC is the primary
financial regulatory agency, as defined
in section 2(12)(B) of the Dodd-Frank
Wall Street Reform and Consumer
Protection Act of 2010 (12 U.S.C.
5301(12)(B)).
23. Section 225.10(a) is revised to
read as follows:
§ 255.10 Prohibition on acquiring or
retaining an ownership interest in and
having certain relationships with a covered
fund.
*
*
*
*
*
(a)(1) General prohibition. Except as
otherwise provided in this subpart, a
covered banking entity may not, as
principal, directly or indirectly, acquire
or retain any ownership interest in or
sponsor a covered fund.
(2) Registered investment advisers. A
covered banking entity that is a covered
banking entity because it is an
investment adviser identified in section
2(12)(B)(iii) of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act of 2010 shall comply with the
restrictions on covered fund activities or
investments set forth in subpart C and
§ ll.20 of subpart D issued by the
agency identified in section 3(q) of the
Federal Deposit Insurance Act (12
U.S.C. 1813(q)) that regulates the
banking entity described in § 255.2
(e)(1), (2) or (3) with which the
investment adviser is affiliated.
E:\FR\FM\07NOP2.SGM
07NOP2
68972
Federal Register / Vol. 76, No. 215 / Monday, November 7, 2011 / Proposed Rules
Note to paragraph (a): Nothing set forth in
paragraph (a)(2) of this section shall limit the
SEC’s authority under any other provision of
law, including pursuant to section 13 of the
Bank Holding Company Act.
emcdonald on DSK5VPTVN1PROD with PROPOSALS2
*
*
*
VerDate Mar<15>2010
*
*
20:19 Nov 04, 2011
Jkt 226001
Dated: October 7, 2011.
John Walsh,
Acting Comptroller of the Currency.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
By order of the Board of Governors of the
Federal Reserve System, October 11, 2011.
Jennifer J. Johnson,
Secretary of the Board.
By the Securities and Exchange
Commission.
Dated: October 12, 2011.
Elizabeth M. Murphy,
Secretary.
By order of the Board of Directors.
Dated at Washington, DC, this 11th day of
October, 2011.
[FR Doc. 2011–27184 Filed 11–4–11; 8:45 am]
PO 00000
Frm 00128
Fmt 4701
Sfmt 9990
BILLING CODE 6210–01–P; 8011–11–P; 4810–33–P;
6714–01–P
E:\FR\FM\07NOP2.SGM
07NOP2
| File Type | application/pdf |
| File Modified | 2011-11-05 |
| File Created | 2011-11-05 |